I'm hardly a leading expert on MMT, but I've been looking at macroeconomic functions with an MMT lens, since I stumbled onto it a year and a half ago. So this is my 2 cents answer to each of Prof. Quiggin's propositions:
1. Except during the period since the GFC, money creation has not been an important source of finance for developed countries
There are two entities that can create money in the economy - the government, via public spending, and the banks, via loan creation. During normal times, a responsive but prudent government should incur a small deficit, large enough to buy the services of a vital sector of the economy. This sector that primarily benefits from government spending, whether public employees, government contractors, or what have you, then turn around and spend this income on other goods and services provided by other members of the economy. On the basis of these various incomes created, banks can lend to the private sector, so that this sector can engage in the investments needed to grow the economy, and create more private income, without further need for government spending.
I believe there is a stable level of government deficit that promotes growth. It's a deficit level just large enough to create private incomes to make private businesses stable, and willing to hire more people, and thus leading to a positive spending multiplier.
2. Except under extreme conditions like those of the GFC, money creation cannot be used as a significant source of finance for public expenditure without giving rise to inflation and (if persisted with) hyperinflation
Yes, I agree. Once initial government spending has been done, the resulting positive spending multiplier should lead the private sector spending and investment to take over from there. The resulting flow of money in the economy should already ensure adequate incomes for all.
Nick Rowe has what I find is a helful illustration to explain this-think of backscratcher economy. Think of an economy composed of ten backscratchers, where everybody earns income by providing backscratching services to one another. On the side, four of them earn additional income by buying and selling houses and financial assets among each another, funded by borrowing. For some reason, someone becomes greedy and buys houses for more than they usually sell for.
Because this resulted in a windfall to the person he bought the house from, this causes others to believe that there is money to be made from buying and selling houses. This cascades into a boom, until prices are no longer supportable by straight backscratcher income. If those four backscratchers found themselves over-indebted because they kept on buying houses in the run-up of prices, they now will no longer be buying backscratches, and will save money to pay down their debt.
If four of ten backscratchers are now no longer buying backscratches, then the remaining six people can no longer all earn the same backscratch income as before. In all likelihood, four people will not be getting income, and they in turn will stop buying backscratches from others. In this scenario, the backscratcher economy is in danger of deflating into zero backscrcratches, unless the government steps in and buys some backscratches.
Because the government has to step in and buy some more backscratches, whereas before it probably just bought one scratch, it will end up injecting more money into the economy, to make up for the backscratching income now being hoarded by the over-indebted. So yes, I agree that money creation as a source of finance for public expenditure is only significant during times of depression, when a significant part of the private sector is withdrawing money from the economy.
When there is no extreme condition, when there is demand for ten backscratches and people are just changing their preferences for type of backscratch, government spending on more backscratches only bids up the cost of a backscratch.
3. Government deficits must be financed primarily by the issue of public debt
Not necessarily. It can be financed by just creating more money. MMTers claim that all money in the economy has been spent into existence by the government.
It's probably true, if you consider that banks are able to fund their loan creation, when amounts are in excess of existing interbank loans, by borrowing from the Central Bank. When the Central Bank creates money via these loans, it effectively is a liability of the government (in the sense that when any holder redeems it from the government, the government can pay for it with tax payment credits).
I find this thinking of the mechanism of money growth credible. It's much more credible, don't you think, than thinking that a major global economy can grow its GDP indefinitely, with half of GDP coming from one sector (FIRE) which increasingly is composed more and more of people selling houses and financial assets to one another for ever higher amounts.
4. The ratio of public debt to GDP cannot rise indefinitely, since governments will ultimately find it impossible to borrow
As far as I know, government spending IS part of GDP. So at the minimum, we need to see that every $1 of government debt is due to $1 of actual government spending. In order that debt does not grow faster as a percentage of GDP, there should be a positive multiplier effect. So government needs to be careful what it spends money on.
For as long as the government is spending to purchase the services of people who will in turn spend it into the economy, there should be a multiplier effect on government spending. In the backscratcher economy, government should spend it on backscratchers who will readily turn around and buy backscratches from others. This means buying four backscratches from the four individuals who would have otherwise had no income because of those hoarding their income.
Government should should not spend it buying the houses from those over-indebted backscratchers, because they might not spend the income they get from government buying other backscratches, but use it to buy even more houses.
5. The larger the deficits governments want to run during deficits, the larger the surpluses they must run in booms
My position is: The larger the bust, the larger the deficit. The smaller the bust, the smaller the deficit. When there is a backscratcher boom, due to productivity improvements, government could incur a surplus. The larger the boom, due to an asset boom, the more it needs to regulate asset speculation.
Ideally, the growing tax base of a growing private sector economy is what leads to deficit reduction, not cuts in government spending. Because if the government cuts its one unit of backscratch demand, this could cascade to less aggregate demand for scratches in the larger economy.
* reposted due to Blogger outage
Update: Tom Hickey gives more nuance in comments on the full mechanism of how Treasury spending, via crediting bank reserves with the Fed, creates currency.
"Banks are only able to create credit money (loans create deposits) because they have access to the settlement system, in the US, the FRS, and they need to obtain both reserves for settlement and vault cash to meet customer demand. So while banks can create money through extending credit, it is not spendable without government high powered money for settlement.
High powered money comes from currency issuance. When the Treasury injects net financial assets through deficit expenditure, then bank reserves increase correspondingly, since the central bank provides reserves to clear. Treasury security issuance is operationally unnecessary. It drains reserves so that the cb can hit its target rate. This simply changes the composition and term structure of govt. liabilities without affecting NFA. The same could be accomplished by the Fed paying a support rate on excess reserves equal to the target rate, making tsy issuance unnecessary to drain reserves. Should the political authority so choose, Treasury could be authorized to issue currency directly as notes in addition to the coin that it presently issues."
High powered money comes from currency issuance. When the Treasury injects net financial assets through deficit expenditure, then bank reserves increase correspondingly, since the central bank provides reserves to clear. Treasury security issuance is operationally unnecessary. It drains reserves so that the cb can hit its target rate. This simply changes the composition and term structure of govt. liabilities without affecting NFA. The same could be accomplished by the Fed paying a support rate on excess reserves equal to the target rate, making tsy issuance unnecessary to drain reserves. Should the political authority so choose, Treasury could be authorized to issue currency directly as notes in addition to the coin that it presently issues."
3 comments:
1. The MMT view is that the appropriate size of the government fiscal balance is determined by two factors, domestic private desire to save and the ROW's desire to save in the country's currency. Since these are the two nongovernment sources of demand leakage, the government fiscal balance must accomodate them in order to maintain the economy at full employment with price stability. Since there is generally a domestic private desire to save and not all countries can be net exporters, a fiscal deficit is the norm rather than the exception.
2. MMT describes how all final transactions are settled in high powered money, that is, cash for direct and bank reserves for intermediated settlement. Banks are only able to create credit money (loans create deposits) because they have access to the settlement system, in the US, the FRS, and they need to obtain both reserves for settlement and vault cash to meet customer demand. So while banks can create money through extending credit, it is not spendable without government high powered money for settlement.
High powered money comes from currency issuance. When the Treasury injects net financial assets through deficit expenditure, then bank reserves increase correspondingly, since the central bank provides reserves to clear. Treasury security issuance is operationally unnecessary. It drains reserves so that the cb can hit its target rate. This simply changes the composition and term structure of govt. liabilities without affecting NFA. The same could be accomplished by the Fed paying a support rate on excess reserves equal to the target rate, making tsy issuance unnecessary to drain reserves. Should the political authority so choose, Treasury could be authorized to issue currency directly as notes in addition to the coin that it presently issues.
Tom, I think this is important to highlight: "fiscal balance is determined by two factors, domestic private desire to save and the ROW's desire to save in the country's currency."
On the second point of ROW's desire to save in first country's currency, ROW's normal reason is not to save in first country's currency, but to create jobs for ROW's own citizens. This need not come at the expense of jobs at first country, for if its government keeps spending to fund both the ROW desire, and to maintain its own citizens' local jobs, ROW will eventually realize that the savings it accumulates with its surpluses with first country is worth nothing, and wil probably just cause inflation in its own economy, unless it starts spending it back on first country's production, too.
Agreed. That is the MMT view as I understand it from the developers.
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