What, in your opinion, is the shape of the Long Run Phillips Curve?
Supplementary: if you use the words "full-employment" in your answer, can you do your best to explain what you mean by this. (This is not a "gotcha!" question. I know that's a tall order, because it's not always easy to come up with a simple theoretically and empirically watertight definition of theoretical concepts; many orthodox economists have equal difficulty explaining what they mean by the "natural rate of unemployment".)
I think that Modern Monetary Theorists want "orthodox" macroeconomists to engage them more. I'm not sure that I'm really orthodox, but anyway; I sympathise with their desire, and this is an attempt to meet it.
Here is my "rational reconstruction" of the MMT answer. By that I mean here is what I can best assume they believe if I want to make sense of what they say:
"The Long Run Phillips Curve in {inflation, unemployment} space is L-shaped. Alternatively, the Long Run Aggregate Supply curve in {Price level, real income} space is reverse-L-shaped. The price level, or rate of inflation, is exogenous with respect to Aggregate Demand until you hit "full employment" (or "full employment output"). Then it turns vertical. So increases in Aggregate Demand (for example, due to money-financed increases in government spending, transfers, or tax cuts) will cause output to increase and unemployment to fall, with no effect on the price level or inflation, until you hit "full-employment". Thereafter they only affect inflation."
That's what I used to believe in 1972, when I was studying A-level economics and politics. (I only got a D; but perhaps, I hope, it was because I did very badly on the politics part?)
In 1972 I couldn't define what I meant by "full employment". But now i think I can rationally reconstruct what I would or should have meant by "full employment". Here it is:
"An economy is at "full employment" when an increase in Aggregate Demand won't increase employment even in the short run."
To put it another way, I made no distinction between the Long and Short Run Phillips and Aggregate Supply curves.
OK. Now for the comments.
Worthwhile Canadian Initiative 
BTW,
“standard macro” does not have savings doled out as investment, but there is a “supply curve” of savings, and a “demand curve” for investment, with the interest rate equilibrating between the two, so that the S = I.
The real problem with loanable funds is not that it assumes that savings “causes” investment, but that it treats financial assets as if they were consumption goods. It assumes two separate populations of producers and consumers, with an increasing marginal cost of production as well as a decreasing marginal utility of consumption.
But as soon as it possible to expand your balance sheet — i.e. to borrow in order to lend, then you no longer have a supply curve that shifts with quantity. It may shift with quantity, but the direction of the shift is unknown:
If there is a surge in borrowing to buy financial assets, then that could result in falling real yields, so that interest rates decline with the quantity borrowed. If there is a surge in borrowing to buy capital goods, then that may also result in falling real yields with the quantity borrowed. If there is a surge in borrowing to buy consumption goods, then there may be an increase in profits (and real yields), so that the rate climbs with the quantity borrowed.
Whatever the rate of return happens to be, as long as there is an investment opportunity that meets or exceeds that rate, then it will get funded, regardless of how much people have ‘saved’. Whether or not the funding of that investment lifts the rate of return demanded for subsequent investments will depend on how the investment changes the expected profit opportunities in the economy as a whole; there is not a finite stock of funds that is depleted, forcing yields to increase as the existing pool of funds runs out.
RSJ: A person who takes out a loan to buy a car has increased their balance sheet. They now have a new (real) asset — the car (valued at something), plus a new (financial) liability — the loan itself. I don’t see this as saving.
A person who buys a car out of cash debits their cash account (asset) and now has a real asset (car). They are clearly (nominally) dissaving, although at a macro level no new (net) financial asset is being created. We’re just shifting an asset from a buyer to a seller. NIPA, I believe, is at the sector level.
If you look at a household level at net financial asset change, it will tell you something about that household but nothing about the sector. At a sector level, there can be no change in net financial assets unless the Govt deficit spends.
The problem with the standard macro S=I are legion. I agree with your point that savings does not “cause” investment, the way the standard Macro story is told, but I think it is also true that the narrative embedded in the “loanable funds” model is that money saved gets loaned out for investment.
W:
“A person who takes out a loan to buy a car has increased their balance sheet.”
They have decreased their financial assets, exchanging them for real goods. They have dissaved. This is how people spend money, their stock of financial assets decreases and their stock of goods (whether for consumption or investment) goes up.
Really, this is a tautology — and the contortions required to equate an increase in your net financial assets with dissaving is massive. An increase in your net financial assets is saving, and a decrease is dissaving — this is simple stuff.
As a result, there is no difference between increasing your financial assets by increasing your holdings of treasuries or deposit accounts or private bonds. In all cases you are saving. And when you reduce your net financial assets, you are dissaving.
“If you look at a household level at net financial asset change, it will tell you something about that household but nothing about the sector. ”
What exactly did you mean when you said that someone purchasing a private sector bond is investing but someone purchasing a government bond was saving? You were making a claim about a household, and in order to challenge that view, we have to stick with that household. Yes, the behavior of that household does not tell you anything about the sector, nation or world economy.
All I did was point out that the bond purchase or sale could just be a financial sector portfolio shift, or a balance sheet expansion, and at the end of the day, the instrument held did not matter — what mattered was the change in financial assets held by that household, under the simple assumption that money in = money spent on either financial assets or goods.
All of this should be orthodoxy — I think you just aren’t connecting the dots because your intuition “buying a private sector bond is investing, but buying a government bond is what rentiers do” is clouding your ability to apply definitions consistently.
RSJ: Yes, we agree that the individual who borrowed money to buy the car has spent money, and reduced their (individual) NFA, but the individual who sold the car has credited their financial asset. At a sector level, of course net financial assets are unchanged, but financial assets have increased as we have a new asset (receivable/loan) and a new liability (deposit/deposit) in the sector. I have repeatedly said that NFA is unchanged (as of course it must be), but gross financial assets have increased (at a sector level) because someone has taken on a new loan.
This is not a contortion, it’s very basic horizontal money (credit) expansion. Private sector credit extension creates no new net financial assets (it cannot) but does increase gross financial assets. And I do not count a sector taking on (gross) debt as “saving” because it clearly is not.
When someone purchased a private bond they increase private sector credit (by taking the other side of that trade) and make a credit decision. When someone purchases a Govt bond they are not making a credit decision (although, as you say, they are taking on all kinds of other risk) AND they are not changing the quantity of private sector credit, or the quantity of outstanding Govt liabilities.
W,
OK, Good. I think we agree that dissaving is a decrease in the household’s NFA, and saving is an increase in the household’s NFA. Excellent progress so far.
“At a sector level, of course net financial assets are unchanged”
Huh?
When looking at the spending decisions of a household, the NFA is of the household. It certainly changes.
When aggregating households, the economically relevant “sector” is the household, or personal sector. In that case, NFA will increase if the matching liability is outside this sector — primarily issued by a business. This is what measures the real wealth of households. And for most questions, this is the appropriate sector to look at.
If you start aggregating further, you start to lose information and the numbers start to be less and less relevant to questions of consumption, investment, prices, and aggregate demand. Once your “sector” is the earth, then NFA never changes and you have zero relevance. Already by the time you aggregate to the “private” sector, you are already citing mostly meaningless numbers.
The MMT obsession of arbitrarily defining net worth as aggregated across the entire private is a huge blunder. It means that capital growth is never measured and is never reflected in household net worth. Household net worth is also not properly measured. All the claims of households on businesses cancel with the liabilities of the business and what you are left with is an economically insignificant residual, one in which the value of capital completely disappears. It is not as dumb as looking at the NFA of the entire earth, but it’s almost as dumb. Then enormous importance is placed on this residual, and bad economics follows as a result.
To elaborate further, Net Financial Assets is just assets minus liabilities of the balance sheet you are looking at. Then you start to consolidate the balance sheets of various economic actors and you get an NFA of a larger group.
In the process of that balance sheet consolidation, you lose certain information, namely the assets that members of the group hold that are matched by liabilities in that group. So as you do this, your model loses the dynamics of spending shifts due to one subgroup borrowing from another subgroup. Whether that is important or not depends on how much you aggregate and whether these shifts are important economic drivers.
This is the exact equivalent of selecting a “representative agent”. But even the simplest macro models realize that their representative agents cannot be both businesses and households, because if you do that, then you have no model of production or capital accumulation. Even the simplest infinite time horizon models operate at the level of representative households working for and holding claims on representative businesses, and interacting with the government and foreign sectors. Better models have more sectors and overlapping generations of households and businesses.
But when you just look at the consolidated balance sheet of the entire private sector, then there are no businesses or households, so you lose all information about capital growth and production — that is excessive aggregation, and does not give a meaningful measure of household spending decisions or business investment decisions, since you can’t measure any of these numbers by looking at the aggregate balance sheet of the private sector.
If you want that type of information, you need to limit your balance sheet consolidation to households — at the very most. And it would be really better to disaggregate a bit further and consolidate households by income level, or occupation, and look at the NFA of each.
Then you can talk about sectoral balances between households and financial or non-financial businesses, or between wealthy and poor households, and get something that is both consistent from an accounting level as well as modeling something that is economically significant — the process by which capital grows and earns a return.
But when all of that is aggregated away, then you start thinking that capital grows at an exogenous, government controlled rate, and that household net worth is exactly equal to the stock of government bonds and currency. And then you start believing that saving can only be defined as the accumulation of government liabilities, and that leads you to start making all of the harmful policy recommendations.
RSJ:
I disagree. The right way to carve up a sectors depends on the question you’re trying to answer. You lose somethings when you consolidate households and businesses, but you also gain some things. The key (for MMT) being the difference between a currency issuer and a currency user. The confusion of the economics progression around this distinction is absolutely central, and I think it’s perfectly reasonable to try and explain this by splitting the two into two difference sectors.
MMT goes even further, btw., and lumps foreign Government and state and local Governments in with households and businesses, which is why you sometimes see that sector called “non-Federal Govt”. But it is crystal clear on who can issue currency, and who cannnot, something you see confused every day in the pages of macro text books and, by emanation, the pages of the NYTimes.
I also don’t agree that this issuer/user distinction is less relevant, dumb, etc. The residual it leaves is thought unimportant by economists, but it is causing a 10% unemployment rate which, in my book, means it merits some importance. I think you put it best elsewhere when you said economics believes that banking is both utterly transparent and irrelevant, while at the same time being indispensable!
I don’t know why you think this distinction destroys the value of capital. I don’t think that and I’m very comfortable with the distinction. You may be missing the real vs nominal distinction (something else that I have found MMT is absolutely crystal clear on). Non-Fed NFA precisely equals Fed debt, but non-Fed NA is different, and that’s where you have your real goods. No one claims that the private sector can’t increase it’s stock of real goods by itself, of course it can, but it cannot increase its stock of net financial assets.
But when all of that is aggregated away, then you start thinking that capital grows at an exogenous, government controlled rate, and that household net worth is exactly equal to the stock of government bonds and currency. And then you start believing that saving can only be defined as the accumulation of government liabilities, and that leads you to start making all of the harmful policy recommendations.
I dunno RSJ. I divide the world into issuer/user and I don’t reach the conclusions you do.
I think we’re done. Thanks for the good discussion! I learned a lot about the yield curve.
It was an enjoyable discussion, W.
In fairness, I used the word “dumb”, not “stupid”:)
That was maybe too over the top, but the point is that it is a residual. The actual decisions to spend or not spend, or the causes of unemployment, cannot be reduced to just looking at the quantity of government liabilities, as the decision makers (e.g. households and businesses) do not see private sector NFA, they see their own NFA, which necessarily includes changes to bank deposits, bonds, and equities — none of which are government liabilities, or even move in the same direction as government liabilities.
Of course you can argue that if the government deficit spent to hire all of the unemployed, then there would be no unemployment, and from that you can conclude that the unemployment is “caused” by a lack of deficit spending. But I think this is misleading.
We had lower unemployment during the “30 glorious years” from 1950-1970 than we did in the period from 1980-2010. But the former period had government debt/GDP decreasing rapidly, and the latter period had government debt/GDP increasing, meaning that private sector NFA was low in the low unemployment period and higher in the higher period. So in order to really understands what drives unemployment, you can’t focus on the residual, but need to disaggregate and look at the various NFAs of the households and businesses. Anyways, good discussion.