Today, I am in the mountains north of Melbourne (Healesville) talking to the – Chair Forum – which is a gathering of all the Superannuation Fund Board chairs. I am presenting the argument that the reliance on monetary policy and the pursuit of fiscal austerity in this neoliberal era, which has been pushed to ridiculous extremes around the globe, has culminated in the socio-economic and ecological crisis that besets the world and is pushing more and more policy makers to express their doubts about the previous policy consensus. I will obviously frame this in the context of Modern Monetary Theory (MMT), given that our work has been the only consistent voice in this debate over a quarter of the century. What economists are suddenly coming to realise has been core MMT knowledge from the outset.
There is increasing evidence that MMT is now mainstreaming.
Last week, the conservative Australian daily, The Australian published an article on MMT. It was critical but that is not the point.
Yesterday (January 28, 2020), the major financial daily, the Australian Financial Review (AFR), published an article – Why you need to know about modern monetary theory – which, although containing some errors, represents a very important step in the broader acceptance of our ideas.
There has been an evolution of these articles about MMT in the mainstream media around the world over the last several years, as the mainstream policy consensus starts to break down.
The first generation expressed the fears of the mainstream that a credible challenger was in its midst and chose to publicise the criticisms from mainstream macroeconomists such as Kenneth Rogoff, Paul Krugman, Larry Summers and others as well as giving space to a potpourri of critics who displayed little knowledge of what they were actually writing about.
Then some more serious attempts to engage emerged, but still not capturing what MMT was actually about.
More recently, I have seen some articles that more faithfully attempts to introduce MMT ideas to their readers and restrict the temptation to just repeat the standard mainstream attacks that have been present since we first set out on this journey in the mid-1990s.
The AFR article is an example of the latter.
It argues that “Conventional economics has struggled to explain much of what’s happening in the world today” and that “Modern monetary theory (MMT) uses iron-clad rules of accounting to offer not just plausible but logical explanations for many conundrums that leave orthodox economists scratching their heads.”
There are problems with the article though, although, in general, it marks are huge step forward to the mainstreaming of our ideas.
For example, the article repeats the claim that MMT is just ‘accounting’, or ‘description’, or an ‘observation’.
Finally, it’s not really a “theory” – it’s actually a straight-up application of accounting rules to explain how money works in an economy where the government controls its own currency. In other words, an economy like Australia’s. It’s not unlike how the “theory” of gravity is simply an application of the rules of physics.
That is an oft-repeated claim but if MMT was just “an application of accounting rules” then we would have very little to say.
The clue that the article is a bit confused here is the next phrase “to explain”.
I put this point to rest in this blog post – Understanding what the T in MMT involves (September 20, 2018).
Accounting is clearly important to MMT as we aim to be stock-flow consistent.
An example, is the sectoral balances framework, which we inherited from past approaches to providing an alternative perspective of the National Accounting framework.
By dint of the accounting definitions inherent in that framework, clearly it must always be the case that a government deficit is exactly equal to a non-government surplus and vice versa.
Decomposing that to another level, we know that the sum of the government financial balance, the private domestic financial balance and the external financial balance must always add to zero, which is just a derivative of the accounting statement in the previous paragraph.
But if that is all MMT was then we don’t get far.
The question is how do those financial balances adjust when one or more changes to ensure that accounting identity is maintained.
The answer requires us to theorise about economic (and human) behaviour.
What drives saving and consumption decisions by households?
What drives investment behaviour by firms?
What drives import spending?
What drives exports?
Behavioural theories are required to answer those questions and they are important parts of the body of work that we now refer to as MMT.
But the fact that the mainstream press is now focusing on the policy dissonance and associating MMT with a way of resolving the ignorance and contradictions that besets mainstream macroeconomics is an important development.
In that regard, the – Minutes of the Federal Open Market Committee – from the October 29-30 meeting, which record the discussion of the US central bank’s monetary policy setting body, were quite interesting.
The meeting considered a “Review of Monetary Policy Strategy, Tools, and Communication Practices”
As governments resist the increasing call to prioritise fiscal stimulus to overcome the policy void, central bankers are trying to come to terms with the options they might have left in an effort to avoid recession.
Moreover, it is not just recession that is of concern to them. They are also trying to maintain their own credibility by pushing inflation rates up to their explicit or implicit inflation targets.
The central banks really trapped themselves by articulating their policy stance in terms of an inflation target, which they then call their desired stability levels.
The problem is that inflation rates have consistently been below their targets despite massive growth in central bank balance sheets as a result of QE and other policy interventions.
It is only a matter of time, when the consensus will shift and acknowledge that the policy instruments they were using that have failed to achieve their goal to stimulate inflation were motivated by mainstream theory.
The failure is a failure of that mainstream theory.
Only MMT has been able to explain this failure.
The discussions at the FOMC, in this regard, were interesting.
A part of the briefing the FOMC participated in focused on “balance sheet tools”, which up until now had been principally “the large-scale asset purchase programs implemented by the Federal Reserve after the financial crisis.”
However, at this meeting they discussed:
… policy tools that the Federal Reserve had not used in the recent past, participants discussed the benefits and costs of using balance sheet tools to cap rates on short- or long-maturity Treasury securities through open market operations as necessary.
Read that again.
The central bank was confirming that it had the policy tools available to cap government bond yields (rates) at whatever maturity it chooses, including all rates.
The dicsussion noted that various likely benefits, including “might require a smaller amount of asset purchases to provide a similar amount of accommodation as a quantity-based program purchasing longer-maturity securities”.
But, as expected, some FOMC members were antagonistic because:
… managing longer-term interest rates might be seen as interacting with the federal debt management process.
That is central bank speak for the central bank using its currency-issuing capacity to facilitate the treasury department deficit spending without any intrinsic need for the latter to match those deficits with debt-issuance in the non-government sector.
The fact that the US central bank acknowledges this capacity stands in contradistinction to on-going mainstream macroeconomic theory.
Even the more ‘progressive’ New Keynesians fall prey to the myth that fiscal deficits drive up interest rates.
Remember Paul Krugman (January 9, 2017) – Deficits Matter Again – asserting that:
What changes once we’re close to full employment? Basically, government borrowing once again competes with the private sector for a limited amount of money. This means that deficit spending no longer provides much if any economic boost, because it drives up interest rates and “crowds out” private investment.
This supply-determined view of banking is clearly not describing the way banks operate in the real world.
Loans create deposits whether the economy is at full employment or has idle capacity.
Banks do not have a finite quantity of ‘money’ to dish out and will extend loans to credit-worthy borrowers. If they cannot find the reserves in the interbank market to cover shortfalls when the transactions are resolved within the daily payments system, they know they can always access the necessary reserves from the central bank.
But, moreover, the idea that the ‘market’ determines interest rates and bond yields assumes that the government and the central bank is passive.
They may be. But only by choice.
The point that the FOMC Minutes quoted above is making is that the central bank can always control bond yields at any maturity they desire including all maturities and sets the short-term interest rate, which then conditions market rates anyway.
According to the statement released by the Bank of Japan (July 31, 2018) – Strengthening the Framework for Continuous Powerful Monetary Easing – the QQE with Yield Curve Control – program has several aims, including:
The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent” and in a footnote they said “In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately.”
I wrote about QE in Japan in these blog posts among others:
1. Bank of Japan’s QE strategy is failing (April 24, 2018).
2. Japan again demonstrates basic errors in mainstream macroeconomic theory (August 28, 2019).
3. Bank of Japan once again shows who calls the shots (September 3, 2018).
The lesson that most economists do not understand is that the bond markets operate within the space granted to them by the policy decisions of the government.
The central bank always calls the shots on yields and the bond markets only set yields if the government allows them to.
This should tell you that all the claims made by mainstream economists and the sycophantic commentators that just copy their words that bond markets will drive yields up when they lose trust in a government’s ability to pay and this sparks a crisis which can only be resolved by fiscal austerity are hollow.
The bond markets can never drive a currency-issuing government into insolvency.
The bond markets can never drive yields up to elevated levels unless the government (via its central banks) allows that.
The bond markets are mendicants in this context.
In this blog post – Direct central bank purchases of government debt (October 2, 2014) – I discussed the way the Australian government shifted in the 1980s from a tap system of debt sales to the current auction system.
In the former system, the government set the rate it would pay on debt issued and if the bond markets were not happy with the return and declined to buy the debt, the central bank would always buy the difference.
In the neoliberal era, this was the anathema so they shifted to a system where the government would announce an amount it wanted to borrow and the bond dealers would then bid for the debt by disclosing yields they were prepared to pay.
We saw this play out before our eyes when the systems shifted.
In 2000, the Deputy Chief Executive Officer of Australian Office of Financial Management (a division of Treasury that manages the debt) claimed the old tap system where the central bank would always buy debt not wanted by the private sector was:
… breaching what is today regarded as a central tenet of government financing – that the government fully fund itself in the market. It then became the central bank’s task to operate in the market to offset the obvious inflationary consequences of this form of financing, muddying the waters between monetary policy and debt management operations.
The so-called “central tenet” – is pure ideology and has no foundation in any economic theory. It is a political statement. But mainstream economics is happy to blur the boundaries between theory and ideology when it suits.
What they really wanted to deliver was an elaborate system of corporate welfare so that the financial markets could get their hands on risk-free financial assets upon which they could benchmark their speculative pursuits.
The impact of this antagonism to direct central bank purchase at the time saw the government also abandon their commitment to full employment, which satisfied the conservatives who saw unemployment as a way to redistribute more of the national income toward profits.
The auction model merely supplied the required volume of government paper at whatever price was bid in the market. So there was never any shortfall of bids because obviously the auction would drive the price (returns) up so that the desired holdings of bonds by the private sector increased accordingly.
But you see the ideology behind the decision by examining the documentation of the day. This quote is from a speech from the Deputy Chief Executive Officer of AOFM:
The reduced fiscal discipline associated with a government having a capacity to raise cheap funds from the central bank, the likely inflationary consequences of this form of ‘official sector’ funding … It is with good reason that it is now widely accepted that sound financial management requires that the two activities are kept separate.
Read it over: reduced fiscal discipline … that was the driving force. They were aiming to wind back the government and so they wanted to impose as many voluntary constraints on its operations as they could think off.
So the fact that the Bank of Japan has been basically funding fiscal deficits at zero burden without “inflationary consequences” should tell you that the hype around central bank yield capping is ideological rather than sound economic logic.
And now, the US Federal Reserve is considering returning to a cap system, which it successfully deployed after the Second World War.
The Wall Street Journal article (January 26, 2020) – Fed Officials Weigh New Recession-Fighting Tool: Capping Treasury Yields – provides some historical discussion about this.
Also see my blog post – Operation twist – then and now (March 31, 2010) – for more MMT-oriented analysis of the US period of yield capping.
The WSJ tells us that:
With yield caps, by contrast, the Fed would commit to purchase unlimited amounts at a particular maturity to peg rates at the target.
The central bank can always do this.
There is never a reason for yields on government bonds rising should that be deemed undesirable.
So the categorical or blanket claim that fiscal deficits will drive up yields is just false.
Of course, the better solution is for the government to stop issuing debt altogether and instructing its central bank to credit bank accounts when spending needs to be facilitated.
After all, the build up of the asset side of central banks around the world over the last decade is really just a sign that this has been happening anyway – via some institutional gymnastics that assuage fear but don’t alter the facts.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.