A few months back, I crushed Bob Murphy and the Austrian take on MMT. Here is a quick quote:
“Discussion of Murphy’s mistakes: Murphy makes two fundamental mistakes. The first mistake results from his confusion of assets and savings. Murphy doesn’t understand the meaning of the word savings in an national accounting sense, or deliberately confuses real and monetary accountings.
He is making the same mistake today in his new post on MMT. He just makes it more explicitly, so it is easier to see.
Truth be told, I’ve corresponded briefly over email with Mr. Murphy. He was a nice and kind person. He makes a serious mistake in his thinking. And frankly, I think the Austrians would knock it out of the park with a minimalist construction of MMT. Unfortunately, they are insane because they don’t recognize any government as being legitimate. Even kind and nice people can be insane.
Update: The always excellent Cullen Roche takes on the same topic over at the Pragmatic Capitalist. And I’ve got a few trolls!
“Chapter 2: In Which the Traders Crucible slays the Intertemporal Government Budget Constraint, and Mr. Rowe demonstrates his Worth
There has been lots of confusion lately over at Brad Delong’s place by the usually unconfused Brad. Nick Rowe of the incorrectly named Worthwhile Canadian Initiative jumped in. (why incorrectly named? Should be named “Essential Canadian Initiative” – the dude is freakin’ smmmmaaaarrt, and you’ll see why later.).
But this is about the budget constraint. The Intertemporal Government Budget Constraint has a single, seemingly innocuous assumption of no Ponzi for government spending. The no Ponzi assumption is that the net present value of our spending/debt must equal the net present value of future taxation. The books must balance across generations. If this doesn’t hold, the currency must go to zero. Sounds prudent right?
There is only one problem with this assumption. We cannot know if it is being violated or not with much certainty at all. We cannot see the future. We do not know with perfect knowledge if this constraint holds. We cannot know if the no Ponzi criteria is being held with certainty, because we cannot see the future.
And it gets worse, much worse. We cannot tell if the no Ponzi criteria is being violated within a rather large band of certainty. In fact, anyone who says we conform to the no Ponzi criteria must be lying, given the history of governments. But then, anyone who says we are not conforming to the no Ponzi assumption is lying too. They ignore hard empirical data from today, right now, given todays data, and given history of the United States. So far, the U.S. has held to the no Ponzi quite well.
All the data points to that the U.S. holds to the no Ponzi over time. And yet we are foolish to assume we can hold to it
This to me sounds like a paradox. There is no reasonably certain correct answer.
Is Observation the Key?
Still, We can only know what we observe today.
All we can know today is what people think about the value of their money. If the no Ponzi assumption holds or does not hold, we have to look to current inflation rates to tell us the opinion of what people think is the ultimately unknowable answer. There is no other way to tell other than inflation rates today, because the future is obscured to our observation.
It turns out the assumption is irrelevant for this reason.
The no Ponzi assumption is irrelevant
The no Ponzi assumption kinda sorta ignores the fact that any violation of the assumption has to be observable today.
We know this because the conclusion of the no Ponzi assumption says words like “We would see rates of inflation increase to levels that make g < r if people think the no Ponzi assumption is being violated.” But then people forget we cannot know the future with much certainty, so there is this eternal hand wringing over current inflation rates.
These people cannot know if there is a Ponzi violation. It’s a guess, at best. It’s mad-cap speculation at worst. How can we ever really tell?
Future Ponzi violations or no violations are impossible to know information. They are not falsifiable for any current levels of real growth or real interest rates. Nobody knows, or can know, what the future levels of primary deficits will be 20 or 100 years or 1000 years from today. Anyone can always say “Well, future levels of spending might be too high and spur hyperinflation,” and there nothing anyone could ever say that will prove that statement false. Those levels of future spending might turn hyperinflationary or not, and we cannot know.
Of course they could also say “We are going to be so rich in the future when we energy that costs 5% of current costs that these current deficits are trivial”. How can you tell?
Todays evidence shows we are within the bounds of any reasonable no Ponzi assumption given by Scott Fullwiler. But who in the hell knows? We cannot know the future.
So how does can the no Ponzi assumption help us manage policy real world policy in any practical way? It doesn’t. It’s a myth, a spook story economists tell their kids at night. “Spend too much, and the Intertemporal Government Budget Constraint will get you.”
The only way we can possibly guess if this assumption is being violated is through current inflation rates, real interest rates, and rates of real growth. Even then, these observable rates change all the time. Over the course of decades, these observable rates are all over the place.
Still we have some guidance here with observable market prices of things. All violations of the no Ponzi assumption must be observable. If we don’t have significant inflation, the no Ponzi cannot be being violated as far as we could ever know.
Inflation is the observable change in the price of money in real world goods, services, and transactions, including all financial assets. In other words, the overall market for money will show us the violations of the no Ponzi assumption.
Violations of the no Ponzi assumption must be observable otherwise the EMH is false for the largest, most transparent, most liquid market possible
If the violations of the no Ponzi criteria are not observable for the most liquid and transparent possible market in any economy, then the EMH must be wrong. No EMH in the market for money has devastating consequences.
It’s at this point where I raise the head of the IGBC and proclaim the dragon slain. Either you believe the inflation rate as the only way to tell if people believe the IGBC is holding, or go back to believing in crystal balls telling the future. If you insist on a strong belief in magic, then I hand over the head of the EMH.
As an aside, even if the violations are not observable, it would be foolish to act in any way but to accept the EMH as true in the market for money – which as far as i can tell, is the largest, most transparent, most liquid market possible within current human experience.
This might sound astonishing, but I am not over yet. Living in a no Ponzi world has incredible consequences. Nick Rowe knows exactly what I am talking about. We are living in a world where g is greater than r, nearly all the time, except when some normal business cycle pushes g below r.
Next up, “Chapter 3, in which Mr. Rowe proves his worth.”
Hope all is well. You say you don’t “get” MMT :
Does the same thing hold true for the federal government? Well, the feds have the Fed, which can print money. But there are constraints on that, too — they’re not as sharp as the constraints on governments that can’t print money, but too much reliance on the printing press leads to unacceptable inflation. (Cue the MMT people — but after repeated discussions, I still don’t get how they sidestep the issue of limits on seignorage.)
We don’t sidestep the limits of seignorage. We just recognize the limits of seignorage are the only limits. We recognize the limits of seignorage are self-imposed. There is no bogey-man of insolvency in the closet, waiting to throw extra inflation upon us.
The “unacceptable inflation” of your concern results from the assumption of a possibility of insolvency. Take away the assumption of insolvency, and what remains is inflation. We can observe inflation.
We can debate the proper level of inflation. That level could be 20% or 2% or 200% or 0% or -5%. Personally, I would be very much against a 20% or 200% inflation rate. But 20% inflation will not cause us to go broke, because we cannot go broke! It would just be 20% inflation.
We have a self-imposed inflation constraint. And Inflation is observable.
Here is a crucial distinction for MMT:
…This is just a way of saying that a debt that is affordable at 4% interest may not be affordable at 20% interest, because of the solvency constraint. So using the tool of the printing press is a defacto admission of insolvency, therefore bypassing the bond market must trigger currency debasement. But these two ideas – the interest on the government debt and the debasement of a currency – cannot be linked through solvency, because governments issuing debt in their own currency cannot become insolvent. Therefore, losing access to the bond markets isn’t the cause currency debasement, because the link of insolvency is impossible.
It does’t matter what the interest rate is on government debt, the government cannot become insolvent. It could be 1000000%. There is no point where the yields on bonds cause a run that results in the government not being able to issue more money.
Now, by this point, you must be thinking – why in the hell is he concerned with this difference? Any interest rate of 100000% would be debasing the currency like Zimbabwe on steriods! Why is the Traders Crucible going nuts over how many Angels are dancing[sic “on the head of a pin, and”] about the difference between insolvency and debasement?
Well, we can directly observe the debasement of a currency in an economy through the inflation rate. We can directly observe the process of debasement and loss of value of the currency through inflation.
[Update: Tom Hickey responds too.]
[Update: Mr. Krugman, if you read this, I have a question. What percentage of the text of the culture novels are about the responsibilities of gods? :) ]
Remember this blast from late December?
But I think the argument for Tech Stocks Right Now! in massive size is very compelling.
- Businesses have put off tech spending for a few years – and this may as well be 50 years for a normal industry. Tech decays in usefulness quickly.
- Tech spending is the first to get cut in a downturn, because you can put it off for a bit. However, it comes back on line quickly if there is a recovery, because it is cheap.
- There are many new business focused software techologies coming on line next year that will be staggeringly useful for businesses.
The business depreciation acceleration is coming at a perfect time for business spending, but it will have an outsized impact on tech spending within the business community. It will have a particularly strong impact on tech spending this year. In the past, current spending gooses tech stocks enormously.
Go long, long, long Tech!
Check out this article from Bloomberg:
Intel Corp. (INTC) and International Business Machines Corp. (IBM) issued sales and profit forecasts that reflected demand from companies eager to upgrade computer systems left fallow during the recession.
IBM, the largest computer-services provider, boosted its full-year profit forecast, while Intel, the top chipmaker, forecast second-quarter sales higher than analysts predicted. VMware Inc. (VMW) and Juniper Networks Inc. (JNPR), two other business- technology providers, also met or topped analysts’ projections.
The entire article is essentially a recap of my post from December.
I’ve been hugely busy for the last 2 weeks. When I wrote out the rule Friday morning for the first time, I didn’t have any time to write out reasoning or even about the choice of targets.
I am still very busy, but I have a little bit of additional background on the choices, plus some very quick notes.
I’ve realized this is more of a functional finance rule than an MMT rule. MMT has a rule already for this – it is the famous and controversial Employer of Last resort. Famous in the MMT world, but unfortunately controversial for most people. Part of the reason I created a rule was to form a practical rule we can use today, without the need to implement the ELR immediately. Let’s face it, the ELR won’t be voted into law next year. We need something useable and practical now. Thanks to Scott and Beowulf for pointing out the rule is more functional finance than MMT.
Since a country with a sovereign currency cannot go bankrupt, the only remaining worries for this government is the inflation rate and the unemployment rate. I’ve gone into this with some detail here and over at Interfluidity.
It is very possible that Interfluidity is correct and we need to be concerned with a discontinuous jump in inflation. I don’t think this is the case for reasons I think I laid out in the comments section at Interfluidity, but it is entirely possible (and thinking about Soros-Popper, extremely likely) that I am incorrect. We need more research into inflation under a sovereign currency regime.
So we have two targets – the Feds famous dual mandate – of unemployment and inflation. I prefer to target them directly rather than indirectly through GDP. However, Scott Sumner and David Beckworth have made a good case for targeting NGDP. This targets inflation and real growth in a single easy to understand number. I consider NGDP targeting to be a superior to than the Taylor rule.
Still, I don’t think an NGDP target is as good as targeting unemployment. Unemployment is bad for reasons beyond the sheer economic loss associated with able people sitting around. We do not need to make a choice between everybody working and high economic growth – we can presumably have both. NGDP could theoretically limit the economy below full employment due to assuming growth causes inflation. An unemployment target is less likely to run into a self imposed limitation on economic growth.
Warren Mosler has hinted that he thinks that real economic growth could be 10%+ with good policy. China has grown at this rate for decades, and Japan had growth approaching this level for decades until they changed their policy. We don’t know what is possible for long term growth with good policy – we have not yet had the good policy part. An NGDP target is a potential self-imposed throttle on economic growth.
Beowulf pointed me to Pavlina R. Tcherneva’s paper on fiscal policy. In it, she makes a great case for targeting effective demand over aggregate demand. The ELR is superior to the TC rule in that it targets effective demand, where the TC rule only targets aggregate demand through the mechanism of % government deficit. It is a must read paper on the topic, and I wish I had read it the day it came out. The distinction between Aggregate Demand and Effective Demand eviscerates NGDP targeting or targeting inflation alone. I cannot recommend this paper highly enough.
Beowulf points out that Okun’s law has been unstable. Yes, it has. As far as I know, most economic regressions are unstable. It’s a problem with any rule that uses empirical relationships in with economic data. Still, I think using the current accepted multiplier of 1.8 would be a good place to start. [Update: Beowulf points out why not just use Bernanke’s 2.0 as the multiplier? Hard to argue with that one, right, Mr. Bernanke?]
Okun’s law also assumes there is some maximum potential GDP rate to generate the multiplier. This results in something like the NAIRU for the target unemployment rate. Using this in the law is a self imposed limit on growth, and another reason the ELR is superior.
We can use the TC rule with the ELR as a special case where (u-u) = 0 We are then left with a rule that targets inflation and population growth.
What is the proper inflation rate to use? Good question.
I used population growth as part of this equation because it is the largest single deflationary (or inflationary) pressure facing any economy. Maybe I am wrong, but I think of it like this:
100 agents, two groups of 50, with $50 total in the economy, no credit allowed, no desire for savings. Each day 50 of them produce 100 units of food, which is then of course priced at $1 per unit. The other 50 buy and then consume food and lay about. The groups switch every day in production and idle time. Then one day, 10 more identical agents show up with no money and equally join groups, so now each group has 55 in it. The price of the food produced must go down.
Deflation isn’t a problem in this toy economy, but in the real world deflation has much worse consequences than inflation. Anytime you can increase your wealth relative to other humans by sitting on your ass instead of working your ass off, there is a problem.
Anyway, thats all for now!
What does Warren mean when he writes:
“He doesn’t seem to grasp the notion that imports are real benefits and exports real costs.”
When you exchange “alter a few bytes in a computer” for something “useful in the real world”, it is a benefit to one side of that trade, and it isn’t the side that gives the useful stuff.
King Midas couldn’t eat anything because everything he touched turned to gold. As a result, his avarice turned to starvation very quickly – even though he could create what was a valuable asset in unlimited quantities.
In the real world, money is valuable because it eases trade. But in the end, you cannot use money to do anything practical in the real world. You cannot build with it, eat it, or engineer with it except in the most extraordinary circumstances, and even then you’ll find better materials just laying around on the ground around you, even in the desert or artic.
Physical Money has no real world benefit – be it paper or computer money. So when Mosler says that imports are a real benefit, he means that we get to exchange something that isn’t even as useful as hot air for a real world good or service that has use to us.
When we send a few hundred billion video game tokens to China and they give us tables, toys, and auto parts, we’re coming out way way ahead on that trade in the real world. They get nothing, and we get useful stuff.
Interesting article here in the FT Blog about how the Private Sector must be under reporting their Surplus.
The blog post makes a hash of it, but the UBs economist George Magnus seems to know the Balance sheet stuff cold, even if he won’t let on that he knows other ways to think about our favorite equation, I = S + (G-T) + (N-X). He even drops serious and repeated Minsky references – how can he not know his Randall Wray and Billy Mitchell?
Magnus points out that the private sector “must” be underreporting its savings, because they don’t add up with other known numbers:
“The data, through Q3:2010, reveal that the surge in the government deficit to 10% GDP is basically the counterpart of the continuing surplus earned by foreigners (in effect, the current account position), and the sharp turnaround from deficit to surplus in the household and non-financial corporate sectors. Put another way, private sector deleveraging has been accommodated without traumatic damage to the economy by the government’s willingness to borrow (temporarily) on its behalf.
This much is self-evident to people familiar with the balance sheet approach to booms and busts. But now it gets a bit more interesting, because the Fed’s data don’t add up properly any more. Chart 1 shows that the private sector surplus last year was running at about 5% of GDP. If we use commercial bank data to estimate the net financial investment of the sector, the private sector surplus would be about 3.5% GDP. Now go figure. Even adding in the overseas surplus, how does this square with government borrowing of 10% of GDP?
The answer is that there appears to chronic under-reporting of the private sector surplus. So, look at Chart 2, where the solid line is the private sector financial balance as reported in the Flow of Funds, but the dashed line is the private sector as a residual, calculated as the government plus the overseas balance. Mostly, these two series are in the same ballpark – until the financial crisis. To make the flow of funds data balance as they should, the private sector surplus ‘needs’ to be a lot closer to 8.5% of GDP, which is 3.5% GDP larger than officially stated, and 5% GDP larger allowing for the inclusion of financial institutions.”
This is serious stuff – what is going on? I don’t have any good ideas yet. MMTer’s out there – any ideas?