Adair Turner has just released a new paper – The Case for Monetary Finance – An Essentially Political Issue – which he presented at the 16th Jacques Polak Annual Research Conference, hosted by the IMF in Washington on November 5-6, 2015. The New Yorker columnist John Cassidy decided to weigh into this topic in his recent article (November 23, 2015) – Printing Money. The topic is, of course, what we now call Overt Monetary Financing (OMF), which simply means that all of the unnecessary hoopla of governments matching their deficit spending with bond-issuance to the private bond markets, as if the latter are funding the former, is dispensed with. That artefact from the fixed exchange rate Bretton Woods system is maintained as a voluntary procedure by fiat-currency issuing governments but only provides financial assets to the non-government sector in the form of ‘corporate welfare’. The debt issuance of debt has nothing to do with funding the spending and is used by all and sundry to attack such spending for creating so-called ‘debt mountains’. OMF brings together the central bank and the treasury functions of government into a coherent framework whereby the central bank merely credits private bank accounts on behalf of the government to indicate the spending initiatives implemented by the Treasury.
As an aside, I liked the interview that John Cassidy did with Eugene Fama at the beginning of the crisis. He allowed Fama to demonstrate how ridiculous his ideas and assessments were.
Please read my blog – How to fail a simple macroeconomics examination – for more discussion on this point.
But in his current piece he is way off the mark.
Cassidy claimed that the world was stuck in a low growth era that “In economic-policy circles, the phrase of the moment is ‘secular stagnation’.”
He poses the question:
What could get us out of the rut? Until recently, the textbook prescription for slow growth involved cutting interest rates and introducing a fiscal stimulus, with the Treasury issuing debt to pay for more government spending or for tax cuts (aimed to spur household spending).
But then claims that “neither of the traditional policy responses is readily available” because interest rates are already close to 0 and political (US) and legal (Eurozone) constraints prevent any further fiscal stimulus.
This is where the recent intervention by Adair Turner, the previous head of the British Financial Services Authority, comes in.
There is a new book that accompanies new paper. It is interesting to me as a scholar that he fails to acknowledge any of the academic contributions of Modern Monetary Theory (MMT) writers in any of his work.
We have been at the forefront of proposals to use so-called Overt Monetary Financing (OMF) to accompany appropriate fiscal stimulus in various countries where aggregate spending is clearly below that necessary to achieve and sustain full employment for the last twenty years or so.
Given that, it is incumbent on authors who make similar proposals in more recent times to at least acknowledge they are part of a lineage of ideas. Turner fails in this regard.
I refined my discussion in one of the chapters of my current book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).
From an MMT perspective, OMF is a desirable option that allows the currency issuer to maximise its impact on the economy in the most effective manner possible.
But in the neo-liberal world of taboo, ‘monetary financing’ is seen as a radical suggestion. It wasn’t always so. Abba Lerner’s second law of functional finance advocated the central bank ‘printing money’ to match government deficit spending sufficient to achieve and sustain full employment.
Turner also fails to acknowledge the significant, early work of Lerner in this regard. His selective use of literature is annoying to say the least.
In his 1943 article – Functional Finance and Federal Debt – Abba Lerner said:
The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …
Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability …
[Reference: Lerner, A. (1943) ‘Functional Finance and the Federal Debt’, Social Research, 10(1), 38–51].
The focus on government should not be on the deficits but on the prosperity and inclusion that full employment delivers.
He also understood that people are “easily frightened by fairy tales of terrible consequences” when new ideas are presented.
The sense of fright is driven by a lack of education that leaves people unable to comprehend how the economy actually operates.
Neo-liberals magnify that sense of fright, by demonising what are otherwise sensible and viable explanations of economic matters.
They know that by elevating these ideas into the domain of fear and taboo, they increase the probability that political acceptance of the ideas will not be forthcoming.
That strategy advances their ideological agenda. The basic rules that should guide government fiscal policy are, as Lerner noted, “extremely simple” and “it is this simplicity which makes the public suspect it as too slick).
Neo-liberals who have vested interests in ensuring that the public does not understand the true options available to a government that issues its own currency manipulate that suspicion.
In the place of these simple truths, neo-liberals advance a sequence of myths and metaphors that they know will resonate with the public and become the ‘reality’.
The idea of OMF is very simple and does not actually involve any printing presses at all. While the exact institutional detail can vary from nation to nation, governments typically spend by drawing on a bank account they have with the central bank.
An instruction is sent to the central bank from the treasury to transfer some funds out of this account into an account in the private sector, which is held by the recipient of the spending.
A similar operation might occur when a government cheque is posted to a private citizen who then deposits the cheque with their bank. That bank seeks the funds from the central bank, which writes down the government’s account, and the private bank writes up the private citizen’s account.
All these transactions are done electronically through computer systems. So government spending can really be simplified down to typing in numbers to various accounts in the banking system.
When economists talk of ‘printing money’ they are referring to the process whereby the central bank adds some numbers to the treasury’s bank account to match its spending plans and in return is given treasury bonds to an equivalent value. That is where the term ‘debt monetisation’ comes from.
Instead of selling debt to the private sector, the treasury simply sells it to the central bank, which then creates new funds in return.
This accounting smokescreen is, of course, unnecessary. The central bank doesn’t need the offsetting asset (government debt) given that it creates the currency ‘out of thin air’. So the swapping of public debt for account credits is just an accounting convention.
I read an interesting blog this morning about the nonsense in using the term ‘printing money’ when referring to government spending or central bank balance sheet expansion – see – ‘Printing Money’ – A Grammatical Fiction.
Turner invokes the 1948 article by Milton Friedman as evidence that even arch free market economists support the money financing approach.
[Reference: Friedman. M. (1948) ‘A Monetary and Fiscal Framework for Economic Stability’, American Economic Review 38(3), 245-264].
There is a sort of security in this approach because it suggests the radical idea is not that radical at all. But this is a negative approach for progressives to take. The preferred option is to explain that OMF merely recognises that a currency issuing government never needs to borrow or tax in order to spend.
Friedman (1948: 5) wrote:
… government expenditures would be financed entirely by tax revenues or the creation of money, that is, the use of non-interest bearing securities. Government would not issue interest bearing securities to the public.
My references to Turner in the following discussion are from his Cass Business School lecture on February 6, 2013. His lecture was entitled ““Debt, Money, and Mephistopheles: How Do We Get Out of this Mess?”. The New Economic Thinking paper referred to above just builds on the ideas he outlined in that lecture.
Turner suggested that serious consideration be given to the “extreme option” of “overt money finance (OMF) of fiscal deficits’, which would involve the ‘permanent monetisation of government debt”. He channelled Friedman’s claim “that government deficits should always be financed in that fashion”.
But Friedman’s proposals were part of what was known as the Chicago Plan (emanating out of the free market bastion at the University of Chicago), which proposed a broad regime change where private banks would be prevented from creating new money and public deficits would be the only source of new money.
Equally, the government would run a balanced fiscal position over the cycle and destroy the money created in the downturn when they ran offsetting surpluses in the upturn. This is a very different proposition to the current suggestion for OMF that is developed by MMT proponents.
Turner claims that OMF is seen by an increasing number of economists and commentators as a way to get out of the “mess”. OMF supports fiscal expansion, which directly stimulates the economy by putting extra dollars of spending into the economy.
It is now clear that a reliance on monetary policy to resolve the crisis has failed and will continue to fail while fiscal policy is forced by the austerity mania to act in a pro-cyclical fashion.
Turner revives Friedman’s use of the term a “helicopter drop” to describe a situation where the “government printing dollar bills and then using them to make a lump-sum payment to citizens” – as if they had been dropped on the population from a helicopter flying above.
The former US Federal Reserve Chairman Ben Bernanke revived the idea of a ‘helicopter drop’ in 2002. In a speech to the National Economists Club in Washington (November 21, 2002) – Deflation: Making Sure “It” Doesn’t Happen Here – Bernanke talked about methods to avoid deflation.
Bernanke advocated a “money-financed tax cut” which he said was equivalent to Friedman’s anti-deflation proposal to drop money from helicopters in order to stimulate spending.
Bernanke said that when total spending collapses, a nation endures rising unemployment and ultimately deflation, as “producers cut prices on an ongoing basis in order to find buyers”. As the recession deepens, interest rates drop to zero, which reduces the flexibility of monetary policy.
Even from the conservative eye of Ben Bernanke, these situations call for a significant increase in fiscal deficits to stimulate spending and confidence, with the central bank issuing new money to support the deficits.
From the perspective of MMT, a helicopter drop is equivalent to an increase in the fiscal deficit in the sense that new financial assets are created and the net worth of the non-government sector increases.
Turner’s latest paper assumes that the economic and administrative issues relating to OMF are well understood. He says that:
Monetary finance of increased fiscal deficit will always stimulate aggregate nominal demand: in some circumstances it will be a more certain and/or less risky way to achieve that stimulation than any alternative policy lever: and the scale of stimulus can be appropriately calibrated and controlled – there is no knife edge nonlinearity which makes dangerously high inflation inevitable.
However, once “we accept that monetary finance is a feasible policy option” there remain “great political risks”, which need “a set of rules and responsibilities which will guard against its dangerous misuse” to be determined.
It is here that I depart with his approach (more about which below).
Turner understands that the “helicopter money” terminology does not reflect “modern reality”. He says that OMF:
… would typically involve the creation of additional deposit rather than paper money. This would be initially in the form of deposit money in the government’s own current accounts which would then be transferred into private deposit accounts either as a tax cut or through additional public expenditure.
So no printing presses or coin stamping machines are involved. Progressives should stop using the term ‘printing money’ when discussing these matters, even if they make finger gestures as they speak to indicate the term is in inverted commas!
Turner goes into an elaborate discussion about the difference between so-called “debt-financed government deficit spending” and “money finance deficits”.
This is the sort of stuff that students are forced to learn in intermediate and later courses in macroeconomics at universities around the world. It is largely nonsensical.
When the government matches its deficit spending with debt-issuance to the non-government sector it is really only altering the composition of the wealth portfolio of the non-government sector. It swaps bonds for bank deposits essentially.
The impact of the government spending is not influenced by these monetary operations, as Turner infers. That impact is the same irrespective of whether debt is issued to the non-government sector to match deficits or not.
That insight also bears upon the discussion of inflation risk, which I will return to presently.
Cassidy’s knee jerk response other than to conclude that Turner’s proposal is a “Merry Christmas, everyone!” is to write:
If, despite Turner’s impressive credentials, the words “hyperinflation,” “Weimar Republic,” and “Robert Mugabe’s Zimbabwe” are whirling around in your head, he would certainly understand. “My proposals will horrify many economists and policymakers, and in particular central bankers,” he writes. “‘Printing money’ to finance public deficits is a taboo policy. It has indeed almost the status of a mortal sin.”
It is a pity that Cassidy thinks it’s worth his time to rehearse these worn out arguments about the alleged link between expanding bank reserves and inflation.
The point to note is that the inflation risk lies in the spending not the monetary operations (debt-issuance etc) that might or might not accompany the spending.
All spending (private or public) is inflationary if it drives nominal aggregate demand faster than the real capacity of the economy to absorb it.
Increased government spending is not inflationary if there are idle real resources that can be brought back into productive use (for example, unemployment).
Related propositions include the claims that OMF would devalue the currency whereas issuing bonds to the private sector reduces the inflation risk of deficits. Neither claim is true.
First, there is no difference in the inflation risk attached to a particular level of net public spending when the government matches its deficit with bond issuance relative to a situation where it issues no debt, that is, invests directly.
Bond purchases reflect portfolio decisions regarding how private wealth is held. If the funds that we used for bond purchases were spent on goods and services as an alternative, then the budget deficit would be lower as a result.
Second, the provision of credit by the central bank (in return for treasury bonds) will only be inflationary if there is no fiscal space.
Fiscal space is not defined in terms of some given financial ratios (such as a public debt ratio).
Rather, it refers to the extent of the available real resources that the government is able to utilise in pursuit of its socio-economic program.
Further, hyperinflation examples such as 1920s Germany and modern-day Zimbabwe do not support the claim that deficits cause inflation. In both cases, there were major reductions in the supply capacity of the economy prior to the inflation episode.
Please read my blog – Zimbabwe for hyperventilators 101 – for more discussion on this point.
As an aside, Cassidy notes that a number of economists have in the past proposed to defy the taboo of OMF and says that:
More recently, a number of liberal economists rallying under the banner of “Modern Monetary Theory” have urged the government to reverse budget cuts, financing the spending with money created by the Fed.
Which is a 100 per cent accurate assessment of the Modern Monetary Theory (MMT) position.
He then makes the extraordinary statement that:
Even Paul Krugman, who is usually a big supporter of stimulus programs, has distanced himself from Modern Monetary Theory, pointing to the danger of inflation from excessive monetary growth.
So there you have it – that ‘authority’ on macroeconomics, Paul Krugman, who has consistently revealed a lack of understanding of the way the banking system operates is now the judge and jury on whether MMT is to be regarded as serious input into the macroeconomic policy discussion.
But moreover, Cassidy appears to just be rehearsing the worn out mainstream economics rhetoric when he says:
… creating money does pose other dangers,like an alarming jump in inflation.
My blog yesterday – Takahashi Korekiyo was before Keynes and saved Japan from the Great Depression – was a demonstration of one historical example where this policy has not generated inflation. There are other exmples as Cassidy acknowledges.
But then as if they are applicable Cassidy pulls out the usual scare examples “like the hyperinflation experienced by the … Weimar Germany, and modern Zimbabwe.”
Those examples provided very little guidance on what would happen to a modern state which abandoned matching fiscal deficits with debt issuance to the non-government sector as noted above.
There is a dishonesty in journalism that keeps throwing those examples up without informing the reader of what actually happened in each case.
No-one who advocates OMF is suggesting that a government would continue expanding nominal spending via ever-growing deficits once an economy had reached full capacity and full employment. It is obvious that if such a strategy was pursued then ever-increasing inflation would be the result.
Turner gives some fuel to this neo-liberal argument by claiming that:
If we accept money finance as a normal operation, deployed continuously year after year, the danger that future governments will abuse it is greatly increased …
To overcome this “danger” Turner says that rules would need to be employed.
… we can still place the use of monetary finance within the constraints of central bank independence and of inflation targeting: and we can still preserve the legally defined self-denying ordinance which prevents politicians from enjoying discretion to implement inflationary policies.
In other words, he wants to subjugate fiscal policy, which is normally the responsibility of the democratically-elected government, to the non-elected and unaccountable central bank management boards who would then maintain:
… independent control over the quantity of monetary finance allowed, guided by a clearly defined price stability rule.
That is, break the link between the exercise of democracy and the accountability of economic policy.
Cassidy doesn’t take up the issue of the diminution Diminution of democratic oversight, rather he doubts whether so-called “independent central bankers aren’t immune to temptation, or to political pressures: many of them are political appointees, after all.”
The latter recognition makes you wonder why he used the term “independent central bankers” at all.
Cassidy thinks that if “money finance … proved successful, there would be enormous pressure to use it for other purposes, such as debt reduction” and “the very hint of such a policy being enacted could sour the markets”.
To which any reasonable observer, who understood the way the monetary system operates, would say so what?
What exactly would a sour market do that was sufficient to undermine the capacity of the government to advance well-being in this way?
I’m often confronted with arguments by sceptics who say ‘the markets’ will be unhappy, or retaliate, but when I asked them, specifically, to articulate exactly what they think the markets (whoever they are) will or can do, I am met with a sort of jumbled set of propositions or more typically, silence.
Cassidy should have outlined what he thinks the “markets” could do. They clearly would be sulking because there public debt ‘teat’ would be drying up and so they would have to do use their imaginations to develop a new low risk asset on which to price their other riskier debt instruments. A guaranteed annuity in the form of a risk-free public bond is a very attractive asset for these parasites.
But there’s not much they can do to undermine a government intent on improving the well-being of its people.
Cassidy even admits later in his piece that:
the Bank of Japan, the country’s central bank, now owns about a fifth of this debt … Since one arm of the Japanese government is effectively lending to another arm, the public debt owned by the central bank could simply be written off. If that happened, Japan would have created a great deal of money and used it to reduce its debt burden—a form of money finance. And it’s hard to see how this would generate a spike in inflation.
So how would a souring of private markets stop that? And why would this, for example, generate increased inflationary expectations, which is one way in which mainstream economists claim monetary financing generates inflation?
It is interesting that more people are now talking about things that the MMT crowd have been writing and thinking about for a fair while now.
It is clear that ideas that were considered ‘crazy’ some years ago and now being entertained as being plausible by the mainstream media.
Given the vilification that our small group endured when we set out on this MMT journey, I find all of this rather amusing. Apparently it takes a British lord to give an idea credibility. So be it.
It is better that these ideas penetrate the mainstream debate through which ever means than be sequestered by the mainstream media and wheeled out as a way of humiliating commentators who dare to challenge the mainstream paradigm.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.