This post continues my critical evaluation of Dylan Matthews’s, post published on Ezra Klein’s blog called “You know the deficit hawks. Now meet the deficit owls.”
Here’s the next exchange envisioned by Dylan:
“According to Galbraith and the others, monetary policy as currently conducted by the Fed does not work. The Fed generally uses one of two levers to increase growth and employment. It can lower short-term interest rates by buying up short-term government bonds on the open market. If short-term rates are near-zero, as they are now, the Fed can try “quantitative easing,” or large-scale purchases of assets (such as bonds) from the private sector including longer-term Treasuries using money the Fed creates. This is what the Fed did in 2008 and 2010, in an emergency effort to boost the economy.
“According to Modern Monetary Theory, the Fed buying up Treasuries is just, in Galbraith’s words, a “bookkeeping operation” that does not add income to American households and thus cannot be inflationary.
“It seemed clear to me that . . . flooding the economy with money by buying up government bonds . . . is not going to change anybody’s behavior,” Galbraith says. “They would just end up with cash reserves which would sit idle in the banking system, and that is exactly what in fact happened.
“The theorists just “have no idea how quantitative easing works,” says Joe Gagnon, an economist at the Peterson Institute who managed the Fed’s first round of quantitative easing in 2008. Even if the money the Fed uses to buy bonds stays in bank reserves — or money that’s held in reserve — increasing those reserves should still lead to increased borrowing and ripple throughout the system.”
Evidently, Gagnon has no idea that increasing the amount of reserves does not lead to increased borrowing, because banks don’t need more reserves to make loans. All they need are credit worthy borrowers and access to the Fed discount window to make whatever quantity of loans they want to. This is one of the main points about the banking system MMT makes. Put simply: lending is not reserve constrained! It’s constrained by bank willingness to lend to credit worthy borrowers.
Dylan’s next point is:
“Mainstreamers are equally baffled by another claim of the theory: that budget surpluses in and of themselves are bad for the economy. According to Modern Monetary Theory, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is, in effect, “taking money from private pockets and forcing them to make that up by going deeper into debt,” Galbraith says, reiterating his White House comments.
“The mainstream crowd finds this argument as funny now as they did when Galbraith presented it to Clinton. “I have two words to answer that: Australia and Canada,” Gagnon says. “If Jamie Galbraith would look them up, he would see immediate proof he’s wrong. Australia has had a long-running budget surplus now, they actually have no national debt whatsoever, they’re the fastest-growing, healthiest economy in the world.” Canada, similarly, has run consistent surpluses while achieving high growth.”
Gagnon must be kidding, or at least totally ignorant about Jamie’s background, and the major contributors to the MMT synthesis, Of course, Jamie is quite familiar with Canada having close ties to the land of his father’s birth, and MMT economists know all they need to know about Australia, since MMT leader Bill Mitchell is constantly writing about the Australian economy and its various tragedies. However, the point here is that Gagnon doesn’t see that these two nations show that MMT’s Sectoral Financial Balances (SFB) model is exactly right in its explanations, since they are able to run surpluses without disaster, only because, unlike the United States, the foreign sectors of their economies run deficits (that is Canada and Australia run trade surpluses) large enough to accommodate the private sector savings desires of Australians and also the Government’s desire to run a budget surplus. The US however, currently has a need to run Government deficits of 10% to support both our private sector savings desires of 6% of GDP, and our foreign sector’s desires to export 4% of US GDP to US consumers so they can accumulate US dollars in the form of electronic credits.
Default vs. Hyperinflation?
“But MMT’s own relationship to real-world cases can be a little hit-or-miss. Mosler, the hedge fund manager, credits his role in the movement to an epiphany in the early 1990s, when markets grew concerned that Italy was about to default. Mosler figured that Italy, which at that time still issued its own currency, the lira, could not default as long as it had the ability to print more liras. He bet accordingly, and when Italy did not default, he made a tidy sum. “There was an enormous amount of money to be made if you could bring yourself around to the idea that they couldn’t default,” he says.
“Later that decade, he learned there was also a lot of money to be lost. When similar fears surfaced about Russia, he again bet against default. Despite having its own currency, Russia defaulted, forcing Mosler to liquidate one of his funds and wiping out much of his $850 million in investments in the country. Mosler credits this to Russia’s fixed exchange rate policy of the time and insists that if it had only acted like a country with its own currency, default could have been avoided.
“But the case could also prove what critics insist: Default, while technically always avoidable, is sometimes the best available option.”
Well, this last is a mouthful. Yes, Warren Mosler made a lot of money on his “bets” on Italy, and lost a lot on Russia. But what this shows is that Governments can voluntarily default if they choose to. MMT economists have always said this and still say it. So why is political stupidity or perfidy counted against the truth of the MMT proposition that Governments sovereign in their currency have no fiscal solvency problems, only voluntary constraints and political problems?
On the contrary, I think the Russian case is one of the primary illustrations of a point that deficit owls have been trying to spread far and wide. Namely, that sometimes default is due to stupidity and perfidy and not to economic forces and that citizens in a democracy need to be aware of that, and of the full capabilities of currency sovereign Governments to always pay debts incurred in their fiat currency and to spend whatever is necessary to enable full employment in their nations. They are never, never, out of money except by choice. So, the real questions are:
– why are they choosing to default?
– Who will benefit from this political choice?
– And who will be asked to pay the price?
And how does the Russian case “prove” that: “Default, while technically always avoidable, is sometimes the best available option”? Is Dylan, through this quote from Gregory Mankiw suggesting that “public purpose” in Russia was better served by its voluntary default than it would have been if the Russians repaid their ruble debts in the rubles they might have created had they wished to? I’m afraid that both Dylan and Mankiw will have to prove that statement to me, since Russian citizens seem to have suffered quite a lot by taking the default choice and accepting austerity when they didn’t have to do so.