Why money matters
Some commenters who are sympathetic to MMT seem unfamiliar with the standard view of why money matters. They argue that swapping base money for an equal dollar value of bonds doesn’t matter, because the recipient of the new money is no better off than before. It’s true they are (approximately) no better off, but that’s NOT why economists think money matters. It would be nice if commenters showed they understood the traditional view, and then explained why it’s wrong and MMT is right.
Conventional economists believe that an injection of new base money creates a situation of excess cash balances. Keynesians believe the attempt to get rid of these excess cash balances causes bond prices to rise (i.e. interest rates to fall), and this boosts AD. Monetarists believe that the attempt to get rid of excess cash balances causes the price of a wide range of assets to rise, not just bond prices. Thus the Fed announcements of January 2001 and September 2007 caused only a small decline in short-term interest rates, but a big rise in stock prices. (BTW, long-term rates actually rose both times due to the Fisher effect—a factor ignored by MMTers.)
Monetary stimulus boosts the prices of T-bills, stocks, commodities, real estate and foreign exchange. I.e., it depreciates a currency. During normal times such as the 1990s, the difference between Keynesians and monetarists is just a theoretical curiosity. They both agree that monetary policy drives NGDP; they merely differ in how they see the transmission mechanism.
When rates fall to zero, however, the monetarist model is clearly superior. In March 2009, the Fed announced a QE program and as a result stocks rose and the dollar sharply depreciated against foreign currencies. That’s consistent with the monetarist model and inconsistent with the (extreme) old Keynesian view that monetary injections don’t matter at zero rates. (In fairness, New Keynesians have a more nuanced view.) MMTers seem to think money never matters, even at positive interest rates, although as I pointed out in this post it’s hard to be sure, as their statements are so contradictory.
Here’s an analogy. When there’s a big apple crop, the new apples are sold at market prices. The wholesalers who buy the apples do so at competitive prices and thus don’t feel any richer. They see no need to go out and spend more. But they do have excess apples, which puts downward pressure on the value of apples.
Inflation is a fall in the value of cash. A big crop of new money puts downward pressure on the value of cash. If the government sells me a briefcase full of $1 million cash in exchange for an equal value of bonds, I’m no richer than before. I won’t go out and buy a new Ferrari. But I will have much more cash than I prefer to hold, and I’ll get rid of that extra cash.
And here’s where the fallacy of composition comes in. While I can get rid of the extra cash by purchasing bonds, stocks, commodities, real estate or foreign exchange; society as a whole cannot get rid of the excess cash by purchasing other assets. Doing so is merely “passing the buck”.
But the public’s attempt to get rid of excess cash balances will drive up the price of a wide range of assets, leading to more total spending, more NGDP. Eventually NGDP will rise high enough so that people are willing to hold the larger cash balances, and a new equilibrium is established.
All of this is ignored by MMTers. They seem to think that swapping cash for bonds is “irrelevant”, even when interest rates are positive.
In fact, an exogenous and permanent increase in the money supply of X% will cause prices and NGDP to rise by X% in the long run. Money is neutral in the long run; just as changing a country’s measuring stick from feet to meters doesn’t change the actual (“real”) length of objects.
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28. November 2020 at 15:22
Sumner: ” Money is neutral in the long run” – and just how long is the long run, professor?
28. November 2020 at 16:00
‘If the government sells me a briefcase full of $1 million cash in exchange for an equal value of bonds, I’m no richer than before. I won’t go out and buy a new Ferrari. But I will have much cash than I prefer to hold, and I’ll get rid of that extra cash.’
I think an MMTer might respond by asking why I will have more cash than I prefer to hold. The government lowers the rate of interest on bonds and this causes me to switch some of my wealth from bonds to cash. But why is there excess cash given that both before and after the change I hold exactly as much cash as I choose to given the prevailing interest rates?
The lower rates of interest might mean I will want to borrow (and spend) more. On the other I now get less interest income so this might mean I spend less.
So (for an MMTer) its not clear even what direction the expansion of the money supply will push spending.
28. November 2020 at 16:32
I agree that MMT is either horribly explained or lacks some crucial reality at its core.
On the other hand, expecting the domestic economy of the US to expand if the Federal Reserve buys bonds and other securities on globalized asset markets is a bit of a stretch also.
Unfortunately for those of us who might wish to see a real-world experiment, every time the Fed has purchased a few trillion dollars in securities (in a world with more than $500 trillion of investable assets), the US government has been conducting large fiscal deficits. Other central banks have also been running quantitative-easing programs.
Scott Sumner places a lot of faith in the “expectations fairy.” Judging from history, the expectations fairy has a minus sign in front of it. For generations, top macroeconomists ever predicted higher rates of inflation and interest rates due to Fed policies, but instead we have seen lower rates of inflation and interest rates.
Add on, I don’t see any reasonable prospect for the expectations fairy to work when central banks have a squeamish aversion to almost any rate of inflation. Perhaps the expectations fairy would work if Jerome Powell would say, “We are targeting 5% annual inflation for the next four years, and have committed to $1 trillion a month in quantitative easing until we hit that target.”
How can Scott Sumner expect the expectations fairy to work if central bankers keep the fairy in a small bird cage?
The MMT crowd has one thing is right, and that’s if you want to increase domestic spending on a sensible timeline, then increase domestic spending on a sensible timeline.
Ben Bernanke and Stanley Fischer have recommended money-financed fiscal programs. I would prefer these be enacted through tax cuts, such as a holiday on Social Security contributions.
I don’t have a fancy manifold theory for why Social Security tax cuts would work, I just think they would.
28. November 2020 at 19:23
Ray, 879 days.
Market, If you double the monetary base, and the prices of many assets rise as a result, then the economy is out of its long run equilibrium.
If you assume that nominal wages and prices are sticky in the short run, then if becomes profitable to produce more assets than before.
If you assume wages and prices rise, then we are at QED. So either way the MMTers lose.
BTW, if MMTers say the effect of a change in interest rates is ambiguous (which is true) then why does the MMT textbook also say that higher interest rates are contractionary?
And how do MMTers explain the fact that (empirically) open market purchases are expansionary in the real world?
28. November 2020 at 21:25
‘If you double the monetary base, and the prices of many assets rise as a result, then the economy is out of its long run equilibrium.’
I think that in your (and my) view that when (after a rates fall) people choose to swap bonds for money they have in mind to then spend some of that money on other assets that will provide a higher rate of return than bonds now do. This kicks off a ‘hot potato’ effect that ultimately leads to more spending and higher NGDP. I see no evidence that MMT acknowledges that such an effect exists. I think this is because they reject Wickselianism and natural rate theories upon which the Hot Potato Effect is based. In their view (as far as I can tell) the rate of return on other assets will adjust to the rate of return that the government sets on bonds so people will just sit on the new money with no incentive to spend it.
‘BTW, if MMTers say the effect of a change in interest rates is ambiguous (which is true) then why does the MMT textbook also say that higher interest rates are contraction?’
I have indeed noticed that MMT theorists tend to say (most of the time) that OMO makes no difference to anything real – but in the small print they do seem to acknowledge that higher interest rates are actually contractionary. I don’t know why.
‘And how do MMTers explain the fact that (empirically) open market purchases are expansionary in the real world?’
I think they deny this by pointing to empirical evidence from Japan since 1990 and the rest of the world since the GFC, and ignoring data from other times when OMO seemingly allowed inflation targets to be consistently hit.
28. November 2020 at 21:47
A lot of MMT discussion about the effectiveness of monetary policy takes the context of the economic situation into account as part of their discussion. I think it would be fair in critiquing what they say to also try to recognize what kind of situations the economy was in when monetary policy is likely to decide to try to influence the course of the economy. What state the economy is in when any policy is implemented is probably useful to know. And how the economy reacts might depend on those conditions?
Why not start by providing the reason or situation that the central bank might consider an ‘injection of new base money’? Wouldn’t it be fair to say that they were trying to provide a solution for (or to avoid) an economy in which there was a lack of aggregate demand- like what causes the majority of recessions?
MMT says that monetary policy is mostly not effective at stimulating demand in an economy that is suffering from a lack of demand. I am sure you are familiar with the reasons why they say that. Most of them are really not unusual criticisms. But perhaps the authors of that text book will change ‘irrelevant’ to ‘almost always irrelevant’ in the next edition as a result of your critique.
You are a Professor of Economics with a doctorate from Chicago who has taught monetary theory for many years. I am sure you know monetary theory better than me. But you should not assume that commenters like me do not have any familiarity with the basic ideas of monetary economic theory just because we discount them. Sometimes we know your theory and just think some of it is not really the best way to describe what is happening or what is possible.
29. November 2020 at 00:37
Scott seems to have completely the wrong end of the stick as to what the basic form of stimulus advocated by MMT actually is. MMT does not advocate swapping bonds for cash: it advocates having the Fed create new money with government then spending that into the economy and/or cutting taxes. The UK’s monetary reform organisation, Positive Money has long advocated the same. Plus Ben Bernanke gave his blessing to that sort of arrangement a year or two ago.
There’s a good argument behind that “monetary / fiscal coordination” as follows. Having two quite separate organisations with powers to influence aggregate demand (the central bank and second, government) makes about as much sense as a car with two steering wheels controlled by a husband and wife having a matrimonial row.
29. November 2020 at 02:08
“If the government sells me a briefcase full of $1 million cash in exchange for an equal value of bonds,”
A government will not make you buy nor sell their bonds.
Such acctions occur with previous planing by persons and institutions irrespective of big OMO by fED.
Please do not make it look like it is forced upon people. SO people that sell bonds already have plans what to do with cahs received.
“But the public’s attempt to get rid of excess cash balances will drive up the price of a wide range of assets,”
WoooW
Total idiocy and it happens only in hyperinflation, which causes more inflation but nobody were talking about hyperinflation situation, now you introduce it as an escape route.
Value of cash is totaly irrelevant to people and economy, except in the extremes. What matters is that wages grow and its purchasing power. Economic theories are about well being of people not about well being of false models.
Inflation is a rise in prices by definition. Not about value of the cash.
Inflation is a necessity in a debt economy. Over time it reduces the burden of debt.
Monetarists have never warned us ybout dangers of deflation, only crying about inflation. Yet, when deflation happened so many people begin to suffer and their kids, suicides increased twofold (3x in Greece)
Bad economists kept warning about inflation and never mentioned the real dangers of deflation. So all the dangers of inflation were simply a huge BS.
Inflation is a neccessity in debt economy that serves lessening the burden of debt. Once inflation dissapears the debt becomes unmanagable and economy crashes.
Inflation is an indication of growth and it follows GDP growth. Just check out the China for last 40 years.
Wage growth enables more debt and more debt enables growth. Inflation is an indication not a cause. steeve keen has found 0,97 correlation of debt acceleration and uneployment. such correlation points to causation.
29. November 2020 at 03:23
The general feeling amongst MMTers is that monetary policy is uncertain in its distribution and response profile. So you don’t use it at all. You just ‘park it’ where it needs to be to ensure there is sufficient capital development in the economy (probably at zero).
Ban all bank lending except capital development lending 0% overdrafts capital development lending agency business deliver state funds monetarise debt. Implement the Job Guarantee to counter deflationary effect bank regulation.
Then you use fiscal policy to manage the economy. Strong auto-stablisers, like the Job Guarantee, to counter balance the business cycle and maintain the economy on ‘automatic pilot’. Then the government sets discretionary fiscal policy at a level that keeps everybody busy and the Job Guarantee pool numbers low at the height of the business cycle.
You don’t drive a car by throwing your weight around and hoping you can ‘nudge’ the wheels in the right direction. You get hold of the steering wheel!
29. November 2020 at 06:38
Jure – how can you be in disagreement with excess cash driving up the price of assets? Do yourself a favor and take a look at a graph of the money supply versus the S&P 500.
You seem to have yourself all twisted up here…
“Value of cash is totaly irrelevant to people and economy, except in the extremes. What matters is that wages grow and its purchasing power.”
You say the “value of cash” doesn’t matter but what does matter is “its purchasing power.” Please enlighten me as to the difference between these two things?
29. November 2020 at 07:41
The two-fold monetization and sterilization of deficit financing (or predominately open market operations with exclusively bank counterparties) requires that the velocity of circulation falls (tantamount to secular stagnation), that monetary savings are idled in the payment’s system.
Anyone who has kept their eyes open knows the accelerated trend in interest rates:
Larry Summers: “Our estimates suggest that the advanced economy neutral real rate (“Rstar”—Wicksell’s neutral or natural interest rate at which investment fully absorbs saving at full employment), has declined by about 300 basis points since 1980 and is now in the neighborhood of zero.”
The long-standing historical evidence is that an increase in money products, QE forever (or the accelerated increase in Reserve Bank credit since the early 1980s), decreases the real rate of interest (increases the supply of loan funds, while offsetting the demand for loan funds), and has a negative economic multiplier (is “money illusion”, exaggerates asset inflation and income inequality relative to the real output of goods and services).
The increase in money products results artificial mal-investment in dubious non-productive assets, the misallocation and mal-distribution of available credit. The resultant drop in velocity produces an excess of savings over real investment outlets (over the demand for capital goods), and thereby a drop in productivity.
The error, the biggest one in the history of mankind, is that all bank-held savings are frozen (have zero payment’s velocity).
Money velocity, deposit turnover, decelerates because banks can’t use savings deposits. Obtusely, from the viewpoint of the system, banks pay for their earning assets with new money. I.e., any primary bank deposit is a derivative deposit from a system’s perspective (items due from other banks).
And as Dr. Philip George says; ““When interest rates go up, flows into savings and time deposits increase” ( the ratio of M1 to the sum of 12 months savings ).
Link “The Riddle of Money Finally Solved”
http://www.philipji.com/riddle-of-money/
In other words, MMT will result in a death spiral.
29. November 2020 at 09:10
Market, There is a mountain of empirical work done by monetarists. I wonder how much of this they have actually examined. Someone linked to a Bill Mitchell post claiming that monetarists believe velocity is constant. Sigh . . .
Just reading Friedman and Schwartz’s Monetary History you’d know that’s not true.
Jerry, You said:
“But you should not assume that commenters like me do not have any familiarity with the basic ideas of monetary economic theory just because we discount them.”
That is most certainly NOT why I think they are uninformed. Rather the CONTENT their argument suggests they don’t understand the theories they are criticizing. Read Ralph’s comment (right after yours) for an example. Or Jure’s comment.
BTW, the MMT textbook constantly cites Keynes as an inspiration, but he’d be horrified by MMT.
You said:
“But perhaps the authors of that text book will change ‘irrelevant’ to ‘almost always irrelevant’ in the next edition as a result of your critique.”
That wouldn’t help, as monetary policy is always relevant.
Ralph, You said:
“Scott seems to have completely the wrong end of the stick as to what the basic form of stimulus advocated by MMT actually is.”
That’s simply false, and an indication that you haven’t understood my posts on MMT. Read them again until you understand them. I understand what MMTers are advocating.
Jure, There are so many problems with your comment that I just don’t have time to refute them all. Read my short course on money, with links in the right margin of this blog.
29. November 2020 at 10:30
It’s hard for me reconcile this statement
and the belief that the Cantillon effect is insignificant.
Given the quantity theory of money, isn’t the Cantillon effect just another way of saying the system returns to equilibrium through normal market mechanisms?
29. November 2020 at 12:24
@Sumner: (how long is long for money neutrality): “Ray, 879 days” – finally a straight answer! That’s over two years, when in fact most economics textbooks (e.g., Olivier Blanchard’s intro book) say money is not neutral for at most about three months (from a diagram in his book). But we’re making progress! And where’s your data for this assertion? Or do you just make it up as you go along, like the Austrians?
@Spencer B Hall – do you realize the Austrians make the same mistake that the Keynesians and monetarists make? They believe in the money multiplier. In fact, money is neutral, and indeed just a medium of exchange. You can have a crash in prices (or a rise in prices) without an increase in the money supply. Google “shadow banks”, “bitcoin” or just do a thought experiment as the kooky Austrians like to do.
@Dr. Ben Cole – to answer a question you posed a few posts ago, if the USA enslaved a country and extracted their resources, like the Japanese did in Manchuria, would it have gotten the USA out of the Great Depression (as it did Japan)? You say no. But in fact, this happened. It’s called World War II, and widely credited to getting the USA out of the Great Depression. The government requisitioned by force certain industries (Ford motor company is the chief example, forcing them to make war machines). While economist Robert Higgs would question whether the means justified the ends, it’s still true that such ‘forced production and consumption’, like in Manchuria, got the USA out of the Great Depression (which technically ended in 1934, as Sumner outlines in his Midas Paradox book) once and for all.
Shorter version: fiscalism works, monetarism doesn’t work. Period.
29. November 2020 at 13:32
Scott, Thanks for your suggestion that I should re-read all the articles you’ve written on MMT, where apparently I’ll discover that you do in fact understand that the main form of stimulus advocated by MMT is simply to create new money and spend it, and/or cut taxes.
You shouldn’t be too surprised to learn that I do not have time to re-read all those articles. But I’m sure that you, as the author of them, know which of your articles state that the main form of stimulus advocated by MMT is as above. So perhaps you could direct me to those articles.
29. November 2020 at 13:35
Modern monetarists seem to seek to address a concern (and critique?) around old-school monetarism’s admission of policy having “long and variable lags” by invoking a “targeting the forecast” approach. But, if we had NGDP futures, I’d assume we would need various time-horizons: 5-year, 10-year, 30-year, etc. Which time-horizon forecast would you target ? What if monetary policy alone (w/o fiscal) only moved the 30-year expectations ? My point is that many commenters (and MMTers?) seem to be suggesting that money-financed fiscal deficits would be able to get NGDP back on-track with (1) much smaller monetary policy interventions and (2) on much shorter time horizons vs. monetary policy alone ?
29. November 2020 at 14:38
Carl, My point is that the effect doesn’t come from the first person who receives the new money, it comes from the existence of excess cash balances that impacts many markets that are completely unrelated to who first gets the money.
Ralph, I never said I wrote on the topic, I said I never wrote anything that conflicted with your claim. Read my post again. Did I say MMTers don’t favor money financed deficits? I just read their textbook; I think I understand their policy preferences.
Ricardo, Normally I’d target NGDP one-year forward. But during Covid it would have made more sense to target 2-years forward.
Monetary policy is far less costly than fiscal policy, as it doesn’t create future tax obligations.
29. November 2020 at 16:08
Sorry. I didn’t mean to argue about the net effect. I was just puzzling about the mechanics of dispersal.
29. November 2020 at 16:42
re: “ou can have a crash in prices (or a rise in prices) without an increase in the money supply.”
So?
29. November 2020 at 16:43
re: ” “long and variable lags”
No such phenomenon. Monetary lags are mathematical constants and have been for > 100 years.
29. November 2020 at 20:26
Nick S
“Jure – how can you be in disagreement with excess cash driving up the price of assets?” S&P 500 is a paper asset and i am not in a dissagreement on driving the price of paper assets, but those are not included in CPI nor matter much to majority of people.
And i was talking about wage’s purchasing power or the real wage, not money purchasing power as you present it. You can reread it and comprehend better.
29. November 2020 at 21:28
Scot,
YOu think that i am wrong but that is just because it is a new paradigm for you which you do not want to comrehend. YOu want to teach otheres not to be taught, so you think you comprehended what you read, but you did not nor you want to. But, at the same time, you pretend to understand and argue and present arguments that are off topic and pretend to win. For example, talking about FED acctions and then presenting the proof of Denmark; talking bout monetary policy then presenting fiscal actions in ˙98 as a proof…
I find few examples of you mixing up monetary and fiscal policies in your argument, mixing up asset prices and CPI, even using changed definitions of terms (like “inflation is drop in value of cash”) just as austrians changed the definition of inflation to say “rise in money supply” not as commonly defined as a rise in prices.
The core paradigm difference in MMT is a clear demarcation line between a financial system and a real economy while other conomics mix it up willy nilly as to get arguments and bad models with “correct” results.
” In March 2009, the Fed announced a QE program and as a result stocks rose and the dollar sharply depreciated against foreign currencies. …. MMTers seem to think money never matters,”
If you wrote “..base money never matters” you would be correct given that MMT assumes that FED does its job in targeting the rate. But in this sentence you falsly accuse MMT of completely opposite of truth. MMT is only about money and its effects on the economy. MMT is not about the real economy about labor, physical capital, production. MMT is only about financial systems and how it affects the real economy. Bad economists mix up financial system operations with the real economy as they see fit to produce desired results and conclusions. I can see it few times in your arguents Mr. Sumner. You call it money neutrality but then turn around and call against inflation. If inflation is important, then the money is not neutral to the economy. But, you want to claim it both ways just to excuse a bad argument.
“BTW, the MMT textbook constantly cites Keynes as an inspiration, but he’d be horrified by MMT.”
LOL
MMT acctually gives the description of financial systems that explain why many of Keynes’s writings are correct, like the most influential and outrageous claim “If the Treasury were to fill old bottles with banknotes, bury them–” is correct and costless.
But you do not desire to understand MMT paradigm so you claim what you want and trow false accusations at MMT
30. November 2020 at 05:50
What if there is a better explanation for the impact of “money” on AD than those put forth by conventional, Keynesian, and monetarist economists?
If the supply-demand balance for total world USD liquidity shifts in a way that reduces the real value of the USD, people will choose to buy more stuff because, if prices are “sticky,” real prices have fallen.
Note that the key issue is “total world USD liquidity,” not “base money.” Jeff Snider has pointed out that “on the run” Treasuries are as or more useful to the financial system for creating liquidity than are bank reserves, so the impact of QE depends upon *what* the Fed buys, not just how much.
The CRB Index appears to be a “good enough” (inverse) indicator of the real value of the USD. As I write this, the CRB Index is 160.62, which is only 69% of its 10-year average. This means that we are in a monetary deflation that would be severe enough to cause a recession even without COVID.
One thing that puzzles me is the fixation of monetary economists on interest rates. Unless “that which is paid back” is the same *thing* as “that which is borrowed,” an interest rate is indeterminate and meaningless. Because the USD is currently floating and undefined, all interest rates are currently meaningless.
Also, monetary control via interest rate targeting yields one equation with two unknowns, and therefore an indeterminate real value for the USD, and therefore a system that tends to overshoot and run away (like it is doing right now).
30. November 2020 at 05:58
Although Scott knows MMT is idiotic, he chooses to address their theory head on—-which of course is correct—he is an economist after all.
When I look at the vote count fraud, we have a different response by experts. Perhaps the fraud assertion is idiotic. But where are the Nate Silvers of the world who are willing to address the theory head on?
It is less idiotic than MMT. But I have not found any one who has attempted to systematically debunk the fraud theories. My prior on that is because to look at it too closely scares them.
30. November 2020 at 07:22
@Michael Rulle –
https://votepatternanalysis.substack.com/p/voting-anomalies-2020
(“The significance of this property will be further explained in later sections of this report. Nearly every vote update, across states of all sizes and political leanings follow this statistical pattern. A very small number, however, are especially aberrant. Of the seven vote updates which follow the pattern the least, four individual vote updates — two in Michigan, one in Wisconsin, and one in Georgia — were particularly anomalous and influential with respect to this property and all occurred within the same five hour window. In particular, we are able to quantify the extent of compliance with this property and discover that, of the 8,954 vote updates used in the analysis, these four decisive updates were the 1st, 2nd, 4th, and 7th most anomalous updates in the entire data set. Not only does each of these vote updates not follow the generally observed pattern, but the anomalous behavior of these updates is particularly extreme. That is, these vote updates are outliers of the outliers.”)
Strange statistical artifact or some ballot stuffing? A closer look than just a mechanical recount might be in order.
30. November 2020 at 09:37
Jure, You said:
“you think you comprehended what you read, but you did not nor you want to”
Don’t you think it odd that almost none of the top economists in America, even Keynesian economists, can comprehend MMT? Might there be something wrong with the presentation?
When you respond like a member of a religious cult, don’t expect other economists to take your arguments seriously.
Louis, I think that market NGDP expectations is better than a commodity price index, although the latter is usually better than base money, as you say.
Michael, You said:
“But I have not found any one who has attempted to systematically debunk the fraud theories.”
I’ve done so many times in the comment section of this blog. Trumpistas send me links of evidence of alleged fraud, and I explained why they are wrong.
BTW, the Trump administration is perfectly within its rights to present such evidence in a court of law. I’m still waiting.
1. December 2020 at 08:14
Where is the discussion on labor utilization and wellbeing? Folks here are measuring the wrong things. MMT focuses on what matters. Interest rates and the price of some commodity rising is of lesser importance. Also where’s the discussion on increased labor utilization resulting in increased production of goods and services offsetting the added money so –> NO INFLATION.
1. December 2020 at 10:20
Francisco, Before getting into those issues I’d like to understand the basic MMT model, their way of looking at issues. That’s why I asked some simple questions. It’s a pity than no MMTer is able to give me a coherent answer. What should I infer from that?
1. December 2020 at 21:31
Scott claims in his last three paras that MMTers ignore the fact that extra cash balances will increase NGDP. That is totally untrue.
For example an article by Bill Mitchell refers to the fact that what he calls “unmet savings desires” (i.e. an inadequate stock of cash in private sector hands) results in “mass unemployment”. See:
https://gimms.org.uk/2018/12/20/basic-principles-of-mmt/
And Stephanie Kelton says “the government has to allow the deficit to go where it needs to go in order to accommodate the private sector’s net savings desires.” That’s here:
https://stephaniekelton.com/paul-krugman-asked-me-about-modern-monetary-theory-here-are-4-answers/
Also word search for “savings desires” in these articles:
http://bilbo.economicoutlook.net/blog/?p=34214
https://tribunemag.co.uk/2019/06/for-mmt
https://www.pragcap.com/cant-debunk-mmt/
I hope I’ve made my point.
2. December 2020 at 08:57
Ralph, You are mixing up flow variables such as saving and income with a stock variable (money).
3. December 2020 at 15:17
MMTers would probably claim (and i would agree) that higher asset prices does not affect GDP much. Japan seems to be a good example of this, the Central Bank bought massive amounts of assets and pushed up asset prices, but had a fairly limited (though not zero) effect on GDP.
3. December 2020 at 15:47
This is also why you’re (partially) wrong about MMT. Asset prices having relatively little effect on GDP means the Central Bank can buy up a large proportion of government debt without causing higher NGDP growth, and thus governments do indeed have a large capacity to deficit spend without needing to increase taxes in the future or causing inflation.
3. December 2020 at 16:12
Arilando, You said:
“MMTers would probably claim (and i would agree) that higher asset prices does not affect GDP much.”
Japanese stock prices are far lower today than in 1991, even in nominal terms. Real estate has also been weak. So Japan’s not the example an MMTers would want to cite for asset prices not helping.
But I will say that I don’t believe that high asset prices always raise NGDP rather I’d argue that higher asset prices tend to boost NGDP when they are caused by monetary stimulus.
Your second comment is based on a misconception. Much of the debt purchase is with interest bearing reserves. There’s no free lunch. Governments have some ability to fund spending by purchasing bonds with zero interest currency notes, but it’s a trivial share of GDP (except this year, when currency demand is surging).
4. December 2020 at 04:06
The Central Bank doesn’t need to pay interest on reserves though. That’s a policy choice.
4. December 2020 at 05:01
Scott, Re your claim that I’ve mixed flows with stocks, the links I gave above to Stephanie Kelton, Bill Mitchell etc refer very specifically to stocks.
4. December 2020 at 10:53
Arilando, Yes, and I oppose IOER. But if they stop paying IOER then then need to reduce the base to hit their inflation target. And so the debt has not been monetized. Or they can reduce the trend NGDP growth rate (the Japanese option), which increases the debt burden by reducing the denominator (debt/NGDP)
Ralph, Imagine how Krugman would react reading that Kelton response. He’d think “This is worse than anything I ever read from the worst student I ever taught at Princeton.” It’s just totally incoherent.
For instance, her response to the first question is “no” and the explanation is basically “yes”. Krugman would be pulling his hair out.
When MMTers send out links like that, do they really expect the nonsense is going to convince mainstream economists to take their ideas seriously?
5. December 2020 at 03:48
I’m pretty sure Japan has had negative or zero interest on reserves for a long time.
5. December 2020 at 10:15
Arilando, Yes, as I said there are two possible reasons for big reserve demand, IOER or ultra slow NGDP growth. Japan chose the latter.
6. December 2020 at 12:34
The core initial problem is his characterisation of MMT’s attitude towards money. In this article, he writes:
All of this is ignored by MMTers. They seem to think that swapping cash for bonds is “irrelevant”, even when interest rates are positive.
This assertion is based on the following quotation from MWW (page 342):
Second, they would challenge the theory of inflation based on QTM, and argue that if a fiscal deficit gives rise to demand pull inflation, then the ex post composition of ΔB + ΔMb in Equation (21.1) is irrelevant. Overall spending in the economy is the driver of the inflation process, and not the ex post distribution of net financial assets created between bonds and base money.
Note how this is a statement about a theory of inflation, and not a statement to the effect that open market operations (central bank buying of bonds, as seen in Quantitative Easing) have no effect on anything. The word “irrelevant” has been stripped out of context. If we jump ahead to pages 556 of MWW, we see the standard MMT story: bonds are issued to drain reserves. This is done to allow the interest rate target to be hit, and is a standard MMT story.
I am willing to accept that the quoted passage might have logic that is hard to follow, but it makes sense in the context of later content of the book. On page 362, MWW state “However, by the mid-1980s they had all discovered that they were unable to control the money supply, and abandoned this major plank of Monetarist thinking.” The story is the the stock of money (the delta M in the quote) is determined by private sector preferences, and does not tell us much about inflation.
I wrote about this in my previous post, citing more advanced literature that argues that the interest rate constraint was binding, even during the Volcker experiment. They even quote Volcker to that effect.
On the one hand, we have Scott Sumner arguing that the Fed controlled the monetary base without any reference to interest rates. On the other hand, we have MMT scholars as well as Paul Volcker pointing out that there was an interest rate constraint. I view Volcker as a better source than Sumner in this instance.
6. December 2020 at 12:35
As for the positive interest rate assertion, there are two cases:
If the central bank pays interest on settlement balances — which is now standard in the developed countries — those balances are fungible with short-dated govvie paper. The effect of this is discussed in the rest of the essay.
The other case is where settlement balances conform to classical economic models, and they pay 0% interest – e.g., pre-2008 Fed. The MMT literature says all over the place that large excess reserve balances would drive the Fed Funds rate to zero. The effect is that the central bank loses control over interest rates, and we revert to previous case where interest paid on reserves matches that of short-dated govvies.
In the first case, to what extent the hypothetical reserve injection matters, it depends upon the effect of 0% interest rates.
There is also the corner case where the Fed injects reserves in such a fashion that it avoids the Fed Funds “going to infinity” (realistically, forcing banks to the discount window) or 0%. As I showed in the chart, excess reserves as a percentage of all reserves were normally small in the pre-2008 era, and so it is unclear how wide the band of reserve injections is. The usual argument is to throw out this corner case, and treat any amount of excess reserves driving Fed Funds to 0%. Although this might be an interesting hypothetical question, there is no way of ever testing it.
Obviously, Monetarists might object to the MMT logic, but they are free to read the appropriate literature — which consists of monographs/journal articles, and not just an Economics 101 analogue. This is exactly the standard neoclassicals make when faced with the deluge of complaints from the heterodox-aligned.
In the current article, Sumner makes a veiled attack on commenters on his website — which includes myself.
It would be nice if commenters showed they understood the traditional view, and then explained why it’s wrong and MMT is right.
Very simply, I (and other academic MMT proponents) understand the classical, neoclassical, and heterodox MMT views on the matter, whereas Sumner is still trying to understand the MMT/heterodox position — and mis-characterising it — so he is not a strong position to throw shade.
QE With Interest On Reserves
In either of the two frameworks discussed above, bond buying by the central bank that creates excess reserves involves the private sector swapping risk-free bonds versus settlement balances. If the bond is short-term, the interest rate on the bond is roughly equal to the policy rate — modulo spread-specific technicals that only a handful of specialists care about. (From a bond manager perspective, multiply the spread by the duration/DV01, and the net result is a nothingburger.)
(There is a special case I am ignoring here — qualitative easing. That is, the central bank buying risky assets. I leave that discussion to people who care about risk assets; I’m a default-remote kind of analyst.)
I will grab a couple paragraphs from Sumner’s argument. Since I have seen a few thousand variations of this argument posted in financial social media since 2010, I will assume the reader is also familiar with them.
Monetary stimulus boosts the prices of T-bills, stocks, commodities, real estate and foreign exchange. I.e., it depreciates a currency. During normal times such as the 1990s, the difference between Keynesians and monetarists is just a theoretical curiosity. They both agree that monetary policy drives NGDP; they merely differ in how they see the transmission mechanism.
When rates fall to zero, however, the monetarist model is clearly superior. In March 2009, the Fed announced a QE program and as a result stocks rose and the dollar sharply depreciated against foreign currencies. That’s consistent with the monetarist model and inconsistent with the (extreme) old Keynesian view that monetary injections don’t matter at zero rates. (In fairness, New Keynesians have a more nuanced view.) MMTers seem to think money never matters, even at positive interest rates, although as I pointed out in this post it’s hard to be sure, as their statements are so contradictory.
6. December 2020 at 12:36
Rate Expectations Matter
I will admit that I am not an expert on archaic interest rate determination theories — for the same reason I didn’t study phlogiston in my Thermodynamics class.
If we look at any modern mathematical finance treatment, as well as the recent neoclassical literature, observed interest rates are decomposed into a number of factors. The simplest version is rate expectations + the term premium. Although many post-Keynesians have a bug up their posterior about rates expectations — too close to efficient markets — MMT does not follow that lead. There might be hand-waving about market efficiency, but there is no doubt that bond yields are a policy variable (intermediated by the central bank reaction function).
Anyone with an understanding of the modern literature would phrase the issue as follows: does the change in private sector balance sheets affect the term premium? I will not offer an honest opinion, since my blog would probably lose it’s Family Friendly™ status.
If anyone paid attention to the actual debates by competent interest rate analysts, the story about QE in the past decade was a signalling effect. Even if the purchases did not directly change the term premium, they offered a signal about the timeline to the first rate hike. (Negative rates were not seen as an option in the U.S.) As such, rate expectations can explain a fall in bond yields, even the term premium is unaffected. This means that falling bond yields cannot be used as evidence that QE lowered the term premium; the Fed could have achieved the exact same outcome with open mouth operations (“forward guidance” in central bank speak).
Very simply, we need some actual statistical evidence of an effect of balance sheet size, and the evidence is mixed (in the most polite phrasing).
In any event, MMT is in-line with modern interest rate theories, which explains why it there are fans of MMT across the risk-free rate trading complex. If you want to argue that fixed income quants do not understand interest rates
6. December 2020 at 12:38
Counter-Example: Japan
For a non-dual Y-axis chart that shows difficulties with the “money matters” thesis, the above chart is all one needs to look at. (I grabbed the first time series I could get off DB.nomics, and I don’t claim it is necessarily the most conclusive version.)
https://db.nomics.world/IMF/MFS/M.JP.FASMB_PC_CP_A_PT
7. December 2020 at 14:09
Kester, I’ve now read the entire book, and the passage I quoted was not taken out of context. Further reading adds more and more problems to the analysis.
You said:
“On the one hand, we have Scott Sumner arguing that the Fed controlled the monetary base without any reference to interest rates.”
Where did I say that?
Interest rate targeting does not mean that the central bank cannot control the money supply, it means that attempts to control the money supply can only occur if the central bank is willing to adjust the interest rate target. But guess what—it is! Look at interest rates from 1979-82; they gyrated wildly. The fact that Volcker said they were still paying attention to interest rates does not mean that the Fed was not controlling the money supply, just that it understood it needed to adjust its rate target to do so.
You said:
“The MMT literature says all over the place that large excess reserve balances would drive the Fed Funds rate to zero.”
That’s because MMTers ignore the income and Fisher effects. Monetary injections often raise inflation by raising inflationary expectations. The 1960s were a classic example. It CAN drive rates to zero in some cases, but in other cases it can create hyperinflation.
You said:
“story about QE in the past decade was a signalling effect.”
That’s also the view of market monetarists. The difference is that we think it’s about the signaling of future money growth (relative to demand).
You said:
“If you want to argue that fixed income quants do not understand interest rates”
My impression is that financial market people know a lot about how interest rates relate to each other (term structure, risk structure, etc.) but not very much about what drives interest rate changes over time. I wouldn’t ask financial market people for an explanation of why 10-year bond yields went from 2.5% to 15% between the late 1940s and the early 1980s.
Not sure the point of your final comment. If I showed you a graph demonstrating that budget deficits were higher during recessions would you regard that as proof that deficit spending is not expansionary?