“Second, it is possible, depending on the openness of the economy and the propensity to import for a strongly growing economy to push the trade position into deficit and with flexible exchange rates promote depreciation. The depreciation, by definition, means that the imported goods component of the price index will rise. Under some circumstances this may promote inflationary pressures. It is unlikely that the magnitude of this impact will be large.”

The US and many other countries import most of their oil. If a currency depreciates, then the relative price of oil rises. In a fossil fuel-dependent economy, won’t that have a large impact?

If you depend on imported oil, or food, or employ most of your population in producing commodities for export, then exchange rates matter. Floating exchange rates may have freed monetary policy to pursue full employment (if neoliberal central bankers could grasp MMT) but it has also introduced more volatility into the currency markets, exacerbated by speculation and short-selling. The post-Bretton Woods era is full of currency crises and attempts by governments to avoid them by building up US Dollar reserves and hence weakening domestic employment and propping up the reserve currency (described by Michael Hudson as dollar hegemony).

How does MMT address these issues?

total UK public debt was D=M+B, where M was base money and B was bonds. So they monetised 193 bn of existing bonds so:

M went up 193Bn
Y went down 193Bn

No change to net debt

Then they issue 200 bn of new bonds, so now debt is D+200bn, and total outstanding bonds has gone up by 7Bn. Base money up by 193Bn.

Monetisation of existing bonds doesn’t change the overall debt position, and in my view, doesn’t have as much effect on liquidity as one might think, if one views government bonds as nearly as money-like as base money.

score me out of 10 bill.

Thanks for writing answers to my questions. I have a copy of “Understanding Modern Money” right here

My point about QE was this; if the UK Govt sells bonds to the market and the BofE buys bonds from the market with newly created money, then essentially the BofE has given the UK Govt free money that has no interest attached!

I know I know I know that in a Modern Monetary Economy there is no limit on what a sovereign nation can spend and that it is political constraints that put a limit on it and cause bonds having to be sold to match up with the deficit. But that is what makes the QE even more amazing… we are doing exactly what you argue for just in a rather roundabout way. The UK Govt is deficit spending with newly created money with no interest attached.

Can’t QE be seen in this light?

Thanks,

Alex

you say

“I think you answer your own question. It woud not make more sense to describe my position as follows: “the government should support the private sectors desire for liquidity” when I am talking about running deficits. The net spending is supporting aggregate demand. ”

Fair enough but a side effect is that these actions of supporting demand also add liquidity.

If there is a lack of demand is that the same thing in practice as excessive liquidity preference?

If so, then why is it preferable to accommodate excessive liquidity preference rather than attempt to reverse that sentiment?

“When the private sector decides it wants to spend less and save more then aggregate demand requires additional support. The increased net public spending manifests in real terms as higher output and employment (assuming there is excess capacity) and manifests in financial terms as increased a net increase in financial assets held by the non-government sector denominated in the currency of issue.”

I think it is more correct to say ‘net public lending’, since the borrowers are in fact the public (they are being advanced public goods and services they never personally paid for), however the same public is on the hook for the interest on the national debt that accumulates as a result.

It only makes sense to talk about net public spending (rather than lending) if we can be 100% sure that there will be no future interest costs associated with that spending. For example, if reserves are created as a result of spending, and in future it may become required to pay interest on those reserves, then it is definitely lending going on, not spending.

I guess this is where ‘the natural rate is zero’ comes in? So you can treat spending to reserves as spending, not lending/borrowing?

However, even if this is the case, when aggregate demand picks up at some point in the future then taxation is the only means of tightening, which would result in a fall in reserves, potentially to the point where they become scarce in the interbank market. At this point assuming demand is still strong, how can further tightening be accomplished without causing bank failures and deflation?

Thanks for your input. I should have said at the outset of yesterday’s blog that the questions should not be seen as self-contained and you should combine answers where relevant. In that sense you would not have characterised my position as:

… unquestioning devotion to the idea that inflation only occurs when aggregate demand exceeds output capacity is equally unsatisfactory. Why? Because the examples in which inflation has occured in economies containing spare capacity (ie significant levels of unemployment) are too numerous to ignore.

If you consider Questions 1, 4 and 11 together you will understand that I consider inflation to be more than a “demand-pull” phenomena. The current hysteria is focusing on demand-pull stories though. In Questions 4 and 11, I clearly indicate that stagflationary situations can occur. I also wrote a PhD about this topic.

You then said:

In Australia over the last 50 years, we have never reached full employment, and yet inflation has been ever present. During some periods, such as much of the 1970s, both inflation and unemployment occurred simultaneously at unusually high levels.

That is factually incorrect. For example, between September 1959 and June 1974, Australia averaged 2 per cent unemployment with virtually zero underemployment and no hidden unemployment. That was full employment. We abandoned that 36 years ago. Further, accelerating or even high inflation has not been ever present since 1960.

Further I have included a graph so we get a correct understanding of the 1970s in Australia which were marked by the stagflationary episode. If you study it you will see first – low inflation and full employment in the early 1970s with strong federal deficit support from aggregate demand. Then you see the rapid escalation in inflation which was all cost-push pressures – sectoral wage pushes; margin-pushes; and the imported oil shock. As I explained in my response to Question 11, as the wage-price battle was going on in the labour market the then Labor government chose to ratify the inflation by not reducing the nominal pressure so that unemployment was maintained at very low levels. That slight rise in unemployment in the early 1970s lost the conservative government power and Labor sought to reduce unemployment back to its Post War lows.

With mounting political pressure and the undermining of the government that was going on via CIA involvement etc, the Labour government reacted by tightening fiscal policy and an extreme tightening of monetary policy. Unemployment rates then skyrocketed and have been high ever since. So the unemployment was a policy creation – cutting back aggregate demand as a poor way to deal with what was essentially a cost-push price shock that needed a different approach.

The inflation persisted and hence the stagflation – because expectations of inflation became entrenched into nominal contracts.

So clearly the inflation started as a cost-push leading to a wage-price spiral which was ultimately crushed by the 1991 recession but was moderated during the rapid growth period of the 1980s – that is, inflation stabilised during that period.

But at present all the talk is of demand-pull inflation and that is what is usually associated with the arguments about deficit spending.
best wishes
bill

I think you answer your own question. It woud not make more sense to describe my position as follows: “the government should support the private sectors desire for liquidity” when I am talking about running deficits. The net spending is supporting aggregate demand. When the private sector decides it wants to spend less and save more then aggregate demand requires additional support. The increased net public spending manifests in real terms as higher output and employment (assuming there is excess capacity) and manifests in financial terms as increased a net increase in financial assets held by the non-government sector denominated in the currency of issue.

The fact that the private sector may want to hold bonds rather than bank deposits is a portfolio choice they make which implies they desire less liquidity even though bonds are highly liquid. But they are not equivalent to cash – you can buy a sandwich with a government bond or liquidate it for cash at some ATM on the street corner.

So in that sense, buying a bond is clearly a preference for storing wealth in a less liquid form.

It is also true that investors make risk-return judgements on assets all the time and at some point may prefer non-government paper to government paper. That is going on all the time.

best wishes
bill

Let me rehearse a couple of commonly held views, myths perhaps:

While hiring from a pool of unemployed people is a fairly quick process, perhaps it is the rebuilding of physical capacity that cannot catch up with a pick up in aggregate demand? Pulling the plug on a factory is instantaneous. Dis-assembling and selling in parts takes a few more days. All this can happen simultaneously, or perhaps within weeks at various plants. When the economy returns, however, gathering the necessary capital, physically rebuilding, let alone developing a web of business relationships probably takes a lot more time. So in essence, capacity is fast on the way down, not on the way up. To add insult to injury, in recent Western history, rebuilding often takes place in countries offering cheaper labor, although that tends to keep capacity, as measured by unemployment, up, in the domestic country.

Or perhaps there is a two-tiered economy, separated by jobs skills and such, one very affected, the other moderately, in terms of jobs, such that the overall level of unemployment is a poor measure of the output gap. When the economy picks up, it’s possible that those “on top” have a bias towards buying goods and services within their group, so that the output gap in that segment of the economy is smaller to begin with, and shrinks faster. Since the “new economy” is relative bigger than before the slump, the net effet can be quite high, for the two groups combined.