Last week (July 14, 2020), a former deputy governor of the Reserve Bank of Australia (RBA), Stephen Grenville wrote an article – Modern Monetary Theory and mainstream economics converging. The title suggests a gathering of minds between two paradigms – the degenerative mainstream macroeconomics and the emerging Modern Monetary Theory (MMT). I wouldn’t represent what is happening in that way. Convergence implies a harmonious process. The reality is that some of the mainstream economists have realised that their approach is deeply flawed and events over many years have demonstrated those flaws, while ratifying the empirical content of central MMT propositions. Our position has been consistent over 25 years. Now, the mainstream is fracturing and economists are trying to save face and remain relevant by suggesting, in various ways, that they knew all of the MMT insights all along, or variants on that theme. They didn’t. They were deeply opposed and hostile to key MMT insights that are now becoming widely acknowledged as correct. In trying to maintain this image of convergence, Stephen Grenville’s article, while quite insightful in many ways, misleads his readership and mispresents key MMT elements.
Stephen Grenville considers many of the taboos about “the perils of budget deficits” or Central banks “abandoning time-honoured conventions and funding these budget deficits to a greater or lesser degree by buying government bonds” are evaporating within the economics profession as the practice and empirics of the last several decades demonstrate the major insights of MMT and expose the fictions that underpin the main body of mainstream economics.
There is no doubt about that.
The key propositions of mainstream macroeconomics are false. There are not nuances here. False is false.
Fiscal deficits do not drive up interest rates because there is a finite pool of savings that government competes with non-government borrowers over.
When central banks credit bank accounts and add reserves to the banking system, inflation does not follow.
Fiscal deficits do not undermine economic growth by causing an offsetting fall in non-government spending as people fear higher future tax burdens and therefore increase their saving.
Alleged thresholds for government debt, after which insolvency becomes inevitable, have never been realised. Fake news. There are no limits to public debt issued in the currency of issue.
Bond markets do not have the capacity to force elevated yields onto a government against its wishes. The government (central bank and treasury) can determine the conditions of any bond auctions including setting the yields.
No mainstream economist considered any of those previous statements to have veracity. They vilified MMT economists for years – as being cranks, charlatons, and whatever filthy insult they could legally get away with.
They were wrong.
Stephen Grenville acknowledges that. He also hints that mainstreamers have been caught out when he says:
Mainstream economists are adamant that they are not supporters of MMT, although just where they disagree is sometimes unclear.
There is nowhere to go when the body of work you have devoted your life to as an academic or practictioner is exposed as a fiction.
One of the interesting elements of this paradigm tension now is watching the ways the mainstream economists seek to defend their reputations while progressively trying to adopt MMT propositions but deny they are doing that.
As an MMT economist who was there at the beginning and has been part of the whole evolution I have a long memory of the sort of things these mainstreamers said and wrote when they thought we were not relevant or did not have any effective voice.
Now everyone wants to know about our work – the tide has turned and the discomfort among the mainstreamers is for all to behold.
Stephen Grenville doesn’t represent MMT correctly in a number of places, although I would say that I don’t think this is not out of the usual malice that accompanies such articles. I think he has genuinely tried to come to grips with our work.
He says, for example:
… the MMT core message – run deficits to maintain full employment and fund them by money-printing.
Once again trying to understand MMT by reframining it back into mainstream concepts.
Mainstream economists deploy the ‘government budget constraint’ (GBC) framework to analyse fiscal policy decisions. Accordingly, governments are alleged to face a financial constraint and have to fund spending via taxation, bond issuance, or ‘money printing’,the latter referring to some idea that the central bank ensures the currency injections on behalf of government are facilitated.
In the mainstream approach, all sources of ‘funds’ carry alleged ‘costs’ (taxes distort behaviour, bond issuance drives up interest rates, and money finance is inflation). As a result, fiscal deficits are largely eschewed.
MMT economists never construct government spending in this way. There is no ‘money printing’ involved.
Government spending is performed in the same way irrespective of the accompanying monetary operations. There is no spending ‘out’ of taxes, or spending out of bond sales, or spending out of central bank reserve creation.
Interestingly, Stephen Grenville implicitly acknowledges that the rejection of the use of deficits to maintain full employment, the approach which dominated the three decades following the Second World War, was really driven by the “Thatcher/Regan (sic) revolution” that:
… was preaching the ‘small government’ creed – that governments should do as little as possible.
Preaching = religion.
The rise in acceptance of Monetarism was not based on an empirical rejection of the Keynesian orthodoxy.
American economist Alan Blinder wrote in 1988 (p.278) that is:
… was instead a triumph of a priori theorising over empiricism, of intellectual aesthetics over observation and, in some measure, of conservative ideology over liberalism. It was not, in a word, a Kuhnian scientific revolution.
(Reference: Blinder, A. (1988) ‘The fall and rise of Keynesian economics’, Economic Record, 64(187), 278-294.)
There was a concerted campaign including the publication of the Powell Manifesto and the funding of a burgeoning number of right-wing think tanks by those who saw gain in undermining the commitment to full employment and various financial and labour market regulations to promote the idea of Monetarism irrespective of the facts.
Please read my blog – The right-wing counter attack – 1971 (March 24, 2016) – for more discussion on this point.
The perception created by the academics and think tanks was successful in making inflation appear to be a worse bogey person than unemployment.
Alan Blinder also saw through the ideological campaign, although he remained within the mainstream.
In his 1987 book – Hard heads soft hearts – he wrote (p.33):
The political revival of free-market ideology in the 1980s is, I presume, based on the market’s remarkable ability to root out inefficiency. But not all inefficiencies are created equal. In particular, high unemployment represents a waste of resources so colossal that no one truly interested in efficiency can be complacent about it. It is both ironic and tragic that, in searching out ways to improve economic efficiency, we seem to have ignored the biggest inefficiency of them all.
He also wrote (pp.45-50):
Promiscuity? Sloth? Perfidy? When will inflation be blamed for floods, famine, pestilence, and acne? … the myth that the inflationary demon, unless exorcised, will inevitably grow is exactly that – a myth. There is neither theoretical nor statistical support for the popular notion that inflation has a built-in tendency to accelerate. As rational individuals, we do not volunteer for a lobotomy to cure a head cold. Yet, as a collectivity, we routinely prescribe the economic equivalent of lobotomy (high unemployment) as a cure for the inflationary cold. Why?
So while Stephen Grenville is correct in writing “has revived the old Keynesian message: if the economy has spare capacity, governments should expand the budget to bring the economy back to full employment” it is also true that this ‘old message’ was not abandoned because it was proven to be incorrect or would lead to damaging policies.
It was abandoned because shifting the policy focus away from ‘full employment’ and fiscal activism towards ‘full employability’ repressed wages growth, allowed for deregulation to tilt the balance of power in the distributional system towards capital, and facilitated major shifts in national income distribution away from workers.
It was a power play not a knowledge revolution.
But Stephen Grenville still hangs onto old notions.
The MMT proponents argue that if the government bond issue raises interest rates so as to crowd-out the deficit stimulus, the government should instead fund its deficit by using the money-creation capacity of the central bank.
I don’t know one (credible) MMT proponent who thinks that government bond issues push up yields and “crowd-out” public stimulus, if we are referring to a currency-issuing government.
The whole crowding out fiction is derived from the classical loanable funds ideas, categorically rejected in the 1930s but still in vogue post Monetarism.
Mainstream economists think that banks loan out deposits, and, as there is a finite pool of ‘savings’, any competition for those savings from government deficits will drive up interest rates and damage interest-sensitive non-government spending.
Go to any mainstream macroeconomics or monetary economics textbook and you will find this story.
MMT provides a point of departure, which is ground in the foundations of a fiat monetary system and the banking reality, rather than a fictional world constructed by mainstream economists that allows them to draw the convenient conclusions they require to give ‘authority’ to their policy positions.
But, in the real world, loans create deposits. Banks will extend credit to any credit worthy customers knowing they can always get the reserves to cover the payments system implications from the central bank if necessary. Banks do not loan out reserves. There is no finite pool of savings that is squeezed by government auctions in debt markets.
Stephen Grenville acknowledges these facts when he disabuses the reader of the notion that banks loan out reserves (using a US example, which applies everywhere):
Nor did the extra base money held by the banks cause them to increase their lending: bank credit actually fell in the major economies during the two years after the crisis. The banks had already made all the loans to bankable customers that they wanted to make, and they had nothing better to do with the excess base money other than to put it with the Fed in the form of banks’ reserves.
He accuses us of being “slippery, on the detail here, as this is the chief vulnerability of the MMT narrative.”
My understanding of the MMT literature (as a major contributor) is that there is no slipperiness at all on the consequences of a central bank crediting bank accounts to facilitate government spending, nor any monetary operations that might accompany such accounting choices.
We are very explicit as to what happens.
Our – Macroeconomics – textbook, for example, lays out all the accounting and the consequences of different choices – like bond-issuance, no bond-issuance, etc.
Other MMT books and articles do the same.
But apparently we miss or deliberately avoid the central flaw in our work.
Which according to Stephen Grenville can be explained in this way – fiscal deficits ultimately end up:
… increasing the banks’ reserves at the central bank.
It is these banks’ reserves that are, in effect, funding the budget deficit. They are NOT free of interest cost, as central banks pay the banks a market-related interest return. And they DO increase official-sector debt – these reserves are a liability of the central bank to the banking system, and so should properly be counted as part of official debt.
In short, the core MMT promise, sometimes implicit, is interest-free financing which doesn’t add to official debt. This is clearly wrong. Milton Friedman got this much right: ‘there is no free lunch’.
The reserves are indeed liabilities of the government. For example, the banks could swap them for vault cash and the central bank (the government) would have to give them the cash and write down the non-cash reserve accounts.
But we have to get the causality right.
Where did the reserves come from? Answer: the net government spending.
If the government was running a balance – spending equals taxation – there would be no build up of reserves coming from government fiscal policy. There would be no capacity in the non-government sector to accumulate net financial assets in the currency of issue.
Sure banks can create loans which create deposits, but nothing net is created.
The fiscal deficit is, in fact, financing the bank reserves in this case, not the other way around.
Further, whether they are “free of interest cost” is a policy choice of government.
The central bank could decline to pay a return on excess reserves and the short-term interest rate would drop to zero (or thereabouts) as the banks tried to rid themselves of their excess holdings in the interbank market by loaning them to other banks.
Ultimately, when there is a system-wide excess of reserves, such competitive behaviour is futile. The banks only can shuffle the excess around among themselves.
But while the reserves are a liability of government, they are qualitatively different to government bonds which are issued to the non-government sector via primary auctions and then traded for speculative purposes in the secondary markets.
Banks cannot loan out reserves (except within the interbank market). They cannot ‘spend’ these reserves to buy shares or other assets.
They cannot trade them for speculative profit with other non-bank counterparties.
And whether we call them ‘government debt’ or not alters nothing – the government can meet any of its liabilities with key stroke entries. No real resources are sacrificed in doing so.
The only sense that Milton Friedman’s ‘no free lunch’ can be applicable, is if it relates to real resource costs. The numbers that governments enter into ‘fiscal statements’ are not costs. The costs of a government program are the real resources it deploys (and, when there is already full employment, takes from other uses).
Stephen Grenville also thinks that “the heretical idea of ‘helicopter money’, essentially the same as MMT.”
But, the concept of helicopter money is not remotely the same as MMT.
You might like to read these blog posts among others:
1. Helicopter money is a fiscal operation and is not inherently inflationary (September 6, 2016).
2. Keep the helicopters on their pads and just spend (December 20, 2012).
3. The ‘rats’ are deserting the mainstream ship – and everyone wants in (September 25, 2019).
4. The consolidated government – treasury and central bank (August 20, 2010).
6. Overt Monetary Financing – again (November 18, 2015).
7. OMF – paranoia for many but a solution for all (November 28, 2013).
The conflation with ‘helicopter money’ and MMT reflects the tendency by mainstream economists to reframe everything back into their flawed framework.
The helicopter references comes from Milton Friedman’s suggestion in the introduction (page 4) to his collection of essays – ‘The Optimum Quantity of Money and other Essays”, Chicago: Aldine Publishing Company, 1969 – that a chronic episode of price deflation could be resolved by “dropping money out of a helicopter”.
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 Overt Monetary Financing that is developed by MMT proponents.
Governments spend by crediting bank accounts (and in some cases sending out cheques to recipients), which then are deposited in bank accounts.
But, from the perspective of MMT, a helicopter drop, as some alternative regime to ‘fund’ government spending, is an inapplicable construct.
The reality is that an increase in the fiscal deficit introduces new financial assets and the net worth of the non-government sector increases.
Whether the government matches the deficit with bonds-issued to the central bank or bonds auctioned to the non-government sector is moot. This choice certaintly has implications for the way the central bank manages liquidity.
The point is that the central bank can add whatever numbers to the treasury’s bank account that the government requires without question.
There is not a shift to a ‘helicopter drop’ regime, if governments refrain from issuing debt to the non-government sector but account for the transactions solely within the government sector.
The fact is that it is the consolidated government that issues the currency and spends it into existence. The two arms of government have to work together on a daily basis for their individual policy ambitions to be effective.
So terminology such as “money-financed deficits” are also inapplicable.
All public spending is accounted for and facilitated by the central bank in the same way. There is no code book which is used to delineate ‘tax matched spending’, ‘debt matched spending’, etc.
Given Stephen Grenville’s professional background, he will have an intimate knowledge of this coordination between the arms of government.
Further, think about the act of issuing a bond to the non-government sector or not.
In the case of a bond being issued, the private purchaser just engages in an asset swap within his/her existing wealth portfolio.
If no bond is issued, the impact on the net financial asset position in the non-government sector is identical and comes from the government spending injection. In this case, there is no portfolio shuffle in the non-government sector.
And the spending boost is identical in both cases.
Some think that by selling a bond, the spending impact is lower. But the funds used to purchase the bond were not being spent anyway. And had they been, the need for the fiscal deficit would be reduced because non-government spending would be higher.
Stephen Grenville thinks that the issue here is that of ‘financial repression’.
This is because bank reserves would rise under the no-bond issuance case rather than be drained by open market operations. The banks would be forced to hold them.
But I will leave his argument here for another day. Time is up.
One of the more interesting articles about MMT from a critic who has worked within central banks at a senior level.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.