Doomed from the start

Today I have been studying data from the EMU economies where the individual member states surrendered their currency sovereignty and comparing it to other nations which have sovereign currencies (Australia, Denmark, Japan, the UK and the US). This is part of a larger project I am involved in. While the glare of the spotlight is currently on Greece and how the EMU handles the issue, most commentators conveniently forget that this problem has been many years in the making and is both a product of initial design folly and subsequent behaviour by some member states.

From the outset, as I have noted in several blogs the initial structural design of the Eurozone was never compatible with a federal arrangement that could cope with large asymmetric shocks.

The selection of EMU nations never formed an optimal currency area despite the bevy of lackey economists who wrote a plethora of mathematical papers purporting to “prove” that it was. Please see the blog – España se está muriendo for a detailed discussion on that specific aspect of the EMU debacle.

Not having an OCA was one thing. But then the neo-liberal ideologues entered the fray, driven in part by political prejudices that go back into time (particularly World War 2), and conjured up the Stability and Growth Pact (SGP). The restrictions imposed by the SGP were claimed to reflect economic sense but there is nothing in any economic theory that tells us that the design principles of the SGP were optimal.

In fact, from the perspective of modern monetary theory (MMT) the 3 per cent budget deficit to GDP rule is nonsensical. It would be an extraordinary coincidence for a 3 per cent ratio to be consistent with full employment – that is, taking into account the saving preferences of the households and the trade accounts for each country.

In a 2006 book I published with Joan Muysken and Tom Van Veen – Growth and cohesion in the European Union: The Impact of Macroeconomic Policy – we showed that it is widely recognised that these figures were highly arbitrary and were without any solid theoretical foundation or internal consistency.

The current crisis is just the last straw in the myth that the SGP would provide a platform for stability and growth in the EMU. In my recent book (published just before the crisis) with Joan Muysken – Full Employment abandoned – we provided evidence to support the thesis that the SGP failed on both counts – it had provided neither stability nor growth. The crisis has echoed that claim very loudly.

The rationale of controlling government debt and budget deficits were consistent with the rising neo-liberal orthodoxy that promoted inflation control as the macroeconomic policy priority and asserted the primacy of monetary policy (a narrow conception notwithstanding) over fiscal policy. Fiscal policy was forced by this inflation first ideology to become a passive actor on the macroeconomic stage.

As a result of the establishment of the European Central Bank (ECB), European member states now share a common monetary stance. The SGP was designed to place nationally-determined fiscal policy in a straitjacket to avoid the problems that would arise if some runaway member states might follow a reckless spending policy, which in its turn would force the ECB to increase its interest rates. Germany, in particular, wanted fiscal constraints put on countries like Italy and Spain to prevent reckless government spending which could damage compliant countries through higher ECB interest rates.

The indisputable empirical reality is that the EMU countries have never got close to achieving full employment in the period they have had to succumb to the SGP. And the blowout in unemployment in some nations during the crisis is certainly clear evidence that the SGP is incapable of attenuating the magnitude of a serious crisis.

There is a very interesting article published by Lars Jonung, Eoin Drea in the January 2010 edition of Econ Journal Watch, 7(1), 4-52 entitled – It Can’t Happen, It’s a Bad Idea, It Won’t Last: U.S. Economists on the EMU and the Euro, 1989-2002.

It examines how US economists viewed the development and implementation of the EMU from the time of the Delors Report in 1989 through “to the introduction of euro notes and coins in January 2002″. They trace the evolution of ideas on whether the system would work. Most “were skeptical towards the single currency” although they “adjusted their views as European monetary unification progressed.”

I don’t agree with its conclusions but it is an interesting methodology (tracing the evolution of argument) and many of the skeptical comments were prescient.

On February 9, 1998, the Financial Times carried a story which began with the following:

It is a remarkable achievement getting two economics professors to agree on anything. Getting 155 to speak as one is almost unheard of.

It was referring to a letter from 150 German economics professors which called for an “orderly postponement” of the EMU and the FT said the sentiment expressed “also reflects the views of many ordinary Germans who have remained deeply dubious about the benefits of a single currency, in spite of their political leaders.”

The letter questioned “the progress towards economic convergence made by some member states” and claimed there had not been enough fiscal austerity to prepare the region for the introduction of the common currency. They correctly argued that “the euro will not solve Europe’s unemployment problem”. As an aside, you will not find an unemployment target (even a general statement) in the Maastricht criteria – they were all focused on budget and debt targets which tells you how misconstrued the whole arrangement was from the outset.

You can read a collection of news stories and the full letter from the professors HERE.

But all these skeptics for different reasons were correct – the EMU was a bodgy arrangement and would come asunder when the first real crisis hit – that would be now.

But the crisis is one thing. The other important point is that conduct by some of the member states, in particular, Germany, was undermining the logic of the Eurozone from the outset.

Der Spiegel carried an interesting article yesterday (February 9, 2010) entitled – Part 2: Is Germany to Blame?. It was a two-part series the first part being – How Brussels Is Trying to Prevent a Collapse of the Euro.

The article notes that various EMU nations (Spain, France, Portgugal) are being told to pursue harsh austerity packages and in some cases restructure their economies to promotes “economic sectors with higher productivity”. Labour deregulation is also being pushed.

In relation to these pressures, Der Spiegel says:

Resentment is growing in the countries most directly affected. But that frustration is not directed, as might be expected, toward the Commission. Instead, it is increasingly surplus countries coming under fire — with Germany at the forefront.

Representatives from Spain and Portugal especially — but also from France — hold Germany accountable for their current woes. They aren’t alone in that opinion either. “The Greek crisis has German roots,” says Heiner Flassbeck, chief economist at the United Nations Conference on Trade and Development (UNCTAD), in Geneva. It was German wage dumping that got the country’s European neighbors in trouble, he says.

The point being made is that Germany pursued an aggressive low-wage strategy which hammered their workers to ensure that their export prices relative to the other EMU nations would be attractive.

The Germans have always been obsessed with its export competitiveness and in the period before the common currency they would let the Deutschmark do the adjustment for them. With that capacity gone in the EMU arrangement, they pursued another strategy which was to deflate labour costs not via high productivity growth but rather by punitive labour market deregulation.

Der Spiegel reports that “Germany’s position is that the countries now in crisis are themselves at fault for their situation. They lived beyond their means for years, the German government says, financing their economic boom on credit. Now the financial crisis has revealed their weaknesses”.

There is truth in both positions of-course.

But the Germans were aggressive in implementing their so-called “Hartz package of welfare reforms”. A few years ago we did a detailed study of the so-called Hartz reforms in the German labour market. One publicly available Working Paper is available describing some of that research.

The Hartz reforms were the exemplar of the neo-liberal approach to labour market deregulation. They were an integral part of the German government’s “Agenda 2010″. They are a set of recommendations into the German labour market resulting from a 2002 commission, presided by and named after Peter Hartz, a key executive from German car manufacturer Volkswagen.

The recommendations were fully endorsed by the Schroeder government and introduced in four trenches: Hartz I to IV. The reforms of Hartz I to Hartz III, took place in January 2003-2004, while Hartz IV began in January 2005. The reforms represent extremely far reaching in terms of the labour market policy that had been stable for several decades.

The Hartz process was broadly inline with reforms that have been pursued in other industrialised countries, following the OECD’s job study in 1994; a focus on supply side measures and privatisation of public employment agencies to reduce unemployment. The underlying claim was that unemployment was a supply-side problem rather than a systemic failure of the economy to produce enough jobs.

The reforms accelerated the casualisation of the labour market (so-called mini/midi jobs) and there was a sharp fall in regular employment after the introduction of the Hartz reforms.

The German approach had overtones of the old canard of a federal system – “smokestack chasing”. One of the problems that federal systems can encounter is disparate regional development (in states or sub-state regions). A typical issue that arose as countries engaged in the strong growth period after World War 2 was the tax and other concession that states in various countries offered business firms in return for location.

There is a large literature which shows how this practice not only undermines the welfare of other regions in the federal system but also compromise the position of the state doing the “chasing”.

In the current context, the way in which the Germans pursued the Hartz reforms not only meant that they were undermining the welfare of the other EMU nations but also drove the living standards of German workers down.

The following graph shows real hourly earnings index for manufacturing (March 2000 = 100) in selected EMU nations plus Denmark which wisely stayed out of the EMU mess (data taken from the Main Economic Indicators). You can see that real hourly wage indexes were all growing steadily (more or less in line with labour productivity) in the period leading up to the introduction of the common currency.

But after 2000 the trends in the individual nations deviated substantially. Italy and Germany basically set about cutting real hourly earnings as an explicit strategy to retain their export shares whereas the other nations continued to pass on labour productivity growth in the form of real earnings increases. Ireland stands out as as providing much stronger real wages growth for their workers throughout the period shown.

Overall the EMU flatted real hourly earnings growth for workers in the common area.

It is interesting that Denmark, which did not enter the EMU, maintained strong growth in real hourly earnings and has not been damaged nearly as much by the crisis as some of the EMU nations.

EMU: Real manufacturing wages, 1996 to 2008 (March 2000=100)

Another view of these trends is to consider the relationship between real wages and labour productivity. The following graph shows real unit labour costs (derived from the benchmark ULC series and the consumer price indexes provided by the Main Economic Indicators) for EMU area, Ireland, Italy, Germany, Greece, and Spain from March 2000 to June 2009 (the latest data available).

Real unit labour costs (RULC) are identical to the wage share in national income and are constructed in the following way. ULC = Wage rate times employment divided by total output = W.L/Y. Note that L/Y is the inverse of labour productivity. RULC = ULC/P (where P is the price index). So RULC = (W.L/P.Y), that is the wage share (W.L is the total income payments to labour and P.Y is GDP). It can also be written as (W/P)/(Y/L), which is the ratio of the real wage (W/P) to labour productivity (Y/L).

In the 1970s it was thought to be a valuable measure to test the proposition that real wages growth in excess of labour productivity (so RULC rising) would cause unemployment. This was the prediction of the erroneous mainstream (neo-classical) marginal productivity theory. So there was an industry of economists running regressions and drawing graphs etc to show that when RULC rose employment fell – just as they told the Keynesians it would!

The problem with all that hoo-ha was that RULC is a somewhat ambiguous measure because its movements are influenced by both the numerator and the denominator and the latter is highly pro-cyclical – that is, it falls in a recession and rises in the boom (because of hoarding).

So RULC can fall because the real wage is falling as a result of discretionary policies to deregulate the labour market and attack unions. But, equally, it can fall because the economy is booming and productivity growth is strong. So correlations between RULC and employment will render what is referred to as “observational equivalence” with respect to macro theories of employment. Both the mainstream and Keynesians predict a negative correlation between real wages and employment but for vastly different reasons. Anyway, that is all as an aside.

What the graph shows how even prior to the crash the introduction of the Euro has been very damaging for German workers who a result of these developments, the euro has been a costly disaster for almost everyone involved: for German workers, who have had to live with almost non-existent real wage increases; and for the rest of Europe, where economies were once again subjugated by the German export steamroller.

EMU: Real unit labour costs, 2000-2009 (March 2000=100)

Der Spiegel reports that the attitude of the European Commission is that:

… the currency union can exist in the long term only if member countries’ governments implement reforms and coordinate their economic policies.

Which translates into a major victory for the neo-liberals who want to redistribute income away from workers towards profits – that is, the German model. These adjustment processes are now being forced on the Latin EMU nations and Ireland.

When I step back and think about all this in a longer context, the only conclusion I can consistently reach is that there is a madness present.

First, the nations’ leaders agree to surrender their currency sovereignty – they didn’t have to but chose to. They largely mislead their citizens with spurious arguments about optimal currency areas and the rest of the sophistry that the neo-liberal economists happily fed them.

In doing so, they give up their monetary policy independence and so differential circumstances cannot be dealt with by variations in interest rates.

Second, they then invented ridiculous fiscal constraints which have no basis in anything that relates to the way the real economy and the monetary system interacts. Mostly these constraints were a reflection of long-standing suspicions (racism, etc) – that is, they were ideological and political.

Third, Germany then introduces harsh labour market reforms to not only screw their own workers but also to ensure that the other EMU partners are behind the 8-ball.

Fourth, the EMU bosses refuse to introduce any fiscal redistribution capacity to ensure the member states achieve similar growth in real living standards.

Fifth, when the whole things meltdowns due to its design and the German strategy, the nations which are now in extreme crisis are told they have to introduce harsh pro-cyclical fiscal policies to savage living standards of their citizens.

No reasonable economist would ever advocate pro-cyclical fiscal policy. It is the exemplar of the abandonment of public purpose.

All of this also tells us that this is no federation which cares about its individual components. The way the ECB and Brussels is approaching the Greek disaster (and statements coming out of Germany – read the Der Spiegel article) demonstrates that there is no “federal-state” solidarity. The question that arises is why bother then.

Australia is a federation of common language and culture enriched over the years by new entrants from different ethnic backgrounds. But although their is a rich cultural diversity here we all row the same boat and fiscal redistributions are use to ensure that the real standard of living is similar across the vast geographic space.

But not in EMU.

And once you put all that together you realise all of this is voluntary and a product of political choices. There were no financial constraints on the nations and no economic imperative to enter the EMU. The citizens were blinded by a range of spurious arguments and lies coming from economists in the 1990s.

If they realised that they would always be better off as sovereign nations and there were no financial constraints on them retaining that status then they could better compare the decision to stay in the EMU – a political/ideological choice favouring the elites rather than the common folk – with the other political choices now being made and imposed on them by their leaders – the austerity programs.


What the crisis has demonstrated is that the EMU is not an efficient common currency zone. The design of the system will always lead to these destructive outcomes whenever a major economic downturn occurs.

I would choose to leave the Eurozone if I knew that all the choices were voluntary.

I particularly liked the closing comments in an article published by The Australian today (February 10, 2010).

It is even clearer now than it was in 1998 that Europe is not ready for a common currency. The problems that have emerged so far will only get worse if monetary union continues.

The renewed political failure to act on this economic analysis only demonstrates that, far from being an inspired economic project, the euro has always just been one thing: a megalomaniac piece of folly designed by economically illiterate political leaders.

A comment received today on another post asked me to explain my statement:

My aim is to expose the fallacies that exist in the modern debate. I aim to show people that what they think and are told are financial constraints are in fact just political constraints which should be compared to other political decisions – like running harsh austerity programs that impoverish generations of people. Once people understand that some of these so-called financial constraints are political choices then the comparisons become more stark and government may act differently.

The point is as above. We are being continually told that certain policy options are denied or unwise because of financial constraints. So deficits are bad because they “force” the government to go into debt. Rising debt “has to” be paid back via “higher taxes”. Deficits will cause “hyperinflation” and comments like that.

The uninformed voter cannot determine whether these statements which are reinforced by a host of mindless economic commentators are in fact “financial issues” or whether they reflect the ideology of the ruling class. In the latter instance, the politicians making political choices to cement their power bases – that is, making donors happy and whatever.

If people really knew the so-called financial constraints were no such thing and the fiscal austerity programs are thus political choices and alternative political choices not involving harsh austerity are available – then I think the public debate would be different and ultimately different outcomes would emerge.

This is particularly so in the case of the EMU and the choices that citizens now have to stay in and be smashed or leave and face a difficult adjustment period but ultimately enjoy the benefits of the currency sovereignty.

That is enough for today!

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39 Responses to Doomed from the start

  1. Rationalist says:

    This is a very interesting post, it is remarkable to see the trend in Europe over the recent history.

    Just out of curiosity, do you have the data which compares these metrics with that of Australia?

  2. DL says:

    I vaguely recall a ‘group of 5′ economists here in Australia in the 90s proposed a ‘wage freeze’ as part of a hare-brained scheme to reduce unemployment which would have had a similar impact in distributing money away from workers to business.

  3. Oliver says:

    Hi Bill, everyone else,

    Thanks for this great post! It’s very interesting for somebody living in Europe, albeit outside the EMU / EU to see such an objective (I’ll call it that) account of what has been going on here in economic terms. Discussions on EU / EMU issues are often highly emotional here and are usually divided along party lines. You cite 150 German economists and their American counterparts issuing warnings prior to the introduction of the EMU. You say the decision to go forward in spite of these warnings was ultimately a political one, helped along by neo-liberal memes. The tragic coincidence (from an MMT perspective) is that these political and economic forces were by no means naturally aligned and that therefore neo-liberal forces (in the left and right) should not take the whole blame. I would argue that support for the project came from all sides of the political aisle. Apart from what the neo-liberal advisers were shouting at the time, the whole concept of a single currency fits in with the ideological will of many European nations to ‘close ranks’ and build a ‘stable future’ to counteract the inherent and historically proven instabilities. This is a classic theme among all traditional European political forces, especially traditional conservatives, the traditional left and also the third way democrats. A system in which every nation keeps its own currency and goes about its own business is counter-intuitive to this urge. And that was the crux. It was politically very easy to sell the EMU in those nations that are historically most traumatised from WWI & WWII (Germany, Italy, Spain, France) because it fits in with the political story-line. It is also in general those nations least traumatised by a common history (UK, Norway, Switzerland) where support for the EMU and indeed the EU is and was weakest. So I think there are different issues that run parallel that account for the ‘successful’ introduction of the current system. Or at least that is how I interpret it.

  4. A technical point: Bill says, “from the perspective of MMT the 3 per cent budget deficit to GDP rule is nonsensical.” It strikes me that a 3% average annual deficit over a decade or so would be about right, though obviously there needs to be flexibility to greatly increase this in a recession (and reduce it come an inflationary boom). My reasons are as follows.

    Assume: (i) 2% inflation. (ii) Real GDP annual growth of 2%. (iii) National debt is 50% of GDP and that the population are happy with that level of net financial assets, and wish to see their holdings of net financial assets rise in real terms as GDP rises in real terms.

    The deficit needed to effect the above would be (2 + 2) x 0.5 = 2% of GDP (assuming I’ve got my sums right, which is pretty unlikely).

  5. bx12 says:

    Dear Ralph,

    > > hat the population are happy with that level of net financial assets, and wish to see their holdings of net financial assets rise in real terms as GDP rises in real terms.

    I’m glad that you raise this issue because it is a source of confusion for me. I have been assuming and explain it here:

    that in the EMU net spending by the government is a horizontal transaction i.e. does not create net financial assets, as -I also assume- would be the case under a gold standard, and that as a result it must average to zero over a long period.

    I’d really love to hear the right answer from someone with MMT credentials or be referred to the appropriate post.


  6. Tom Hickey says:

    Sergei asserted, “there no horizontal or vertical transactions in the EMU as it operates under the gold standard,” in a comment under On human bondage. It occurs late in the thread, and I didn’t pick it up in time to ask then. This seems to be an appropriate time to do so.

    As far as I understand, the euro is also a non-convertible floating fx currency. While it is true that there is an arrangement about holding gold and foreign reserves, I don’t see any mention of actual currency backing anywhere. In what sense could it be said that the EMU operates under the gold standard?

  7. Mike says:

    Very interesting post.
    I wonder if the Greek president or finance minister ever seriously consider leaving the EMU or if they are already resigned to endless “austerity” programs?

  8. Sergei says:

    Tom Hickey, great you asked.

    What I meant was that EMU has no fiscal authority which means no one is actually “responsible” for the currency. Yes, euro is run by ECB but ECB is not a responsible body in the sense of the sovereign currency issuing government. It has certain privileges in terms of the banking system but where does the “full faith and credit of the issuer” as you said in another blog come from? That is why I said that “EMU as it operates under the gold standard”. The key word is “as” :)

  9. Tom Hickey says:

    Sergei, thanks for the elucidation. I had misunderstood what you were saying, not getting that you meant “as” in the sense of “as if.”

  10. bx12 says:

    Sergei, your clarifications agree with how I understood your first post (I said it was an analogy), but that still leaves the question of why think “there no horizontal or vertical transactions in the EMU” which I understand as saying that these terms are void under that regime. I’m happy to be convinced either way, but for now I think government transactions are horizontal.

  11. Dear Bill, I’m not clear enough about how the Euro works or about what you mean by vertical and horizontal to answer your question. But I’ll read these up over the next week or so and may come up with an answer. Regards, Ralph.

  12. Barton says:

    My view is that yes, the Euro is a non convertible floating currency, but only COLLECTIVELY. For the individual member states the Euro actually functions like a foreign currency against which they actually pegged their original currencies. They have to actually “get” Euros, they have to “earn” them or borrow them to the degree they can. Thus for each one it is like the gold standard. Add to that that this collective body can’t actually function like the monopoly issuer of the currency due to all the constraints imposed upon it because of the narrowness of their mandate and the extreme diffusion of their actual authority, plus the constraints these nations have placed upon themselves fiscally, and voila you have the situation which Warren described as having the potential to create a liquidity crisis for any one of these countries. I may not have all of the mechanisms exactly right but that’s my interpretation. That’s what happens when you give up your currency sovereignty, the right to conduct your own monetary policy and to boot, a large degree of your fiscal sovereignty, too.

  13. Tom Hickey says:

    Barton, thanks. That sounds about right to me. However, I wouldn’t use the gold standard analogy, since I think it confuses the issue more than it sheds light on it.

    US states are in the same boat. But the US states do have the federal government to fall back on to some degree in extremis. I don’t see the US government ever letting a state “go bankrupt.”

  14. Wally says:

    Ive been lurking for a while and am quite intrigued by what Bill and others here have to say. This is really some new stuff.

    There is something I’ve been contemplating in regards to this EU situation and MMT principles. When evaluating the possibilities regarding the issuing of your own currency how much does one have to evaluate the ability to be self sufficient when recommending spending levels.

    Countries like the US, China, Japan and Australia could survive without importing anything since they have vast natural resources plus manufacturing capabilities. The limits on their currency issuance would only be about what they wish to provide for their own correct? But arent other smaller countries truly limited and need the support of exchange markets to keep their buying power? A country like Ireland say or Iceland cant simply spend at whatever level they want because their buying power becomes measured against other countries they need to trade with no? The US on the other hand could simply do what they wish since they would only be competing amongst them selves for their resources.

  15. bx12 says:


    You mention Ireland and its need to import. Let me add this : It’s not a secret that the Irish are a mobile people, by necessity, because as small country, their economy is more likely to be in a dire (now) or a enviable (before) state. The EMU may have accentuated that a bit, but there’s a deeper historical pattern.

    Many are emigrating now to find work in continental Europe or the UK in places that aren’t as economically hurt, in all legality, with entitlement to local health services and the possibly of family visits without fear of visa restrictions. Sure, one could advise to keep all this while dumping the EMU at the same time. That would amount, figuratively, to changing the wedding vows to “I take you to be my spouse not in sorrow but in joy only.”. You just have to see how the UK likes the EU and back to understand how wise that is.

    Granted, EMU is broken because it is founded on the false presumption of an OCA. But of exiting and fixing what’s broken, why is the emphasis on the former? Surely, MMT also can contribute to option 2.

    By the way there’s something I don’t understand about favorably comparing the federation of Australia to the EMU. The monetary, fiscal and trade policies reflect the ongoing neo-liberal consensus just about everywhere, not just EMU. The wholeness of Australia is a legacy from British rule while the EU, a superset of EMU, has a voluntary and democratic process of membership, initially motivated by the desire to have peace in the aftermath of WWI, carried through by generations of some visionary leaders. So now there is a bit of storm in the horizon, the best option is to bid farewell to that? By the way it only took a couple of decades before the much poorer Eastern countries were able to join in. I can’t even count the number of languages spoken in the entire union as a result. So much for narrow mindedness. I’m I getting too sentimental?

  16. RSJ says:

    A 3% rule sounds a bit fishy, but I would favor a policy of keeping deficit spending a constant share of GDP. As you point out, Denmark — with higher marginal tax rates, has managed to keep wages rising and has escaped much of these problems. They do this with a tax regime that discourages windfall seeking, and therefore economic actors in Denmark are less likely to try to accumulate financial claims at a rate faster than the economy can support.

    If you need to deficit spend to maintain employment, then what is wrong with draining the bulk of that back from those who are not spending? I.e., those with a low propensity to consume can instead pay higher taxes, and the government will consume on their behalf, regulating demand. If they begin to spend more, then there is less need for the government to support demand. If you do this, then you will stabilize both inequality and demand, and you will not need to have rising debt to GDP ratios, and neither will you be providing windfalls to the private sector by increasing their financial assets at a rate faster than the overall growth rate of the economy.

  17. Tom Hickey says:

    If you need to deficit spend to maintain employment, then what is wrong with draining the bulk of that back from those who are not spending?….

    Bingo! That’s what progressive taxation is all about, as well as windfall taxes. The money funnels to the top, where it sits, and nominal AD tanks. That’s why lowering upper bracket tax rates is foolish, as well as lowering or repealing the capital gains tax, and reducing or eliminating the inheritance tax on large estates. The lower down the income ladder, the more income is spent and less saved.

    Some saving is good, as well as investment in productivity and innovation, but not hoarding, or using gain for leveraged speculation that makes no real contribution to the economy. Incentives have to be adjusted accordingly. Tax policy can be tailored toward this.

  18. Greg says:

    RSJ and Tom

    I completely agree with what you are getting at but in regards to debt to GDP ratios that you mention RSJ, isnt the real problem not the ratio (MMT says the ratio itself shouldnt matter) but the fact that there are too many people out of productive capacity and simply sitting around collecting interest. IOW, if those at the top would still support productive measures we could have the debt to GDP ratio be 500% without a “financial” problem.

    The problem is that those rent seekers want their cake (not work or “support” work) and eat it too (rising interest rates on their bonds). We could say “you can have your low taxes but you must take low interest rates on your bonds so we can keep production up”. At least I think that could be a trade off.

  19. Oliver says:


    I’ve been pondering the same question and I’m not sure bx12′s answer is very satisfying. Relentlessly float the currency to achieve full employment but send off workers to other countries if they can’t pay for necessary foreign commodities seems contradictory. Maybe one of the MMT specialists has an answer ready? What does it mean under MMT for a small, highly specialised and internationally intertwined country (e.g. Hong Kong, Switzerland, Norway, Iceland, Ireland) to be exposed to volatile currency markets? Is there a trade-off between following the full employment maxim and defending the currency? Is there a point at which a peg to a foreign currency makes sense (I know the HK$ is pegged to the US$)? Still many blanks left to fill in in my MMT understanding :-).

  20. bx12 says:

    > I’m not sure bx12’s answer is very satisfying […] Relentlessly float the currency to achieve full employment but send off workers to other countries if they can’t pay for necessary foreign commodities seems contradictory.

    Did I say that? :-)

    I wasn’t advocating floating the Irish pound again. Although it may have some benefits, that’s not how one conceives of a union, hence my wedding vows analogy. Surely, there ought to be variables other than unemployment when a country like Ireland is on the wrong side of “asymmetric shocks”. Labor mobility is one of them, but it’s insufficient. Perhaps a EU body with discretionary spending powers; an idea that is in the past few days being circulated.

    I have yet to read a backlog of Bill’s posts notably on that salary anchoring mechanism so dear to MMT before arguing any further. However, I already wonder if Paul Krugman’s claim that wages are determined in the national market is in any way connected to that. Anyone?

  21. Tom Hickey says:

    MMT is simply a description of how the monetary/fiscal system works in the vertical relationship of currency issuer to currency users. It is a tool that can be used in fashioning efficient and effective policy for public purpose. But all it does is remove the ignorance. It does not in itself provide any solutions because all policy-making is based on values and there are ways to use the same tools to build very different outcomes.

    David Sloan Wilson observes in a series on Evolution and Economics herethat competition promotes advance in small groups, but altruism benefits larger ones. The problems of nations is based on the fallacy of composition, in which nation states behave as a group of individuals in relation to each other, and large institutions and interest groups within the states do the same, forfeiting the advantages of altruism.

    Fundamentally, conservative and libertarian values promote policy-making based on individualism and fall victim to this fallacy, whereas liberal and progressive value promote policy-making based on altruism and avoid it. Policy-wise, this is about providing incentives that promote evolutionary behavior instead of detracting from it.

  22. bx12 says:

    > David Sloan Wilson observes in a series on Evolution and Economics herethat competition promotes advance in small groups, but altruism benefits larger ones.

    There’s a TED talk of a similar flavor by Dan Pink.

  23. Sergei says:


    let me try to throw an idea though I am definitely not an expert.

    fx-rates refect above all fundamentals of the respective countries. MMT tells how to achieve full potential of the country as well as lower volatility of actual development relative to this potential. These two factors should increase attractiveness of the given currency for foreigners (aka investors)

  24. There’s also a relationship between lower real wages and unemployment. In the list you show of nations in the Eurozone that had the most increase in real wages, Spain and Ireland now have very high levels (10%+) of unemployment. Germany, by contrast, kept its unit labor cost low and has unemployment of only 7.5% now.

    In short, lower labor costs in certain EU countries have helped keep unemployment down.

    Moreover, Germany’s economic situation (which is far, far better than that of the US at the moment) can act as a stimulus for the rest of the EU once recovery begins to take hold. Germany’s demand will help reduce unemployment in Spain and Ireland.

  25. Wally says:

    Thanks bx12 and oliver, I really am just wondering if every country regardless of size and resources available is really better off issuing its own currency or if in fact their could be situations where you truly are better off in some sort of monetary relationship, pegging, fixed exchange, rate with
    someone else? At times it seems like Mr Mitchell does advocate for true sovereignty at all times but I do not want to put words into his mouth. I’m sure its not a simple answer.

  26. bill says:

    Dear Wally

    I never advocate any compromises to full currency sovereignty – all diminish the capacity of the elected government to fulfill its charter to advance full employment and equity in an environmentally sustainable manner.

    Any compromises – pegging, monetary or fiscal rules, voluntary debt-issuing rules – reduce the effectiveness of government in this regard and are totally unnecessary.

    If you examine the situation where compromises are made, I think you will find that most of these constraints serve the interests of the elites and disadvantage the workers.

    best wishes

  27. Wally says:

    Thanks Bill, I think I understand what you are saying. Its about keeping ALL your options open. I can appreciate that.

  28. RSJ says:


    You need to define rentiers and rentier profits first, and try to do this in a consistent manner for accounting purposes. Originally a rentier was someone who had a claim on land but did not work the land. In today’s world, it is (in my definition), anyone who has a financial claim, and receives income from this claim, as opposed to receiving income from labor. Perhaps your definition is different. In my definition, there is no difference between someone receiving dividend income who is also working, and someone just receiving dividend income. The fraction of income received from not working is the rentier income, even though most people both work themselves and hold financial claims on others. In a world in which many people both hold claims and work, it is better to talk of rentier income and rentier profits.

    Rentier income is the actual returns on capital — they share of national income diverted to holders of financial claims as opposed to labor. These tend to be constant over time, although they shift substantially by instrument. According to MMT, this income should rise and fall the with CB target rate, which of course is not the case at all. Saez has done good work in this area. A good of example of people ignoring the data, yet they keep up the farce that interest rates determine rentier income.

    But rentier income, if spent on goods or re-investment, cannot be responsible for a demand shortfall. Rentier profits can. I define rentier *profits* as rentier income net of expenditures on consumption or investment goods. In that case, all rentier profits must be funded by either debt growth in the private sector, or debt growth in the government sector (here, I define debt more generally as the issuance of liabilities).

    I claim that you can still stimulate demand but drain back via high marginal tax rates or taxes on capital returns, so that you are not increasing rentier profits on a net basis, at least not faster than the economic growth rate. You of course need to keep adding net financial assets in line with the overall growth rate because debt is denominated in nominal amounts and prices are sticky. But any excess is a windfall to asset holders, as otherwise their claims would be defaulted upon and their stock of wealth would decrease. Moreover, this understanding of the accounting should convince you that it is not the prevailing *terms of debt repayment* that set the accumulated rentier profits in a period of time, but rather the net growth in borrowing over that time period. This also explains why rentiers demand falling rates. Rentiers do not want high rates, they want more debt growth. That is why banks and rentiers love the idea of costless borrowing — it corresponds to the maximum possible level of subsidy to rentiers in the economy. This is destabilizing, both politically and economically.

    The reason why things like Debt to GDP matter — is that this represents, by accounting identity, the financial assets in the economy. Financial assets are claims on income, and GDP is the underlying income. If there are too many claims on income, or if the claims on income grow faster than the underlying income, then the rentier profits are growing faster than the economy as a whole — this corresponds to a wealth shift from labor to capital, and is a recipe for demand failures and crisis. Even if it is only government debt that is growing, it is still a recipe for demand failures and crisis, as the private sector should pay high enough wages to allow people to buy output, and allowing the private sector to pay lower wages than this level on a consistent basis means that, over time wage shares will come down. This is what has been happening over the last 30 years, a period of time completely devastating to the middle class, marked by falling rates and swelling debt to income ratios.

    So please separate out the issue of government spending — e.g. on Jobs programs — from government *deficit* spending. Unless you believe that the problem with the economy is a shortage of money, you must believe that the problem is a shortage of spending, due to an excess of claims. These claims are held by a small group of people on everyone else. In this case, cancel half the claims to bring them back in line with median wages, and spending will get back on track.

  29. Panayotis says:

    Talking about the EMU here are some facts about Greece.
    1. the unit labor cost is not higher than the EU average.
    2. the unreported income is 40% of GNP so the correct ratio of public debt to GNP is lower than the “optimum” 90% Rogoff/Reinhart measure.
    3. the ratio of private to public debt is less than 1 while in countries like the US and Britain is a multilpe of that.
    4. the growth of public debt is about equal to the average EU growth.

    The problems of Greece is discouragement of private production resulting in a balance of payments deficit and rationing of private behavior of finance and spending together with tax evasion which require a higher public sector cost and deficit spending to mantain the level of income. Austerity measures proposed by the EU and the government will be catastrophic.

  30. Greg says:


    Thanks for your response. You obviously have a much greater depth of understanding than I. You cleared a lot of my fuzzy thinking up and I appreciate it. That is the purpose of this comment section for me.

  31. bx12 says:


    Talking about the 90% Rogoff/Reinhart measure, it’s interesting that Bill Gross (PIMCO) ‘s “ring of fire” includes both the USA and Greece, so Greece is in good company.

    > the unreported income is 40% of GNP

    Are you talking about a black market economy?!

  32. Panayotis says:

    First, the 90% measure is of course arbitrary as their thesis is wrong! I used it to show that the “Greek problem” is not as big as the orthodoxy claims it is. Second, it is a relative black economy of speculative activities due to evasion tactics that rations tax receipts and avoidance strategy that rations public spending. In my approach taxation is not mainly a means to finance public spending (for a country with asovereign currency) but a policy to control excessive behavior although speculators can avoid and evade it raising the budget deficit for a given income level.

  33. Sergei says:

    Tom: The reason why things like Debt to GDP matter — is that this represents, by accounting identity, the financial assets in the economy. Financial assets are claims on income, and GDP is the underlying income.

    Might it be that you stretch it too far? It is quite common to have retired people live from their claims on financial assets. In fact in countries with private pension system it is exactly the case and it is a significant share of “capital”. No numbers here but simply as a share of population it should be greater than a rounding error.

    However when you say “Financial assets are claims on income, and GDP is the underlying income” I assume you mean certain financial assets of the private sector (originated and held). Government debt (net financial assets) is not a claim on GDP. This leads me then to the following point. If we split GDP to income on capital and wages then a fair point to start would be a 50-50 split. Then we get to the democratic election process where it is typical to have two major parties: right (capital) and left (wages). Given each election outcome and established democratic process should this imply that the split of domestic income should reflect the political division in the country?

  34. Tom Hickey says:

    Sergei, I did not say Financial assets are claims on income. RSJ did.

  35. bx12 says:

    Panayotis, Sergei, Ralph, Yossarian,

    About EMU/MMT Warren Mosler has given all the clarifications I needed. Read from this point downward:

  36. /L says:

    3% is probably equaling average public sector investment level. To finance investments by credit is that a real deficit? The ideal in the balanced budget ideals of EU is to have no deficit and pay your investments up front. Roads, bridges etc that might have a useful lifespan of maybe 30-50 years have to be paid up front with current revenues. In Sweden the right wing government in the late 70s abandoned the practice of having a capital/investment budget and a operating budget.

    When the Maastricht treaty was in being the discussion also was encompassing that this arbitrary scheme of constrains was to be in accompany with yearly 3% growth, this part was very quickly forgotten.

  37. Hello Bill,

    I am a kindred spirit. Randy and Warren know me. My blog is at In your discussions of the European Union, you despair for the EU members, because they are unable to control their money supply, and essentially are on a “euro standard.” I agree and have written about this.

    It has occurred to me that the EU members are in the same position as American states, counties and cities, which are on a “dollar standard,” and similarly unable to control their money supply. Because that is not well understood here, these local governments are expected to live “within their means,” and not run large deficits. Unfortunately, normal inflation tends to obsolete all standards, whether gold, euro or dollar. I’ve posted a short article about this at: American states It’s a slightly different take on a familiar subject.


    Rodger Malcolm Mitchell

  38. RSJ:

    “[...] the private sector should pay high enough wages to allow people to buy output, and allowing the private sector to pay lower wages than this level on a consistent basis means that, over time wage shares will come down.” The private sector will pay the minimum wages necessary to obtain labor. As wages rise, there is increasing incentive to replace labor with automation. The “middle class” may become obsolete as a sacred concept. Over time, those who achieve advanced degrees may drift in one direction and those leaving school earlier will drift in the other.

    “Unless you believe that the problem with the economy is a shortage of money [...]“ There is some evidence to indicate that is exactly the problem. Since by definition, a large economy has more money than does a smaller economy, a growing economy requires a growing money supply. The money supply must grow enough to overcome inflation, population growth, a negative balance of payments and the needs of a growing economy. I have data showing that recessions come as a result of declining federal deficit growth, and recoveries correspond with increasing deficit growth.

    “The reason why things like Debt to GDP matter — is that this represents, by accounting identity, the financial assets in the economy.” Do you mean the federal Debt, the GDP or the ratio between the two? Federal debt is the net amount of money the federal government has created since the nation’s inception. GDP is a one year measure of output. A truly apples/oranges ratio. Further, federal debt represents neither the total assets nor the total financial assets, at least not according to any definition I have seen.

    Some (most?) people people think Debt/GDP measures a nation’s ability to pay its debts, which of course, is nonsense. In fact, I see neither predictive nor evaluative purpose for Debt/GDP. However if you do, please tell me what the various % levels mean to you. What happens when a nation’s ratio rises or falls? What would you, as a nation’s leader, do about a rising or falling ratio?

    Rodger Malcolm Mitchell

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