Makroskop is a relatively new media publication in Germany edited by Heiner Flassbeck and Paul Steinhardt. It brings some of the ideas from Modern Monetary Theory (MMT) and other analysis to German-language readers. It is not entirely sympathetic to MMT, differing on the importance of exchange rates. But it is mostly sympathetic. I declined to be a regular contributor when invited at the time they were starting the publication not because I objected to their mission (which I laud) but because their ‘business model’ was a subscription-based service and I consider my work to be open source and available to all, irrespective of whether one has the capacity or the willingness to pay. But I have agreed to contribute occasionally if the material is made open source, an exception to their usual material. Recently, the editors approached me to respond to an article they published from a German political scientist – Modern Monetary Theory: Einwände eines wohlwollenden Zweiflers or in English: Modern Monetary Theory – Questions from a Friendly Critic. The article constitutes the first serious engagement with MMT by German academics and thus warrants attention. Even if you cannot read German you will still be able to glean what the main issues raised in the German article were by the way I have written the English response. The issues raised are of general interest and allow some key principles of MMT to be explicated, which explains why I have taken the time to write a three-part response. Today is Part 1.
The so-called “Friendly Critic” of MMT (self-styled) was Martin Höpner, who is a political scientist associated with the Max-Planck-Institut für Gesellschaftsforschung (Max Planck Institute for Social Research – MPIfG) in Cologne.
The original article (in German) was published on March 20, 2018.
Here is guidance on why Martin Höpner’s contribution is interesting but essentially flawed. To ensure these blog posts do not become too long, I decided not to quote his original German.
So, when I quote Martin Höpner using quotation marks “”, I am providing my translation, and, given my German to English is not perfect, nuanced errors in translation and interpretation (usage) are possible.
Martin Höpner considers MMT to be “one of the most exciting, if not the most exciting theoretical developments of the present day” which is a good start.
But he considers himself to be a “friendly critic”, the meaning of which is hard to interpret. Does that mean he is attracted to MMT but has some quibbles or wants to be attracted but cannot bring himself to accept the basic precepts of MMT? Or something else?
Whatever, his essay raises a series of questions which seem define his skepticism and I am not sure I would place them in the realm of friendship, which in English would suggest a concern for the welfare thereof.
I decided to accept the invitation to respond because the issues he raises are mostly reasonable – (with an exception as you will see in Part 2) and they are issues that many interested readers raise when they first encounter Modern Monetary Theory (MMT).
As an aside, he mentions my name among MMT contributors to Makroscop and suggests I “maintain critical distance to MMT”, which is clearly not correct in my case, given I am one of the founders to this approach to macroeconomics. MMT is central to what I see as one of my academic contributions. I am far from ‘distant’.
An aside though.
Martin Höpner initially summarises what he considers to be the “cornerstones” of MMT, which he correctly acknowledges builds on a range of previous economic approaches (“Keynesianism, Chartalism, and the functional finance approach”).
We could quibble about the “Keynesianism” reference. In fact, I would say it was the work of Keynes not what followed that is of more influence on some of the original developers of MMT, although in my case, it is the work of Marx through to Kalecki that has more influence than Keynes’ General Theory. But that is another aside.
Please read my blog post – Those bad Keynesians are to blame – for more discussion on this point.
The summary points which Martin Höpner uses to set his critique of MMT up are:
1. There is a difference between the currency-issuer and the currency-user, such that the former has no intrinsic financial constraints on its spending. Such a government can always meet any liabilities that are denominated in the currency it issues.
And, if I may extrapolate further, this also means that such a government can purchase anything that is for sale in the currency it issues, including all idle labour.
Which means that the government chooses the unemployment rate. An elevated unemployment rate is always a political decision rather than anything that is forced on a nation by ‘market forces’ or the choice of individuals/households.
2. The governments ability to spend is prior to any revenue it might receive in the form of taxation. Taxation revenue comes from just funds that the government has already spent into existence.
Martin Höpner says: “Decisive is the order: Government expenditures are the condition of the collection of taxes, not vice versa.”
3. Central banks are monopoly creators of “central bank money”, while commercial banks create “bank money” out of thin air – through “balance sheet extension”.
Central banks set the interest rate but cannot control the broad money supply or the volume of “central bank money” in circulation.
This might seem a little confused. On the one hand, the government is a monopoly issuer of its own currency but then cannot control the volume in circulation.
The way to understand it is to realise that the central bank has no choice but to ensure there are enough bank reserves available given its charter is to maintain financial stability.
If cheques start bouncing because of a shortage of reserves then financial panic would follow.
4. “All considerations of deficits and debts must be made from a balance-theoretic perspective”, which means in the language of MMT that context is everything.
A government deficit (surplus) equals dollar-for-dollar a non-government surplus (deficit). This is the ‘balance-theoretic’ that Martin Höpner is referring to.
The non-government sector is comprised of the external and private domestic sectors. If the external sector is in deficit and the private domestic sector desires to save overall, then the government sector has to be in deficit and national income changes will ensure that occurs.
The aim of fiscal policy is not to deliver a particular fiscal outcome (surplus or deficit). Rather, it is to ensure that the discretionary government policy position is sufficient to ensure full employment and price stability, given the spending and saving decisions of the non-government sector.
If from a particular level of national income, the private domestic sector, for example, desires to save more overall and cuts its spending accordingly, then unless there is more net export spending coming in, the government will have to increase its deficit to avoid rising unemployment and a recession.
There is no particular significance in any fiscal outcome. Context is everything.
At this stage, Martin Höpner is in agreement – “Everything indicates that MMT provides the current best descriptive theory of money and credit creation with these points”.
So he believes that the proponents of MMT provide the best understanding of how the monetary systems we live within operate and the capacities that currency-issuing governments maintain.
Where he departs is when we start talking about “prescriptive” (policy) matters.
Here, he considers the policy implications of MMT to be “politically explosive”:
It reaches conclusions that seem contradictory to everything that was previously thought to be known about the room governments have to implement fiscal and monetary policy.
Martin Höpner is worried about some of the practical statements that MMT proponents make.
First, he is worried about the advocacy of flexible exchange rates, which MMT proponents (like me) argue maximises the policy space for government to pursue domestic objectives.
That point is a fact.
Once a nation adopts a currency peg of any description (fixed exchange rate, dollarisation, currency board, etc) it loses its full currency sovereignty and compromises domestic policy aspirations in order to maintain that exchange rate rigidity.
It is not about giving reign to free markets but maximising the sovereignty of the currency-issuer that underpins our advocacy of flexible exchange rates.
It is about removing constraints on policy that compromise the capacity of government to maintain full employment and price stability and deliver equitable outcomes to all.
Martin Höpner’s objection appears to be that MMT proponents present what he considers to be a:
Remarkable … juxtaposition of non-liberal and liberal principles.
“Remarkable” carrying a pejorative inference in this case.
Apparently advocating flexible exchange rates places MMT proponents in the ‘liberal’ camp where the market is dominant. But then, we allegedly adopt non-market policy positions on other matters. That is inconsistent in Martin Höpner’s view.
But at this point, while Martin Höpner more or less accuses MMT proponents of being hypocritical, he reveals he hasn’t fully understood the difference between MMT as a lens, which allow one to see the true workings of fiat monetary systems, and particular value systems that proponents might apply to that understanding.
His first error is to assert that:
MMT propagates state interference to an extent that most citizens find unimaginable.
No it doesn’t.
This is his “non-liberal” allegation.
I have stated this point often but it still seems to escape the attention of many critics (and second-generation MMTers, for that matter).
MMT is not a regime that you ‘apply’ or ‘switch to’ or ‘introduce’.
Rather, MMT is a lens which allows us to see the true (intrinsic) workings of the fiat monetary system.
It helps us better understand the choices available to a currency-issuing government.
It is not a regime but an accurate perspective on reality.
It lifts the veil imposed by neo-liberal ideology and forces the real questions and choices out in the open.
In that sense, MMT is neither right-wing nor left-wing – liberal or non-liberal – or whatever other description of value-systems that you care to deploy.
I mean by that, that while MMT provides a clear lens for viewing the system, to advance specific policy platforms, one has impose a value system (an ideology) onto that understanding.
So, while I, personally, advocate the state resuming its historical responsibility under the Post World War 2 social democratic consensus for sustaining full employment, because my values tell me that the ability to have a job is a key element of a sophisticated society and a starting point for social inclusion and equity, others might consider mass unemployment to be of use.
For example, they would see mass unemployment as advancing the interests of capital by suppressing the capacity of workers to share in productivity growth and maintain real wages.
But they would not be able to say the ‘state has run out money and cannot provide work for all’. They would be forced to justify the state not taking responsibility to eliminate mass unemployment via direct public sector job creation in terms of more venal motives.
So a person who claimed an understanding of the principles of MMT and used that as a lens to explicate the consequences of their policy prescriptions could easily support a very ‘liberal’ set of interventions or a very small ‘state’ footprint totally in accord with neoliberal type conceptions.
But, given that, what one cannot escape are the constraints imposed via national income changes on the fiscal balance as a result of non-government spending and saving decisions.
Even if one opts for a very small government footprint in terms of the proportion of available real resources that the public sector commands to advance public policy initiatives, it would still be the case that that government would have to run fiscal deficits should the non-government sector desire to save overall.
That is inescapable.
Trying to run fiscal surpluses in the face of a non-government sector desire to achieve a surplus itself will just result in a major recession and a fiscal deficit via the automatic stabilisers (as the tax base shrinks, for a start).
That sort of fiscal deficit is what I call a ‘bad’ deficit because it is associated with a rise in unemployment and a loss of national income (as a result of the recession).
The same ‘small’ government should, instead, run a ‘good’ deficit, by allowing their net spending to accommodate – to ‘fund’ – the desire of the non-government sector to save overall.
It would not mean the government was ‘large’ – deficits do not imply anything in particular about the overall ‘size’ of government.
But if the non-government sector enforces a desire to save overall (via its spending actions) then the government has no choice but to fund that via a fiscal deficit or accept recession as the inevitable consequence.
All of this is quite apart from the debate as to whether the dominant neoliberal paradigm is, in fact, ‘liberal’.
As Thomas Fazi and I explain in our new book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017) – the claim that neoliberalism is ‘pro-market’ is a misnomer.
In fact, it just deploys the capacities of the state in different ways to advance the interests of capital at the expense of other claimants on national income.
When state interference is required to protect profits and shareholder capital, the lobbyists will be working night and day to ensure that fiscal or regulative support is achieved.
A far better juxtaposition is between the neoliberal regime that ‘privatises the returns and socialises the losses’ against a progressive policy framework that advances the well-being of all citizens and doesn’t privilege capital in any particular way.
Having clarified those issues, we move on to the next misconception in Martin Höpner concern about flexible exchange rates.
While he asserts the falsehood that MMT is about extensive state intervention, he then claims (thanks to BastaFari for a better translation of this sentence):
On the other hand, MMT trusts in the ability of markets to find the right value for the most important price in capitalist economies after the wage: the exchange rate.
[Note Tuesday morning: as a result of the more accurate translation I have edited the following section up to the +++++ demarcation point].
I have dealt extensively with questions of the exchange rate and the open economy in relation to MMT previously. For example:
1. The capacity of the state and the open economy – Part 1 (February 8, 2016).
2. Is exchange rate depreciation inflationary? (February 9, 2016).
3. Balance of payments constraints (February 10, 2016).
4. Ultimately, real resource availability constrains prosperity (February 11, 2016).
The issues usually relate to the inflationary effects of depreciation including the erosion of living standards, trade competitiveness, and the destabilising impacts of currency speculation.
Taken together these concerns are bundled under a heading – ‘balance of payments constraints’.
So, while MMT proponents argue that the currency-issuing state has no financial constraints, critics argue that the capacity of a nation to increase domestic employment using fiscal deficits is limited by the external sector.
And they argue that these constraints have become more severe in this age of multinational firms with their global supply chains and the increased volume of global capital flows.
These critics erroneously believe that fixed exchange rates provide financial stability and insulate nations from imported inflation, while flexible exchange rates undermine stability.
The long-standing claim is that government deficits, designed to reduce unemployment will not only render a nation uncompetitive as unions took advantage of the higher employment to press ever-increasing wage demands, but the rising income would push out imports, leading to a balance of payments crisis and exchange rate depreciation.
The argument then contends that the Government has to step in and introduce contractionary fiscal policy and/or tighter monetary policy to suppress the wage pressures, reduce import demand and attract higher levels of capital inflow.
It is argued that under these conditions a nation is forced to follow a ‘stop-go’ growth path, where periods of stimulus and growth push the economy up against the balance of payments constraint, which then necessitates an economic downturn (not recession) to restore balance.
While the ‘stop-go’ terminology was really born in the period of fixed exchange rates (Bretton Woods period), it is survived into the flexible exchange rate era.
The first problem these critics find with flexible exchange rates is that nations can ‘import’ inflation from other nations, which negate real income gains made through domestic expansionary policy.
The exchange rate does influence the real value of the nominal incomes that a nation generates via its impact on import prices.
The purchasing value of nominal incomes depends on what the translation of the monetary value into real value is – that is, what is the volume of real goods and services that an income recipient can purchase.
Ostensibly, that depends on the prices of goods and services, some of which will be more influenced by movements in exchange rates than others.
Non-tradable goods and services will be much less influenced by exchange rate movements than direct imports. In many cases, these goods and services will have negligible exposure to exchange rate movements.
The provision of many services, for example, will have little variability to exchange rate fluctuations.
So, movements in the domestic price level are what really matters for the ‘real wage’ and the extent to which those movements are influenced by shifts in import prices arising from exchange rate movements depends on the degree of ‘pass through’ and the importance of imported goods and services to the overall basket that determines the workers’ material living standards.
Imagine a nation (A) that imports good X from nation B, which uses $B.
Say that good X costs nation A, $B5 and the exchange rate is at parity ($A1 = $B1). That means good X costs $A5 per unit.
Then if the currency of A depreciates, say by 20 per cent, such that $A1.20 = $B1, then good X which still costs $B5 will now cost $A6, if the full impacts of the depreciation are included in the local import price.
That situation would represent a ‘pass through’ of 100 per cent.
But suppose local importers decide to defend market share (against say an import competitive product) and take some of the depreciation impact via reducing their margin.
So, for example, the local price might only rise to $A5.20 rather than to $A6.
In this case, the 20 per cent depreciation has led to a 4 per cent rise in local price of imported good X and the ‘pass through’ would be 4/20 or 0.20.
This says that for every 1 per cent in currency depreciation, the local import price of a good will be 20 cents, a relatively low ‘pass through’.
The research evidence is clear – ‘pass through’ estimates are highly variable and depend on many factors including how much spare capacity there is in the economy, the degree of import competition, etc.
But that isn’t the end of the matter.
The second impact depends on how changes in overall consumer price inflation respond to changes in import prices. So ‘pass through’ might be high and rapid but the second impact low and drawn out, making the overall impact inconsequential.
So if imports are a relatively small proportion of goods and services included in the inflation measure, even if the ‘pass through’ is high, the overall impact on the domestic inflation rate will be small.
There is also the question of time lags – how long these separate effects take to impact. In many studies, the sum of the two impacts can take years to manifest.
It is also very difficult to come up with unambiguous estimates of these separate effects.
Estimates for Australia, for example, indicate (Source):
… that exchange rate changes are usually passed through quickly and to a large extent to import prices … [but] … the pass-through of exchange rate changes to overall consumer prices occurs gradually over an extended period … a 10 per cent exchange rate appreciation can typically be expected to result in a reduction in overall consumer prices … of around 1 per cent, spread over around three years.
That is a very small and drawn out effect, hardly justifying the assertion by Martin Höpner the exchange rate is the “most important price” in determining the purchasing power of workers’ wages.
The coherent empirical research on this question suggests that in the real world tells us that the ERPT is weak in most nations for which coherent empirical research has been conducted.
This blog post – Is exchange rate depreciation inflationary? (February 9, 2016) – discusses ‘pass through’ and the impact of exchange rate changes on inflation rates in more detail.
End of Tuesday Edit
Moreover, the history of fixed exchange rates tell us that the operations designed to defend the agreed parities across nations severely restrict the capacity of the government in nations that run external deficits to advance the well-being of the citizenry.
External deficit countries in nations that peg their currencies are prone to recession-bias, as they must restrict fiscal policy stimulus and run higher than otherwise interest rate regimes, the former being more damaging than the latter.
The result, which history has documented time and time again, is elevated levels of mass unemployment and all the costs that come with that degree of labour wastage.
While Germany has historically, at least in the last several decades before adopting the euro, been managing upward pressure on its currency – due to its trading strength and the deliberate policy positions adopted by the Bundesbank (interest rate management), most other nations have had to contend with recessionary biases due to their current account positions.
Their experience is that fixed exchange rates are very damaging.
These costs tend to dwarf all other costs including fluctuations in price levels that might be sourced in exchange rate variability.
Australia is a very open economy that has historically endured large swings in its exchange rate. Between February 29. 1984 and July 31, 1986, the Australian dollar depreciated by 36 per cent against the US dollar – quite a shift.
By January 31, 1989, the exchange rate had appreciated by 48.6 per cent against the US dollar – again, quite a shift in the opposite direction. This is a familiar pattern to citizens of Australia, a primary commodity producer.
Over the first period, Real net national disposable income rose just 3.3 per cent (per capita measure fell by 0.2 per cent), while real GDP rose 8.4 per cent and GDP per capita rose 4.7 per cent.
So even with a massive exchange rate depreciation, which followed major declines in our terms of trade, real per capita living standards barely fell using the Real net national disposable income measure and rose using the GDP per capita measure.
Three years later, Real net national disposable income had risen by 17 per cent (per capita measure rose by 12.2 per cent), while real GDP rose 12.6 per cent and GDP per capita rose 8.1 per cent.
It is also the case that the distributional impacts of those shifts are uneven. Buyers of expensive imported (luxury) cars suffer more than those who purchase the lower-margin cars. Those who take overseas ski holidays at expensive resorts face higher costs. The rest of us go camping up the coast!
Australia regularly goes through these sorts of exchange rate swings but manages to be classified as among the richest per capita nations in the world.
It is simply untrue that a flexible exchange rate system severely compromises the material living standards of workers.
Second, it is false to think that a flexible exchange rate regime is more prone to speculative attacks on a nation’s currency.
If anything, the reverse is true.
When currency traders form the view that a government will have to eventually devalue a fixed peg parity to stem the consequences that accompany a chronic current account deficit they can easily hasten that decision by short-selling. It becomes a self-fulfilling inevitability.
And, in this context, it is also untrue to assert that MMT proponents such as myself advocate total market determined exchange rates when we advocate flexible exchange rates.
I have repeatedly noted that the nation state has the capacity to impose capital controls if there are destabilising financial flows present.
Iceland has demonstrated the effectiveness of using capital controls to stop the financial sector undermining currency stability through speculative capital outflows. Similarly, unproductive capital inflows can be subjected to direct legislative controls.
We outline how this is done in some detail in our new book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017).
That ends Part 1.
In Part 2 we will address criticisms about interest rate management and bond yields.
In Part 3 – and yes, it was a German raising these issues – we will discuss his fear that the political class will go wild once they realise that taxes and bond sales no longer fund government spending and generate … wait for it … uncontrollable inflation.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.