Tuesday, August 28, 2012

A reply to Wray - Part I

By Sergio Cesaratto (Guest Blogger)

“The fact that individual countries no longer have their own currencies and central banks will put new constraints on their ability to run independent fiscal policies. … But more disturbing still is the notion that with a common currency the ‘balance or payments problem’ is eliminated and therefore that individual countries are relieved of the need to pay for their imports with exports. Quite the reverse: the existence or a common currency makes a country more directly dependent on its ability to sell exports and import substitutes than it was before…” Wynne Godley 1991
There are two aspects of the discussion that has taken place in the last weeks (here, here, here, here). The first mainly concerns my first post and regards whether monetary sovereignty is a condition both necessary and sufficient for any country to pursue development and full employment policies; the second concerns the Eurozone (EZ) crisis and was the subject of my second post. Wray mainly focuses on the second issue, and I will do the same. In part 1 of my reply I will, however, briefly dwell on the first aspect that is anyway preliminary and which will lead us to touch upon the EZ troubles anyway. The two questions we deal with in part 1 will, respectively, be: are balance of payments (BoP) preoccupations irrelevant for countries endowed with full monetary sovereignty? Can a currency union suffer of internal BoP troubles? Part 2 (will be posted later) will then be devoted to Wray’s explanation(s) of the EZ crisis.

1. Born in the US
The main argument of my first post was that monetary sovereignty, although a necessary condition for development and full employment policies, is not the magic wand to solve the foreign constraint to those policies. This constraint can be summarised as the necessity for peripheral countries – a set that include from developing countries to highly developed countries like France or Italy – to acquire enough international liquidity to finance the amount of imports generated by a satisfactory level of growth [a useful critical discussion of the theory of the balance-of-payments-constrained growth as presented by Thirlwall - and inspired by Kaldor - is in Palumbo (2012)]. Unless a country issues an internationally accepted currency, no monetary sovereignty would automatically allow fiscal policy to sustain domestic demand in peripheral countries without risking the vicious circle of a falling foreign exchange rate and high inflation. When Mitterand took power in 1981 with strong Keynesian ideas, few month were enough to change his mind – that is to realise that without the German cooperation, that was not there, no expansion in a single country was possible (unless you are ready to adopt more radical measures like import restrictions that, indeed, were in those years proposed by Godley). And that was France! This is not to say that full monetary sovereignty is not relevant, quite the opposite, in the first place in order to pursue a competitive exchange rate and in order to release more space to policies in support of domestic demand consistently with current account (CA) equilibrium. Unfortunately, at least until the late 1990s, peripheral countries have traditionally tried the shortcut of stabilising the nominal exchange rate and financial liberalisations in order to attract foreign capital inflows. In a meaningful sense the poor experience of a number of peripheral countries in the European Monetary Union (EMU) – including Spain, Ireland and Portugal - has been similar and is described on similar lines by Roberto Frenkel (2012), Cesaratto (2012a), Bibow (2012) and many others. We shall come back on this.

From the ensuing debate on blogs, FB etc, it seems that my position has convinced a number of people, likely opening the eyes to some.[1] This was very important for my country in which is very dangerous that too simple formulas enter into the political debate, already suffering of the mainstream vulgarities also influential on the left (see Cesaratto and Pivetti), and of “Berlusconism”. Of course, “Modern Monetary Theory” (MMT) as such has nothing to do with this.[2] I have also been careful to isolate the important messages that come from it, e.g. that a country with full monetary sovereignty cannot default on its sovereign debt if denominated in its own currency. This is important and refreshing, but we cannot stop there.

MMTs recognise of course that CA imbalances can be a source of troubles, but are likely not convinced. With which arguments? Let us quote in this regard a revealing passage by Wray:

“So, yes, the US (and other developed nations to varying degrees) is special, but all is not hopeless for the nations that are “less special”. To the extent that the domestic population must pay taxes in the government’s currency, the government will be able to spend its own currency into circulation. And where the foreign demand for domestic currency assets is limited, there still is the possibility of nongovernment borrowing in foreign currency to promote economic development that will increase the ability to export.

There is also the possibility of international aid in the form of foreign currency. Many developing nations also receive foreign currency through remittances (workers in foreign countries sending foreign currency home). And, finally, foreign direct investment [FDI] provides an additional source of foreign currency.”
So Wray recognise the particularity of the U.S. and of some other developed countries that, as Australia, have enormous endowments of natural resources and stable institutions. What the normal countries might do is then to appeal to official aid, to rely on remittances or on FDI,[3] or finally … to liberalise finance and commit to a stable nominal exchange rate in the attempt to attract foreign capital (what is implied by Wray’s suggestion of “nongovernment borrowing in foreign currency”). A similar position expressed by Bill Mitchell is quoted by blogger “Lord Keynes” (who has words of appreciation for my posts, thanks!) as a possible MMT reply to my view. What Mitchell says is that we should have a new and progressive IMF that alleviates the foreign constraint. But we have not it and we shall not have it, even admitting that it would be sufficiently powerful to solve the problems of big countries.[4] Well, anybody can judge the frailty of these replies.[5] So we remain with a single result: a sovereign central bank is a necessary, essential step, but is not the solution to any problem in all countries.[6]

2. Born in the EU
Of course, the renunciation to full monetary sovereignty is at the bottom of the EZ crisis, but as I argued in my posts, in the first place from the “external” point of view of the ensuing loss of competitiveness for peripheral countries and not-so-peripheral countries like Italy (we shall see in the second part, posted later, that Wray is close to recognise this in his reference to Kregel; monetary unification and financial liberalisation created further troubles on which we shall return in the second part). Wray tends, however, to deny that the origin of the EZ crisis is mainly in the foreign imbalances.

His main argument is that had the EZ been a currency area like the US, it could not have balance of payment crisis. This is so because in the US “we use fiscal policy [that is fiscal transfers] to try to overcome the negative effects on standards of living across states due to different multipliers and other factors related to these current account flows.” (Wray here). So the conclusion is that the EZ crisis “it is not a simple current account story. It is an MMT story about the constraints imposed due to the setup of the EMU, which separated fiscal policy from the currency.” Consider also (Wray here): “We went on to examine the claim that the Euro crisis is a simple BoP problem. That, too, is fallacious. If the EMU had been designed properly, it would not matter whether some member nations ran current account deficits—much as many US states run current account deficits.” So the problem is that the EZ is not the US, since if it were, no BoP crisis would have occurred! It is as one warns not to drive a car with three wheels and somebody else replies: don’t worry, just assume you have four. Warren Mosler’s (implicit) reply to my posts admits it: the CA imbalances are a problem that a sovereign central bank cannot solve and one solution is for the EU to have fiscal transfers of the size of the US and nobody would talk anymore of the EU imbalances. Well, but we have not this Europe and we shall never have it (I clearly myself wrote, as “Lord Keynes” correctly recalls, that the EZ could be a perfect MMT country).

To sum up, Wray’s reasoning is the following: the monetary unification might well have created CA problems (see in Part 2, to follow tomorrow, of this post his reference to Kregel). Transfers from a substantial federal European budget backed by a genuine European central bank (CB) could compensate those imbalances without much pain for the richest local states but as a component of full employment policies.[7] We may then deduct from this that since Europe has not this framework, then it suffers of a CA crisis (although a specific one, as Frenkel or myself have pointed out, we shall return on this). Wray, however, infers that since the EZ could have avoided the crisis, had it the right framework, then it is wrong to talk of a CA crisis. This sounds rather illogical, isn’t?[8] However, once the argument is presented in an ordered way – a wrong institutional design of a non-OCA precisely produces a (specific) BoP crisis – the distance be Wray and me may disappear (see Godley 1991 and Kregel). Notably, the origins of this “wrong institutional design” are not in the ignorance of the political designers. The same inventor of the OCA, the conservative economists Robert Mundell, has recently pointed out that the Euro has not been a failure as long as the ensuing disasters are leading to the destruction of trade unions and the social state, but I suppose this is also an area of broad agreement.

Notes:
[1] A commentator wrote: “The balance of payments position is MMT’s Achilles hell and more and more people are starting to realise it”. I do not think this implies that MMT has not very interesting things to say once it becomes less self-referred.

[2] Things have changed in the meanwhile. Stephanie Kelton has showed great understanding for us, and I believe that her feeling is shared also by other MMTs. We are thinking about having an event together in Rome during her visit to Italy (with Auerbach and Mosler). Even if we shall not be able to organize it, the very fact that we tried is very encouraging."

[3] In an old paper, that I quote in Cesaratto (2012), Kregel warns that FDI is a dangerous form of foreign debt.

[4] I found particularly timely the reference by Ramanan, in the discussion of one of my posts, to the Mexican case of 2008 that well illustrates a typical case of a country with full sovereign monetary that has to recur to the IMF and accept its conditionality to avoid an exchange rate crisis. He rejects the thesis, that "with floating rate currency there are always takers [of the currency] at some price” since eventually it “would become extremely profitable for some to buy stuff from Mexico." To this Ramanan retorts that if “that were the case there would have been no need for Mexico to have gone to the IMF. Now you can start arguing that the central bank didn't use this huge line of credit offered but it’s the availability of this line of credit which gave confidence to the currency markets. In this case the IMF helped but it is not bound to rescue every time. And whenever such events happen, domestic demand has to give in to stabilize the external debt. You can't simply say that there is a price and the markets clear and this is the end of the story. A fall in the currency can stabilize temporarily but this is in expectation of something happening such as an intervention. Now, if the central bank doesn't react to this, it could have created a further outflow of funds depreciating the currency further. Also banks - most importantly - have liabilities in foreign currency and an outflow can further increase this with depreciation leading to banks ending up in trouble rolling over their liabilities. It is for this reason as well that Mexico used the Fed's swap lines. In other circumstances, there is sale of reserve assets, incurring of liabilities of the government in foreign currency etc to help the currency markets function. If what you think is true there would have been no need for Mexico to have gone to the IMF at all. Unfortunately that is pure fantasy stuff. There's a huge literature on how the growth of nations is explained by the balance of payments constraint and its funny how ‘modern monetary theory’ suddenly appears as Magic Pudding Economics!” Italy, a leading industrialised country, in a similar situation had to recur in 1975 to an official German loan (that the social-democrat Chancellor Schmidt accorded using nasty expressions about Italy)

[5] I wish to be conciliatory and avoid sarcasms in this note, but these replies remind me the sentence that Rousseau attributed to Marie Antoinette: « Enfin je me rappelai le pis-aller d’une grande princesse à qui l’on disait que les paysans n’avaient pas de pain, et qui répondit : Qu’ils mangent de la brioch » . Unfortunately, like Marie Antoniette’s brioches, neither conspicuous official aid, nor a progressive IMF, nor democratic FDI that distribute or reinvest profits in the host country, nor successful currency board are there to help.

[6] The non generality of the MMT’s view has been acknowledged by “Lord Keynes”: “MMT would work very well for (1) the US, (2) those nations with strong trade surpluses (say, Germany and Japan), (3) those nations that seem to run near perpetual current account deficits but attract a lot of foreign capital (say, Australia), and (4) even the Eurozone, if it were suitably reformed with a union-wide fiscal policy, would be able to achieve full employment via MMT-style policies. In short, for most of the Western world: it certainly makes sense, and can be regarded as just a more radical form of full employment Keynesian economics. That is why Post Keynesians, by and large, are reasonably receptive to it.

To this Ramanan replied that "for most Western nations" is inexact: “Most Western includes Spain as well which obviously has a constraint. You guys will always make overkills to prove a wrong point.” Interestingly Dan Kervick added: “On neo-chartalist principles, the scope of a county's ability to generate demand for its currency would be determined by the scope of its power to tax. If the Duchy of Grand Fenwick can successfully impose and collect a tax on its people payable in Fennies, then it can successfully create demand inside its country and among its own people for Fennies. That doesn't mean it can create demand for Fennies in Indonesia simply by imposing the tax on Grand Fenwickians”. And “Bruce said”: “MMT is not a magic pill that can convert a country that is deficient in vital scientific and business skills into a wealthy nation.” (I do not believe these people are Trolls, although I much preferred that everybody would use their proper name, particularly of academics, that are without problems of professional privacy). All quotations from here.

[7] The direct intervention of the ECB to sustain the public debts of uncompetitive peripheral EZ countries is a surrogate of fiscal transfers, as Wray alludes in a discussion with Ramanan (who, of course, fully agree): “’transfer’ is the wrong word. Uncle Sam issues the currency and does not have to reduce income in one state to increase it elsewhere. … If we had a fixed economic pie then in real terms we'd be transferring real stuff to the poor regions. But that ain't true, either, as outside WWII we've never operated continuously at anything approaching capacity”. In other words, it would be equivalent if, using the MMT’s wording, a federal Bruxelles “writes a cheque” (creating a deposit at the ECB) financing “fiscal transfers”, or if the ECB directly buys the deficit countries public debt (for a clarification of the MMT’s view see Lavoie).

[8] So the presentation of my thesis that Wray provided is rather unfair: “As discussed at GLF recently, Sergio Cessaratto [sic] (and others) think we got it wrong–our claim is ‘spurious’. MMT is not useful for helping to understand the crisis. It is not a sovereign currency crisis, it is a balance of payment crisis. They have not yet explained why South Dakota or Alabama or Mississippi is not suffering the fate of Greece.” Precisely because Greece is not South Dakota, that country is suffering that fate.

Further references:
Barba A., Pivetti M. (2009) Rising Household Debt: Its Causes and Macroeconomic Implications-A Long-Period Analysis, Cambridge Journal of Economics, Vol. 33, Issue 1, pp. 113-137, 2009.

Cesaratto S. (2012b), Neo-Kaleckian and Sraffian controversies on accumulation theory, Università di Siena, Quaderni del Dipartimento di Economia politica e Statistica, forthcoming Review of Political Economy.

Cynamon B.Z., Fazzari S.M. (2008) Household Debt in the Consumer Age: Source of Growth—Risk of Collapse, Capitalism and Society, vol. 3, article 3.

Palumbo A. (2012), “On the Balance-of-Payments-Constrained Theory of Growth”, in Sraffa and Modern Economics (R. Ciccone, C. Gehrke, G. Mongiovi eds), London: Routledge.

39 comments:

  1. The Monetary Realism guys have been at the forefront in pointing out all these weaknesses in MMT including the CAD issue. You should talk to JKH or Cullen Roche about all of this. They've had the debates already.

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  2. There is no difference between yourself and MMT'ers, Dr. Cesaratto. I'm sure if you discussed this over a cup of coffee it would have been all resolved much quicker. As you said, you only want us to emphasize current account issues a little more and you also admit that monetary sovereignty is of course the more important note to realize. And I think that's what MMT is all about: emphasizing something that is not emphasized enough. It's like Engels said of Marx, he didn't think the mode of production determined everything else, but he wanted to emphasize it because it was underemphasized. The same goes for MMT and monetary sovereignty. On the rest I'm sure the disagreements are negligible (except for Sraffians insistence on a long period price...sorry, that's something that can never be compromised on).

    And funny the trolls from monetary realism come here making statements without actually reading what Dr. Cesaratto said.

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    1. I agree that the differences should not be exaggerated. This is the point also Gennaro Zezza suggested to me. I basically agree.

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  3. "When Mitterand took power in 1981 with strong Keynesian ideas, few month were enough to change his mind – that is to realise that without the German cooperation, that was not there, no expansion in a single country was possible (unless you are ready to adopt more radical measures like import restrictions that, indeed, were in those years proposed by Godley)."

    I've been shouting this from the sidelines for a while now, but every time I say it to one of the MMT critics they tend to ignore the point -- but it is fundamental. With a sovereign currency we do not need to use import restriction policies to ensure that the CAD doesn't get out of control.

    Instead, we can use dirigisme policies in the form of tax breaks and, if the country can get away with it, subsidies, in order to quickly kickstart growth in areas where imports currently dominate. Nicky Kaldor was well aware of this technique and its highly successful deployment in France after WWII.

    I believe that if a country has a sovereign currency, is not concerned with the budget balance (i.e. practices "functional finance") and pursues concerted dirigism policies then pretty much all of the objections to the MMT approach melt away.

    I wrote up a sketch here:

    http://www.nakedcapitalism.com/2012/04/philip-pilkington-mmt-functional-finance-and-dirigisme-sketch-of-an-alternative-economic-approach-for-developing-economies.html

    And I have yet to be given a good reason why MMT policies would not work perfectly well in any country that had a sovereign currency and a reasonably skilled labour force.

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    1. "With a sovereign currency we do not need to use import restriction policies to ensure that the CAD doesn't get out of control."

      Well, MMTers behave as if the balance of payments does not matter. "Imbalance, What Imabalance" is the title of a Wray paper.

      Second, MMTers suggest no capital or import controls are necessary and the Buckaroo model works.

      Third, a subsidy given need not solve the balance of payments problems. It can improve the situation of course but the growth of the nation is still strongly related to the growth of exports and the (new) income elasticity of imports (i.e., if the import propensity is modified). But the external sector still matters and doesn't does not matter.

      Whatever you write at least accepts there is an issue.

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    2. That's not what Cesaratto said. Look:

      "So Wray recognise the particularity of the U.S. and of some other developed countries that, as Australia, have enormous endowments of natural resources and stable institutions. What the normal countries might do is then to appeal to official aid, to rely on remittances or on FDI,[3] or finally … to liberalise finance and commit to a stable nominal exchange rate in the attempt to attract foreign capital (what is implied by Wray’s suggestion of “nongovernment borrowing in foreign currency”). A similar position expressed by Bill Mitchell is quoted by blogger “Lord Keynes” (who has words of appreciation for my posts, thanks!) as a possible MMT reply to my view. What Mitchell says is that we should have a new and progressive IMF that alleviates the foreign constraint. But we have not it and we shall not have it, even admitting that it would be sufficiently powerful to solve the problems of big countries.[4] Well, anybody can judge the frailty of these replies.[5] So we remain with a single result: a sovereign central bank is a necessary, essential step, but is not the solution to any problem in all countries.[6]"


      If we use dirigisme policies, these criticisms melt away. Granted Wray et al have not (yet) started to endorse them, but the MMT framework still works if we integrate them.

      And if we want more exports? Well, we'll use Kaldor's "supply side MMT" policies:

      "Devaluations is not a viable solution because it is too dangerous. It is clear that whatever we must do we must stimulate demand... It is important that the fiscal stimuli should be administered in ways that improve our international competitiveness and reduce the rate of inflation, and therefore I agree with Lady Seear who has said that we should apply the fiscal stimuli so as to reduce our costs and stimulate demand. The best way of doing it is by employment subsidies, as the Regional Employment Premium used to be... I have no confidence in schemes which relate to additional employment only [Phil: read: pure stimulus such as JG], because they are not effective. But across-the-board subsidies which subsidise all employment are a different matter. They are the same as devaluation. A 10 per cent subsidy on wages is the same as a 10 per cent devaluation. (The Economic Consequences of Mrs Thatcher p. 79-80)"


      The simple fact is that, with a sovereign currency and no attention paid toward the budget balance, the MMT framework would work. And I haven't seen a single rational objection to it yet.

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    3. Sorry, are you arguing that income elasticity of imports does not matter?

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    4. Import elasticity of imports is circumvented/managed by subsidising industries that produce substitutes at home.

      Exports can be promoted -- if this is really necessary -- by doing a "virtual devaluation" ala Kaldor by subsidising wages.

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    5. Yes but these things take time and I would imagine the controls were proposed in response to the severe problems.

      What we are discussing falls in the general category of how to make the balance of payments constraint less of a headache.

      However this discussion is best avoided here (with due respect). There's however still a tone to your argument that it doesn't matter too much. A subsidy by the Indian government to car producers is not really going to make them beat BMW. Neither does subsidising Indian car makers make India import less BMWs or take a simpler case simple furniture.

      At any rate there's a huge difference in philosophy here - free trade versus managed trade. The difference is not minor.

      The criticism here is of MMT which absolutely talks of none of these issues and in their world because it doesn't matter. While the points you have raised can be discussed, they divert the discussion.

      I don't think anyone serious here is saying fiscal policy doesn't matter - in fact it matters a lot. But it has to be complemented with so many other things and the fact that MMT doesn't say anything about this is the critique here.

      Your views are not really MMT MMT.

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    7. First of all, it doesn't matter what you or I label my views. I think of them in the MMT tradition, you don't. Others will agree with you -- and still others will agree with me. I see them as MMT, but others can call them what they like.

      Secondly, the BMW example is true, but only to an extent. Yes, some products -- mostly luxury products -- will be unbeatable. And some products -- mostly commodities -- will display some aspects of true "comparative advantage". However, I will say two things to this:

      (1) If we take the opposing argument -- that is, the one for a Bancor-style currency arrangement or some other way to recycle surpluses under a managed exchange-rate system -- these exact same arguments come about. If a country runs a deficit by buying too many BMWs, the money is recycled back in the form of investment, but the country continues to buy BMWs -- then, tough luck. You encounter the same problem. BUT...

      (2) I think PKers generally hope that this can be overcome. Personally, I think it can be overcome with the correct planning. BUT, if you want to follow your arguments and concede that this cannot be overcome, then be my guest. But the end result is policy nihilism.

      My key point is that in a floating FX system all difficulties can be overcome WITH OR WITHOUT international arrangements, provided that the nation-states are (a) currency sovereigns and (b) willing to accommodate the dictates of "functional finance".

      This is by no means a diversion of the discussion. This is an attempt to move the debate on constructively and away from an "us" versus "them" brawl. To ignore this aspect of a currency sovereign's policy space is to allow the debate to remain narrow factional fighting.

      ** As for the debate between "free trade" and "managed trade" I don't recognise the distinction. The moment a country bans, say, child labour trade becomes, in a sense, managed -- as Paul Davidson has noted in his work time and again.

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    8. "I see them as MMT, but others can call them what they like."

      You cannot hold the view "Imbalance, What Imbalance" and say something like ... but but I am open to subsidies hence the former view is about right.

      Second, its not about free versus fair.

      Third, non-price competitiveness has far more importance than price competitiveness and it was Kaldor himself who went at great lengths to point this out.

      "My key point is that in a floating FX system all difficulties can be overcome WITH OR WITHOUT international arrangements, provided that the nation-states are (a) currency sovereigns and (b) willing to accommodate the dictates of "functional finance"."

      is incorrect.


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    9. I will not change your mind on what "MMT" is -- and I don't think trying to do so is productive.

      I've admitted that non-price competitiveness is very important. And what I'm advocating is, like Kaldor, a form of industrial policy -- but one geared toward management of the currency.

      If I'm incorrect you have to be very specific and point out WHY. WHY is it any different for a country to direct production to prevent deficits than to have a surplus recycling mechanism that channels investment into the country after the fact?

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    10. TheIllusionist: your comments certainly appear to be consistent with MMT--to me. Do not pay attention to Ramanan--either he does not understand what we write or he purposely distorts the message to suit his purposes.
      As to your suggestion that Sergio sit down for a cup of coffee with MMT, we did that. I tutored him over the course of 2002-2003 over many cups of coffee in Rome. We made some progress. LRWray

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    11. "I've admitted that non-price competitiveness is very important. And what I'm advocating is, like Kaldor, a form of industrial policy -- but one geared toward management of the currency."

      Because you say the following:

      "My key point is that in a floating FX system all difficulties can be overcome WITH OR WITHOUT international arrangements, provided that the nation-states are (a) currency sovereigns and (b) willing to accommodate the dictates of "functional finance"."

      thereby implying that the balance of payments does not matter at all.

      I will definitely send over quotes from Kaldor which shows how these two are inconsistent.

      A policy which aim to be "protectionist" (rightly) is totally against "Imbalances, What Imbalances?"

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    12. @ Ramanan

      -- "My key point is that in a floating FX system all difficulties can be overcome WITH OR WITHOUT international arrangements, provided that the nation-states are (a) currency sovereigns and (b) willing to accommodate the dictates of "functional finance"."

      thereby implying that the balance of payments does not matter at all. --

      No, that does not imply that BOP does not matter. It implies that if the country is willing to undertake the measures I have outlined, they will be able to alleviate BOP difficulties without the need for international mediation.

      @ LRWray

      Yes, we've been discussing it on the Facebook page and, while these policies have been around for ages (used by France in the post-war era to great success) they get a new flavour when understood in the MMT context. They become an anti-inflation/anti-devaluation measure rather than straightforward industrial policy. This is how, by my reading, Kaldor though of these policies in the early 1980s, but he didn't have the framework with which to cast them in. As I said over at the FB page, Kaldor's policies were ahead of his theories on various issues. But it was the theories that his students and followers picked up on.

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    13. Illusionist,

      If Wray is changing his stand (although not confessing it) I am happy for him.

      What you have written is a mixture of sneaking in good ideas into MMT.

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    14. Sorry if this comment appears multiple times.

      "No, that does not imply that BOP does not matter. It implies that if the country is willing to undertake the measures I have outlined, they will be able to alleviate BOP difficulties without the need for international mediation."

      which is a confession that "Imbalances, What Imabalance" is wrong isn't it. C'mon!

      There is a definite literature on what the best policy is. I am sorry, your points - although good - barely touch the rich subject.

      More importantly, why change the definition of what is MMT.


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    15. Let's clear this up: the "imbalances, what imbalances" argument is based on the notion that CADs are not "imbalances" because the country that runs the surplus, at that moment in time, accepts IOUs from the deficit countries. The idea here -- as in John Harvey's work -- is to stress that capital flows are just as important as trade flows in CASs and CADs.

      You want my dollar; I want your Nissan. We both get what we want. We are not "out of balance".

      Such a statement, however, does not imply -- as you seem to think it does -- that under certain situations this might not change. Tomorrow, I may want the Nissan, but no one wants my dollars. Then we have a problem. But calling this an "imbalance" is misleading in a floating FX rate system.

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    16. Same with private sector deficits. It is as much a "what imbalance?" until it hurts.

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    17. Yeah, when you owe someone something you don't have. That's an "imbalance". But it can't happen in a floating FX system.

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    18. Wow! We don't owe foreigners anything!

      More seriously - that intuition fails to understand what "market convertibility" is and how the foreign exchange markets work.

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    19. TheIllusionist: Precisely. The title "Imbalances, What Imbalances" was tweaking the noses of those who profess to understand Godley but still persist in seeing "imbalance" in something that must "balance" by identity. It was also dictated by the title of the session in which I was speaking. Obviously, Rmanan did not get past the title of my piece--which is why he pretends to think I've changed my mind. And so many of them also violate simple Keynesian identities--seeing the crisis as a problem of "too much saving" sloshing around the globe that financed "too much spending" in the US. And these are supposedly Keynesians!And so of course it is no surprise that they mistake Greece's problems for current account deficit problems. Greece could of course have had a "balanced" current account but still been forced to default on nonsovereign govt debt. But that is beyond the comprehension of those who still dance down the yellow brick road of the gold standard.

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    21. Assertions as usual Randy. Typical. But since you raised it .. here it goes.

      I think you were the one wrongly pretending to understand Godley when you said he defined saving as NAFA. (as opposed to saving net of investment). Remember the blunder. Precisely when you were challenged to prove you don't confuse.

      Here's your quote:

      “To briefly summarize, at NEP we prefer to use the Godley sectoral balance approach, where he defined private sector saving as “net accumulation of financial assets” (NAFA), using the flow of funds data."

      Who is committing accounting errors?

      Second talking of fixed exchange rates, here is a "first generation MMTer" committing a massive error:

      "the money multiplier is applicable in fixed fx regimes,..."

      http://mainlymacro.blogspot.in/2012/07/kill-money-multiplier.html

      Embarrassing!

      Third, you had substantially wrong data for Ireland CAB in your blog post.

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    22. Ramanan: Are you referring to Capital Account Convertibility (CAC)? If you are, that is completely irrelevant to the argument. It has to do with the Indian central bank and their decisions as to what forms those who want to convert large amount of rupees into FX have to fill in. (It also seems to have been an easy way for CB economists to sneak austerity policies in through the backdoor). This has nothing to do with owing anyone anything and is an obscure quasi-legalistic aspect of FX markets (especially in India).

      So, no, if India runs a trade deficit and Australia accepts rupees you don't "owe" Australia anything. If they recycle those rupees into Indian government debt you owe them... the rupees plus interest, which your government can (and probably will, in the case of debt servicing) issue without limit!

      To tackle the issue I assume that you are referring to regarding CAC: yes, "hot money" flowing into developing countries can cause crises. This is undesirable, but it is up to your government how they want to manage it. If they want capital controls, no problem. But this will have effects on trade etc.

      LRWray: Yeah. It's all one big economy. There are no black holes, as Godley said, it all balances.

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    23. "So, no, if India runs a trade deficit and Australia accepts rupees you don't "owe" Australia anything. If they recycle those rupees into Indian government debt you owe them"

      I am afraid, that is not right.

      If an Australian exporter to India invoices the product in Indian Rupees and when he receives the proceeds, he has the choice of repatriating funds to another currency via an Indian bank which acts as a dealer making a two-way market. When he does that, the Indian bank goes into a short position in foreign currency - meaning its cash balance in a foreign currency gets reduced. It has to attract funds in this foreign currency to keep the balance at normal levels.

      Normally the currency depreciates to bring the position back to normal - when the bank contacts another dealer so that banks have a low net open position at the end of the day. However at times when there are massive outflows, the bank risks a chance of getting too short in foreign currency and hence the central bank would need to intervene. The foreign exchange market doesn't just find the right price always.

      It is for this reason that central banks hold foreign reserves and since they can lose them when there are massive outflows, they ask the government to borrow in foreign currency.

      Read some foreign exchange market microstructure theory!

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    24. What you're talking about is an institutional setup that allows a foreign exporters to sell their rupees after they "earn" them. No one denied that in a floating FX regime people can sell or short the currency of a country. This is simply a decision by the person who owns rupees.

      Now, what about the massive outflows? Well, that's due to your policy choices. In allowing your banks to do these deals and backing them with a CB guarantee your CB commits itself to having to accumulate foreign reserves to prop up your banking sector. That is a purely political choice and such transactions could be shut down tomorrow by the CB.

      YOUR CENTRAL BANK IS ALLOWING VARIOUS PRIVATE BANKS TO GO MASSIVELY SHORT FOREIGN CURRENCY. THEY COULD SHUT THIS DOWN TOMORROW.

      So, back to the original question. Because all this is just window dressing. You, the importer, give the Aussie exporter the rupees. You don't "owe" him anything after this. And now he has the right to flog HIS rupees and drive down the FX rate. MMT takes account of all this.

      IT NEVER DENIES THAT FLOATING FX REGIMES MIGHT NOT GET THEIR CURRENCY DEVALUED DUE TO TRADE DEFICITS. IT ALSO DOESN'T DENY THAT A CB CAN GUARANTEE MASSIVE SHORT POSITIONS IN FOREIGN CURRENCIES FOR THEIR PRIVATE BANKS.

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    25. Also note that were the Indian banks ever seriously short, say, US dollars and the CB was finding it hard to make the markets, the US central bank would almost certainly step in by opening up swap lines.

      We don't live in a global economic warzone. Central banks work together on these issues. It's in their mutual self-interest.

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    26. TheIllusionist: wasting your time on him; Ramanan just makes everything up. Bait and switch is his usual M-O. Such as attributing comments to me that are on some website I've never heard of, never been to, and certainly never posted on. However, nice, informative posts you are providing--keep it up. I'm signing off.

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    27. TheIllusionist August 29, 2012 3:40 PM

      "That is a purely political choice and such transactions could be shut down tomorrow by the CB.

      YOUR CENTRAL BANK IS ALLOWING VARIOUS PRIVATE BANKS TO GO MASSIVELY SHORT FOREIGN CURRENCY. THEY COULD SHUT THIS DOWN TOMORROW"

      No need to shout and no need to come up with dictums of shutting down banks.

      The central bank restricts bank from taking large open positions but in cases where they are large outflows, the banks end up not being able to close their net open position.

      Your "recycling" theory (into Indian government debt in your example) misses this point. It is based on the intuitions of a Walrasian auctioneer without there being dealers in the markets (in this case banks) where changes occur through changes in stocks rather than entirely by price changes.

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    28. "Ramanan just makes everything up."

      Sorry that isn't right.

      Really hate doing this but here is the link authored by you:

      http://neweconomicperspectives.org/2012/03/blog-39-mmt-for-austrians-disagreements.html

      “To briefly summarize, at NEP we prefer to use the Godley sectoral balance approach, where he defined private sector saving as “net accumulation of financial assets” (NAFA), using the flow of funds data."

      (Note "saving" as opposed to "net saving").

      The second one is not by you but as I said an MMTer.

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    29. "The central bank restricts bank from taking large open positions but in cases where they are large outflows, the banks end up not being able to close their net open position."

      But its the same thing as you said in your last comment and that I answered. Take it in steps.

      (1) Aussie exporter accepts rupees for exports.
      (2) He is "owed" nothing after this transaction.
      (3) Indian banks offer to change his currency if he pleases. **
      (4) If he does so the bank may find themselves with an open short position that requires foreign FX to close.
      (5) If lots of exporters are dumping rupees this could require CB intervention.
      (6) [This is my additional point] If the Indian CB runs short on, say, dollars, it is very likely that the Fed will open a swap line with the Indian CB. This shows that, in the real world, there is always a "currency issuer" implicitly standing behind such financial structures.

      However, I have marked step (3) with a ** for a reason. This is key. The Indian CB has decided to let these transactions proceed as part of a liberal trade regime. This is a policy choice and can be rescinded.

      Should it be? I don't know. If the Indian CB ever thought that they might come up short foreign FX and that the foreign CBs might not help them out with liquidity arrangements then maybe it should be closed down. If this is not the case, and the net effects are generally positive, then maybe it should be kept in place.

      The Indian CB takes their position -- I assume -- based on whether they think that this arrangement might ever lead to crisis. I also assume that they factor in that India might start running persistent trade deficits and that in such a case it might be more difficult to back the Indian currency dealers.

      Could this situation potentially lead to some sort of currency crisis? I assume that, given certain circumstances, it could. But is it inevitable? Absolutely not. If a crisis was looming and it looked like the Indian CB were going to be left out in the cold, they could shut the currency dealers down and tell the Aussie exporters that they would have to change their rupees for foreign FX with dealers in their own countries, or wherever.

      Again though. My feeling is that CBs generally recognise that its in their own self-interest to work together on these issues rather than fobbing responsibilities off onto each other in a "race to bottom". So, the issue you raise probably isn't a real world problem.

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    30. Phil,

      I am surprised you understand me but you interpret the description in a rather opposite way.

      "However, I have marked step (3) with a ** for a reason. This is key. The Indian CB has decided to let these transactions proceed as part of a liberal trade regime. This is a policy choice and can be rescinded"

      Yes we live in a world of laissez-faire economy. When we interact with the rest of the world, a system of rules for trading is needed and so is a system of convertibility. And that is market convertibility.

      If banks are not dealing in currencies, I do not know if the system would function at all. It is an alternative world.

      Later you speak as if the Fed's line of credit is easily available. It was generous in the recent crisis when nations had troubles in the external sector (and not generous to India) but the only international lender of the last resort is the IMF and lending comes with the terms and conditions of the lender not the borrower.

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    31. I'm aware of these problems because I've been watching the Chinese situation. They are experiencing a dollar shortage right now. See here:

      http://ftalphaville.ft.com/blog/2012/06/26/1060301/chinas-amazing-short-usd-position/

      I will come back to this in a moment.

      I didn't say that banks couldn't deal in currencies, I said that if India -- for example -- were to run persistent trade deficits it might not be such a good idea to have a free-for-all as far as currency convertibility goes. It might be wiser to tell, for example, Australian exporters to change their rupees for other currencies back in Australia. Australia is in a better position to do this due to their surpluses.

      But back to China, because they have a very real policy option open -- one which I believe India have too. They can liquidate their holdings of US T-bills and use the dollars to buy up the FX needed to meet their short positions. That would put downward pressure on the dollar, not the rupee. It would also put upward pressure on US interest rates.

      Now, my feeling is that the Fed would not like this. So, they'd step in to buy the T-bills that the Chinese (or the Indians) were liquidating.

      Instead of doing this, the Chinese or Indian governments -- if they ever were to have a serious short position -- could call up the Fed and say "Look, Bernanke, we have lots of T-bills and we need FX liquidity. If you don't open up swap lines we're going to have to start liquidating T-bill holdings and that will be a total pain in the ass for you. So, just give us the swap lines and we won't have to do this."

      My guess is that Bernanke would open the swap lines.

      The key point here, again, is that CBs are all interconnected by the assets and liabilities that they hold. It is a very rare situation where, under a floating exchange rate, a country encounters serious problems with foreign liquidity. But if this were to occur, there are usually multiple options open.

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  4. TheIllusionist wrote:
    "we've been discussing it on the Facebook page..."

    Which page would that be, pls?

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    Replies
    1. "MMT, Heterodox and Dissident Economics"

      I hope I didn't violate any Fight Club-style rules there...

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  5. in a monetary union like the US or EU, for purposes of this analysis the only kind of regional problem you can have is an unemployment problem. In other words, if there happens to be full employment in all regions there's no problem, regardless of what the inter regional trade numbers happen to be. If there is unemployment, it's a problem whether related to trade or not, and subject to the same adjustments regardless of source.

    When some regions are at full employment it can be problematic to simply increase aggregate demand at the macro level to sustain full employment in all regions. Should that be the case the 'answer' becomes 'fiscal transfers' where the central govt. directs public spending to the areas of high unemployment. While this works well to sustain full employment throughout the region, it's unfortunately misunderstood as a transfer of wealth to the areas of high unemployment from the taxpayers of the low unemployment regions.

    However, while it's an addition of nominal wealth to the high unemployment regions, and with exports real costs and imports real benefits, if the high unemployment regions are then producing public goods for the entire union, they are in fact exporting public goods and thereby, in real terms, experiencing a reduction of real terms of trade relative to the low unemployment regions.

    www.moslereconomics.com

    ReplyDelete