I am travelling today and so haven’t much time. Given that I am in the letter writing mood at present I decided to write to another of the New York Times columnists Greg Mankiw about a recent article he published. That has taken up my spare time today. So as not to disappoint I have made by letter available for all to read. I am sure Greg won’t mind. So read on …
I have been a letter writing mood the last few days. Yesterday I wrote a letter to our colleague Paul Krugman about some matters that concerned me in his recent portrayal of some work that I am associated with – the school of thought known as Modern Monetary Theory (MMT). I was initially going to take a pretty hard line and get straight to the point – you know the way we are trained in graduate school as economists to tear into arguments we don’t like – no holds barred, give no quarter.
You know how it is like. Especially, during seminars when a non-mainstream economist is presenting their work to us – we don’t hold back then do we – we seek not only to destroy the argument but also the reputation and self-confidence of the speaker. Almost anything goes when these pop sociology lefty types think they can do economics. You know all that though.
Anyway, I was thinking that it would save me time just to go to the jugular in the way that the mainstream graduate schools train us – we all understand that approach. But because I was going to make it public and non-economists might have read it I didn’t want to generate too much negative angst from those who have different cultural expectations and think politeness is giving someone credit for not being truthful. I personally am not sure I should worry about the any middle class sensibilities, which often turn out to be “false politeness” anyway, especially when the views I was concerned about are being used, ultimately, to perpetuate policies which mean entrenched unemployment for millions.
But, just in case, and in the interests of cultural tolerance, I decided to take a softer approach in my letter to Paul Krugman.
Instead I opted to be more polite and to point out that when someone is writing for a newspaper such as the New York Times, which as you know is influential in forming public opinion, they have a duty of care to ensure they do not proliferate mis-representations for the purposes of advancing their own argument.
Especially when the writer is influential themselves and occupies a considerable position among so-called “progressives”. So when a leading academic writer represents a school of thought which challenges his/her world view – upon which they have probably been very well rewarded by way of speaking engagements, consultancies and/or Op-Ed columns – in a way that is untrue that is a concern.
In fact, this sort of poor scholarship abuses the position the person has because it holds the challenging school of thought out for ridicule. We have a polite word for saying things that are not true … we call that lying.
I am not able to assign intent – not being a psychologist – but we all know that we are meant to be trained to ensure that we do not deliberately set up false representations of theories that we may find challenging or threatening to our positions. We are trained instead to do our research thoroughly and to consider each idea on its merits. Anyway, my letter to Paul Krugman was just to point out that issue and tell him I thought he could do better.
I forgot to send the letter.
But the point is that when you write for the New York Times you should take care in what you say.
And on that, while I am in the letter writing mood … if I may … I saw something you also wrote in the New York Times on March 26, 2011. It might have been an article or a blog post but it was a written communication so who cares what I refer to it as. I don’t expect anyone will mind if I sometimes call it an article and other times refer to it as a post. What is at stake there?
Anyway, Greg, if I may intrude for a moment … I just want to make a few … small … well actually not so small … but you will understand … if I just take a little of your time … I know it is precious and you have important things to do … but I thought … ah … I might just point out … you know … nothing too important … well when it comes to it … quite important … things out that I thought … if I may … were not quite … well actually they were dead wrong … but excuse me please.
I refer to your Economic View column – It’s 2026, and the Debt Is Due which was purporting to be a speech written for the US President to be delivered in March 2026 where you consider the President would have “a heavy heart” and would be admitting that the US has a “crisis” on its hands which “is one of our own making. And it is one that leaves us with no good choices”.
I imagine the President would be reflecting back to about now and how he and his Administration handled the current crisis. There is a major crisis now which will reverberate via the children of the unemployed to 2026 and beyond. There are millions of American workers without jobs for no good reason other than the mainstream economics profession has somehow been used by politicians and lobbyists to support a policy situation whereby the government has failed to take its responsibilities seriously.
The US government is deliberately standing by – arguing about nothing important – and leaving millions without work and many of them falling further into poverty. It certainly doesn’t look like a great nation to anyone who understands these things.
And the current crisis that I imagine the President will be talking about in 2026 is definitely “one of our own making”. We listened to economists who preached the virtues of self-regulating markets and pressured governments into giving too much lead to the financial sector. The greed and corruption that is inherent in that sector once let of its leash created a product space that was impossible to risk-assess and ultimately doomed to collapse. As the collapse was building the mainstream economists sat around sipping coffee in their safe tenured jobs telling everyone that the “business cycle was dead”.
They wrote textbooks that they foisted onto their students (at exorbitant prices) which extolled the virtues of deregulation and claimed that the only real policy agenda – now that the macroeconomic questions were solved – you know inflation targeting with passive fiscal policy with unemployment being used to control inflation – was to further deregulate financial and labour markets. The upshot was that all corporate sector, particularly the financial sector pocketed increasingly larger proportions of national income at the expense of the workers and paid economists to make statements supporting this process. Many economists who made such statements under the guise of their academic affiliation never reported that they were actually being paid by companies etc who would benefit from the policy changes being advocated.
As an aside, Greg, I understand that you were asked to appear in the recent movie Inside Job but declined. I guessed you were probably too busy doing community work or spending time with your family to offer any insights.
Anyway, in your article, and excuse my intervention here … you say:
For many years, our nation’s government has lived beyond its means. We have promised ourselves both low taxes and a generous social safety net. But we have not faced the hard reality of budget arithmetic.
The seeds of this crisis were planted long ago, by previous generations. Our parents and grandparents had noble aims. They saw poverty among the elderly and created Social Security. They saw sickness and created Medicare and Medicaid. They saw Americans struggle to afford health insurance and embraced health care reform with subsidies for middle-class families.
I wondered about this Greg. Can I just offer a few small insights. Excuse me for taking that liberty.
A nation’s means is defined by the productive resources that they have at their disposable to put to work in creating real goods and services which people can enjoy. In addition, a nation can access foreigners to send them real resources which can also enhance welfare.
As long as these productive resources are being used in an environmentally sustainable way the best option for a nation is full employment. It maximises income. As economists we are always talking about optimal use of resources and efficiency. Your textbook is full of this stuff. It doesn’t take too much to know that if a nation sacrifices millions of dollars of potential income per day because it keeps millions of its citizens unemployed that it is not using its resources optimally. When you do the sums there is no greater inefficiency than mass unemployment.
For years, the US has had idle labour and capital resources because the national government declined to take responsibility for the spending gap and expanded their fiscal position sufficiently.
The government is overseeing a policy regime that entrenched unemployment and is deliberately forcing the US economy to forego billions in lost income earning opportunities which would have improved the lives of millions and allowed your cities to be more vibrant.
By 2026, the children of those unemployed will be adults and they will inherit the disadvantage.
So Greg, how is the US living beyond its means? Excuse my question.
I suppose you might be thinking that the budget deficits are a sign of spending more than you have in income. A layperson might term that “living beyond your means”. But that only really applies to a household or non-government entity doesn’t it Greg. They are financially constrained and cannot spend more than they earn indefinitely. Eventually they have to pay the piper.
But Greg, the US government is fully sovereign in the US dollar and it can buy at any time anything that is for sale in that currency. As long as there are real goods and services available and there are production opportunities government deficits are not pushing the economy beyond its capacity to produce.
I agree that you might think a government is living beyond the economy’s means – noting that it doesn’t make sense to consider the “means” of a government – if it keeps pushing deficits to the point that there are no idle resources and the economy responds to the increasing spending by inflating prices. That might be a sign that the deficits are too large. But while there is mass pools of idle labour the government has a responsibility to keep pushing higher deficits to ensure that labour is absorbed back into production.
In the speech, you characterise the President reflecting on the admirable safety nets that the US put in place many years ago. You write:
But this expansion in government did not come cheap. Government spending has taken up an increasing share of our national income.
Today, most of the large baby-boom generation is retired. They are no longer working and paying taxes, but they are eligible for the many government benefits we offer the elderly.
Our efforts to control health care costs have failed. We must now acknowledge that rising costs are driven largely by technological advances in saving lives. These advances are welcome, but they are expensive nonetheless.
At the outset, Greg, I note that these safetey nets – pension and health care – are at the lower end of generosity compared to other nations. I also note that many nations have comprehensive state-provided health care and pension systems that have been providing dignity to their citizens for years without major problems. But even in the US they provide some sense of security for your citizens which I think we can all applaud.
I also agree these systems are not “cheap”. The elderly like to eat and they deserve as part of their dignity to have a nice house/apartment and some spare change to enjoy the movies and surf the Internet. All the real resources – excuse me for the bold – my parents told me it was rude to put bold in letters but I just wanted to make sure we appreciated the point – that real resources carry an opportunity cost and can be allocated in one use at the expense of another use.
The same goes for health care. It is in our mutual advantage to keep people healthy and there is a very large public good component in public health. Your textbook tells us that a private market will under-allocate resources to public goods because the market fails to price the social benefits and costs. There are strong net social benefits in public health. So it is only efficient that the government ensure there are high levels of provision. Yes, that doesn’t come “cheap” because once again real resources have to be used.
I note that when there are lots of idle resources the opportunity costs are lower – even zero. I also note that as demography changes we free up resources that we were using to provide child care and primary education etc.
I also like your point about the rising costs being driven by “largely by technological advances in saving lives” – that is, a supply effect rather than a demand inflation. We should be profoundly proud that we can now help people live longer and happier lives Greg. As we get older we will appreciate that.
But the major point is that all these “costs” are just the real resources being used – the food the pensioners eat, the titanium that goes in the replacement hips etc. As long as there is enough of those things available there is no question the federal government in the US can afford to purchase them and make them available to advance public welfare.
The problem is that some people, even you, might not like the government doing that. But then you will vote as a citizen against it. Your opinion as an economist is irrelevant here – we have nothing to say when it comes to making political choices between competing ends. Society has to solve the political problem.
It might be that the health care, for example, will require spending that pushing total spending beyond the current inflation barrier. Then the government has to make political choices. Reduce spending elsewhere or cut back health care spending. Politics not economics.
But mostly I wondered why you didn’t acknowledge the problems America will get itself into as its society ages while at the same time it keeps unemployment so high and reduces the potential productivity growth path. What will matter in 2026 is how productive America is and how many people have productive skills to produce the real goods and services that will define our real standard of living. You will not achieve this desired state by 2026 if the US government doesn’t do something about the hideous unemployment problem it is currently facing.
Perhaps that is what you meant to say but didn’t quite get around to expressing it that way.
Your “speech” then made some interesting points about where the government gets its capacity to spend from. Excuse me for offering some additional points. It is not that you are wrong … perhaps dead wrong is better … but lets not labour the description.
If we had chosen to tax ourselves to pay for this spending, our current problems could have been avoided. But no one likes paying taxes. Taxes not only take money out of our pockets, but they also distort incentives and reduce economic growth. So, instead, we borrowed increasing amounts to pay for these programs.
Yet debt does not avoid hard choices. It only delays them. After last week’s events in the bond market, it is clear that further delay is no longer possible. The day of reckoning is here.
We both know Greg that the US government is fully sovereign in its own currency and as such is never revenue constrained. It is a monopoly issuer of the US currency. Your textbook has a chapter on monopolies so you understand fully what that means when applied to a national government.
So if the US government can spend whenever it chooses – and wisely would spend when there are real resources available (or it can make available) which it can utilise to advance public purpose – what is the purpose of taxation?
We know that governments tax to alter resource allocation – that is to deter people from doing certain things. These are political choices and not germane to our discussion here Greg.
Other than that taxation is used to regulate aggregate demand to ensure that there is ficscal space for the government to pursue its socio-economic program. Taxation Greg, creates unemployment (resources available in seek of work) which government spending then puts to good use – one way or another.
As you know Greg, when the non-government sector decides that it will cut its spending, output and employment falls if the government sector doesn’t pick up the slack. It is really simple “Budget arithmetic” to use your phrase. The only way the government can add to demand in net terms is to run deficits. Trying to tax people to cover the spending Greg may be appropriate at certain times but when there are lots of idle resources it is never appropriate. The economy needs a net spending injection. I am sure you teach that to students in first-year like all responsible teachers of macroeconomics should.
Then we come to debt. If the US government doesn’t need revenue to spend then we have to understand the role of debt issuance in a more sophisticated way. Quite clearly the government doesn’t need to issue debt to net spend. Even the textbooks like yours acknowledge that. I wrote a few blogs on this once which in the interests of keeping this letter short I might refer you too – perhaps to get some feedback from you … but only if you have time.
In short, npw that the central bank in the US is paying interest on excess reserves held with it by the member banks there is no need for debt issuance at all. The central bank used this debt to manage the “cash system” – that is, as a liquidity management tool, to ensure that it could “hit” its target interest rate and ensure that the goings on in the interbank market each day didn’t compromise that monetary policy goal.
I have read your text book on this Greg and couldn’t find any mention of it. That is why I brought it up here. Perhaps you haven’t updated that chapter for some time – but then all this has been operational for a long time before you started writing those books so I wondered … perhaps … what was the issue.
To make sure I didn’t mis-read what you have read Greg, I consulted your textbook again – to check whether I recalled correctly that you consider the role of the central bank is to control the money supply and taught undergraduate students that story. I have spent a lot of time studying the way the monetary system operates and the way the central bank works within the system and I had not gleaned from the study that the “textbook” version was correct.
In your textbook – Principles of Economics (Chapter 27 First Edition) – you tell students that the central bank has “two related jobs”. The first is to “regulate the banks and ensure the health of the financial system” and the second “and more important job”.
To quote you some more:
… is to control the quantity of money that is made available to the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy (emphasis in original).
You then outline how you think the central bank accomplishes this task?
You write that the:
Fed’s primary tool is open-market operations – the purchase and sale of U.S government bonds … If the FOMC decides to increase the money supply, the Fed creates dollars and uses them buy government bonds from the public in the nation’s bond markets. After the purchase, these dollars are in the hands of the public. Thus an open market purchase of bonds by the Fed increases the money supply. Conversely, if the FOMC decides to decrease the money supply, the Fed sells government bonds from its portfolio to the public in the nation’s bond markets. After the sale, the dollars it receives for the bonds are out of the hands of the public. Thus an open market sale of bonds by the Fed decreases the money supply.
Now forgive me for saying so but I think this description of the way the central bank interacts with the banking system and the wider economy is not entirely accurate. One might say … if they were being less polite … that it is totally false.
They might say that in reality, monetary policy is focused on determining the value of a short-term interest rate and that central banks cannot control the money supply. Those with a good knowledge of history would say that the ideas in your textbook are residual from the commodity money systems where the central bank could clearly control the stock of gold, for example. They would say that in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit.
I guess you might have been trying to say that about the old system that died in 1971 when your then President decided enough was enough and introduced the fiat currency monetary system which remains with us today and has freed governments from all sorts of stupid constraints that prevented them from pursuing public purpose effectively.
But … being rather forward … I might suggest that the account of monetary policy in mainstream macroeconomics textbooks such as your own, which try to tell students that monetary policy describes the processes by which the central bank determines the total amount of money in existence or to alter that amount, is not accurate.
If you read up on Modern Monetary Theory (MMT), which I think would be of interest for you, you will learn that the central bank has very little capacity to control the monetary aggregates.
The theory of endogenous money is central to the horizontal analysis in MMT. i outline the difference between vertical and horizontal transactions in a macroeconomy in the suite of blogs I referred to above. It is very important to understand that distinction because it helps us understand the unique capabilities of government policy.
When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).
The essential idea is that the “money supply” in an “entrepreneurial economy” is demand-determined – as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 (Currency plus bank current deposits of the private non-bank sector plus all other bank deposits from the private non-bank sector) is just an arbitrary reflection of the credit circuit.
So the supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept.
We can conclude that central banks clearly do not determine the volume of deposits held each day. These arise from decisions by commercial banks to make loans. The central bank can determine the price of “money” by setting the interest rate on bank reserves. Further expanding the monetary base (bank reserves) as we have argued in recent blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – does not lead to an expansion of credit.
But that was all about bond issuance and I just wondered why your textbook doesn’t cover all that especially when you feel as though you can write about concerns you have with debt in the New York Times.
I also would point out … modestly … that federal debt is really not very well understood. If all the government is doing is borrowing its own spending which would otherwise be sitting in reserve balances in the central banking system then what exactly is the problem. When it borrows it just recodes the accounting location of those balances and call them federal debt. When it pays the debt-holders their due the accounting entries reverse. Numbers in accounts buzzing around the place – what is the issue?
From reading your textbook and many others I guess you think that if the government doesn’t issue this debt then there will be inflation. But when you think about the process of debt-issuance – the buzzing around of numbers – you realise that it is the net spending of government that adds to demand and the monetary operation that may or may not accompany it (debt-issuance or not) does not change aggregate demand at all. I pointed this out to Paul Krugman in my letter – I guess you both are worrying about the same thing – but relax a little – there is no issue.
Later on in the “speech” you write that the President would say:
This morning, the Treasury Department released a detailed report about the nature of the problem. To put it most simply, the bond market no longer trusts us.
For years, the United States government borrowed on good terms. Investors both at home and abroad were confident that we would honor our debts. They were sure that when the time came, we would do the right thing and bring spending and taxes into line.
But over the last several years, as the ratio of our debt to gross domestic product reached ever-higher levels, investors started getting nervous. They demanded higher interest rates to compensate for the perceived risk. Higher interest rates increased the cost of servicing our debt, adding to the upward pressure on spending. We found ourselves in a vicious circle of rising budget deficits and falling investor confidence.
As economists often remind us, crises take longer to arrive than you think, but then they happen much faster than you could have imagined. Last week, when the Treasury tried to auction its most recent issue of government bonds, almost no one was buying. The private market will lend us no more. Our national credit card has been rejected.
Economists have had a very bad record of predicting crisis. In fact, none of the mainstream profession saw the current crisis coming. How do you explain that Greg?
But why would it matter if the bond market didn’t trust the US government? When a financially constrained individual wants to borrow from bank – they have to present themselves as credit-worthy – trust-worthy. But the shoe is on the other foot for the US government and all sovereign governments. The bond markets need the governments to be issuing debt not the other way around.
The US government could simply require the central bank to make the appropriate accounting adjustments to facilitate its spending. That is the power it has as a monopoly issuer of the currency.
Under the fiat monetary system, it is the central bank which sets the short term interest rate which then conditions the longer maturity rates which we call the term structure. I didn’t see much about that in your textbook Greg but then perhaps I missed it. It is very important though that students understand the freedom the central bank has in a non-convertible currency system.
So none of the above section in the “speech” you have written for the President in 2026 applies to the fiat monetary system. In that context, I tried to figure out why you put it in there and I came up with two theories.
I think maybe you are still stuck in the old days and maybe have been too busy to notice that the US no longer functions in a fixed exchange rate system with a convertible currency. President Nixon put that system to bed in 1971. I know you like history but things have moved on Greg … but excuse me for pointing that out.
Alternatively, you have some deeper insight and imagine that the US is going to go back to a fixed exchange rate system and offer gold convertibility to holders of the US dollar. I cannot imagine the US government being so stupid as to agree to that Greg, but perhaps you know better. In which case, you will join me in arguing against any such policy blunder.
The only other thing I noted in the “speech” that was of interest was that the “IMF headquarters had moved to Beijing by 2026”. I hope that turns out to be true for residents of Washington DC. It would reduce the city pollution levels I think. So a good move.
But if I may do a bit of editing to the rest of the “speech” I think the President might actually present the Horticulture Award for 2026 and I think you would be very proud to have once again captured that award for services to the gardeners of the World.
Given the current crisis has exposed all the mainstream theories to be inapplicable and worse – totally dangerous to the design of effective fiscal and monetary policy – eventually people are going to hand in all the mainstream economics textbooks to the local pulping depot for recycling into compost – assuming the ink is bio-degradable. Your textbook leads the way Greg so there will be hundreds of thousands offered up for composting. The world benefits in two ways: less mind pollution and more compost. Win-win. The President will speak glowingly of you in that context. You should be proud that you at least have made that contribution to humanity.
Anyway, that is enough for today.
ps all typos and grammatical errors in this letter are likely to be my own fault!