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The Weekend Quiz – August 28-29, 2021 – answers and discussion

Here are the answers with discussion for this Weekend’s Quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of Modern Monetary Theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

Here are the answers with discussion for yesterday’s quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

Question 1:

In a fiat monetary system (for example, US or Australia) with an on-going external deficit, if you desire the domestic private sector to reduce its overall debt levels without employment losses, then you have to support the national government increasing the fiscal deficit beyond the size of the external deficit in line with the private de-leveraging process.

The answer is True.

This question is an application of the sectoral balances framework that can be derived from the National Accounts for any nation.

To refresh your memory the sectoral balances are derived as follows. The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.

From the sources perspective we write:

GDP = C + I + G + (X – M)

which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X – M).

Expression (1) tells us that total income in the economy per period will be exactly equal to total spending from all sources of expenditure.

We also have to acknowledge that financial balances of the sectors are impacted by net government taxes (T) which includes all taxes and transfer and interest payments (the latter are not counted independently in the expenditure Expression (1)).

Further, as noted above the trade account is only one aspect of the financial flows between the domestic economy and the external sector. we have to include net external income flows (FNI).

Adding in the net external income flows (FNI) to Expression (2) for GDP we get the familiar gross national product or gross national income measure (GNP):

(2) GNP = C + I + G + (X – M) + FNI

To render this approach into the sectoral balances form, we subtract total taxes and transfers (T) from both sides of Expression (3) to get:

(3) GNP – T = C + I + G + (X – M) + FNI – T

Now we can collect the terms by arranging them according to the three sectoral balances:

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)

The the terms in Expression (4) are relatively easy to understand now.

The term (GNP – C – T) represents total income less the amount consumed less the amount paid to government in taxes (taking into account transfers coming the other way). In other words, it represents private domestic saving.

The left-hand side of Equation (4), (GNP – C – T) – I, thus is the overall saving of the private domestic sector, which is distinct from total household saving denoted by the term (GNP – C – T).

In other words, the left-hand side of Equation (4) is the private domestic financial balance and if it is positive then the sector is spending less than its total income and if it is negative the sector is spending more than it total income.

The term (G – T) is the government financial balance and is in deficit if government spending (G) is greater than government tax revenue minus transfers (T), and in surplus if the balance is negative.

Finally, the other right-hand side term (X – M + FNI) is the external financial balance, commonly known as the current account balance (CAB). It is in surplus if positive and deficit if negative.

In English we could say that:

The private financial balance equals the sum of the government financial balance plus the current account balance.

We can re-write Expression (6) in this way to get the sectoral balances equation:

(5) (S – I) = (G – T) + CAB

which is interpreted as meaning that government sector deficits (G – T > 0) and current account surpluses (CAB > 0) generate national income and net financial assets for the private domestic sector.

Conversely, government surpluses (G – T < 0) and current account deficits (CAB < 0) reduce national income and undermine the capacity of the private domestic sector to add financial assets.

Expression (5) can also be written as:

(6) [(S – I) – CAB] = (G – T)

where the term on the left-hand side [(S – I) – CAB] is the non-government sector financial balance and is of equal and opposite sign to the government financial balance.

This is the familiar MMT statement that a government sector deficit (surplus) is equal dollar-for-dollar to the non-government sector surplus (deficit).

The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)) plus net income transfers.

All these relationships (equations) hold as a matter of accounting and not matters of opinion.

To help us answer the specific question posed, we can identify three states all involving public and external deficits:

  • Case A: Fiscal Deficit (G – T) < Current Account balance (X – M) deficit.
  • Case B: Fiscal Deficit (G – T) = Current Account balance (X – M) deficit.
  • Case C: Fiscal Deficit (G – T) > Current Account balance (X – M) deficit.

The following Table shows these three cases expressing the balances as percentages of GDP.

Case A shows the situation where the external deficit exceeds the public deficit and the private domestic sector is in deficit.

In this case, there can be no overall private domestic sector de-leveraging.

With the external balance set at a 2 per cent of GDP, as the government moves into larger deficit, the private domestic balance approaches balance (Case B).

Case B also does not permit the private sector to save overall.

Once the fiscal deficit is large enough (3 per cent of GDP) to offset the demand-draining external deficit (2 per cent of GDP) the private domestic sector can save overall (Case C).

In this situation, the fiscal deficits are supporting aggregate spending which allows income growth to be sufficient to generate savings greater than investment in the private domestic sector but have to be able to offset the demand-draining impacts of the external deficits to provide sufficient income growth for the private domestic sector to save.

Sectoral Balance Interpretation of Result Case A Case B Case C
External Balance (X – M) Deficit is negative -2 -2 -2
Fiscal Balance (G – T) Deficit is positive 1 2 3
Private Domestic Balance (S – I) Deficit is negative -1 0 1

For the domestic private sector (households and firms) to reduce their overall levels of debt they have to net save overall.

The behavioural implications of this accounting result would manifest as reduced consumption or investment, which, in turn, would reduce overall aggregate demand.

The normal inventory-cycle view of what happens next goes like this.

Output and employment are functions of aggregate spending.

Firms form expectations of future aggregate demand and produce accordingly.

They are uncertain about the actual demand that will be realised as the output emerges from the production process.

The first signal firms get that household consumption is falling is in the unintended build-up of inventories.

That signals to firms that they were overly optimistic about the level of demand in that particular period.

Once this realisation becomes consolidated, that is, firms generally realise they have over-produced, output starts to fall.

Firms lay-off workers and the loss of income starts to multiply as those workers reduce their spending elsewhere.

At that point, the economy is heading for a recession.

So the only way to avoid these spiralling employment losses would be for an exogenous intervention to occur.

Given the question assumes on-going external deficits, the implication is that the exogenous intervention would come from an expanding public deficit.

Clearly, if the external sector improved the expansion could come from net exports.

It is possible that at the same time that the households and firms are reducing their consumption in an attempt to lift the saving ratio, net exports boom.

A net exports boom adds to aggregate demand (the spending injection via exports is greater than the spending leakage via imports).

So it is possible that the public fiscal balance could actually go towards surplus and the private domestic sector increase its saving ratio if net exports were strong enough.

The important point is that the three sectors add to demand in their own ways.

Total GDP and employment are dependent on aggregate demand.

Variations in aggregate demand thus cause variations in output (GDP), incomes and employment. But a variation in spending in one sector can be made up via offsetting changes in the other sectors.

So the fiscal deficit has to increase continually to support the net saving desires of the private domestic sector.

The following blog posts may be of further interest to you:

Question 2:

The only time that fiscal surplus represents increased national savings is when the government creates a sovereign fund.

The answer is False.

From the perspective of Modern Monetary Theory (MMT) the national government’s ability to make timely payment of its own currency is never numerically constrained by revenues from taxing and/or borrowing.

Therefore the creation of a sovereign fund by purchasing assets in financial markets in no way enhances the government’s ability to meet future obligations.

In fact, the entire concept of government pre-funding an unfunded liability in its currency of issue has no application whatsoever in the context of a flexible exchange rate and the modern monetary system.

The misconception that “public saving” is required to fund future public expenditure is often rehearsed in the financial media.

In rejecting the notion that public surpluses create a cache of money that can be spent later we note that Government spends by crediting an account held by the commercial banks at the central bank.

There is no revenue constraint – government cheques don’t bounce!

Additionally, taxation consists of debiting an account held by the commercial banks at the central bank.

The funds debited are “accounted for” but don’t actually “go anywhere” and “accumulate”.

Thus is makes no sense to say that a sovereign government is saving in its own currency.

Saving is an act that revenue-constrained households do to enhance their future consumption opportunities.

The sacrifice of consumption now provides more funds in the future (via compounding).

But the government doesn’t have to sacrifice spending now to spend in the future.

The concept of pre-funding future liabilities does apply to fixed exchange rate regimes, as sufficient reserves must be held to facilitate guaranteed conversion features of the currency.

It also applies to non-government users of a currency.

Their ability to spend is a function of their revenues and reserves of that currency.

So at the heart of the mis-perceptions about sovereign funds is the false analogy mainstream macroeconomics draws between private household fiscals and the government fiscal.

Households, the users of the currency, must finance their spending prior to the fact, which means that the government, as the issuer of the currency, must spend first (credit private bank accounts) before it can subsequently tax (debit private accounts).

Government spending is the source of the funds the private sector requires to pay its taxes and to net save and is not inherently revenue constrained.

However, trying to squeeze the economy to generate these mythical “pools of funds” which are then allocated to the sovereign fund as if they exist is very damaging.

You can think of this in two stages.

First, the national government spends less than it taxes and this leads to ever decreasing levels of net private savings (unless there is a strong positive net exports response).

The private deficits are manifest in the public surpluses and increasingly leverage the private sector.

The deteriorating private debt to income ratios which result will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity.

Second, while that process is going on, the Federal Government is actually spending an equivalent amount that it is draining from the private sector (through tax revenues) in the financial and broader asset markets (domestic and abroad) buying up speculative assets including shares and real estate.

Accordingly, creating a sovereign fund amounts to the government competing in the private equity market to fuel speculation in financial assets and distort allocations of capital.

However, as you can see from pulling it apart, this behaviour has been grossly misrepresented as providing “future savings”.

Say the sovereign government ran a $15 billion surplus in the last financial year.

It could then purchase that amount of financial assets in the domestic and international capital markets.

But from an accounting perspective the Government would no longer have run that surplus because the $15 billion would be recorded as spending and the fiscal would break even.

In these situations, the public debate should be focused on whether this is the best use of public funds.

It would be hard to justify this sort of spending when basic infrastructure provision and employment creation has been ignored for many years by neo-liberal governments.

So all we are talking about is a different portfolio of assets.

The following blog post may be of further interest to you:

Question 3:

The massive build-up of Chinese holdings of US government debt allowed US citizens to enjoy a higher material standard of living overall at the expense of the residents of China.

The answer is True.

The use of the descriptor overall signals that we are considering the macroeconomic outcomes in this question.

We might have concerns about the distributional consequences within the US that might arise from an on-going external deficit – that is that some might benefit while others will be losing jobs as manufacturing heads to China.

But when we think in macroeconomic terms (which is mostly the case in this blog) we are dealing with aggregates and so the distributional questions, while very important, are abstracted from.

That statement is not entirely accurate because one of the important insights that progressive economists such as Kalecki provided was that distribution of income does impact on aggregate demand.

Please read my blog post – Michal Kalecki – The Political Aspects of Full Employment – for more discussion on this point.

First, China can only do what the Americans and everyone else it trades with allow them to do.

They cannot sell a penny’s worth of output in USD and therefore accumulate the USD which they then use to buy US treasury bonds if the US citizens didn’t buy their stuff.

Presumably, people buy imported goods made in China instead of locally-made goods (which are more expensive) because they perceive it is their best interests to do so.

There is often a curious inconsistency among those who advocated free markets.

They hate government involvement in the economy yet propose complex regulative structures (for example, tariffs) which would increase government control on resource allocation and, not to mention it, force citizens (against their will) to purchase goods and services they reject in an open comparison (on price and whatever other characteristics).

Many economists do not fully understand how to interpret the balance of payments in a fiat monetary system.

For example, most will associate the rise in the current account deficit (exports less than imports plus net invisibles) with an outflow of capital.

They then argue that the only way the US (if we use it as an example) can counter this is if US financial institutions borrow from abroad.

They then assume that this is a problem because it means, allegedly, that the US nation is “living beyond its means”. It it true that the higher the level of US foreign debt, the more its economy becomes linked to changing conditions in international credit markets.

But the way this situation is usually constructed is dubious.

First, exports are a cost – a nation has to give something real to foreigners that it we could use domestically – so there is an opportunity cost involved in exports.

Second, imports are a benefit – they represent foreigners giving a nation something real that they could use themselves but which the local economy will benefit from having.

The opportunity cost is all theirs!

Thus, on balance, if a nation can persuade foreigners to send more ships filled with things than it has to send in return (net export deficit) then that is a net benefit to the local economy.

I am abstracting from all the arguments (valid mostly!) that says we cannot measure welfare in a material way.

I know all the arguments that support that position and largely agree with them.

So how can we have a situation where foreigners are giving up more real things than they get from the local economy (in a macroeconommic sense)?

The answer lies in the fact that the local nation’s current account deficit “finances” the desire of foreigners to accumulate net financial claims denominated in $AUDs.

Think about that carefully.

The standard conception is exactly the opposite – that the foreigners finance the local economy’s profligate spending patterns.

In fact, the local trade deficit allows the foreigners to accumulate these financial assets (claims on the local economy).

The local economy gains in real terms – more ships full coming in than leave! – and foreigners achieve their desired financial portfolio. So in general that seems like a good outcome for all.

The problem is that if the foreigners change their desire to accumulate financial assets in the local currency then they will become unwilling to allow the “real terms of trade” (ships going and coming with real things) to remain in the local nation’s favour.

Then the local econmy has to adjust its export and import behaviour accordingly. If this transition is sudden then some disruptions can occur.

In general, these adjustments are not sudden.

So if you understand this then you will be able to appreciate the following juxtaposition:

  • Neo-liberal myth: US consumers have to borrow $billions from foreigners to keep consuming.
  • MMT reality: US consumers are funding $billions in foreign savings (accumulation of $US-denominated financial assets by foreigners).

Here is a transactional account of how this works which starts off with a US citizen buying a Chinese product.

  • US citizen buys a nice little Chinese car.
  • If the US consumer pays cash, then his/her bank account is debited and the Chinese car dealer’s account is credited – this has the impact of increasing foreign savings of US dollar-denominated financial assets. Total deposits in the US banking system, so far, are unchanged.
  • If the US consumer takes out a loan to buy the car, then his/her bank’s balance sheet now records the loan as an asset and creates a deposit (the loan) on the liability side. When the US consumer then hands the cheque over to the car dealer (representing the Chinese firm – ignore intervening transactions) the Chinese car company has a new asset (bank deposit) and my loan boosts overall bank deposits (loans create deposits). Foreign savings in US dollars rise by the amount of the loan.
  • So the trade deficit (1 car in this case) results from the Chinese car firm’s desire to net save US dollar-denominated financial assets and sell goods and services to the US in order to get those assets – it is the only way they can accumulate financial assets in a foreign currency.

What if the Chinese car company then decided to buy US Government debt instead of holding the US dollar-denominated bank deposits?

Some more accounting transactions would occur.

  • The Chinese company would put in an order for the bonds which would transfer the bank deposit into the hands of the central bank (Federal Reserve) who is selling the bond (ignore the specifics of which particular account in the Government is relevant) and in return hand over a bit of paper called a bond to the Chinese car maker’s lawyers or representative.
  • The US Government’s foreign debt rises by that amount.
  • But this merely means that the US Government promises, on maturity of the bond, to credit the Chinese car firm’s bank account (add reserves to the commercial bank the car firm deals with) with the face value of the bond plus interest and debit some account at the central bank (or whatever specific accounting structure deals with bond sales and purchases).

If you understand all of that then you will clearly understand that this merely amounts to substituting a non-interest bearing reserve balance for an interest-bearing Government bond.

That transaction can never present any problems of solvency for a sovereign government.

The US consumers get all the real goods and services and the Chinese have bits of paper.

I know some so-called progressives worry about the stock of debt that the Chinese are holding.

But the US government holds all the cards. The debt is in US dollars and they never leave the US system.

The Chinese may decide they have accumulated enough and will seek to alter the real terms of trade (that is, reduce its desire to export to the US).

In that situation the US will no longer be able to exploit the material advantages and the adjustment might be sharp and painful.

But that doesn’t negate that while the situation is as described the material benefits are flowing in favour of the US citizens (overall).

The following blog posts may be of further interest to you:

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.

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    This Post Has 29 Comments
    1. I don’t want to complain too much about these, but…
      Question 1-In a fiat monetary system (for example, US or Australia) with an on-going external deficit, if you desire the domestic private sector to reduce its overall debt levels without employment losses, then you have to support the national government increasing the fiscal deficit beyond the size of the external deficit in line with the private de-leveraging process.

      Well why do you have to support an increasing fiscal deficit? Why could you not support a policy that reduced the external deficit instead?

      Question 3-The massive build-up of Chinese holdings of US government debt allowed US citizens to enjoy a higher material standard of living overall at the expense of the residents of China.

      It seems to me that it doesn’t matter if the Chinese used their export surpluses to buy US government debt or just held that as deposits in the banking system. That China bought a lot of US Treasury bonds is not, per se, a reason that US citizens might enjoy a higher standard of living. Leaving aside my disagreements about the long term benefits of having large trade deficits.

      So I think you got two out of three answers to your own quiz wrong.

    2. Jerry, to play devil’s advocate I’ll try to support Bill’s answers.
      #1
      Your answer would be correct in a MCQ setting. However, in a T/F question given an ongoing external deficit there isn’t any other way to reduce private domestic indebtedness but to increase fiscal deficit by a greater amount than the foreign sector leakages. Thus, the answer is T.
      #3
      MMTers posit that for any country imports are benefit and exports are cost. In this respect the importing country consumes more than its domestic production and the opposite is true for the exporting country. The massive buildup of Chinese holding of US government debt is a clear indication that people in China sacrifice present consumption whereas Americans enjoy increased present material well-being. The USA is in a unique position to sustain prolonged continuous large external trade deficits due to the special role of the US dollar as the international reserve currency. No other country can do that. Thus, the answer is T.

    3. Demetrios, this is very flattering-“Your answer would be correct in a MCQ setting” -maybe more so if I knew what MCQ meant. Regardless, it seems to me that if there was a credible policy to turn a trade deficit into a trade surplus that might enable the private sector to save if the government did not increase its deficit.

      On question 3- I can say with near certainty that Bill would not agree with a lot of the end of your explanation. Anyways, the point is that China is saving in US Dollars in the question and it matters not whether that saving is denominated in Treasury Bonds or US currency or reserves.

      And as an aside- I still don’t agree that all imports are a benefit to society, or that all exports are always a negative either. Which I hope doesn’t get me kicked out of the MMT community just yet.

    4. Jerry,
      Your points look valid to me. Turns out I don’t know what “overall debt levels” are. The term only shows up in the question, original and quoted by you. Not in the discussion.

    5. Jerry, MCQ stands for Multiple Choice Question. What I mean is that your answer would be correct in a MCQ setting where more than one answers are possible, but certainly not as question #1 is framed.
      From an expanded consumption point of view imports are contributing to society’s welfare, as long as the country in question can pay for them without external borrowing and without eventually falling into IMF’s hands.

    6. Jerry says: “I still don’t agree that all imports are a benefit to society, or that all exports are always a negative either.” Certainly that makes sense, and I don’t think the MMT community (and although that word is used promiscuously these days, I think there kind of is one) would disagree. Shouldn’t self-sufficiency be a goal of every nation, especially in this precarious and oppressive neoliberal world order? Shouldn’t nations produce essential goods and services, (using their own currency) whenever possible to protect their citizens from shortages and from foreign pressure and exploitation? At the same time, if a particular nation has an excess of goods or services in a particular area, shouldn’t that nation export some of them to benefit not only its citizens but those of other nations, in which there is a shortage of such necessities? I suspect it’s when international commerce expands beyond essential goods and services into luxuries (and the lusts for them) that the import/export system goes awry…as does IMHO the ENTIRE economic enterprise. The simple idea of a donut economy, operating within environmental constraints and discouraging greed instead of encouraging it, fueling it, feeding off it, seems so obviously right to me. Perhaps this is what Covid is trying to tell us before it’s too late, before we’ve totally destroyed the ecosphere. On my better days, I like to think so.

    7. I don’t buy this “exports are a cost and imports are a benefit” argument.

      Firstly, if you want to ongoingly purchase the goods of another country you have to sell them something in return or hope they are willing to increase ongoingly their local currency financial assets. Without exports your indebtedness to other countries will continually build up. And you are a country whose currency is not well regarded then the country that sells you their goods will want you to supply them with currency that is acceptable.

      Secondly, imports divert income away from domestic goods and domestic employment.

      Bill in one breath mentions all these counter arguments then in the next accepts the “exports are a cost and imports are a benefit” maxim. Don’t get it.

      Then there is the use of the sectoral balance equation to mount all kinds of macrofinancial arguments. These arguments are accompanied by a series of “if” statements. With “if” statements any argument can be mounted. The SBE does not demonstrate causality. It is an ex post accounting identity. It has no functional or distributional content at all.

      It could be just as easily said that $1 dollar of saving causes $1 dollar of government deficit as it is to say the opposite. These statements are meaningless without a behavioural function to back them up.

      A $1increase in government deficit might reduce saving by $1 and reduce investment by $2 – net increase in S-I of $1. Would this be a good or bad outcome? Who’s to say without a behvioural/functional model?

      A $1 increase in government deficit might increase net savings by $1but nothing can be said about how that dollar in extra saving is distributed. It might be that it causes a $2 loss in saving for the less well off and a $3 increase in savings for the better well off – net $1 increase in overall saving. The SBE can say nothing about these matters per se.

      Making arguments about macrofinancial matters using the SBE is fraught with danger.

    8. Henry, it has always been my understanding that there are reasonable, if arguable, behavioral assumptions behind MMT analysis of sectoral balances. Even question 1, which I thought was a trick question originally, there is an assumption made that the US or Australia is not going to suddenly shift from being a net importer to being a net exporter. Probably a very reasonable assumption over the next ten years.

    9. Dear Demetrios Gizelis (at 2021/08/29 at 5:23 pm)

      You asserted

      The USA is in a unique position to sustain prolonged continuous large external trade deficits due to the special role of the US dollar as the international reserve currency. No other country can do that …

      This point is a common misconception that people hold.

      If this assertion was true, then how do you explain the fact that Australia, which is a small, open economy has been able to run rather large and continuous external deficits for 5 decades and counting, enjoys no collapse of its currency, and we have a very high, material standard of living?

      best wishes
      bill

    10. Jerry,

      MMT makes a virtue of the assertion that a $1 increase in the government deficit increases private saving by a $1. It sounds like a reasonable thing to argue, given the SBE. But I don’t think that is a sound basis upon which to make an argument which aims to overturn standing mainstream economics.

      And when it comes to thinking about the effect of government deficits on investment and distributional aspects, I think the relationships are even more tenuous. The analysis requires a stronger functional basis.

      Government spending might increase by $1 but what does it do to taxation and the G-T balance? The answer to this question cannot be ascertained by looking at the SBE.

    11. Yeah Henry. Don’t really need sectoral balance equations to show how stupid ‘loanable funds theory’ is. And a lot of mainstream economics is based in part on that and falls apart once you realize that just isn’t the way it works now- if ever.

      Maybe they taught you better than me- I was not a great student to begin with and probably missed more than a few things back then. But mostly I think they were just wrong.

      What can sectoral balance equations tell you? Well at least they can tell you that some ideas are never going to work.

    12. Dear Bill (on 2021/8/30 at 10:26)
      Thanks for the correction.
      However, although Australia’s external debt (absolute amount) is less than 10% of that of US I don’t think it would be able to pay off its international creditors, if suddenly demanded total immediate payment, with the same easiness and repercussions as the USA.
      This is what I meant that the USA is in a unique position because of its dollar serving as international reserve currency.
      Kind regards,
      Demetrios

    13. “I don’t think it would be able to pay off its international creditors, if suddenly demanded total immediate payment”

      Why not, given that it is just a swap to Aussie Dollars?

      The important thing to remember is that when a currency goes down, *all* the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade – which depresses their own economy.

      *Any one* of those other economies can intervene in the foreign exchange markets, purchase the ‘spare’ currency and that will halt the slide *for everybody*. And all exporters to an import nation have a central bank with infinite capacity to do that.

      Since there is no magical source of untapped demand anywhere in the world, the exporters to Australia rely upon Australian demand to keep them employed. Therefore they will find a way of making the exchange.

      Every argument against floating rate currencies relies upon the idea that ‘Rest of the World’ acts in unison. That is no more likely than all the oxygen molecules in a room leaping to one corner sufficiently long enough to suffocate you – even though that possibility isn’t ruled out by quantum mechanics.

      The rest of the world is a set of regions and economies in competition for the business of the import nation.

    14. Dear Henry (on 2021/8/30 at 4:45)
      You said
      “It could be just as easily said that $1 dollar of saving causes $1 dollar of government deficit as it is to say the opposite. These statements are meaningless without a behavioural function to back them up.”
      Furthermore,
      “A $1increase in government deficit might reduce saving by $1 and reduce investment by $2 – net increase in S-I of $1. Would this be a good or bad outcome? Who’s to say without a behvioural/functional model?”
      In the early seventies Prof. Anwar Shaikh of The New School for Social Research published a famous article in a leading mainstream journal entitled “Laws of Algebra and Laws of Economics” to show the absurdity of neoclassical production function.
      In your case you’re tempted to use naive numerical examples to prove your points. Are you serious that if I decide to increase my savings, it will cause a public deficit increase by an equal amount? The direction of causality is only from deficit spending to private saving, and this is a behavioural assumption.
      Secondly, I doubt that you can find even one mainstream economist to accept that increasing government deficit will lead to a simultaneous reduction in both saving and investment! What happened to the government injection into the economy? Is there such a thing as negative expenditure or tax multiplier? What you say is tantamount to the MPC being greater than one, saving becomes negative and the multiplayer is negative as well! If this were the case, then you would have refuted Keynes’s hypothesis that the MPC is positive and less than one. However, numerous empirical studies in different countries have estimated the MPC to always been positive and less than one, what they disagree upon is the exact magnitude of the multiplier value.
      All the best,
      Demetrios

    15. Dear Neil (on 2021/8/30 at 18:56)
      You’ve used selectively my argument by neglecting the last sentence, which says
      “…with the same easiness and repercussions as the USA.”
      What I mean by that is because the American dollar is by far more important than the Aussie dollar as reserve currency, the negative shock of foreign debt deleveraging in the US economy would be negligible in comparison to the Australian economy.
      Best wishes,
      Demetrios

    16. Demetrios,

      “In your case you’re tempted to use naive numerical examples to prove your points. ”

      It’s what MMters do all the time. And in any event I wasn’t proving anything. Just demonstrating the inanity of using the SBE the way MMTers use it.

      “Are you serious that if I decide to increase my savings, it will cause a public deficit increase by an equal amount? ”

      Why not?

      “…increasing government deficit will lead to a simultaneous reduction in both saving and investment!”

      Mainstreamers might argue that case. Even Keynes came close to suggesting Ricardian Equivalence was a possibility.

      “What you say is tantamount to the MPC being greater than one, saving becomes negative and the multiplayer is negative as well!”

      Not necessarily. For one thing we are talking about changes in variables not absolute levels of variables.

      And primarily, your post supports my argument that the SBE is of no use by itself. You had to invoke behavioural relationships to support its use. Whether those relationships are a fair representation of the possibilities is another matter.

    17. I don’t know what your point is Henry. Would you disagree if I said ‘if a country is going to run large external deficits, its government will need to run even larger fiscal deficits if you desire the domestic private sector to reduce its overall debt levels without employment losses? That would be a statement derived from sectoral balance equations. Why would it be wrong? What’s your problem with that statement?

      Ricardian Equivalence? Seriously? At least Keynes was from a time where countries were off and on and back off gold standards so maybe he might have had a tiny bit of justification for believing that garbage. But no- you say he came close to stating something similar. Which means he didn’t.

      And what is the problem with behavioral models? Why is this the weak link in sectoral balances stuff? You’re going to cite ‘Ricardian Equivalence’ which is a theory of behavior- an idiotic theory of behavior-as supporting your disdain for sectoral balance identities?

      I don’t get it.

    18. Jerry,

      ” What’s your problem with that statement?”

      Firstly, it begins with “If”. With an “if” statement you can manufacture any conclusion you want.

      I’m not arguing the statement is “wrong”, just convenient. You can’t be sure exactly what will happen if a government increases the deficit without a functional equation. MMters are of the habit of saying a $1 increase in the government deficit will increase saving by $1.

      I say, prove it.

      “Ricardian Equivalence?”

      From the GT page 120:

      “With the confused psychology which often prevails, the Government programme may, through it’s effect on “confidence”, increase liquidity-preference or diminish the marginal efficiency of capital, which again, may retard other investment unless measures are taken to offset it.”

      Sounds pretty close to me.

      “Why is this the weak link in sectoral balances stuff? ”

      The SBE is an ex post accounting identity. It cannot be used to explain causation.

    19. Henry,
      I ask
      “Are you serious that if I decide to increase my savings, it will cause a public deficit increase by an equal amount? ”
      You reply
      “Why not?”
      That’s a very convincing answer!
      You argue
      “…increasing government deficit will lead to a simultaneous reduction in both saving (sic) and investment!”
      and justify by saying
      “Mainstreamers might argue that case. Even Keynes came close to suggesting Ricardian Equivalence was a possibility.”
      You’re completely astray about the so called Barro-Ricardo equivalence theory. This theory posits that rational consumers and investors in anticipation of higher future taxes to pay for current deficit financed government expenditure will increase (not decrease) current saving and decrease investment, respectively. Thus, there will be an equivalent decrease in private spending and negate the prospective increase in income.
      I say
      “What you say is tantamount to the MPC being greater than one, saving becomes negative and the multiplier is negative as well!”
      You reply
      “Not necessarily. For one thing we are talking about changes in variables not absolute levels of variables.”
      This not only incoherent but it shows complete unfamiliarity what MPC is all about as well. Allow me to remind you that the Marginal Propensity to Consume is defined as the change in consumption divided by the change in income that brought it.
      Finally, a friendly advice. Before starting a public debate on some economic issue check your knowledge in order to avoid any future embarrassment.
      Best wishes,
      Demetrios

    20. Sounds like Keynes. God forbid he would write anything clearly. But ‘confused psychology’ sounds somewhat like he didn’t approve of the conclusions that might lead to an effect on ‘confidence’ and perhaps spending. It is not Barro’s ‘Ricardian Equivalence’.

    21. Demetrios,

      “That’s a very convincing answer!”

      It’s as lame as MMTers saying a $1 increase in the deficit will increase saving by $1. You are poking fun at yourself.

    22. Jerry,

      “But ‘confused psychology’ sounds somewhat like he didn’t approve of the conclusions …”

      Keynes may not have approved of the “confused psychology” – it has nothing to do with what he approves of – he is saying the effect is a possibility.

      And it seems to me, Demetrios, in explaining the effect, more or less describes what Keynes wrote. I have no doubt Demetrios will object again, but this is just nitpicking. And of course Ricardo did not use the language of rational expectations used by Barro when he revived the the effect. And the irony is that Ricardo himself discounted the effect (but Keynes thought it possible).

      I said “For one thing we are talking about changes in variables not absolute levels of variables.” I think you should think about this a little more clearly and the context in which it was said.

    23. Henry,
      You’ve demonstrated times and again that you’re a diehard neoclassical economics advocate which of course is your privilege, and there isn’t any objection to that. Perhaps you’re lured by the prestige of being part of the profession’s majority, unlike us folks who insist of looking at the world as it is. Because this is what MMT is all about: a description or lens of how a sovereign monetary economy operates, unconstrained by financial resources and limited only by real resources availability as to avoid inflationary pressure. We strongly believe that MMT coupled with a NGD policy and a JG program is capable of contributing to increasing the welfare of the overwhelming majority of citizens and enhance our democracy.
      In any case, I always enjoy “arguing” with you.
      Best wishes,
      Demetrios

    24. Demetrios,

      “You’ve demonstrated times and again that you’re a diehard neoclassical economics advocate….. ”

      This is absolutely laughable.

      Firstly, while I have a degree in economics, I am not a professional economist.

      Secondly, I am thankful I am old enough to have been trained in Keynesian macroeconomics and not in the ideologically riven nonsense that followed it.

    25. Henry,
      Your admiration of neoclassical economics is evident from your acceptance of the loanable funds theory, and this is pitiful. Unless you don’t realise it.
      Additionally, if you’ve been trained in Keynesian macroeconomics, how do you justify the soundness of finding the inverse of consumption function and say that income is a function of consumption as well? Because when you say that an additional $1 in deficit spending can create an additional $1 in saving and the opposite, is not different than inverting the consumption function! Have you ever seen an inverse consumption function with the axises reversed, similarly to Marshallian cross diagram? However, the direction of causality is that extra government expenditure creates income which in turn stimulates consumption (and saving) and so on up to the point at which the additional leakages equal the initial injection. This is definitely not an egg or chicken argument.
      And now to the main point; Wynne Godley’s sectoral balances actual data unambiguously show that increase in deficit spending leads to an increase in domestic private saving dollar for dollar, given a balanced external sector, and not the other way around, as you’re very stubbornly insisting.
      That’s enough for now.

    26. Well Henry, I’m not going to do research for you. You have admitted in the past that for at least some of these identities, reasonable causal claims can be inferred. And I have interacted with you long enough to suspect that you do not really think the idea of Ricardian Equivalence is much of a good idea. Or that Keynes was going to pre-empt Barro with such a claim.

      But it is always fun arguing with you and I think you feel the same way about arguing with us. And that is a good thing.

      “I’m not arguing the statement is “wrong”, just convenient.” This must be a new type of argumentation where obvious points are to be avoided?

      “MMters are of the habit of saying a $1 increase in the government deficit will increase saving by $1. I say, prove it.” I say look at what happened when US government dropped about a trillion dollars on households during this pandemic- household saving went way up. If you can’t see a connection it is because you are averting your eyes.

      I will always enjoy arguing with you because you are generally fair and interesting and polite enough and very smart. But tell me honestly about your opinion of Robert Barro’s ‘Ricardian Equivalence’ ideas.

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