(I had been planning to write this post before Steven Landsburg started a whole blogosphere argument about what taxes are for. Honest!)
Functional Finance says you only use taxes if you want to reduce Aggregate Demand to prevent inflation. The Long Run Government Budget Constraint says you use taxes to pay for past, present or future government spending. They sound very different. They aren't.
There's a general principle in economics: first you eat the free lunches; then you look at the hard trade-offs. Functional Finance says "first eat the free lunches". The Long Run Government Budget Constraint says "then look at the hard trade-offs".
Suppose, just suppose, that if you kept on doing what you were planning to do, you never had to worry about inflation. Not now, not in the future, not ever. Because Aggregate Demand was too low now, and was projected to be too low forever. So you are not worried about inflation. Instead you are worried about deflation. And you were a government that could print your own money. What would you do?
You would print money and spend it. Or print money and use it to finance tax cuts. And you would keep on doing it, more and more, until you got to the point where you did start to worry about inflation. You first eat all the free lunches.
That's the underlying kernel of truth in Abba Lerner's Functional Finance (pdf) [see also his book The Economics of Control (pdf)]. And I don't know of any mainstream macroeconomist who would disagree. You use taxes only so you don't have to print money. When you get to the point that Aggregate Demand is high enough, so you start to worry about inflation, you use taxes to finance past, present, or future government expenditure precisely because you don't want to print more money and make inflation higher.
Suppose inflation isn't a problem right now, because Aggregate Demand is currently too low. Does that mean the government should print money and spend it? Not necessarily. Print money yes, but instead of spending it on goods, or on tax cuts, it might be better to use it to buy back some interest-paying government bonds. Because even though inflation isn't a problem right now, it may be a problem some time in the future. So you can buy the money back in future, by re-issuing the bonds (and save on interest in the meantime) without having to raise future taxes or cut future spending.
Here's an easier way to think about it. Print enough money to get Aggregate Demand and inflation where you want it to be. That's the free lunch the government can eat. Any additional government spending must be paid for, sooner or later, with taxes. The present value of taxes, plus the present value of newly-printed money (seigniorage), equals the present value of government spending, plus the existing debt.
Seigniorage revenue belongs in the government budget constraint. The government can pay for part of its spending by printing money. But don't get too excited. It's not that big, on average. If central bank currency is around 5% of annual nominal income, and if nominal income is growing at 5% per year (3% real plus 2% inflation) then 5% x 5% = 0.25% of GDP. (In the right ballpark for Canada — it shows up as the profits the Bank of Canada hands over to the government — but maybe double it for the US). Printing money is a nice little sideline, but we are still going to need taxes.
Let's ask a slightly different question. Why do governments pay interest on their debt? Actually, it sounds like a different question, but it's really the same question. Why finance government deficits with interest-paying debt, when you could use non-interest-paying currency?
The answer is the same: you pay interest on the debt to encourage people to hold it and stop people spending it. If you cut the interest rate on government debt, will people sell it back to the government for money, spend the money, and cause inflation? If not, then Aggregate Demand is too low, and the problem is deflation, not inflation. So there's a free lunch from cutting the interest rate on government debt. And the government should eat that free lunch. And then the Long Run Government Budget Constraint kicks in again.
Now suppose the real rate of interest on government debt is below the real growth rate of the economy. (Or the nominal rate of interest is below the growth rate of nominal GDP — same thing). And suppose it will be like that forever, if you keep on doing what you were planning to do. The government can run a Ponzi scheme forever. It can borrow and spend, then borrow to pay the interest forever, and the debt grows more slowly than the economy, and the debt/GDP ratio declines over time. The Long Run Government Budget Constraint is undefined. The Present Value of taxes can be less than the Present Value of Government spending.
That's another free lunch that needs eating. The economy is dynamically inefficient. The economy wants a Ponzi scheme. And the government should satisfy that demand. Issue debt until the interest rate equals the growth rate. Then the Long Run Government Budget Constraint kicks in again.
Worthwhile Canadian Initiative 
Why are getting angry at banks in Canada when they are effectively nationalized anyway? All bank stocks are broadly held by law. No individual may hold more than 10% of a bank’s shares and foreigners may hold no more than 25% in total.
Bank stocks are a mainstay in every mutual fund, RRSP and pension plan in Canada, including the Canada Pension Plan and the Quebec Pension Plan.
Sure, most Canadians don’t care about the slice of the banks they own, but the fact remains it’s there. Bank profits come from Canadians and go right back to Canadians, to a large extent. They aren’t Crown Corporations but the financial effect of their ownership is almost as broad.
suppose there’s a major emergency, so G has to be big this period, but you know it will be smaller next period. If private demand is roughly the same in the 2 periods, your version of FF would mean big taxes this period and small taxes next period. That is generally not optimal. The deadweight costs of distorting taxes will be bigger than if taxes were smoothed. Generally, it’s much better to use bond-finance to handle fluctuations in the amount of G you want.
Sure, no argument. We have two macroeconomic instruments, the tax level and the choice of bonds vs money. When we need to make big adjustments in G and are worried about the distortionary effect of offsetting tax adjustments, we’ll want to turn the bonds-vs-money knob. But that’s different from saying that there is an independent constraint on the size of the public debt or deficit. The desirability of smoothing taxes over time is completely separate from the question of whether the position of the public balance sheet is an independent consideration in setting tax levels.
The question is, given our decision about the optimal share of public expenditures in total output, and the observed inflation rate and deviation of total from potential output, do we choose a lower level of spending, or a higher level of taxation, if the government deficit and/or stock of debt is large, than if they are small? If you say No, you believe in functional finance. If you say Yes, you don’t. It’s really that simple.
JW: good thought-experiment. Let me re-state it. Suppose you have decided on the optimal paths of G and T and M over time. Then suddenly, just before you implement that policy, you find the government owes an additional $100 debt you had missed. How do you revise your optimal policy?
I say you increase T and/or cut G by (r-g)$100. (r is real interest rate, g is growth rate of real GDP.) If you don’t do this, the debt/GDP ratio will grow without limit, which is not sustainable.
Nick,
Re Derridative’s comment. Set seigniorage to zero for simplicity; write the primary deficit as,
(G – T)/Y = ∆(B/Y) – (r – g)B/Y
Say that r – g = -0.01 and that ∆(B/Y) = 0
Then,
(G – T)/Y = (0.01)B/Y
As B/Y becomes small (Y is increasing over time), (G – T)/Y must become small as well.
Suppose you have decided on the optimal paths of G and T and M over time. Then suddenly, just before you implement that policy, you find the government owes an additional $100 debt you had missed. How do you revise your optimal policy? I say you increase T and/or cut G by (r-g)$100.
And I say you don’t change T and G at all. Unlimited growth in the debt/GDP ratio is only unsustainable if you can identify a specific economic mechanism that brings it to a halt, within an economically-relevant horizon.
More concretely, if something in economics is sustainable for more than a few decades, it’s sustainable, period. None of the relevant relationships are stable enough for models with longer horizons to matter. (Of course this is not the case for e.g. climate models!) Sure, “If something can’t go one forever, it will stop.” But it’s equally true that if something can go on forever, it still will stop. And something that can’t go on forever, can still go on for an arbitrarily long time.
No, that’s not right is it.
Anyway, we’ve gotten tot he crux of the matter here. To say the debt/GDP ratio cannot rise without limit, is to say that there’s some limit to that ratio which cannot be crossed, independent of the macroeconomic effects of additional borrowing. Lerner’s whole point is, No there’s not.
vimothy: I’m not sure. Just can’t get my head straight on it.
JW: Yes, we are getting to the crux of it. It’s exactly the same sort of arguments that explain why a chain letter can’t keep growing for ever (if the rate of interest on the chain letter exceeds the growth rate of the economy). Take an overlapping generations model for example. The old sell the bonds to the young, who grow old, and sell them to the next generation. If the debt/GDP ratio gets too big, the next generation of young simply won’t be able to afford to buy the bonds off the old.
Someone help me out here.
Say r – g = α < 0 and that ∆(B/Y) = 0. Then,
(G – T)/Y = αB/Y
Govt can run a constant deficit as a proportion of GDP equal to αB/Y while keeping ∆(B/Y) = 0…?
JW: which makes me note something ironic. The only model I can think of where the debt/GDP ratio could grow without limit is Barro’s model of Ricardian Equivalence. For there, the old generation bequeath the bonds to the young, rather than selling them to the young. But in Barro’s model, the choice between bond- and tax-finance is irrelevant anyway. Bond-financed tax cuts do not increase consumption demand or shift the IS curve.
vimothy: it sounds right when r exceeds g. Don’t see why it can’t also be right when r-g is negative. But my brain is getting old and tired.
Anyway, assume you are right! Suppose g=3% and r=2% and B/Y=30%. Ballpark for Canada. Then you can run a permanent primary deficit of 0.3% of GDP. About the same as seigniorage. A second nice little sideline, but not enough to pay the (T)bills 😉
vimothy: I think you are right. If so, then you and Derridative have really cleared up something that my head wasn’t clear on last night. Flashes of light going off!
Compare your formula to my formula for seigniorage. Properly interpreted, they are exactly the same!! Currency pays a real interest rate of minus 2% (in Canada, with 2% inflation target). So seigniorage on currency is exactly the same as seigniorage on any government liability that pays a real rate of interest less than the real growth rate.
Bingo!
It looks right to me. Govts can run continuous primary deficits as a constant proportion of GDP and stabilise public debt as a proportion of GDP if r < g because the growth rate of Y is greater than the growth rate of the debt. If you want the debt and the economy to grow at the same rate, the govt primary surplus / deficit must make up the difference between r and g.
Impossible to think straight in this heat though. And like you say, ultimately pretty negligible.
Nick, Cool! I love economics for those light-bulb moments. Which formula for seigniorage, sorry?
vimothy: seigniorage is dM/P, = (dM/M)(M/P). If inflation is 2%, and real growth is 3%, then dM/M is 2%+3% for M to stay a fixed ratio to Nominal GDP.
assume M/P is 5% of Nominal GDP, and nominal GDP is growing at 3% real plus 2% inflation =5%. So seigniorage = (dM/M)(M/NGDP)=5%*5% = 0.25% of GDP.
The only difference is that the real rate of interest on currency is negative, being minus 2% inflation.
Nick,
Here is a more legible copy of the Lerner “Functional Finance and Federal Debt” paper
Nick, you’re defining seigniorage as govt’s profit on inside money, RSJ is saying govt should use taxing power to claim (or rather reclaim) seigniorage on outside money as well.
As for Abba Lerner, his Functional Finance ideas were further developed in his book The Economics of Control, I’ll let Lord Keynes explain which parts to look at:
I have marked with particular satisfaction and profit three pairs of chapters-chap. 20 [Production and Time] and 21 [Interest, Investment and Employment I], chap. 24 [Interest, Investment and Employment III (functional finance)] and 25 [Capital, Investment and Interest], chap. 28 [Foreign Trade III (in a capitalist economy)] and 29 [Foreign Trade IV (in the controlled economy)].
Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance.
http://socialdemocracy21stcentury.blogspot.com/2010/09/would-keynes-have-endorsed-modern.html
Here’s a pdf of Lerner’s book
Click to access The_Economics_of_control.pdf
Vimothy,
“Govt can run a constant deficit as a proportion of GDP equal to αB/Y while keeping ∆(B/Y) = 0…?”
The government has very less control over its deficit and is endogenously determined by the private sector. The question then is if that is the case, whats the worry ? The answer is that the government controls its expenditures and the tax rate. The deficit and the debt are determined by G, t (tax rate), and the private sector (such as via the propensity to consume). The fiscal stance of governments is such that it does not bring full employment. The private sector can grow by itself if its expenditure is greater than its income which is an unsustainable process because it leads to increased indebtedness and can cause a big recession.
Thanks Clonal and beowulf! Links updated.
beowulf: “Nick, you’re defining seigniorage as govt’s profit on inside money, RSJ is saying govt should use taxing power to claim (or rather reclaim) seigniorage on outside money as well.”
Yep. (But both you and RSJ are using “inside money” and “outside money” in the exact opposite senses to which they are normally used in monetary theory.)
YW Nick. I don’t think RSJ used the term “inside money” so reversing the terms is just on me.
Instead of further mangling what RSJ’s proposing, I’ll just link to his post on the topic.
Beowulf,
Hey, thanks for that. I’m ashamed to say, I’ve never read The Economics of Control. From your link to my Kindle.
“Anyway, assume you are right! Suppose g=3% and r=2% and B/Y=30%. Ballpark for Canada. Then you can run a permanent primary deficit of 0.3% of GDP. About the same as seigniorage.”
IMO, that’s not the right way to think about this. What r < g means is that given any primary deficit/GDP bound, there is a (finite) Debt/GDP bound that is a function of the deficit to GDP bound.
And more importantly, if you exceed your primary deficit/GDP bound for a while, it doesn’t matter, because over time, your debt to GDP will fall back to target if you only lower future deficit spending to the target.
Therefore there is never any future tax obligation. At best there is an obligation that future deficit spending be reduced back to the target. The economy “forgets” past violations of the deficit/GDP bound, as time whittles them away without the need to run surpluses.
The best example was reductions in debt after WW2. There were no surpluses — well, there were rare negligible surpluses, but the debt/GDP ratio fell rapidly just with time and economic growth.
Nick, Understood.
“So you are not worried about inflation. Instead you are worried about deflation. And you were a government that could print your own money. What would you do?
“You would print money and spend it. Or print money and use it to finance tax cuts. And you would keep on doing it, more and more, until you got to the point where you did start to worry about inflation. You first eat all the free lunches.
“That’s the underlying kernel of truth in Abba Lerner’s Functional Finance (pdf) [see also his book The Economics of Control (pdf)]. And I don’t know of any mainstream macroeconomist who would disagree.”
Gee, Nick, where are those guys hiding? Why aren’t they advising gov’ts in the U.S. or Europe? If they aren’t advising gov’ts, why aren’t they writing op-ed pieces in newspapers or appearing on TV news shows to point out the sea of nonsense that we are awash in?
Or perhaps a better way of looking at this is that Ricardian equivalence is a self-consistent logical loop:
Because r > g, future deficit spending implies future tax increases, and therefore the household sector is indifferent between holding government bonds (with deficit spending) and not holding government bonds (with a balanced budget), so the sale and purchase of bonds has no effect on rates.
The seignorage view is that households do demand government bonds, and are willing to pay a premium for them over the return on capital.Households value the secure payment over the variable payment because they are credit constrained and therefore cannot consume according to PIH.
Because they pay a premium, r < g (where r is the risk-free rate, not the rate charged to the private sector). Because r < g, then there will not be future tax increases, and therefore they value them. Another loop.
But the second loop is limited, in that the public’s insurance demands are limited, and so increasing the stock of debt beyond this insurance demand will result in higher rates.
The government can only enjoy the benefits of r < g to the extent that the stock of debt does not exceed the insurance demand. Beyond that, additional debt sales will cause r to increase.
Both “loops” are internally consistent, but only one — the non-Ricardian loop — is consistent with the data. It makes no sense for households to pay a premium for bonds over capital if they do not consider bonds to be wealth.
Whether or not r < g tells you which loop you are on.
Ramanan, Primary deficit is G – T, and (you’ve already agreed that) the govt controls both those variables.
Nick,
You may also find Keynes thoughts on Lerner’s Functional Finance in this 2002 article by David Colander “Functional Finance, New Classical Economics and Great Great Grandsons” http://community.middlebury.edu/~colander/articles/Functional Finance, New Classical Economics and Great Great Grandsons.pdf
Quote:
It is a grand book worthy of one’s hopes of you. A most powerful piece of well organized analysis with high aesthetic qualities, though written more perhaps than you see yourself for the cognoscenti in the temple and not for those at the gate. Anyhow I prefer it for intellectual enjoyment to any recent attempts in this vein.
In the second of the two books which you have placed within one cover, I have marked with particular satisfaction and profit three pairs of chapters—chap 20 and 21, chap 24 and 25, and chap 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going — I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!1
The above letter from John Maynard Keynes to Abba Lerner celebrating his book The Economics of Control contains the essence of my view of functional finance
End Quote
JW Mason, You’re welcome. Its a pretty interesting read. I noticed Lerner thanked Friedrich Hayek (among others) in the preface. He’d been a student of Hayek’s at LSE but this book is definitely the anti-Road to Serfdom (The Road from Serfdom?). Its a marvel Hayek didn’t stroke out by Chapter 1, “The three principle problems to be faced in a controlled economy are employment, monopoly and the distribution of income… unless these primary tasks are accomplished the economy is uncontrolled.” (p. 3).
Gee, Nick, where are those guys hiding? Why aren’t they advising gov’ts in the U.S. or Europe? If they aren’t advising gov’ts, why aren’t they writing op-ed pieces in newspapers or appearing on TV news shows to point out the sea of nonsense that we are awash in?
Because they are deeply unfashionable. The “lower taxes, free-market” Hayekian/Friedman crowd won the day. We spent three decades driving the Demand Managers from office and replacing them with inflation-hawks. Such is our reward for this decision.
The public understands taxes. They don’t understand, or have forgotten the plague of chronic unemployment. Curiously the newspapers of the 1930’s were also rife with the delusion of seeing inflation at every turn, just like today. Eerily like today. We’ve come full circle.
We need a celebrity. Somebody to go on PBS like Milton Friedman did and explain all this. Actually Milton Friedman’s greatest economic contribution to both macro and micro was entirely practical: designing and implementing automatic payroll income tax deductions to finance WWII. It’s what makes modern government possible. Much as he later hated the beast, he played a key role in creating it.
Aggregate Demand Management isn’t something to be feared; it isn’t innately anti-capitalist, even though the Road to Serfdom fans might think it so. ADM’s flip side is Aggregate Supply. Under an ADM regime the free market, that is price-determined consumer-driven micro choices are what controls the distribution of aggregate supply. Prices determine how we slice the pie and provide the signals on what consumers want. What’s wrong with that?
All ADM says is that Aggregate Demand can be played with to ensure that an economy can consume Aggregate Supply most of the time so that chronic unemployment does not result. You can sugar-coat it with some social programs but you don’t have to. This appeals to me on humanitarian and compassionate grounds but it isn’t strictly necessary.
It forms the basis of the post-war social contract but we’ve spent 30 years demolishing that. I think we were wrong, collectively.
“Primary deficit is G – T, and (you’ve already agreed that) the govt controls both those variables.”
Taxes are paid as a proportion of (nominal) income, which the government does not control. Government spending includes automatic stabilizers, which are also not controlled.
So the private sector can force the government into a budget deficit, merely by becoming poorer (earning less income) and requiring more benefit payments.
Also from Mathew Forstater’s “LERNER, Abba Ptachya (1903-1982)” http://www.cfeps.org/pubs/wp/wp52.htm
Quote:
Decisions concerning taxation are to be made only with regard to the economic effects in terms of the promotion of full employment, price stability, or other economic goals, and not ever because ‘the government needs to make money payments’ (Lerner, 1943, p. 354). Likewise, ‘the government should borrow only if… the effects’ of borrowing are desired, for example ‘if otherwise the rate of interest would be too low’ (Lerner, 1943, p. 355).
These points of view were repeated and elaborated by Lerner in his 1951 book, The Economics of Employment:
[T]axes should never be imposed for the sake of the tax revenues. It is true that taxation makes money available to the government, but this is not an effect of any importance because money can be made available to the government so much more easily by having some created by the Treasury. (1951, p. 131, original emphasis).
Likewise, ‘borrowing’ is also not a funding operation for Lerner.
What are the purposes of taxation and borrowing, if not to fund government spending? The purpose of taxation for Lerner is its ‘effect on the public of influencing their economic behavior’ (Lerner, 1951, p. 131, original emphasis) including, as we will see below, creating a demand for government fiat currency. Like taxation, borrowing is not a funding operation; rather, it is a means of managing reserves and controlling the overnight interest rate when the government runs a budget deficit:
[T]he spending of money…out of deficits keeps on increasing the stock of money [and bank reserves] and this keeps on pushing down the rate of interest. Somehow the government must prevent the rate of interest from being pushed down by the additions to the stock of money coming from its own expenditures…. There is an obvious way of doing this. The government can borrow back the money it is spending (Lerner, 1951, p. 10-11, original emphases).
Two extraordinary results follow from Lerner’s analysis here. First, the implication is that ‘borrowing’ logically follows, rather than precedes, government spending. In fact, this analysis questions the accuracy and relevance of the term ‘borrowing’ itself for discussing government bond sales. Second, note that the budget deficit is causing interest rates to fall, the exact opposite from what traditional theory has long predicted (i.e., ‘deficits cause high interest rates’).
The role of taxation and borrowing, reserve management and interest rate maintenance will become clearer upon examination of two, less well-known, Lerner contributions, ‘Money as a Creature of the State’ (1947) and his Encyclopaedia Britannica entry on ‘Money’ (1946), which place him squarely in the Keynes-Knapp Chartalist school, and which is key to fully understanding the possibility and effectiveness of Functional Finance. The ability of the government to conduct fiscal and monetary policy according to the principles of Functional Finance is made possible by the fact that, as the title of Lerner’s paper states, ‘money [i]s a creature of the state’:
The government — which is what the state means in practice — by virtue of its power to create or destroy money by fiat and its power to take money away from people by taxation, is in a position to keep the rate of spending of the economy at the level required to fill its two great responsibilities, the prevention of depression, and the maintenance of the value of money. (Lerner, 1947, p. 314)
In adopting this view Lerner followed Keynes ….
End Quote
“Gee, Nick, where are those guys hiding? Why aren’t they advising gov’ts in the U.S. or Europe? If they aren’t advising gov’ts, why aren’t they writing op-ed pieces in newspapers or appearing on TV news shows to point out the sea of nonsense that we are awash in?”
Perhaps I’m missing something, but wouldn’t most economists agree in practice with what Nick Rowe is saying here? Disregarding the inflation hawks sitting on Fed committees (they are mostly playing reputational games; besides, nothing says you couldn’t have inflation hawks in a MMT world), most economists expressly make Nick’s point: below-target expected inflation is effectively a license to print money, and not doing this in 2008 was a clear failure of monetary policy (or “aggregate demand management”, to use Determinant’s term).
vimothy | April 23, 2011 at 11:12 PM,
No I was referring to the tax rate as opposed to total taxes.
Total taxes is dependent on the level of activity in the private sector.
Of course, there is nothing preventing the government from targeting a level of deficit. For example, if the deficit is more than the target, tighten policy and if less, relax … but that policy leads to sustained unemployment and has to give in sometime.
“When you get to the point that Aggregate Demand is high enough, so you start to worry about inflation, you use taxes to finance past, present, or future government expenditure precisely because you don’t want to print more money and make inflation higher.”
Some people say that it’s too late when you start to worry about inflation. They say that the change from deflation to inflation is not continuous, and by the time you start to worry about inflation, two-digit inflation — if not hyperinflation — is inevitable. This claim is sometimes called ketchup theory.
Many people wonder why BOJ doesn’t move more aggressively. The answer lies in this theory. Believe it or not, this theory is very prevalent among Japanese macroeconomists. (Although it isn’t known by the name of “ketchup theory” in Japan — maybe because we mainly use tube instead of bottle as ketchup container. 🙂
anon: “Perhaps I’m missing something, but wouldn’t most economists agree in practice with what Nick Rowe is saying here? Disregarding the inflation hawks sitting on Fed committees (they are mostly playing reputational games; besides, nothing says you couldn’t have inflation hawks in a MMT world), most economists expressly make Nick’s point: below-target expected inflation is effectively a license to print money,….”
You are not missing anything. I don’t think there’s anything I have written here (with the possible exception of the bit I wrote right at the end on dynamic inconsistency when r is less than g) that any mainstream economist would disagree with. They might not have thought about it in terms of “Functional Finance”. They might have expressed the same basic ideas in a different way. But that’s all. (Many don’t like the phrase “printing money” that I have used.)
In fact, what I have written here (except for the bit right at the end) is effectively institutionalised in Canada (and most countries). The job of the Bank of Canada is to find the free lunches, grab them, and hand them over to the government so the government can eat them. And the job of the government is to obey the long run government budget constraint, including the free lunches that the Bank of Canada gives it once a year when it hands its profits over to the government.
But not everyone is getting it, the way you are.
“….and not doing this [printing money] in 2008 was a clear failure of monetary policy (or “aggregate demand management”, to use Determinant’s term).”
Though most mainstream macroeconomists would disagree with you on this part. Scott Sumner has been arguing for this, but many would say that monetary policy can’t do much at the ZLB, and/or that events happened too big and quick for us to blame central banks.
“Aggregate demand management” by the way is a fairly standard term, though perhaps it has a slightly old-fashioned Keynesian flavour.
himaginary: I think the “ketchup theory” is at the back of a lot of economists’ minds. I’m surprised that the only explicit mention of it is in that Economist article.
Thank you by the way for translating so many of my posts into Japanese! I often read them, with Google translate, to see your added commentary.
Determinant: “It forms the basis of the post-war social contract but we’ve spent 30 years demolishing that. I think we were wrong, collectively.”
I don’t really see it that way. Most central banks target inflation. Rightly or wrongly, they see inflation targeting as a good way in practice to implement aggregate demand management. By “flexible” inflation targeting, they believe they can keep the unemployment rate about as close as is practically feasible to what they call the NAIRU, or the “natural rate”, or what we used to call, oxymoronically, “full-employment unemployment”.
In the last couple of years only, some however did seem to lose faith that aggregate demand management was possible. See my old post http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/05/the-orthodox-loss-of-faith.html
And the Eurozone is a mess.
Clonal: thanks. But I would say that Lerner and Keynes have basically won their war on that point, at least to the extent that they had a valid point. What I have been trying to do in this post is elucidate the extent to which their point is valid.
RSJ: I like your 11.04 “loops” comment. I think you are onto something.
Except just for this bit, where you go badly wrong, in confusing what is wealth for the individual and what is wealth in aggregate:
“Both “loops” are internally consistent, but only one — the non-Ricardian loop — is consistent with the data. It makes no sense for households to pay a premium for bonds over capital if they do not consider bonds to be wealth.”
In a Barro-Ricardo world, a government bond is wealth for the individual who holds it, just not net wealth in aggregate.
Beowulf,
Thanks for Abba Lerner’s book.
It seems Lerner’s attitude toward describing imports are benefits is totally different from what is argued in the Chartalists’ blogs. Lerner seems to be describing situations in which protectionists measures are being taken by nations and in that scenario, imports would be benefits. That attitude is drastically different from saying something like “we can purchase anything foreigners want to sell us” and narrative around that.
And if the govt didn’t run a deficit, nobody could earn any money and nobody could save, amirite?!
Anyway, empirically you have something like govt expenditure constant over the cycle, and its take from net taxes moving pro-cyclically, falling in the bust as output contracts and transfer payments increase.
But the idea that the govt cannot control its deficit and so should not worry about its budget constraint is very wrong. Even in Godley and Lavoie’s model, which Ramanan is referring to, where there is no economic activity whatsoever without govt spending, steady state equilibria are defined by constant ratios of financial stocks and flows, i.e. the steady state is characterised by precisely the same sort of rule for the national debt that Nick and I were just discussing!
Which brings me to a more general observation about the MMT blogregore: inconsistency. Because MMT is basically an ideology for many of its proponents, at times positions are advanced for political reasons, and done so without regard for the fact that they contradict other positions. (To be fair/clear, this doesn’t apply to Ramanan or RSJ). The endogeneity of the budget deficit is a classic Mitchell cliché, but it’s never put next to that popular deus ex machina, gubbermint sovereignty, and examined. Warren Mosler has said to me numerous times that the govt can basically take whatever it likes and do whatever it wants and the private sector has no choice but to take its lumps. (Or see this recent Winterspeak statement: “A government’s capacity to impose taxes has nothing to do with the quality of the real economy it oversees and everything to do with its sovereign power.”) So how do we get from there to it being totally unable to control its budget?
Vimothy,
Thanks for saying it doesn’t apply to me 🙂 I am quite an MMT criticizer, though quite a fan of Post Keynesianism. Yes, I agree there is a lot of inconsistency in MMT definitions and it starts from the definition of “sovereignty”.
At any rate, what you have written above is not an argument. For example, you argued that some definition of wealth is all wrong without checking that national accountants use the same definition.
It is crucial to get what is endogenous and what is exogenous right.
In the G&L models you are refering to, the long-run is just a state which is reached due to decisions taken by various sectors. The fun is in the states that lie between two steady states… how economies move from state A to B .. and how policy can affect output, what happens if consumers’ propensity to consume decreases and those things.
Back to the argument, the government sets its expenditures and the tax rate not taxes. High activity leads to high inflow of receipts – for example during the dot-com boom, there were a lot of capital gains and high taxes received by the US government. The US govt didn’t decide the AMOUNT.
For let us suppose, that the government tries to achieve a deficit of 2%. This can be done by increasing the tax rate. Highly likely that the increase in tax rates causes a deterioration of output leading to deterioration of the budget balance.
The insistence of controlling the budget is equivalent to Milton Friedman’s insistence that the money supply be controlled.
Well, I would disagree on the effectiveness of ADM coordination between the Bank of Canada and the Government, but it’s really a government problem, not the Bank’s. The Bank has to do what it’s told to do which is target inflation.
Robert Skiddelsky has a good book on Keynes for today. For somebody like myself or Min there is a good table in there which summarizes the institutional role changes over the last 50 years as we moved from worrying about unemployment to worrying about inflation.
In an MMT world the Ministry of Finance would take a much more proactive stance in macro issues than it does at present. Rarely do we see income taxes adjusted for macro management anymore.
Though this thread has shown the difference between a sustainable budget deficit and a nominal surplus is so small as to be negligible given Canada’s present interest rate, monetary and growth conditions. Lucky for us a nominal balanced budget isn’t a bad thing that way and it helps make the politics easier to sell.
Vimothy,
Winterspeak is just an anonymous blogger and don’t think should be included in MMTers.
Btw, it should be clearly identified what MMT is. For example Nick posted on Delong’s website about the name “MMT” 😉
“MMTers” are basically a few Neochartalists and can be categorized in Post Keynesian Economics thought you will see “MMT is not Post Keynesian” in Bill Mitchell’s blog. Don’t think PKEists themselves identify with Neochartalists. Here is a list of Neochartalists – Randy Wray, Bill Mitchell, Warren Mosler, Scott Fullwiler, Palvina Tcherneva, Stephanie Bell Kelton, Mathew Forstater, Eric Tymoigne …
So there is some overlap but very little. What is PKE itself is debatable but I believe one can give some proper answers.
“So how do we get from there to it being totally unable to control its budget”
Ha ha, you’ve independently come up with the Heisenberg uncertainty principle* (and since Heisenberg didn’t publish in peer-reviewed economic journals, you’ll get the credit). The govt can target budget deficit or aggregate demand but not both simultaneously.
*principle implies that it is impossible to determine simultaneously both the position and the momentum of an electron or any other particle with any great degree of accuracy or certainty. This is not a statement about researchers’ ability to measure the quantities. Rather, it is a statement about the system itself.
http://en.wikipedia.org/wiki/Uncertainty_principle
“Which brings me to a more general observation about the MMT blogregore: inconsistency. Because MMT is basically an ideology for many of its proponents, at times positions are advanced for political reasons, and done so without regard for the fact that they contradict other positions.”
are you talking about actual mmt economists? or just random people you find on the internet? (btw, what you described there is not a contradiction, as mosler is always discussing how monopolists will determine prices or quantities, but not both) because i can find random neoclassical economics proponents dicking around on the blogosphere and present you with tons, tons of contradictions
“And if the govt didn’t run a deficit, nobody could earn any money and nobody could save, amirite?!”
so, so lazy
“That attitude is drastically different from saying something like “we can purchase anything foreigners want to sell us” and narrative around that. ”
Yes, I noticed that (granted we were still under the gold standard in the 40’s). But like Donald Trump, it appears that Lerner was in-Ramananigm. :o)
http://moslereconomics.com/2011/04/21/robert-reichs-no-so-innocent-fraud/comment-page-1/#comment-50105
Ramanan,
Yes, I respect you for that. I think disagreement is a defining characteristic of honest debate. Where do MMTers criticise other MMTers?
I am defining wealth as a stock with the present value of future income flows. This way of characterising wealth doesn’t make sense in Godley and Lavoie’s model—e.g. in the model SIM which we discussed on the last thread, wealth is just the stock of money the govt has spent into existence. There are no individuals in the model anyway, so why would they care about their future income?
I have all the EViews files though and agree that it’s fun to play about with them.
I think I’ve been clear about what I believe to be endogenous and what I believe to be within the govt’s power to control, so I won’t argue with you about that.
More interesting, to me, is the way you associate a surplus with a contraction in output. A common MMT argument about the necessity of a deficit for growth or macro stability goes like this. Every time the US govt has run a surplus is has caused a massive contraction in output. Therefore, don’t run any surpluses and you won’t have any massive contractions in output. But if you put this next to the idea of budget endogeneity, you realise that the reason surpluses sometimes lead a crash might be because they naturally coincide with the peak of the cycle—because the govt’s take from net taxes is higher when output is higher, for the reasons you give.
Also, you’re not being fair to Winterspeak. All the non-pseudonymous academic bloggers respect him/her, so it seems reasonable to use one of his/her statements as characteristic of a particular line of MMT thought. In any case, as I wrote above, it’s a statement that is totally consistent with something that Warren has been pretty clear about.
“But if you put this next to the idea of budget endogeneity, you realise that the reason surpluses sometimes lead a crash might be because they naturally coincide with the peak of the cycle—because the govt’s take from net taxes is higher when output is higher, for the reasons you give.”
yes, because none of the times that the gov’t has run a surplus has been because of the purposeful efforts of fiscal ‘conservatives’
This paper, “Implications of a Budget Surplus at Mid-Year 2000”, was quite prescient:
http://www.cfeps.org/pubs/pn/pn0001.html
The author’s main point is that economic growth based on private debt is dangerous. But nowhere does the author say that loose fiscal policy prevents bubbles!
“The Long Run Government Budget Constraint is undefined.”
Don’t some mainstream economists believe that it is, that the long run limit of G-T = 0? Not only that, don’t they believe that that belief is rational?
Determinant,
You said:
“Because they are deeply unfashionable. The “lower taxes, free-market” Hayekian/Friedman crowd won the day. We spent three decades driving the Demand Managers from office and replacing them with inflation-hawks. Such is our reward for this decision.”
From Lerner’s biography at the New School http://homepage.newschool.edu/~het/profiles/lerner.htm
Quote:
As can be gathered from this (partial) list of contributions, it is shameful that an economist who contributed so much to the arsenal of economics should nonetheless have been condemned to roam in the professional underground. Any one of his contributions should easily have earned him a Nobel Prize, and the sum total of them earned him the recognition as one of the most remarkable economists of the century. But to the staid professionals of academia, Lerner was simply not “one of us”
End Quote
On the Lerner comment above, I will say this much: I had two mentors (one was my thesis adviser, and the other was a philosophical mentor) who were nominated — both were very deserving — one did not get the award because “He was not one of us!”