Many readers ask me to provide a Modern Monetary Theory (MMT) rule for sound fiscal management. I had done this often but apparently not concisely enough. It is important to understand what the limits on fiscal deficits are in term of prudent fiscal practice given that terms such as fiscal sustainability, fiscal consolidation, fiscal austerity are in the media almost every day without fail. The mainstream version of fiscal responsibility is based on false premises and is not an applicable guide for sovereign governments to base their policy decisions on. MMT provides a coherent fiscal position for governments to aim for. In this blog, I juxtapose that position with the sort of narrative that is now coming out of the OECD with renewed vigour – after they went a bit quiet once it was clear they were exposed by the magnitude of the economic crisis. But they are back, strutting and arrogant as before and threatening the jobs of millions. So here is the full employment fiscal deficit condition that makes a mockery of the IMF and OECD narratives.
I get many E-mails every week from people asking me to explain exactly what a deficit is. They understand that a budget deficit is the difference between revenue and spending but then become confused as a result of being so ingrained with narratives emanating from politicians and lobbyists who misuse terms and always try to conflate deficits and debt. So today’s blog is a basic primer on deficits and why you should welcome them (usually) and why we all should sleep tight when the government is in deficit. So – budget deficit basics …
I stole the title of today’s blog from an article I wrote for the US weekly – The Nation – which will come out on April 4 in print. The on-line version is out now. It comes out in the same week that the nations that are leading the austerity charge – Ireland and Britain – publish disastrous labour market data. The Irish data is nothing short of atrocious some 2 years after their government led them down the austerity path promising salvation. Where are the economists who from the desks of their safe jobs were highly vocal in promoting the myth of the “fiscal contraction expansion”? Still sipping Chardonnay from their safe jobs I dare say. The article, in part, is about how these liars have convinced governments to push their economies over the brink. It is also about how the same lies that are being to used to justify the austerity barrow were used to justify the massive deregulation that led to the financial sector feeding frenzy and caused the crisis in the first place. When we will ever learn? In today’s blog I offer a video commentary on the thoughts behind the article in this blog (which as it turns out didn’t save me much time – I seem to type faster than I speak!).
The UN Food and Agriculture Organisation (FAO) released their monthly index of food prices yesterday (January 5, 2011) which showed that the index reached a record high in December 2010 “surpassing the levels of 2008 when the cost of food sparked riots around the world, and prompting warnings of prices being in “danger territory”” (Source). There are several reasons why food prices will move even higher – the catastrophic floods in Northern Queensland being among them. The rising food prices are once again leading to calls for interest rates to rise in order to minimise the inflationary consequences. That motivated me to write Part 2 of my series on inflation – in this case supply-side motivated inflations. In Part 1 of the series – Modern monetary theory and inflation – Part 1 – I concentrated on demand-side origins.
I am travelling today and have a full schedule ahead and haven’t much time to write anything. But it just happens that the multimedia presentations and documentation for the Fiscal Sustainability Teach-Ins and Counter-Conference which was held at the George Washington University, Washington DC on Wednesday, April 28, 2010 have just been made available by the team which organised the event. The Teach-In was a grass roots exercised designed to counter the conference organised by the arch deficit-terrorists at the Peter G. Peterson Foundation, which was also held on April 28 in Washington D.C. – just across town from our event. While that event also chose to focus on “fiscal sustainability”, the reality is that it will merely rehearsed the standard and erroneous neo-liberal objections to government activity in the economy. Given my time constraints today I thought it was serendipitous that this material became available overnight. So the following blog provides access to video and all the documentation for my session. Very special thanks to Selise and Lambert (and their team) for taking the time to document and prepare all this material.
In recent days, there has been some talk here about wealth effects and how they might complicate the interpretation of the multiplier. The claims made about that the multiplier understates the likely expansion as a result of the wealth effects is somewhat misleading but that is another story. The fact is that the inclusion of wealth effects has a long standing in economics. They were initially used as part of the mainstream denial that involuntary unemployment could exist in a market economy with flexible prices. This goes back to the famous Keynes versus Classics debates. In that debate, the mainstream argued that the wealth effects would be sufficient to restore full employment during a recession without any need for government intervention. The problem is that the ideas do not withstand scrutiny – either theoretically and empirically. They certainly do not provide a credible attack on the Modern Monetary Theory (MMT) claim that fiscal policy intervention is required to combat a situation where aggregate demand is deficient relative to the productive capacity of the economy. This spending gap manifests as involuntary unemployment in the absence of an appropriate policy response. Given the ideological position that these “wealth effects” have occupied in the literature I am always suspicious when someone proposes we take them seriously. That is what this blog is about.
Sometimes we get lost in detail and forget the simple macroeconomic relationships that sit below the complexity. I also like to get lost in detail too – to work out tricky little aspects of the financial system, etc but it is always a sobering experience to go right back to the beginning. I have been forcing myself to think “basic” lately as I progress the macroeconomics textbook that my mate Randy Wray and I are writing at present. It seems that our national governments have lost their perspective to think at this basic level – to really understand what drives prosperity in their nations. The evidence for this statement lies in the various fiscal austerity plans that are being rehearsed around the world at present. The most blatant and severe example of this in the non-EMU world has just been announced in Britain. This is a case of a government driven by ideology deliberately inflicting massive damage on its citizens while lying to the population about the necessity for such a policy. Its fits my definition of a state-motivated terrorist attack. If only the people of Britain understood the most basic economic relationship – aggregate demand drives output and national income. Cut spending and prosperity falls. Only by lying to the people, has the British government been able to take this policy path.
Today’s blog was a little later than usual for various reasons – travel, time differences and other activities that had to take precedence. The title comes from a paper I wrote in 2008 which was published last year and reflects the notion that fiscal policy – appropriately applied can always make a difference for the better. I have noted some scepticism about this proposition and claims that the situation in countries such as Iceland refute the confidence I have in the effectiveness of fiscal policy. My response is that these claims misconstrue my statement and like a lot of criticisms of Modern Monetary Theory (MMT) they choose to set up stylisations that are not those advanced by the leading writers of MMT. So I thought I would just reflect a bit on that today.
In yesterday’s blog – If only the citizens knew what was going on! – I noted that it makes very little sense from a flow of funds perspective to consider the central bank not to be part of a consolidated government sector along with the treasury. The notion of a consolidated government sector is a basic Modern Monetary Theory starting point and allows us to demonstrate the essential relationship between the government and non-government sectors whereby net financial assets enter and exit the economy without complicating the analysis unduly. This simplicity leads to many insights all of which remain valid as operational options when we add more detail to the model. However, it still seems that readers are confused by this and somehow think that the consolidation is misleading. So for today’s blog I aim to explain in more detail what this consolidation is about. It should disabuse you of the notion that the mainstream macroeconomics obsession with central bank independence is nothing more than an ideological attack on the capacity of government to produce full employment which also undermines our democratic rights.
It regularly comes up in the comments section that Modern Monetary Theory (MMT) lacks a concern for inflation. That somehow we ignore the inflation risk. One of the surprising aspects of the public debate as the current economic crisis unfolded was the repetitive concern that people had about inflation. There concerns echoed at the same time as the real economy in almost every nation collapsed, capacity utilisation rates were going down below 70 per cent and more in most nations and unemployment was sky-rocketing. But still the inflation anxiety was regularly being voiced. These commentators could not believe that rising budget deficits or a significant build-up of bank reserves do not inevitably cause inflation. The fact is that in voicing those concerns just tells me they never really understand how the monetary system operates. Further in suggesting the MMT lacks a concern for inflation those making these statements belie their own lack of research. Full employment and price stability is at the heart of MMT. The body of theory and policy applications that stem from that theory integrate the notion of a nominal anchor as a core element. That is what this blog is about.