The spurious victory of MMT

Sergio Cesaratto (Guest Blogger)

In a widely read blog aggregator Randy Wray has declared victory of MMT and that we are all MMTs by now. Victory on who? And I personally do not feel MMT, or better I feel MMT, Sraffian, Kaleckian, Marxist and many other things, each taken with a degree of salt. Fanaticism and over-excitement is not part of heterodox Economics, let alone of academic work, and the fact that Wray got so nervous after a initial critical comment by a reader is telling that we might be far away from a cold and equilibrate economic dialogue. MMT has provided a lot of important insights, as other approaches, about the European crisis. Also intellectual adversaries like Werner Sinn have contributed to our understanding of the crisis, in this case over the role of Target 2 (that for the first time or so Wray mentions). MMT has, indeed, missed the main feature of the EZ crisis: its nature of a balance of payment crisis. Anyway, I do not see the MMT explanation as alternative, but as complementary to the BoP crisis view. In this regard, more modesty would help everybody in our common scientific and political enterprise. While my own view of the EZ crisis as a BoP crisis is here (this WP is a longer version of an article in a book that will be published likely by Routledge, a blog version is here), below you can find some critical remarks on the MMT view of the EZ crisis part of a longer paper that will be published in Spanish. These remarks develop a bit further the post on MMT already published here which is also a section of the WP. Having said so, I am ready to acknowledge that along Godley 1992, De Grauwe 1998, Kelton and Wray (and few others like Barba and Pivetti) have provided prescient predictions of the forthcoming crisis, each emphasises one aspect of it.

Let us consider an economy in which a deficit of the public sector is accompanied by a current account deficit. Given full monetary sovereignty, the MMT scholars apply the same argument envisaged for a closed economy to an open economy: a public deficit corresponds to net private wealth desired either by the domestic private sector or by the foreign sector, so there are no limits to the foreign holdings of Government bonds “so long as the rest of the world wants to accumulate its IOUs”:

“a country can run a current account deficit so long as the rest of the world wants to accumulate its IOUs. The country’s capital account surplus “balances” its current account deficit…. We can even view the current account deficit as resulting from a rest of world desire to accumulate net savings in the form of claims on the country.” (Wray 2011 MMP26).

It is hard to believe that the proviso “long as the rest of the world wants to accumulate its IOUs” applies to the majority of the countries.

To sustain his view, Wray extends the Chartalist tax-theory of money – the currency issued by the State to finance its spending is accepted since the State itself accepts tax payments only in that currency – to the foreign sector, although this is not required to pay taxes in the deficit country:

“Any sovereign State obtains “something for nothing” by imposing a tax liability and then issuing the currency used by those with tax liabilities to meet the obligation. The only difference here is that the U.S. government has obtained output produced outside the U.S., by those who are not subject to its sovereign power—in other words, by those not subject to U.S. taxes. However, even within any nation there can be individuals who avoid and evade taxes imposed by the sovereign power, but who are still willing to offer their output to obtain the sovereign’s currency. Why? Because those who are not able to avoid and evade taxes need the currency, hence, are willing to offer their own output to obtain the currency. The U.S. dollar has value outside the U.S. because U.S. taxpayers need the currency.” (Wray 2006a: 22)

It does not seem that, however, the Chinese wish dollars to buy goods from the U.S. taxpayers (or to buy goods from those who would like to buy U.S. goods). Chinese do not export to the U.S. in order to import from them, but accept nonetheless U.S. dollars from complex reasons that make that currency unique that we do not consider here. A part the particular status of the US dollar as the favourite international currency, it may be argued that only the strong currencies of countries with persistent CA surpluses – that it is useful to denominate here mercantilist countries, say Switzerland or Germany – may have the status of international currencies. Liabilities denominated in the currencies of the non-mercantilist countries (with the exception of the US) do not have the unlimited acceptance that Wray pretends they would anyway have just on the basis of full monetary sovereignty that include the disregard of the foreign exchange rate (disregard that might discourage foreigners to accept IOUs denominated in that currency, as Wray (2011 MMP 11) pretends in passages like this:

“What is important for our analysis, however, is that on a floating exchange rate, a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate. Indeed, the government does not have to promise to make any conversions at all.”

However, precisely the lack of this promise, or its long run unsustainability (as in many examples of currency board), and the expectation of a depreciation of the currency that implies that the government of a non-mercantilist country might have to pay on its liabilities interest rates that would make the domestic and, symmetrically, foreign deficit and debts unsustainable. So, it is not so much the full monetary sovereignty of a currency that matters, but the underlying secular CA situation of a country that makes the difference in terms of sustainability of those debts (Frenkel and Rapetti 2009: 689). Floating exchange rates helps, of course, but not so much because they assure the acceptance of any amount of national liabilities at sustainable interest rates – how could they? - but because they may contribute to long-run balanced foreign accounts and (symmetrically) to the stabilisation of domestic stock and flow accounts. Unfortunately Wray (2011 MMP 25) seems to invite the countries “where the foreign demand for domestic currency assets is limited” to pursue the catastrophic road of foreign borrowing (for them “there still is the possibility of non government borrowing in foreign currency to promote economic development that will increase the ability to export”) which, by the way, presupposes a renunciation to monetary sovereignty.

Wray insists, however, on only one aspect of full monetary sovereignty, that we can define as ‘internal’, that is the possibility of the government to finance any amount of spending at the desired nominal interest rate, while conceding at most a benign neglect to the exchange rate role in securing the external balance, what we may define as the ‘external’ side of monetary sovereignty. If, for instance:

“it is believed that a budget deficit can raise demand and increase a trade deficit or cause inflation—either of which might negatively impact the foreign exchange value of the currency—the central bank might react by raising the target interest rate to increase rest of world (…) demand for the currency. Fiscal policy is also constrained by perceived pressures on exchange rates. To be sure, even nations on floating exchange rates formulate monetary and fiscal policy with some consideration given to possible impacts on exchange rates. However, with fixed exchange rate systems, there is very little room to maneuver ... What we might call sovereign power is severely reduced. It is no coincidence that countries operating with fixed exchange rates today strive for policy austerity—and that they are quickly punished when they adopt overly expansionary policy. The principles discussed above do not really apply to government finance in a nation on a fixed exchange rate. Effectively, government liabilities are “backed by” foreign currency and gold reserves as there is a promise to convert domestic currency at a fixed exchange rate. Adoption of flexible exchange rates increases independence of domestic policy. (Wray 2006b: 9)

But, once again, the difficulty does not seem that there is “a promise to convert domestic currency at a fixed exchange rate”: as long as a country has abundant foreign reserves this is not a problem at all. The true question is again the structural foreign account situation of a country. Fixed exchange systems or currency unions perfectly fit mercantilist countries, as the experience of Germany in the Bretton Woods, EMU and EMS regimes shows (Cesaratto and Stirati 2011). Of course, it does not fit non-mercantilist countries. With fixed exchange rates it not so much the limit to the possibility of debt monetization that cause high interest rates (as long as a country retains a sovereign central bank monetization is in principle always possible), but the fact that the exchange rate might be inconsistent with the foreign imbalances. This may lead at the same time to restrictive domestic policies, that negatively affect the GDP growth, and to higher interest rates in order to assure the external financing of the foreign/domestic debts. The higher interest rates worsen net foreign incomes balance of the CA (and symmetrically the interest costs of domestic debts). This, combined with the GDP stagnation, places the country on an unsustainable domestic debt/GDP path.[1] Non-mercantilist countries need floating regimes not to be able to issue any amount of foreign liabilities - as long as they are “backed by the national currency – as Wray pretends, but because the exchange rate flexibility is the necessary instrument, within many limits, to render consistent the support to domestic demand with balanced foreign accounts. (Controls of capital outflows might be also necessary to let the country to finance fiscal deficits at sustainable interest rates). [2] For a third kind of country, the foreign exchange regime is irrelevant: as the US Treasury Secretary Paul Polson once famously said: “The dollar is our money, but is your problem”. This is the “exorbitant privilege” famously denounced by the then De Gaulle’s finance minister Giscard D’Estaing.

Wray, however, if he does not neglect that the prerogative to let the foreign debt levitate is due to ‘dollar hegemony’, that is an American prerogative, it al least to downplay it as an ancillary problem. Indeed, where he explicitly discusses the point, he reluctantly (but openly) admits that the irrelevance proposition that any State “can run budget deficits that help to fuel current account deficits without worry about government or national insolvency” applies indeed only to the US: “precisely because the rest of the world wants Dollars. But surely that cannot be true of any other nation. Today, the US Dollar is the international reserve currency—making the US special”, and “the two main reasons why the US can run persistent current account deficits are: a) virtually all its foreign-held debt is in Dollars; and b) external demand for Dollar-denominated assets is high—for a variety of reasons. “ (Wray 2011 MMP 25).

So Wray is correct when he says that full money sovereignty is helpful to pursue national full employment policies, but not for the right reasons. It is not true that, a part the US, ‘normal countries’ can finance any amount of government (and even private) spending by issuing an internationally accepted currency (so without care for the foreign accounts). In particular, non-mercantilist countries typically experience the foreign constraint to their full employment policies. In their case full monetary sovereignty matters not so much in the ‘internal’ sense of being freely able to issue any amount of money – what is plainly impossible – but from the ‘external’ point of view of floating exchange rates that take care of the external equilibrium while the country pursue the desired policies. It is this external role of the sovereign monetary regime that frees (as well known) monetary policy to finance government spending at a sustainable interest rate (this may require also capital controls). A proof of why Wray is wrong is in the EZ periphery’s experience: in spite of the lack of national monetary sovereignty, during the EMU years private and government spending benefited of low nominal interest rates (and negative real interest rates): a sovereign central bank could not have done better from that point of view. The problems came form the external aspect of the lack of full monetary sovereignty: the impossibility of adjusting the growing foreign imbalances (due to strong imports and lose of price competitiveness). These imbalances are at the basis of the consequent growing sovereign spreads, not the ECB policy. Of course, a strong action by the ECB to abate the spreads (what it could do) would be enormously helpful once the spreads rose. But it would not solve the external imbalances that were at the origin of the crisis and that, indeed, matured when the sovereign spreads were at historically low level.

Of course, at the European aggregate level and with the backing of the ECB the financial imbalances would be perfectly sustainable, and indeed the EZ would a perfect MMT country that issue an international currency (and even with a balanced CA with the rest of the world). The institutional change required for the EZ to resemble the US would, however, be too challenging for a club of independent nations as real Europe is. This would require a transfer of many government budget functions to a federal government along the existing public debts, while local States would work as the American local States. Federal transfers from dynamic to troubled areas should dramatically increase while minimum standard welfare rights should be universally recognised to all European citizens. Labour mobility and infra-EZ direct investment should be incentivised. Beautiful but out of reach. Of course much less would be required to re-balance the EZ, but even that sounds utopia given that it entails a profound change in the mercantilist attitude of the dominant economy.

Returning to the criticism to Wray and his MMT fellows, full monetary sovereign, that is the power of a country to issue a non-convertible currency that is fully accepted for domestic and foreign payments, is not, with the possible exception of the US, a full prerogative of all countries and, therefore, the panacea MMT exponents envisage. The evident neglect of the foreign exchange troubles that a ‘normal‘ country would incur if a larger government deficit/debt are associated to an increasing foreign deficit/net debt, implies a neglect by the MMT of the foreign constraint that ‘normal’ countries meet in sustaining full employment demand even with flexible exchange rates. MMT exponents reflect too much the US unique position as issuer of the main international mean of payment.[3] The neglect of the foreign constraint – which can be expressed as the necessity for ‘normal’ countries to keep the CA in balance over the long run, i.e. a balance between revenues and leakages of international currencies – leads the MMT exponents to a one-sided interpretation of the European troubles. These do not straightforwardly depend on the abandonment of national monetary sovereignty as the power to monetise public (and domestic) debts, in particular the high sovereign spreads do not depend on this. It is rather the abandonment of the currencies flexibilities in a non optimal currency area in the context of financial liberalisation that has led first to the capital flows from the core to the periphery that typically develops in a fixed exchange setting. Later, the ensuing external/domestic imbalances were ultimately made unsustainable by the capital flow reversal (also typical) and consequent dramatic rise in the sovereign (and non sovereign) spreads. So the story in not precisely that told by the MMT scholars. The story must pass through the foreign imbalances that, however, are neglected by them, probably reflecting some American insularity.

References:
Frenkel R. and Rapetti M. (2009) A developing country view of the current global crisis: what should not be forgotten and what should be done, Camb. J. Econ. (2009) 33 (4): 685-702.

C. Sardoni & L. Randall Wray, 2007. "Fixed and Flexible Exchange Rates and Currency Sovereignty," Economics Working Paper Archive wp_489, Levy Economics Institute,

Wray L.R. (2006a) Understanding Policy in a Floating Rate Regime, Working Paper No. 51, Center for Full Employment and Price Stability, University of Missouri-Kansas City

Wray L.R. (2006b) Extending Minsky's Classifications of Fragility to Government and the Open Economy by. Working Paper No. 450 The Levy Economics Institute.
Wray L.R. (2011 MMP 11) Modern Money Theory and Alternative Exchange Rate Regimes http://www.neweconomicperspectives.org/2011/08/mmp-blog-11-modern-money-theory-and.html

Wray L.R. (2011 MMP 25), Currency Solvency and the Special Case of the US Dollar http://neweconomicperspectives.org/2011/11/mmp-blog-25-currency-solvency-and.html
Wray L.R. (2011 MMP 26) Sovereign Currency and Government Policy in the Open Economy, http://neweconomicperspectives.org/2011/11/mmp-blog-26-sovereign-currency-and.html

Notes:
[1] That pegging is not a problem for mercantilist countries is partially recognised by Nersisyan and Wray (2010: 13): ‘Adoption of a peg forces a government to surrender at least some fiscal and monetary policy space—of course, constraints are less restrictive if the nation can run current account surpluses to accumulate foreign currency (or precious metal) reserves’.

[2] Sardoni and Wray (2007: 15-6) regards the flexibility of the exchange rate as a pre-requisite for full employment fiscal policy in so far as the state can finance spending not taking the external parities into account. Their only preoccupation is about the possible consequences on domestic inflation, while the positive effects of the trade balance are even regarded suspiciously (since a trade deficit is seen as sustainable and positive from a domestic welfare point of view). These arguments seem to reflect the unique U.S. position and do not look general.

[3] The EZ is in the same position, but it unfortunately does not take advantage of this opportunity.