“Under NGDPLT, it becomes the job of Fiscal policy to control inflation.”

The title of this post was left in a recent comment by Morgan Warstler.  What he means is that NGDPLT takes nominal spending off the table, all that’s left is for the government to try to influence the split between P and Y.  And that means demand policies don’t work, all fiscal policy must be supply-side, aimed at more growth and hence less inflation.

If conservatives understood this then market monetarism would go from being a fringe movement eyed suspiciously by those on the right, to a position where we’d be headline speakers at CPAC.

While we’re at it, Morgan’s wage subsidy scheme makes the minimum wage and welfare obsolete.

PS.  I have a bubble post (with Shiller bleg) over at Econlog.


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89 Responses to ““Under NGDPLT, it becomes the job of Fiscal policy to control inflation.””

  1. Gravatar of W. Peden W. Peden
    24. March 2014 at 06:19

    That somewhat exaggerates things (presumably fiscal policy involves other considerations than productive output) but the basic idea is right.

  2. Gravatar of Michael Michael
    24. March 2014 at 06:23

    I think that Morgan is both right and wrong. Right on the basic idea (NGDPLT mostly takes demand off the table), but wrong that GOP politicians are any more interested in ending cronyism than the Democrats. Different cronies perhaps, though not as different as many would expect.

    Morgan’s right that NGDPLT puts more of a spotlight on the costs of political handouts. But perhaps that is part of the ireason why MM is still a fringe movement… Over time MM would gore a lot of sacred political cows, after all.

  3. Gravatar of Morgan Warstler Morgan Warstler
    24. March 2014 at 07:36

    Michael, we should be just as happy with Dem’s turning their strategy into nuking GOP handouts too.

    Similarly, if govt. is making productivity gains, that’s growth, so Dems have real plays on their side too.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. March 2014 at 08:06

    Something like the fiscal side controlling inflation happened in Chile after the 1973 coup. As Pinochet privatized hundreds of businesses that Allende had nationalized (and others that had been informally seized by las turbas) the increase in productivity increased the supply side and moderated the 1,000% inflation rate the junta inherited.

    Of course, it took Chicago Boys to really bring inflation down to reasonable levels over many years.

  5. Gravatar of benjamin cole benjamin cole
    24. March 2014 at 08:07

    Kudos to Morgan. ..but someday look at federal agency spending (that is, not spending financed by FICA). Once you take DoD, VA, DHS, Intelligence and rural subsidies…hardly much else left.
    And I would shoot for 5 perceng NGDP growth…jn a democratic nation, structural reforms are impossible…think ethanol and zinc pennies…

  6. Gravatar of TravisV TravisV
    24. March 2014 at 08:17

    Dear Market Monetarists,

    Christopher Mahoney wrote this excellent piece on Austrianism vs. Market Monetarism:

    http://capitalismandfredom.blogspot.com/2014/03/the-unsound-doctrine-of-sound-money.html

    Is that the right way to think about it?

  7. Gravatar of Morgan Warstler Morgan Warstler
    24. March 2014 at 08:32

    Benji,

    There’s no reason government can’t deliver 3-4% productivity gains YOY for a solid 10-20 years.

    Eventually, this is the Dem’s best play.

  8. Gravatar of Tommy Dorsett Tommy Dorsett
    24. March 2014 at 08:36

    Re Shiller et al: It’s funny how the bears who have been wrong on every basis point of this five year equity market run get such a pass. Shiller is the star academic, but his bearish fluffer John Hussman, a coward like likes to humiliate himself by calling others out in forums in which they cannot respond, has warned the public repeatedly of an imminent stock market crash essentially every year for the last two decades. That this broken clock actually told time twice is taken as a yardstick for his boldness and accuracy is just nauseating. And of course he loves the shiller CAPE ratio. Clown show in clown shoes.

  9. Gravatar of Philippe Philippe
    24. March 2014 at 08:38

    I think it would be a very good idea to try these plans. Once they fail miserably they can then be forgotten. If they are never tried people can always pretend that they might actually work.

  10. Gravatar of Tom Brown Tom Brown
    24. March 2014 at 11:03

    Philippe,

    “I think it would be a very good idea to try these plans. Once they fail miserably they can then be forgotten. If they are never tried people can always pretend that they might actually work.”

    is it fair to say you’re more liberal than conservative? If so, then this is a great marketing ploy to win over (most?) liberals too then! “Let’s try it and get this sure-to-fail idea out of the way so we can move on.” Scott, being a “practical libertarian” can surely see the value of “winning over” liberals too, right? :D

  11. Gravatar of B.B. B.B.
    24. March 2014 at 11:42

    I would like to hear your opinion about the new paper published at Brookings on targeting nominal GDP.

    http://www.brookings.edu/~/media/Projects/BPEA/Spring%202014/2014a_Sheedy.pdf

  12. Gravatar of TallDave TallDave
    24. March 2014 at 11:50

    Morgan’s scheme is very interesting. If we were closer to Patri Friedman’s dream of “competitive government” it could be tested.

    Meanwhile, looks like China is starting to butt up against the middle income trap. I suspect the elites do not have the stomach for the necessary reforms. We’ll see…

    http://www.businessweek.com/articles/2014-03-24/why-chinas-manufacturing-sector-has-hit-a-wall

  13. Gravatar of TallDave TallDave
    24. March 2014 at 11:59

    Also, on the right a lot of people still seem confused as to why we have a 2% inflation target vs a zero or negative target. The monetarist view of the TGD is apparently not widely understood.

  14. Gravatar of Steve Steve
    24. March 2014 at 16:44

    “Under NGDPLT, it becomes the job of Fiscal policy to control inflation.”

    Shhh, don’t tell Krugman; he’ll advocate NGDPLT AND a higher inflation target!

    ;)

  15. Gravatar of benjamin cole benjamin cole
    24. March 2014 at 16:57

    Morgan—
    Which party will get rid of ethanol? Zinc pennies? Drug and sex laws? The VA? The $1.5 trillion F-35 fighter jet?
    Sadly, we are stuck with structural rigidities…
    So, be robust on NGDP growth…some inflation (contrary to FOMC hysterics) is okay…

  16. Gravatar of Matt Waters Matt Waters
    24. March 2014 at 17:51

    I went away for awhile, but this sentence in the “low interest rates are inflationary post” really stumped me.

    “A fall in interest rates will increase the demand for base money”

    It’s stated axiomatically, but I’m having a fairly hard time understanding this. For anybody wanting a store of value versus merely a medium of exchange, if 3-month Treasuries are even something small like 0.5%, why in the world would they have base money instead?

    Based on at least 2008 the demand seems EXTREMELY elastic around 0-0.1% or so. Even with 1% rates in 2003, the monetary base was only required reserves and currency necessary mostly for black markets and Arab sheiks. Required reserves actually decreased during the Bush pre-2008 years because shadow banks figured out ways to do lower-reserve banking with repo and commercial paper (so-called “M3″).

    The far more direct explanation for low interest rates = low inflation is that, with low or negative NGDP growth, many fewer positive-NPV investments exist outside of the government.

  17. Gravatar of TravisV TravisV
    24. March 2014 at 17:57

    Brad DeLong disagrees with Krugman (!) and agrees with Sumner……

    http://equitablegrowth.org/2014/03/24/2351/no-i-really-do-not-think-that-we-were-doomed-to-the-lesser-depression-plus-the-greater-stagnation-i-think-paul-krugman-gets-one-wrong-here-monday-focus-march-24-2014

  18. Gravatar of TallDave TallDave
    24. March 2014 at 17:59

    Nice find TravisV.

  19. Gravatar of TravisV TravisV
    24. March 2014 at 18:02

    Jeremy Grantham drives me NUTS:

    “over the next seven years, we think the market will have negative returns. The next bust will be unlike any other, because the Fed and other centrals banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before. Assets are overpriced generally. They will be cheap again. That’s how we will pay for this. It’s going to be very painful for investors.”

    ……..

    “The theory is that lower interest rates are supposed to spur capital spending, right? Then why is capital spending so weak at this stage of the cycle. There is no evidence at all that quantitative easing has boosted capital spending”

    http://finance.fortune.cnn.com/2014/03/24/jeremy-grantham-federal-reserve

  20. Gravatar of Major_Freedom Major_Freedom
    24. March 2014 at 18:12

    TravisV:

    Given that it’s just as nutty to have your sunshine and lollipops prediction of the future, what is it in principle that Grantham said that was wrong?

  21. Gravatar of TravisV TravisV
    24. March 2014 at 18:23

    Major_Freedom,

    Above, Grantham suggested that “the next bust” will be substantially bigger than the 2008/09 bust.

    Is the probability that he’s correct above 50% or below 50%?

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. March 2014 at 18:25

    Scott,
    Off Topic. (And not meant to be a comment on this post.)

    Random comment made by MMTer heard in the internets:

    “For example, hyperinflations are typically associated with countries running fiscal deficits of around 50% of GDP.”

    Hmmm, is this really true?

    Using the Hanke-Krus hyperinflation table as the definitive list of hyperflations:

    http://upload.wikimedia.org/wikipedia/en/8/88/The_Hanke_Krus_Hyperinflation_Table.pdf

    It turns out that fiscal deficit data is hard to come by for these incidents. However, here is a list culled from the database for “A Modern History of Fiscal Prudence and Profligacy” (MHFPP) by Paolo Mauro et al (2013):

    http://www.imf.org/external/pubs/cat/longres.aspx?sk=40222.0

    And supplemented by the IMF World Economic Outlook, the World Bank (WB), Michael Bordo’s financial crises database, and AMECO. These are nations and years in which hyperinflation occured. All fiscal balances are as a percent of GDP.

    Country Year Balance Source
    Argentina 1989 (-0.2) MHFPP
    Argentina 1990 (-0.1) MHFPP
    Belarus 1992 (-4.8) WB
    Bolivia 1984 (-25.4) MHFPP
    Bolivia 1985 (-9.8) MHFPP
    Brazil 1989 (-18.6) Bordo
    Brazil 1990 (-5.8) Bordo
    Bulgaria 1991 (-3.4) WB
    Bulgaria 1997 (+0.8) MHFPP
    Chile 1973 (-7.3) MHFPP
    Congo 1991 (-12.5) IMF
    Congo 1992 (-13.0) IMF
    Congo 1993 (-12.5) IMF
    Congo 1994 (-13.3) IMF
    D.R.Congo 1998 (-6.3) IMF
    Germany 1920 (-22.0) Bordo
    Latvia 1992 (-0.5) AMECO
    Nicaragua 1986 (-7.3) MHFPP
    Nicaragua 1988 (-22.4) MHFPP
    Nicaragua 1990 (-15.2) MHFPP
    Nicaragua 1991 (-3.5) MHFPP
    Peru 1988 (-3.5) MHFPP
    Peru 1990 (-8.0) MHFPP
    Uzbekistan 1992 (+2.2) IMF
    Zimbawbwe 2007 (-3.9) IMF
    Zimbabwe 2008 (-2.7) IMF

    The median fiscal deficit on this list is 6.8% of GDP.

    To put this into perspective there are 19 deficits listed in the MHFPP database larger than the largest deficit on the above list: 1) the UK from 1915-18 and 1941-45, 2) Italy from 1915-17, 1942 and 1944, 3) Finland from 1940-41, 4) Greece in 1898, 5) the US in 1943, and 6) Ireland in 2010.

    So although fiscal deficits tend to be much larger than average during hyperinflations, large fiscal deficits are neither necessary nor sufficient to cause hyperinflation.

    P.S. There is only one deficit out of the 5450 deficits listed in the MHFPP database that is over 50% of GDP: the UK in 1916 (50.6%).

  23. Gravatar of Major_Freedom Major_Freedom
    24. March 2014 at 18:54

    TravisV:

    “Above, Grantham suggested that “the next bust” will be substantially bigger than the 2008/09 bust.”

    How is it less nutty to say that the next bust will not be? I’m being serious. If A says rainbows, and B says hellfire, who’s wrong and why?

    We can’t scientifically predict what the Fed will do, and more importantly we can’t scientifically predict when existing investment errors in real terms will be revealed and exposed.

    Is it your belief that anyone who predicts the opposite of sunshine and rainbows, are a priori crazy and there is absolutely no requirement to explain why or how they are crazy? Like it’s a physical law of the universe that the future will be what you say it is?

    What if there are two kinds of people, those who make predictions of the economy, and those who are not crazy?

  24. Gravatar of TravisV TravisV
    24. March 2014 at 19:16

    Major_Freedom,

    I sincerely believe that Shinzo Abe, Sumner, Woodford, Bernanke and Yellen have made the world a safer place. As a result of their efforts:

    (1) Central bankers have a better grasp of the importance of forward guidance than they did in 2008/09; and

    (2) Central bankers are more comfortable with “unconventional monetary policy” (such as QE) than they were in 2008/09.

    As a result, when “the next bust” happens, the unemployment rate will not increase nearly as much as it did in 2008/09.

    It’s very difficult to argue with my reasoning above (you haven’t refuted it, for example). Therefore, I’m very confident in that prediction.

    I also feel that real value of the S&P 500 will be substantially higher ten years from now. However, Ben Cole and others have made me less confident in that prediction than I am about the (lack of) severity of the next bust.

    To repeat: I am very very confident that the next bust will not be as severe as the 2008/09 bust.

  25. Gravatar of Benjamin Cole Benjamin Cole
    24. March 2014 at 21:31

    Travis–

    The good news is that you are right.

    The bad news is that you are right.

    Japan had no “bubbles” 1992 to 2012. Ergo, they had no busts.

    That’s the outlook for the USA too.

  26. Gravatar of Benjamin Cole Benjamin Cole
    24. March 2014 at 21:41

    Travis–

    Although, 10 years is a long time. It may be possible that Fed culture, or the zeitgeist of the economics profession will gravitate towards Market Monetarism somewhere in a 10-year time frame.

    I have optimistic days.

    More than we want to admit, an economist’s outlook and recommendations are influenced, perhaps even dictated, by their personality, age and politics.

    Robert Shiller? You ever see him on TV? So circumspect, wrinkled-forehead, careful. And always the stock markets are overpriced says Shiller.

    Volcker? Now an old man. Calls for a single-mandate Fed. But if he were instead a young real-estate developer, the same call?

    The Fed? Really, it has one economist who likes Market Monetarism, and that’s it?

    But, as I say, 10 years is a long time…maybe something will happen….

  27. Gravatar of Jonathan H Jonathan H
    24. March 2014 at 22:02

    Mark A. Sadowski very interesting data set. It seems to show that monetary policy can always be effective under the proper regime.

  28. Gravatar of Negation of Ideology Negation of Ideology
    25. March 2014 at 00:43

    Brilliant post. I particularly liked this:

    “And that means demand policies don’t work, all fiscal policy must be supply-side, aimed at more growth and hence less inflation.”

    I’d add the point that this is true whether you use NGDPLT or not. Fiscal demand policies don’t work because of monetary offset. NGDPLT makes that reality more obvious, which is a good thing.

    If it causes people to think of government as a deliverer of public goods like security and infrastructure, rather than a massive make-work program, then those productivity gains Morgan talks about are possible.

  29. Gravatar of Ralph Musgrave Ralph Musgrave
    25. March 2014 at 01:51

    I haven’t totally got to grips with Morgan Warstler’s wage subsidy scheme, but it seems similar to the system I’ve been advocating for 20 years, e.g. see:

    http://mpra.ub.uni-muenchen.de/19094/

    Essentially the point is that as unemployment falls, the marginal product of labour falls, and indeed falls below the min wage / union wage etc. Thus if we are to find work for the remaining unemployed, they’ll have to be hired out to employers at a sub min wage rate. The only difficulty is how to do that without employers and employees abusing the system: i.e. using the employment subsidy to take on employees who are perfectly viable. But the latter problem can be solved, I think.

    I may have misrepresented Morgan’s ideas there, in which case – apologies.

  30. Gravatar of nickik nickik
    25. March 2014 at 02:15

    @TravisV

    Christopher Mahoney has absolutely no clue about Austrians. Really he has not a single clue. It seams he gets all his information about the history and the theory of Austrians from Krugmans blogs comments or something.

    Almost everything he says is completely wrong.

    Please do yourself a favor and never read this again, never post it anywhere again. Its among the worst text on Austrians I have ever read.

    I would so like to rip this apart but that’s not the point about this post.

  31. Gravatar of Major_Freedom Major_Freedom
    25. March 2014 at 04:35

    The logic behind Morgan’s statement (which is the title of this blogpost) has a problem. How can a money printer engage in a money printing activity, and not be responsible for (what I believe Morgan is calling “price”) inflation?

    Seems like he is saying that targeting a constant means you are no longer having any effect on that which the constant is a factor. But acting so that a statistic doesn’t change (in this case rate of growth of spending) doesn’t mean that all of a sudden everyone else is now responsible for that which the statistic is a component (in this case prices). A constant growth in spending is itself a determinant of prices.

    Would it make any sense to say that if someone wants to target a particular rate of growth in volume of water being dumped into a house, that “it is now up the homeowners” to decide how much water they want in each room?

    Morgan wants to believe that if it doesn’t take much thought to target say 100 gallons of water into and out of the house each day, that dumping water into a person’s house no longer has any effect on how much water is in each room, or how much water is rising in each room. The rate of change of water growth in each room is now a matter of “fiscal policy” because Morgan has decided on 100 gallons into and out of the house.

    But what about those who believe this activity will cause increasing damage to the house? Woild it be the fault of the homeowners?

  32. Gravatar of Major_Freedom Major_Freedom
    25. March 2014 at 04:57

    TravisV:

    Sincerity does not mean accuracy.

    I don’t intend to doubt your sincerity. You have faith in socialist planning. I do not. I sincerely believe that Greenspan, and Bernanke (and more than likely Yellen) have made (will make) the world a more dangerous place precisely because of the reason you believe they made it safer.

    In my theory, the world is safer the more decentralized is the power, control, and decision making, and it is less safe the less decentralized is power, control, and decision making.

    Does a person make a construction site safer or more dangerous if they divert some of the attention away from the builders and make them believe that their error filled actions are succeeding in reaching the intended goal? You believe that such a person is doing good because if the construction project errors are revealed now, then the site might elect or hire a Hitler like foreman. Thus, that person who is diverting the attention away from the workers and managers is really doing us all a favor.

    I believe that your view of humanity is “monsters just waiting to get out should economic distress be experienced.”

    I believe that view is naive and wrong. I think purposefully deluding people is how to turn them into monsters, because you prevent them from experiencing the effects of their choices. That desensitizes and twists people’s minds and makes them intellectually weaker and less and less able to deal with reality. That then has the effect of them turning to more and more statism. Dictatorship.

    Socialism is actually a system of social retrogression. It is why socialists have to call themselves progressives. Reaction formation.

    I sincerely believe that the tighter you grip society as a means to stabilize it, the more counterproductive your actions will be and the corrections from unrelenting individual action will eventually break through.

    You are thinking from a basis of fear. I am thinking from another basis. That is, incidentally, why I get a lot of flak. I make people who have been deluded into comfort, to feel just a little too afraid. You need to believe socialism makes you safer. You need a mommy and daddy in charge. I don’t. That is the difference. Everything else is rationalization.

  33. Gravatar of ssumner ssumner
    25. March 2014 at 05:15

    Yes, Morgan is somewhat too optimistic about the GOP.

    B.B. I haven’t had time to read that paper, but I gather it focuses on credit markets. I agree that NGDP will help stabilize credit markets, but I think the main advantage is that it stabilizes labor markets.

    TallDave, China will do the necessary reforms. They are beginning to reform the financial system right now.

    Matt. There are literally 100s of empirical studies showing that the demand for base money is a downward sloping function of interest rates. It might be the LEAST controversial assertion in all of macroeconomics. If the opportunity cost of holding cash rises, you hold less—look at the data during the German hyperinflation, when money demand fell to very low levels.

    Mark, 50% of GDP!! I didn’t even need to check the data, but thanks for confirming.

  34. Gravatar of Morgan Warstler Morgan Warstler
    25. March 2014 at 05:49

    MF,

    No all I’m saying is that under a 4% NGDPLT, we’re on auto-pilot on MP, so the govt’s fiscal policy becomes the hero or the goat on the makeup of that 4%.

    If we have 4% inflation and no real growth for 3 years – the problem is USG policy (fiscal) – it means taxes are wrong, regulations are wrong, etc.

    If we have 4% real growth and no inflation – the USG has been doing things right, tax policy is right, regulations are right.

    And yes, MF I mean relatively right – in relation to each other.

    More generally, in light of the forces of digital deflation (things getting cheaper) increases in USG spending will be inflationary and increases in USG productivity will be real growth.

    This is why I say the Dems have some real plays – making governments 3-4% more productive YOY is possible. It might not be their favorite play, but there’s no reason under NGDPLT the Dems don’t wake up and say; if we run this thing like a business, we’ll be liked and given more trust.

    It’ll be their only real play. They’ll be fighting uphill on anything that causes inflation instead of growth.

  35. Gravatar of TravisV TravisV
    25. March 2014 at 07:27

    Morgan, sorry for stealing your thread.

    Ben Cole, thanks, I’m glad at least one other person is confident enough to agree with me that the next bust will be smaller than the last one. I wish more market monetarists would openly state their agreement about higher stability. Isn’t that what the recent increases in stock and other asset prices telling us?

    nickik, could you at least point me to some writings about the enlightened Austrian view that show me where Mahoney’s description of it (which I thought was very charitable) goes wrong?

  36. Gravatar of Michael Byrnes Michael Byrnes
    25. March 2014 at 07:27

    Morgan wrote:

    “This is why I say the Dems have some real plays – making governments 3-4% more productive YOY is possible. It might not be their favorite play, but there’s no reason under NGDPLT the Dems don’t wake up and say; if we run this thing like a business, we’ll be liked and given more trust.”

    The main problem is that no one on either side wants to run government like a business. The political right and left both have their own particular interests – and there is major overlap between them on some bad policies such as bailouts, zoning, occupational licensing, etc.

    You are of course correct that under NGDPLT, anything that limits real growth would raise the price level. But I don’t think this fact is going to persuade pols to want to adopt NGDPLT.

  37. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    25. March 2014 at 07:28

    Mark Sadowski, James Rolph Edwards, in his ‘Painful Birth’

    http://www.amazon.com/Painful-Birth-Became-Prosperous-Society/dp/0761859993

    gives a deficit as % of GDP for Chile in 1973 as 30.5% (up from 10% in 1971). His sources are;

    ‘The World Bank, “World Tables 1992″ (Washington DC: World Bank) for the 1971 observation; and Vittorio Corbo and Leonardo Hernandez, “Successes and Failures in Real Convergence: The Case of Chile,” in ‘Living Standards and the Weslth of Nations,’ eds. Leszek Balcerowicz and Stanley Fischer (Cambridge, MA: MIT Press, 2006): 120 (Table 5.1), for the 1973….’

  38. Gravatar of Cory Cory
    25. March 2014 at 07:54

    So, if a GOP candidate reads this board it seems to me the proposal is this:

    “Let’s institute NGDPLT and repeal the income tax. Forget about Democrat arguments that we won’t “have enough revenue”. Forget about “The Deficit”. Repealing income tax will increase deficit sure but is good for the supply side and this puts the onus on the Democrats to find a way to make sure their spending programs aren’t inflationary if they want to keep them.”

    Also, seems to me that Morgan’s idea is largely compatible with both Liberal and Conservative conceptions of justice.

  39. Gravatar of TallDave TallDave
    25. March 2014 at 08:01

    Thanks Mark, that’s a very common fallacy in these discussions. I’ll have to bookmark that comment.

    Scott — I know they claim that, but they are also engaging in massive suppression of reporting on the true state of affairs. How can we trust any data from China when this kind of thing is happening?

    http://www.nytimes.com/2013/11/09/world/asia/bloomberg-news-is-said-to-curb-articles-that-might-anger-china.html?pagewanted=all&_r=0

  40. Gravatar of TallDave TallDave
    25. March 2014 at 08:13

    Patrick R. Sullivan,

    I assume Mark is referring to the post-junta budget, which would have cut deficits. But see the table, it still took a few years to rein in hyperinflation.

    http://en.wikipedia.org/wiki/Economic_history_of_Chile#Monetarist_shock_therapy_and_.E2.80.9Cseven_modernisations.E2.80.9D_.281973-1982.29

  41. Gravatar of Cory Cory
    25. March 2014 at 08:31

    Mark A. Sadowski,

    Thank you for your prolific blogging and very enlightening post(s).

    It seems to me it is a common view that budget deficits are correlated with inflation. As you point out, this is a mistake.

    But, for example, if you watch the Khan Academy video on hyperinflation, he suggests that the rise in inflation in the mid-60′s was proximately caused by the Johnson Administration increasing expenditures on the Vietnam War and the War on Poverty in conjunction with the implementation of the Kennedy Tax Cuts when unemployment was at 4%.

    I take it that the Market Monetarist position is that the proximate cause was the FED’s failure to tighten monetary policy in reaction to those policies.

    So might I ask, what is your position on the “goodness” or “badness” of a Federal Deficit?

    If I were to guess, a deficit is never the proximate cause of inflation because M is unchanged due to the sale of treasury securities when the Federal Government runs a deficit. But, the question is what the deficit does to Real GDP?

    So, a deficit of 15% of GDP might be fine so long as it is caused by something like the repeal of income taxes or hiring citizens to build more productive capacity. But a deficit of 5% of GDP that results from handing out EBT cards to the unemployed would be bad.

    Politicians always obsess over the size of the deficit but it seems to me it’s not the size of the deficit per se but the nature of the programs that cause the deficit in determining whether a budget deficit is “good” or “bad” or what have you.

  42. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    25. March 2014 at 10:10

    Tall Dave, the coup was in September 1973, so the deficit for that year was a result of Allende’s policies. For ’74 it had dropped to 5.4%, according to Edwards (using Chile’s central bank numbers).

  43. Gravatar of Britmouse Britmouse
    25. March 2014 at 10:30

    Mark, why aren’t you blogging yet?

  44. Gravatar of Morgan Warstler Morgan Warstler
    25. March 2014 at 11:50

    Mark would be a great addition for Econlog.

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 12:06

    Patrick R. Sullivan,
    Corbo and Hernandez’s paper can be found here:

    http://www.nbpnews.pl/konferencje/radisson/Mowcy/corbo/Corbo_paper.pdf

    Evidently they got their figure for the 1973 deficit from the Central Bank of Chile. However, the statistics database of the Central Bank of Chile only extends back to 1996 so there is no way for me to confirm if this is still their estimate of the fiscal deficit for that year.

  46. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 12:06

    Patrick R. Sullivan,
    Mauro, Romeu, Binder and Zaman (2013) get their fiscal data for Chile from “Economía Chilena 1810-1995: Estadísticas Históricas” (1998) by Braun-Llona, Braun-Llona (that’s not a typo), Briones, Díaz, Lüders and Wagner (page 78-81):

    http://www.economia.puc.cl/docs/dt_187.pdf

    And in turn Braun-Llona et al get their fiscal data from “Economía Chilena 1810-1995: Cuentas Fiscales” (1998) By Jofre, Lüders and Wagner (Spanish only):

    http://www.economia.puc.cl/docs/dt_188.pdf

    The sources of Jofre et al are described on page 5. They list three sources for their 1973 data: 1) the Ministry of Finance, 2) the Budget Department, and 3) the IMF.

    My sense is that the Chilean estimates of Mauro et al, Braun-Llona et al, and Jofre et al far eclipse Corbo and Hernandez’s estimates for both comprehensiveness and accuracy.

  47. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 12:18

    Patrick R. Sullivan and Tall Dave,
    Michael Bordo cites B.R. Mitchell as his source for Chile’s fiscal data and he gives a figure of 6.4% of GDP for 1973.

    The Mauro et al, Braun-Llona et al, and Jofre et al figures show that from 1965-78 Chile only had deficits over 2% of GDP in 1971-74. They were 8.0%, 12.7%, 7.3% and 5.8% of GDP in 1971 through 1974 respectively.

  48. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 12:43

    Cory,
    I talk about the evidence against the idea that fiscal policy played a role in the Great Inflation here:

    http://www.themoneyillusion.com/?p=25932

    “So might I ask, what is your position on the “goodness” or “badness” of a Federal Deficit?

    If I were to guess, a deficit is never the proximate cause of inflation because M is unchanged due to the sale of treasury securities when the Federal Government runs a deficit. But, the question is what the deficit does to Real GDP?”

    Yes, fiscal deficits can only increase the rate of increase in NGDP, and hence the average rate of inflation, if they are not offset by monetary policy.

    I would argue that the manner in which government spending is financed has little effect on long run RGDP growth. So the issue is not really whether there is a deficit or not, nor even necessarily how much is spent relative to GDP. What matters is how the revenue is raised and what it is spent on.

    The empirical research evidence on tax structure suggests that property and consumption taxes are more long run RGDP growth promoting than income taxes, and that corporate income taxes are especially detrimental to long run RGDP growth. The empirical research evidence on public expenditure structure is far more mixed, but in theory at least, fixed investment should be more growth enhancing than any other kind of government spending.

  49. Gravatar of Tom Brown Tom Brown
    25. March 2014 at 13:05

    Mark, what is “fixed investment” (your final paragraph)?

  50. Gravatar of Tom Brown Tom Brown
    25. March 2014 at 13:07

    Britmouse, I know the answer to that mystery: Mark is afraid that having a blog would force him to be charitable, and he doesn’t want to go there. :D

    http://www.themoneyillusion.com/?p=26438#comment-325346

    Well that’s one reason anyway.

  51. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 13:53

    Tom Brown,
    “Fixed investment” refers to espenditures on equipment and structures:

    http://en.wikipedia.org/wiki/Fixed_investment

  52. Gravatar of Mark A. Sadowski Mark A. Sadowski
    25. March 2014 at 14:02

    I probably should add spending on R&D and education to that list.

  53. Gravatar of Philippe Philippe
    25. March 2014 at 16:07

    Mark,

    I don’t know about the other examples on your list, but in the case of Zimbabwe, whilst the official fiscal deficit was below 3% the real fiscal deficit (according to an IMF working paper) was closer to 75%. This is because official figures failed to count massive ‘quasi-fiscal losses’ by the central bank:

    “In Zimbabwe soaring inflation is due more to the Reserve Bank of Zimbabwe’s substantial quasi-fiscal activity than to conventional government budget deficits. The average central government fiscal deficit for 2003–2005 has been below 3 percent of GDP and since 2001 the primary balance has been in surplus in all years except 2004. However, as shown above, massive quasi-fiscal activities have been carried out outside the budget without adequate provisions for their financing. Therefore, a truer fiscal picture would include both the activity of the government and the QFAs of the RBZ in the fiscal balance.”

    “Realized quasi-fiscal losses are estimated to have amounted to about 75 percent of GDP in 2006″.

    http://www.imf.org/external/pubs/ft/wp/2007/wp0798.pdf

  54. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 04:01

    Philippe,
    “I don’t know about the other examples on your list, but in the case of Zimbabwe, whilst the official fiscal deficit was below 3% the real fiscal deficit (according to an IMF working paper) was closer to 75%. This is because official figures failed to count massive ‘quasi-fiscal losses’ by the central bank:…”

    Stella and Mackenzie (1996) define a Quasi-Fiscal Activity (QFA) as “an operation or measure carried out by a central bank or other public financial institution with an effect that can, in principle, be duplicated by budgetary measures in the form of an explicit tax, subsidy, or direct expenditure and that has or may have an impact on the financial operations of the central bank, other public financial institutions, or government.”

    Munoz says in her introduction:

    “…Some sense of the macroeconomic impact of QFAs can be gleaned by reference to the size of central bank losses. While central bank losses in most countries have not exceeded 10 percent of GDP, Zimbabwe’s flow of realized central bank quasi-fiscal losses are estimated to have amounted to 75 percent of GDP in 2006…”

    She provides no source for the 10% figure.

    I was however able to find the following paper on central bank QFA by Markiewicz (2001):

    http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Documents/dp0201.pdf

    What makes this paper particularly useful is that it looks at central bank QFA as it is practiced more generally, methodically estimates central bank quasi-fiscal deficits, and that it focuses on 17 transition countries during 1992-99, a period of time when nine of these countries experienced hyperinflation.

    Markiewicz points out that central banks carrying out traditional monetary operations in stable macroeconomic environments will typically make profits. Table 2 on Page 19 shows that the largest central bank loss among these countries was for the Czech Republic, which was 2.8% of GDP in 1998. Only three other of these countries’ central banks suffered losses during this time period: Estonia, Russia and Slovenia. Incidentally Estonia’s central bank suffered a loss of 1.2% of GDP in 1992, which was a hyperinflation year. (I did not include Estonia in my list since I do not have fiscal data for that year.)

    Central bank QFA typically comes in one of two flavors: financial operations, and exchange rate operations. Table 4 on page 28 provides Markiewicz’s estimates of central bank QFA deficits. Note that whereas central bank losses were rare among these countries, QFA deficits were quite common, with all but the central bank of Romania suffering a QFA deficit during 1994-99.

    The largest central bank QFA deficit was in Slovakia in 1995 (10.9% of GDP). Among the countries that experienced hyperinflation during this time period, we have Armenia (1.2% of GDP in 1994), Bulgaria (4.9% of GDP in 1997) and the Ukraine (3.6% of GDP in 1994). The only one of these incidents that is on my list, because I have fiscal data for that country in that year, is Bulgaria.

    So in short, even if we assume the “real” fiscal deficit should include the *quasi*-fiscal deficit of the central bank (I do not), outside of Zimbabwe I can find no QFA deficit estimate larger than 10.9% of GDP. And when one restricts our attention to countries actually experiencing hyperinflation in a given year, the largest QFA deficit is only 3.6% of GDP.

  55. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 04:14

    Correction:

    “And when one restricts our attention to countries actually experiencing hyperinflation in a given year, the largest QFA deficit is only 3.6% of GDP.”

    should read

    “And when one restricts our attention to countries actually experiencing hyperinflation in a given year, the largest QFA deficit is only 4.9% of GDP.”

  56. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 04:55

    Philippe,
    To see why I am skeptical of describing central bank QFA deficits as part of the “real” fiscal deficit we need to take a closer look at the specific sources of the central bank QFA deficit for Zimbabwe. Munoz’s estimates only span 2003-06, which precedes the years of actual hyperinflation in 2007-08, so let’s look at her estimate for the first 10 months of 2006 which can be found on Table 2 on page 8.

    There are three primary components to Zimbabwe’s central bank QFA deficit: 1) interest cost of Reserve Bank of Zimbabwe (RBZ) bills, 2) subsidies and 3) realized exchange rate loss. These were 41.4%, 15.4% and 7.7% of annual GDP respectively in the first 10 months of 2006. Adjusting for the length of time brings these figures to 49.7%, 18.5% and 9.2% of GDP or a total of 77.4% of GDP.

    Ironically, RBZ bills were securities that the central bank issued in order to *reduce* the size of the monetary base. Needless to say this backfired in a big way, as interest payments of the bills only caused the monetary base to expand exponentially. Over three quarters of the subsidies consisted of the provision of free foreign exchange to the public sector. Realized foreign exchange losses were a result of the RBZ’s foreign exchange monopoly, which in almost any other country would have been enormously profitable. The RBZ unfortunately had a bad habit of buying high from exporters and selling low to importers.

    So nearly two thirds of the central bank QFA deficit was attributable to something uniquely Zimbabwean: a central bank subjecting itself to self induced interest rate risk with the failed intent of tightening monetary policy. The foreign exchange losses were due to the mismanagement of its forex monopoly. Only the subsidies have the air of anything remotely fiscal, but the vast majority of those subsidies went straight to the public sector, no different than say when the Federal Reserve turns over its interest income to the US Treasury, and thus more resembling a form of revenue than a form of expenditure.

    How anyone can consider this to be part of the “real” fiscal deficit is beyond me.

  57. Gravatar of Cory Cory
    26. March 2014 at 05:59

    “Ironically, RBZ bills were securities that the central bank issued in order to *reduce* the size of the monetary base. Needless to say this backfired in a big way, as interest payments of the bills only caused the monetary base to expand exponentially.”

    Seems to me the ultimate limit on the United States’ ability to finance its expenditures with the issuance of Treasury Securities then is the degree to which interest payments on those securities would increase the monetary base.

    So, if Interest expense on outstanding treasuries for FY 2014 is going to be $400 billion…that is the minimum level of taxation that is required if we want to have no net increase in M due to government expenditures being financed by the issuance of treasury securities.

  58. Gravatar of TallDave TallDave
    26. March 2014 at 06:37

    Maybe Chile’s fiscal calendar is relevant there? It’s awfully strange there is such a wide divergence, I mean we’re talking about Chile not Chad.

  59. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 06:37

    Cory,
    The monetary policy implications of the interest on securities issued by a central bank and the interest on securities issued by a treasury are entirely different. Interest payments on securities issued by a central bank add to the monetary base (the monetary base is the main liability of the central bank). Interest payments on securities issued by the treasury do not.

    Generally speaking, central banks do not issue debt securities. The RBZ did so to tighten monetary policy and instead it led to hyperinflation.

  60. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    26. March 2014 at 08:09

    ‘The Mauro et al, Braun-Llona et al, and Jofre et al figures show that from 1965-78 Chile only had deficits over 2% of GDP in 1971-74. They were 8.0%, 12.7%, 7.3% and 5.8% of GDP in 1971 through 1974 respectively.’

    Is that credible, given the 1000% inflation rate?

  61. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 08:28

    TallDave,
    Another possibility that crossed my mind was different definitions of government (i.e. general vs central). But all of the measures are for central government, and all seem to be for calendar years.

    In my opinion the 30.5% figure is simply not believable. Central government spending was only about 30.8% of GDP in 1973 according to Mauro et al, so that would imply Chile simply didn’t collect any taxes that year. And again, there is not just one, but two estimates (Bordo) that contradict the magnitude of the deficit figure.

    And with the exception of Greece in 1898, the only countries I can find record of running deficits that large are all relatively advanced countries. The only reason why I think Greece was able to borrow that much money was that France, Russia and the UK guaranteed some of the securities they issued to help pay reparations for the war they had recently lost against the Ottoman Empire:

    http://scripophily.net/greece.html

    To borrow that kind of money you need a reasonably well functioning bond market.

    It would be nice if we could find out if the Central Bank of Chile still stands behind that estimate.

  62. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 08:36

    Patrick R. Sullivan,
    “Is that credible, given the 1000% inflation rate?”

    Inflation is always and everywhere a monetary phenomenon, not a fiscal one. That was one of the whole points of constructing the list.

  63. Gravatar of Cory Cory
    26. March 2014 at 09:21

    Mark,

    You said:

    “Interest payments on securities issued by a central bank add to the monetary base (the monetary base is the main liability of the central bank). Interest payments on securities issued by the treasury do not.”

    I was not clear enough in my previous statement. I agree with what you say here because the Treasury has to either sell another treasury or get tax revenue to make an interest payment to another bond holder and the sale of that additional treasury security or collection of taxes would ensure that the interest payment results in no net increase in the monetary base.

    What I meant to suggest was that it might not be a great idea to cover interest payments to X bondholders with proceeds obtained from selling new treasury securities.

    Wouldn’t we least want to have enough tax revenue to cover at least those interest payments? Or, does it at the end of the day not make any difference?

    Seems to me you might risk getting to the point that the Austrians talk about where only the FED is willing to buy the new securities and then that does increase the monetary base.

    But maybe that’s really an unlikely problem???

    So long as people are willing and able to buy U.S. Treasuries, perhaps the Federal Government could always cover its interest payments with the sale of additional treasuries, and there’s no good reason to think people wouldn’t want them and that’s all nonsense???

    As former Assistant Treasury Secretary Frank Newman has suggested, maybe the Bond vigilantes have it backwards…treasuries are always preferable to bank accounts and we need not worry about the Treasury being unable to find willing buyers???

    The reason I posed the question in the first place is because
    you said this earlier:

    “I would argue that the manner in which government spending is financed has little effect on long run RGDP growth. So the issue is not really whether there is a deficit or not, nor even necessarily how much is spent relative to GDP. What matters is how the revenue is raised and what it is spent on.”

    I imagined this statement in the extreme case, “well what if the Federal Government just stopped collecting tax revenue?”

    It is hard for me to imagine that a Federal Government could get away with “zero” tax revenue even if it had the most efficient and RGDP promoting allocations of bond proceeds imaginable but maybe it can?

    Maybe I’m just not thinking outside the box enough but it’s hard for me to imagine that the Federal Government would be able to get away with financing its expenditures, including interest payments bond securities, solely with the sale of treasury securities of different maturities covering interest payments with the proceeds from the sale of additional securities but perhaps I am wrong. Maybe all that matters is whether the allocation of bond proceeds promotes RGDP growth?

  64. Gravatar of Philippe Philippe
    26. March 2014 at 09:30

    Mark,

    “How anyone can consider this to be part of the “real” fiscal deficit is beyond me.”

    The paper you quoted argues that central bank ‘quasi-fiscal losses’ should be counted as part of the overall fiscal deficit:

    “The analysis of fiscal policy in any transition country has to include estimation of QFO. Otherwise, the analysis is incomplete and conclusions may not be valid.” (p.30)

    “The paper includes a calculation of QFDCB [central bank quasi-fiscal deficits] for a broad sample of transition countries. These figures may be aggregated with general government deficit to obtain realistic public sector balances.” (p.30)

    “In order to derive aggregated public sector deficit the ‘net’ QFDCB can be added to general government deficit.” p.27

    “Central banks have been involved in QFO in numerous transition countries, but rarely do they record losses. As was mentioned before, permanent losses usually represent a hidden fiscal deficit.” p.20

    http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Documents/dp0201.pdf

  65. Gravatar of Philippe Philippe
    26. March 2014 at 10:22

    Mark,

    your list states that during the 1989-90 hyperinflation in Brazil, the public fiscal deficit was 18.6% in 1989 and 5.8% in 1990. In contrast this IMF publication by Carmen Reinhart and Miguel Savastano indicates that the fiscal deficit in 89-90 was 56.3% (excluding quasi-fiscal losses). (See table 2 on page 3). The paper also claims that “sharp reductions in fiscal deficits are always a critical element of a stabilisation program, regardless of the choice of monetary anchor”.

    https://www.imf.org/external/pubs/ft/fandd/2003/06/pdf/reinhard.pdf

  66. Gravatar of Scott Sumner Scott Sumner
    26. March 2014 at 10:53

    TallDave, The press is full of skeptical/negative reporting on China. I hope the Bloomberg story is not true. Remember that literally millions of overseas business people constantly visit China and do business there. It’s not exactly a state secret whether China is reforming or not. Even the Chinese newspapers are often surprisingly critical of the government.

    Mark, Patrick, et all, I haven’t had time to fully keep up with the seignorage discussion, but one general comment. A fairly small budget deficit can be associated with a fairly high steady state inflation rate. For instance, with a trend inflation rate of 100%, the real demand for base money might be only 1% or 2% of GDP. Then doubling the base every year (to maintain 100% inflation) would only monetize a deficit of 1% to 2% of GDP. At least I believe that is correct.

  67. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 10:56

    Cory,
    I wasn’t suggesting that we should try and finance government expenditures solely with deficits. You asked me about the effect of deficits on long run growth. What is fiscally sustainable is an entirely different question. I don’t see them as inextricably linked.

  68. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 12:37

    Philippe,
    I’m specifically not interested in the *public sector balance*. I’m fully cognizant of the fact that the central bank is part of the public sector. It is however not part of the treasury. Exchange rate operations and financial operations are not the same as fiscal spending even if they result losses to the central bank balance sheet.

    “In contrast this IMF publication by Carmen Reinhart and Miguel Savastano indicates that the fiscal deficit in 89-90 was 56.3% (excluding quasi-fiscal losses). (See table 2 on page 3).”

    Reinhart and Savastano cite the IMF and Reinhart and Savastano (2002) as the sources of those figures. Reinhart and Savastano (2002) evidently is an unpublished paper, and the IMF doesn’t have figures that far back.

    In any case the correct line to read is the following one labeled “operational deficit”. Note that it reads 2.8% of GDP in 1989 (t) and 0.0% of GDP in 1990.

    The World Bank’s figures show that Brazil’s deficit is 3.4% of GDP in 1990:

    http://data.worldbank.org/indicator/GC.BAL.CASH.GD.ZS?page=4

    The figures I quoted come from Michael Bordo and he cites B.R. Mitchell.

  69. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 12:43

    Philippe,
    The Central Bank of Brazil’s estimates of the operational deficit show that it was 7.1% of gDP in 1989 and (-1.3%) of GDP in 1990. See Page 20:

    http://www.fgv.br/professor/ferreira/PolEconDebt.pdf

    If you read the footnote on the preceding page it mentions why the operational deficit is the correct measure and also that this is what the IMF uses.

    For more on why the operational deficit is the correct measure to use when the inflation rate is at a high level see this paper:

    http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Other/Land%20and%20Environment/BlejerCheasty91.pdf

  70. Gravatar of Philippe Philippe
    26. March 2014 at 14:22

    Mark,

    “Reinhart and Savastano cite the IMF and Reinhart and Savastano (2002) as the sources of those figures.”

    The paper you link to shows a ‘conventional’ budget deficit of 45.3% of GDP for Brazil in 1988 (it has no stats after that year), which is not far off the IMF/Reinhart number. See page 14.

    http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Other/Land%20and%20Environment/BlejerCheasty91.pdf

    “For more on why the operational deficit is the correct measure to use when the inflation rate is at a high level see this paper”

    Here are some quotes from that paper (‘The Measurement of Fiscal Deficits’):

    “the operational deficit has a macroeconomic deficiency: by correcting the deficit for the impact of inflation on it, the ability to assess the impact of the deficit on inflation is lost.” (p.15)

    How very convenient!

    I would say the ‘operational deficit’ is an (adjusted) measure which can serve a purpose, but it is not “the” correct measure. It is clearly the incorrect measure to use if you are trying to evaluate the effect of the deficit on inflation.

    Regarding central bank quasi-fiscal operations:

    “To summarize, ideally, government accounts should incorporate quasi-fiscal revenues and expenditures, leaving central bank accounts covering only monetary activities. A second-best solution would be, first, that central bank operational losses be consolidated into the fiscal deficit by the addition of a transfer from government to the central bank financed by credit from the central bank. Second, an estimate of the size of central bank quasi-fiscal activities falling outside the profit-and-loss account should be made, and then amalgamated into the adjusted fiscal deficit. Such a hybrid deficit would mix net worth with cash concepts, but would have value as a supplementary indicator showing the approximate impact of central bank quasi-fiscal activities on the overall public sector balance.” (p.21)

    So apparently the paper you link to disagrees with you on this point.

    http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Other/Land%20and%20Environment/BlejerCheasty91.pdf

  71. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    26. March 2014 at 16:46

    ‘Inflation is always and everywhere a monetary phenomenon, not a fiscal one. That was one of the whole points of constructing the list.’

    In Chile in the early 70s govt. spending was financed with central bank money creation (something of a tradition in Latin America). While nationalizations of mining and large agricultural estates began before Allende, the increase under him was huge. The way it was done was, the govt paid compensation for the nationalizations with govt. bonds. Which, thanks to the CB monetization quickly became worthless.

    Allende’s confiscations included 19 banks among the almost 500 firms it took over. Those firms accounted for 40% of GDP. In addition to those there were illegal seizures of private businesses and farms by mobs aligned with Allende.

    Eventually the whole country rebelled and took to the streets in 1973. That was Allende’s undoing.

  72. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 19:46

    Philippe,
    “The paper you link to shows a ‘conventional’ budget deficit of 45.3% of GDP for Brazil in 1988 (it has no stats after that year), which is not far off the IMF/Reinhart number. See page 14.”

    Well the following paper shows that the conventional budget deficit was 89.9% of GDP in 1989 (page 54):

    http://www8.iadb.org/res/laresnetwork/files/pr43finaldraft.pdf

    It also shows that the operational deficit was only 7.4% of GDP. Do you really think the deficit was 90% of GDP, leaving only 10% of GDP for tax revenue and/or non-government expenditures?

    “How very convenient!”

    Well, we’re not doing econometric estimates of the impact of the deficit on inflation, are we? We’re only trying to determine its size. As it says on pages 1655-6 of Blejer and Cheasty:

    “Besides its distortionary effects on real revenues (Tanzi 1977),24 and its effects on the real value of government assets
    and liabilities (dealt with in Section V), inflation, while reducing the real value of the outstanding stock of unindexed public debt, may compensate creditors for such erosion in their real assets through higher nominal interest rates. In
    other words, some of the government’s interest payments on its debt are in reality part of the amortization of that debt. If the inflationary component of interest rates is not removed from the interest bill, the deficit will be overstated by the
    size of the amortization element included as interest payments above the line, rather than below.”

    And as for the impact of central bank QFA on the overall *public sector balance*, this is totally irrelevant. I repeat, the issue is the *treasury balance*.

  73. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 19:57

    Patrick R. Sullivan,
    My point is they didn’t need to run a very large deficit to generate hyperinflation. As Scott points out it doesn’t require a lot of monetization to generate very high rates of inflation once you have sufficient money supply velocity.

    By the way, since you’re so interested in the Allende regime, I take it you’ve probably heard of Project Cybersyn:

    http://en.wikipedia.org/wiki/Project_Cybersyn

    One of its more fascinating aspects in my opinion.

  74. Gravatar of Philippe Philippe
    26. March 2014 at 20:10

    “And as for the impact of central bank QFA on the overall *public sector balance*, this is totally irrelevant. I repeat, the issue is the *treasury balance*.”

    The government fiscal deficit is not necessarily just the treasury balance. The paper you provided is about how to calculate fiscal deficits, and it advises including central bank ‘quasi-fiscal losses’. IMF researchers advise doing the same. So it’s not “irrelevant”.

    I’ll look at the other paper on Brazil tomorrow.

  75. Gravatar of Philippe Philippe
    26. March 2014 at 20:13

    love the retro sci-fi operations room

  76. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 20:37

    Philippe,
    “The government fiscal deficit is not necessarily just the treasury balance. The paper you provided is about how to calculate fiscal deficits, and it advises including central bank ‘quasi-fiscal losses’. IMF researchers advise doing the same. So it’s not “irrelevant”.”

    The IMF is interested in calculating the consolidated government balance. I am comparing fiscal policy to monetary policy so I am not interested in consolidating the public sector. These two goals are not at all compatible.

  77. Gravatar of Philippe Philippe
    26. March 2014 at 21:06

    Mark,

    “I am comparing fiscal policy to monetary policy”

    “The analysis of fiscal policy in any transition country has to include estimation of QFO. Otherwise, the analysis is incomplete and conclusions may not be valid.” (p.30)

    http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Documents/dp0201.pdf

    “ideally, government accounts should incorporate quasi-fiscal revenues and expenditures, leaving central bank accounts covering only monetary activities.” (p.21)

    http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Other/Land%20and%20Environment/BlejerCheasty91.pdf

    “an estimate of the size of central bank quasi-fiscal activities falling outside the profit-and-loss account should be made, and then amalgamated into the adjusted fiscal deficit.” (p.21)

    http://piketty.pse.ens.fr/files/capitalisback/CountryData/USA/Other/Land%20and%20Environment/BlejerCheasty91.pdf

    “…a truer fiscal picture would include both the activity of the government and the QFAs of the RBZ in the fiscal balance.”

    http://www.imf.org/external/pubs/ft/wp/2007/wp0798.pdf

    “when the fiscal accounts are adjusted to include the quasi-fiscal activities (QFAs) of the RBZ, the adjusted primary balance shifts to a deficit of almost 25 percent of GDP – a more accurate picture of the true fiscal position. The adjusted overall fiscal deficit or financing requirement, including government and RBZ interest payments, is estimated to have amounted to about 80 percent of GDP in 2006.” (p.9)

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=984615

    The authors of these four papers, two of which you provided, all disagree with you on this matter.

  78. Gravatar of Philippe Philippe
    26. March 2014 at 21:21

    Mark,

    “I am comparing fiscal policy to monetary policy”

    “The analysis of fiscal policy in any transition country has to include estimation of QFO. Otherwise, the analysis is incomplete and conclusions may not be valid.” (Markiewicz, p.30)

    “ideally, government accounts should incorporate quasi-fiscal revenues and expenditures, leaving central bank accounts covering only monetary activities.” (Blejer and Cheasty, p.21)

    “an estimate of the size of central bank quasi-fiscal activities falling outside the profit-and-loss account should be made, and then amalgamated into the adjusted fiscal deficit.” (Blejer and Cheasty, p.21)

    “…a truer fiscal picture would include both the activity of the government and the QFAs of the RBZ in the fiscal balance.” (Munoz, p.12)

    “when the fiscal accounts are adjusted to include the quasi-fiscal activities (QFAs) of the RBZ, the adjusted primary balance shifts to a deficit of almost 25 percent of GDP – a more accurate picture of the true fiscal position. The adjusted overall fiscal deficit or financing requirement, including government and RBZ interest payments, is estimated to have amounted to about 80 percent of GDP in 2006.” (p.9)

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=984615

    The authors of these four papers, two of which you provided, all disagree with you on this matter.

  79. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 22:11

    The authors of these four papers are interested in calculating the consolidated government balance. I am comparing fiscal policy to monetary policy so I am not interested in consolidating the public sector. These two goals are not at all compatible.

  80. Gravatar of Philippe Philippe
    26. March 2014 at 22:37

    No, the authors of these four papers are interested in more accurate measurement of fiscal policy and monetary policy.

    “The analysis of fiscal policy in any transition country has to include estimation of QFO. Otherwise, the analysis is incomplete and conclusions may not be valid.” (Markiewicz, p.30)

    “This paper reviews issues associated with quasi-fiscal operations (QFO) of central banks in a sample of countries in Central and Eastern Europe and the former Soviet Union. The concern is the problem of transparency in fiscal and monetary accounts when the central bank undertakes quasi-fiscal operations and the government falls short of providing full coverage of fiscal operations. QFO can also jeopardize monetary policy designed to maintain price stability. A simple framework is developed to estimate the extent of QFO. In some cases, the magnitude of QFO is significant in indicating underestimation of fiscal deficit figures. We claim that the lack of transparency in fiscal accounts of transition countries warrants serious concern.” (Markiewicz, p.1)

    http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Documents/dp0201.pdf

    “In many countries, the distinction between the responsibilities of the Treasury and the central bank has become blurred, with the latter performing “quasi-fiscal” activities not specifically connected with monetary policy… It has frequently been argued that these quasi-fiscal operations are similar to other budgetary activities.” (Blejer and Cheasty, p.19)

    “ideally, government accounts should incorporate quasi-fiscal revenues and expenditures, leaving central bank accounts covering only monetary activities.” (Blejer and Cheasty, p.21)

    “To prevent measurement biases, central bank losses should be included in the public sector balance by recording, for example, a budgetary transfer or a subsidy from the government, thus properly increasing the recorded fiscal deficit. (Blejer and Cheasty, p.21)

  81. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. March 2014 at 23:07

    Philippe,
    *You* brought up the issue of central bank QFA. I cited Markiewicz only to show that it’s largely irrelevant. According to Markiewicz only one observation on the list had a QFA deficit, and it was only 4.9% of GDP.

    I then showed through the example of Zimbabwe why I don’t think QFA deficits are equivalent to treasury spending (in fact, in Zimbabwe’s case they were a source of treasury revenue). You can quote all you want but it’s not responding to the arguments that I have made.

  82. Gravatar of Philippe Philippe
    26. March 2014 at 23:35

    These papers are all about accurately measuring fiscal policy, so you shouldn’t incorrectly claim that their analysis is “irrelevant” to or ‘incompatible’ with that goal, as you repeatedly did above.

  83. Gravatar of Philippe Philippe
    26. March 2014 at 23:53

    As I pointed out, these papers all argue that central bank QFOs should be included in estimates of fiscal policy, and not monetary policy. The paper you provided to try and justify focusing exclusively on the ‘operational deficit’ and ignoring the ‘conventional deficit’ states very clearly that QFOs should be counted as part of the fiscal deficit and not as part of monetary policy.

  84. Gravatar of Cory Cory
    27. March 2014 at 05:37

    Mark A. Sadowski,

    I did not mean to imply that I thought you were suggesting that we finance our budget deficits with the sale of treasuries only. I suppose I was just wondering aloud on thought I would see what you might have to say about it.

    Maybe I’ll phrase it differently.

    What would your opinion be of a congressman coming out and saying something like the following:

    “we can drastically reduce the income tax or eliminate it altogether and spend more on productive investment like R&D. Stop worrying about the size of the deficit per se or the number of outstanding treasury securities. We need to focus on maximizing RGDP with pro-growth policies. The Japanese have outstanding debt/GDP of 227% and have no problem selling their bonds. Their problem is RGDP. If we overshoot with our fiscal policies, the Federal Reserve will offset our mistakes. Hopefully, the Federal Reserve will adopt NGDPLT and I intend to introduce legislation requiring the Federal Open Market Committee to do so.”

    ^^^To me a politician saying something like that is better than what either side is offering.

    Also,

    Where do you think the FED’s mistakes were in the mid to late 60′s? Fed Funds Rate fell to 1.5% in January of 1966. Seems to me it probably shouldn’t have been falling at that point but it was raised above 6% by September. This apparently lead to fears there would be a recession and so the FED acted to drop the FED Funds Rate to below 4% in May of 1967.

    So, in 1966-67, RGDP fell from 10% down to below 2% and inflation surged up to above 4% and stabilized there until late 1967 when it started to takeoff toward the great inflation.

    What do you think the FED might have done differently? Was the original sin continuing to have easy money into 1966 and reacting too late?

  85. Gravatar of Brian Donohue Brian Donohue
    27. March 2014 at 08:14

    Morgan Warstler for President.

  86. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2014 at 11:51

    “These papers are all about accurately measuring fiscal policy, so you shouldn’t incorrectly claim that their analysis is “irrelevant” to or ‘incompatible’ with that goal, as you repeatedly did above.”

    No, these paper are all about accurately measuring the *public sector deficit*, which runs counter to my declared aim of considering central bank policy separately from treasury policy.

    “As I pointed out, these papers all argue that central bank QFOs should be included in estimates of fiscal policy, and not monetary policy.”

    Yes, but what you did not consider was *why* they were doing this. If a central bank suffers losses to its balance sheet it must either be recapitalized by the treasury or it will be unable to tighten monetary policy. It is obviously beneficial from the standpoint of assessing a country’s consolidated public sector economic policy, as is a frequent aim of the IMF for example. But from the standpoint of simply computing the treasury deficit it is totally irrelevant.

    Now, one additional point with reference to Zimbabwe. A close reading of the paper by Munoz reveals she made no effort to correct for the effect of inflation on the interest cost of RBZ loans. Normally not considering the effect of inflation leads to an overstatement of the central bank surplus as Markiewicz points on on page 13. But the RBZ is unusual in that it issued its own debt securities, meaning unless one corrects for inflation, the interest cost would be greatly exagerated.

    Recall that there are three primary components to Zimbabwe’s central bank QFA deficit: 1) interest cost of Reserve Bank of Zimbabwe (RBZ) bills, 2) subsidies and 3) realized exchange rate loss. These were 41.4%, 15.4% and 7.7% of annual GDP respectively in the first 10 months of 2006. Adjusting for the length of time brings these figures to 49.7%, 18.5% and 9.2% of GDP or a total of 77.4% of GDP.

    No other estimate of the central bank QFA deficit even exceeds 10.9% of GDP, and with good reason. None of the other central banks issued their own debt securities, and hence faced a situation in which the interest cost needed to be corrected for inflation. If the amount of correction for the treasury deficit in the case of Brazil is any hint (see for example page 54 of Bevilaqua and Werneck, 1998), such an adjustment would reduce the interest cost of RBZ bills by up to 95%. Consequently the RBZ’s QFA *operational* deficit is likely closer to 30% of GDP, and even this is outlandish.

    And, more importantly, this still is meaningless from a treasury policy standpoint, as the vast majority of the remainder consists of subsidies to the rest of the public sector (which served to decrease the treasury deficit) and foreign exchange losses, nothing that even remotely resembles *spending* by the treasury.

  87. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. March 2014 at 12:11

    Cory,
    “What would your opinion be of a congressman coming out and saying something like the following:…”

    My personal opinion is that this sounds like a congressional candidate who would receive my vote. But in this political environment such a declaration would likely be political suicide (unless you’re Bernie Sanders).

    “Where do you think the FED’s mistakes were in the mid to late 60′s?”

    “Mistakes” presumes that there was some rules-based policy that the FOMC failed to pursue, when in fact policy was highly discretionary in the mid to late 1960s as your description of the fed funds rate changes and erratic RGDP growth indicates.

    Thus in a larger sense the FOMC’s mistake was in not having some kind of rules-based policy like Inflation Targeting (IT), or Price Level Targeting (PLT) or, better yet NGDPLT, in place. Had they had such a policy, and had worked to develop credibility in the pursuit of that policy, they almost certainly would not have faced the dilemma of imposing the terrible costs of disinflation in the early to mid-1980s.

  88. Gravatar of Philippe Philippe
    27. March 2014 at 13:17

    Mark I’m not going to continue with this discussion. I disagree with your statements but don’t want to spend any more time trying to argue with a brick wall, and I don’t want to start getting annoyed with you. So I propose we agree to disagree.

  89. Gravatar of Mark A. Sadowski Mark A. Sadowski
    10. April 2014 at 06:52

    This comment is more for my own sake then anyone else’s.

    A followup on the Zimbabwean data above.

    Suppose we were to consolidate the general government operational balance into the central bank QFA to produce an estimate of the public sector balance. What would it be?

    Table 2 on page 8 of Munoz shows that 79.9% of the deficit attributable to subsidies went to the public sector. Thus subsidies to the public sector were 14.8% of GDP in 2006. Counting that as revenue to the general government means that the 2006 general government deficit of 2.5% of GDP (according to the IMF WEO) becomes a surplus of 12.3% of GDP. Excluding public sector subsidies the central bank QFA is 15.4% of GDP. Summing them together produces a consolidated public sector operational balance of (-3.1%) of GDP.

    The point of this exercise was to show that the public sector deficit isn’t simply the sum of the general government deficit and the central bank QFA. One needs to take into account that portion of the central bank QFA which is effectively revenue for the general government. In Zimbabwe’s case although the central bank QFA may have been very large, half of it consisted of subsidies to the public sector, and consequently was a source of government revenue.

    I also found the following quote on the relationship between the operational balance and demand (page 20):

    “The measure of the fiscal balance with interest payments adjusted to eliminate the impact of inflation is called the operational balance (see Tanzi et al. (1987)). The operational balance reduces interest payments by the amount that compensates lenders for the erosion of the real value of their claims— notionally equal to the inflation rate times the outstanding debt. From the standpoint of assessing the fiscal stance, this correction is pertinent, since it can be argued that the inflation component of interest payments does not add to the income of the recipients, as it only maintains their net worth in real terms. Rational economic agents will not consider the inflation component of interest payments as net income but rather as principal amortization. In this vein, the inflation component of interest payments does not contribute to demand more than debt repayment does. Also from the standpoint of estimating the underlying balance that would prevail in the absence of inflation, eliminating the inflation compensation component is also necessary—as this expense would not arise if prices were stable.”

    https://www.imf.org/external/pubs/ft/tnm/2010/tnm1002.pdf

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