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.