Thursday, February 7, 2013

Palley on Modern Money Tree (MMT) economics

Tom Palley published a new paper on MMT, available here. From the abstract:
Money, fiscal policy, and interest rates: A critique of Modern Monetary Theory 
This paper excavates the set of ideas known as modern monetary theory (MMT). The principal conclusion is that the macroeconomics of MMT is a restatement of elementary well-understood Keynesian macroeconomics. There is nothing new in MMT’s construction of monetary macroeconomics that warrants the distinct nomenclature of MMT. Moreover, MMT over-simplifies the challenges of attaining non-inflationary full employment by ignoring the dilemmas posed by Phillips curve analysis; the dilemmas associated with maintaining real and financial sector stability; and the dilemmas confronting open economies. Its policy recommendations also rest on over-simplistic analysis that takes little account of political economy difficulties, and its interest rate policy recommendation would likely generate instability. At this time of high unemployment, when too many policymakers are being drawn toward mistaken fiscal austerity, MMT’s polemic on behalf of expansionary fiscal policy is useful. However, that does not justify turning a blind eye to MMT’s oversimplifications of macroeconomic theory and policy.
While agreeing on many theoretical principles the paper suggests that oversimplification limits the understanding of the complexities of policy making.

35 comments:

  1. Some good points there, although Palley himself stumbles on endogenous money concepts.

    In my opinion, the Neochartalists take an alarming amount of self-credit for whatever they write. For example, Bill Mitchell has zero acknowledgement of the work of Moore or Godley in his blog.

    Another example about taxes and acceptability. In an oft-quoted paper "The Dollar Crisis" (1971), Kaldor wrote:

    In the case of a national currency the general acceptability of "fiat money" is ultimately tied to political sovereignty. Everyone in Britain accepts payments in pounds in the confident knowledge that the Government accepts pounds in payment of taxes and the courts will support any debtor who tenders payment in pounds to a creditor. But in a conclave of sovereign states, there can be no such enforceability: the willingness of any country to hold assets in paper "bancor" depends entirely on its confidence that it will continue to be fully acceptable to all other countries

    In other places Kaldor also defined money as having characteristics which Palley says and not exclusively to taxes.

    On things that are original to them, the Neochartalists are incorrect.

    I myself wrote a critique about one particular aspect recently on a 5-part series on debt sustainability. As Palley rightly says, Neochartalists tend to oversimplify. For example, they simply do not understand the response of imports to an increase in output.

    Here: http://www.concertedaction.com/2013/01/05/wynne-godley-and-the-dynamics-of-deficits-and-debts/

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  2. Ramanan,

    Your conclusions in that post are incorrect. Imports cannot explode as a share of GDP. They are bounded. Can you imagine imports to be 100x GDP? 1000x GDP? Take your pick but they would stabilize, and at what level they stabilize is irrelevant, the presence of an asymptotic is relevant.

    So if you sum a time series with growing but bounded deficits, it still converges, simply take the limit of the deficit/GDP ratio and sum that, that is the upper bound and it converges.

    As for taxes driving money, MMT acknowledges this insight is old, Smith wrote about it as did Mitchell Innes. They published the whole book on Innes to bring him back from obscurity.

    Bill Mitchell doesn't wrote about Godley because he hasn't worked with him. But Wray does because he did. But then some accuse MMT-ers of "stealing Godley" because MMT didn't get its name before he died. Oh well.

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    1. No your conclusions are incorrect.

      Imports do not go to 100x GDP but a few percentage points of imports are devastating because net indebtedness keeps increasing.

      Again you fail to understand - which proves Palley. A growing output implies a growing volume of imports which means fiscal policy has to give in since indebtedness to foreigners keeps rising.

      You trivialize the issue and claim debts sustain provided only r<g. Ha!

      For if I believe you, net indebtedness to foreigners does *not* keep rising if GDP keeps rising but exports do not rise. Which is a *foolish* claim.

      For according to your logic, all debts and deficits are sustainable. Why? A: Have you ever seen private sector deficits go to 1000x GDP? Totally nonsensical defense.

      Totally irrelevant comment on acknowledgement.

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    2. The fact remains that if the increase of deficit is bounded *as a share of GDP* then the debt/GDP will stabilize. Your statements that with income imports grow are thus irrelevant. Of course they will grow, as will exports and many other things. Imports have to grow *indefinitely* as a *share* of GDP, which of course they won't, so the primary balance as a share of GDP is bounded. And this is sufficient for the series to be converging.

      Matias,
      I fully believe that Godley would not call himself MMT. What I was pointing out that whatever MMT does is wrong for some people - not mention Godley bad, mention Godley bad. Whatever.

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    3. You still don't understand. Because you simply do not know.


      "The fact remains that if the increase of deficit is bounded *as a share of GDP* then the debt/GDP will stabilize. Your statements that with income imports grow are thus irrelevant."

      Let us say the growth of GDP (nominal) is 10% but exports grow at 0%. Initially imports are at 20, exports at 15 and GDP at 100. Now as the economy grows but if exports do not grow, both the current account deficit and the fiscal deficit grow as a percent of GDP.

      To hold the current account or the trade deficit - i.e., to prevent it from growing requires a fiscal contraction or at least a non-expansion.

      This is because an increase in output also implies an increase in income and hence increase in imports.

      So let us say imports increase 1.5 times the output. So if output rises to 110 i.e., 10% from 100, imports grow to 20 x 1.15 = 23.

      The trade deficit has deteriorated from 5% of GDP to 8% of GDP.

      Next period if there is another 10% growth, the trade deficit grows to 11.45% and so on.

      Simple illustration.

      Take an excel sheet and work all these out for more complicated scenarios instead of making primitive statements (borrowed the phrase from Palley!).

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    4. "The trade deficit has deteriorated from 5% of GDP to 8% of GDP.

      Next period if there is another 10% growth, the trade deficit grows to 11.45% and so on. "

      No, you don't understand. I get all of that you say above. GDP grows, imports grow. The thing is there is a limit to this process in terms of where imports/GDP can go (not imports themselves). Through currency devaluation or whatever, nobody will export to a country that in any year produces X and imports 100X, nobody will want to amass claims on this country.

      So there is a limit to how much net imports/GDP can go, say 200%, or 1000% or whatever. Then pb in your formula is *bounded* by a number pb_0. And that is that. Debt ratio will converge to -pb_0/(g-r).

      You keep confusing imports with imports/GDP. Imports and GDP are not bounded, imports/GDP is bounded, so "pb" is bounded. Your claim that Fullwiler's argument relies on pb being constant is simply incorrect, it relies on pb being bounded.

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    5. No I am not the one confusing.

      The point I am making is that when the current account balance is deteriorating it shows up as a problem in the foreign exchange markets and something has to give in and typically it is fiscal policy.

      Again you simply do not know the models but are fast to claim sustainability. Why claim sustainability for only r<g. Simply claim for for anything and everything.

      "nobody will want to amass claims on this country."

      Yes precisely the point. There are troubles in the fx markets. But for you doesn't matter at all..

      The point you do not seem to understand is that something has to give in to prevent the trade imbalance from growing and typically it is a fall in demand and output.

      Primitive.

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    6. Your argument is self-contradictory. If you assume that imports grow faster than GDP forever (MMT doesn't say this btw), it means that the foreign sector is happy to amass financial assets of the country being an infinite multiple of its GDP, *forever*. If this is so, then unbounded interest payments as a fraction of GDP are *sustainable*! - this is exactly what is necessary to pay the foreigners: a debt/GDP ratio that is growing without bounds.

      Of course, the foreign sector will not be happy to amass an infinite multiple of GDP of any country, so none of this will ever happen, there will be adjustment to the pace of imports/GDP via the exchange rate. You just assumed three impossible things before breakfast.

      MMT does NOT claim that you can have imports growing faster than GDP forever, so how is it a problem of MMT? Don't erect strawmen. MMT says the exchange rate will adjust and the "problem" will fix itself, imports/GDP will stabilize. Nothing to see here.

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    7. "Your argument is self-contradictory."

      No your argument is contradictory.

      First I proved to you non-sustainability. You changed the topic but in your own scenario there is a crisis in the external sector.

      Primitive.
      You bring in 100x GDP to ridicule.

      Consider simple scenarios. A nation has a current account deficit of 5%. If it wants to increase output, this may grow to 6% and the next period 7% and so on. A current account deficit also implies a rise in net indebtedness.

      So if it was initially 40% of GDP, with 5%, 6% and 7% it will grow to around 50-60% depending on various things.

      In your own scenario claims by foreigners becomes unacceptable.

      "(MMT doesn't say this btw),"

      Yes precisely.

      MMT doesn't say this because MMT doesn't know this.

      And since when did MMT become the ultimate truth?

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    8. No, it is you who changed the topic because your post is clearly wrong. I just said that your post on non-sustainability is wrong because it relies on imports/GDP growing without bounds and MMT doesn't say they can grow without bounds. Since imports/GDP are bounded Fullwiler's analysis is correct: debt/GDP is bounded. 'pb' doesn't have to be constant, it just has to be bounded, so you were incorrect. So you proved non-sustainability in a case that is impossible to happen, great. Plus, as I say above, if for any country imports/GDP did grow to infinity, debt/GDP would actually have to go to infinity to finance them. Makes no sense, but is not unsustainable, so you proved nothing.

      You are trying to disprove an MMT claim that MMT never made. MMT always says that fx will adjust and not the output, imports/GDP will be bounded and that will be that, no issue whatsoever.

      If you claim that some country can have imports/GDP going to infinity then the burden of proof is on you. MMT would say such statement is ridiculous.

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    9. "I just said that your post on non-sustainability is wrong because it relies on imports/GDP growing without bounds and MMT doesn't say they can grow without bounds. Since imports/GDP are bounded Fullwiler's analysis is correct: debt/GDP is bounded"

      That is your error precisely. As a Metallica song goes "Arrogance and Ignorance go hand in hand".

      You assume that imports do not grow as fast. This is the reason Fullwiler's argument gets sustainability because of a wrong assumption.

      Actually the sustainability analysis is stronger. Even if imports remain at a constant percent of GDP, the net indebtedness rises forever for scenarios in which exports do not do well.

      The right sustainability analysis considers how exports do and how imports do unlike an unqualified statement.

      To actually improve imports, some action needs to be taken. But for you debts are sustainable without any qualification whatsoever.

      You trivialize the matter with 100x GDP and so on.

      "the burden of proof is on you. "

      You do not seem to know. Check studies on import elasticities of nations and how imports respond to output. Best to just check data for various nations.

      To prevent imports from rising, some action needs to be taken. For example wait to increase output till exports rise sufficiently or put import controls and so on.

      "MMT always says that fx will adjust"

      I do not think that is the claim. The exchange rate can adjust but this in itself in real life does not improve to the extent needed. It may improve a bit in cases but improving to bring the debts to sustainable levels is too strong a claim.

      Again all these points (the ignorance, oversimplification etc) strongly proves Palley right.

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    11. Do you seriously believe imports/GDP can be unbounded? So if all nations grow, how is that possible exactly? Everybody becomes an infinite net importer? Obvious nonsense.

      You have do decide what your claim is.

      If imports/GDP can be unbounded, then debt/GDP *has to* be unbounded to satiate the infinite foreign desire for the currency and there is no unsustainability.

      If "something has to give", like you say, then imports/GDP are bounded and there is no unsustainability.

      No debt is sustainable either way even in your own framework. you just don't realize that.

      I think the second option is the more probable. FX will adjust and imports/GDP will stabilize before hitting infinity. Import elasticities at small changes of GDP cannot be extrapolated forever. It is like saying that if you eat 5 hamburgers a day you gain 1 pound a week, so if you eat 500 a day you will gain 100 pounds a week. Even a child knows something is off with the extrapolation and before that happens "something will have to give" and it will be your gut bursting.

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    12. Actually Fullwiler's error is even worse.

      In his best case current account balance is bounded. Now if exports do not rise sufficiently fast, and if GDP is growing, this actually implies imports are falling as a percent of GDP.

      Worse!

      Let me give an example.

      Let us say GDP is 100

      Exports at 20
      Imports at 25
      Trade deficit = 5% of GDP

      Assume trade deficit stays at 5%

      Assume output rises to 110.
      Exports still at 20.
      Imports at 25.5% to maintain 5% of trade deficit.

      Imports have reduced as a percent of GDP. Earlier imports were 25% of GDP. Now it is 25.5/110 which is 23.18%

      See my point?

      This is opposite of what happens in real life in typical situations.

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    13. "Do you seriously believe imports/GDP can be unbounded? So if all nations grow, how is that possible exactly? Everybody becomes an infinite net importer? Obvious nonsense."

      You trivialize.

      To prevent imports from growing to unsustainable levels, nations take deflationary actions. Because while a simple fiscal expansion brings an increase in output, it also leads to a deterioration of trade balance.

      If I am to believe you, a nation cannot find itself with this situation: CAD rising from 3% in one year to 4% in another and 5% the next year and so on.

      If you see historically, when imports become too high, nations use protectionism and deflation and so on.

      You have to look at data to see how imports can become worse. You don't seem to know.

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    14. "It is like saying that if you eat 5 hamburgers a day you gain 1 pound a week, so if you eat 500 a day you will gain 100 pounds a week. Even a child knows something is off with the extrapolation and before that happens "something will have to give" and it will be your gut bursting."

      If someone eats a lot - your body will easily take it until he/she puts on weight and has heart diseases and so on in which case he/she needs to go on dieting and/or medical care - something which hurts.

      In the same way, rising trade imbalances lead to deflation. To propose a fiscal expansion is to simply ignore the problem.

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    15. First of all, I am glad you criticize MMT, everybody needs that. Your blog is strong. I think you should allow comments there to rehash these issues.

      "To prevent imports from growing to unsustainable levels, nations take deflationary actions. Because while a simple fiscal expansion brings an increase in output, it also leads to a deterioration of trade balance. "

      What are "unsustainable levels"? Please define. MMT says you cannot get to unsustainable levels if you float fx. If people accept the money and willingly send stuff here, it is sustainable by construction. Maybe you define sustainability differently so explain what and how can become unsustainable. We clearly can create as much money as the foreigners want to hold, and if they export here, it means this is what they want - hold more dollars.

      Why do you call increased trade deficit a "deterioration"? I would say improvement, we consume more!

      "If I am to believe you, a nation cannot find itself with this situation: CAD rising from 3% in one year to 4% in another and 5% the next year and so on. "

      No, it can happen. If people outside want to increase their dollar holdings by 3%, 4%, 5% of GDP in consecutive years. No problem, we can consume 3%, 4%, 5% more than we produce, great. MMT has no theory of how much dollars the foreigners will want so has no theory that is able to predict imports and exports. So btw your criticism of Fullwiller's conjectures of imports and exports is off base I think. MMT makes no claim that you can predict trade balance. That is why you need flexible fx to accommodate whatever the foreign and internal sector want to happen.

      "If you see historically, when imports become too high, nations use protectionism and deflation and so on. "

      If they have their own currency? Then they are stupid. US makes no attempts at protectionism or deflation, simply consumes the windfall.

      Many nations do stupid things all the time, you cannot hold MMT accountable for that. People peg currencies, go on gold, borrow in foreign currency etc. etc. You will have an argument against MMT if you show a scenario when a nation is *forced* into deflation while not constraining itself in ways MMT opposes with pegs, austerity, debt ceilings, fixed exchange rates and other stupid stuff.

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    16. Hey Ramanan,

      sorry to interrupt your rapid back and forth, but you write this: "The point I am making is that when the current account balance is deteriorating it shows up as a problem in the foreign exchange markets and something has to give in and typically it is fiscal policy."

      RonT has made the exact same point about the foreign exchange markets. Except that his take - as is most MMTers take - is that what _should_ give is the exchange rate. If you just let the exchange rate do its thing - assuming it is driven by fundamentals - then the exchange rate is the mechanism that ensures the sustainability claimed by MMT.

      You can think of it as a dynamic system where the exchange rate provides a stabilizing feedback loop.

      Of course, if you're hell-bent on maintaining fixed exchange rates, then you run into the sustainability issues you mention. But MMTers do state that quite clearly. Wray likes to talk about the policy space available to governments, and about the trade-offs involved.

      In the end, a lot of MMT writing implicitly assumes that you let the exchange float, because that is in fact what MMTers tend to recommend: Let the exchange rate float and make use of the freedom that this gives when it comes to controlling inflation and unemployment at the same time.

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    17. So I just noticed that in one of your posts, you state the belief that exchange rate adjustments cannot "improve to the extent needed. It may improve a bit in cases but improving to bring the debts to sustainable levels is too strong a claim."

      Do you have any kind of evidence or even just theory to back that up?

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    18. On his website Ramanan has a post where he shows that one can find two functions such that one grows faster than the other. How knew? Contrary to what he appears to believe it proves nothing about economics.

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    19. On his website Ramanan has a post where he shows that one can find two functions such that one grows faster than the other. How knew? Contrary to what he appears to believe it proves nothing about economics.

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    20. RonT. Whatever.

      But just to answer you straight. It proves that for a nation which is weak in its external sector, growth brings comes with rising indebtedness to foreigners. Read some PKE

      Nicholai,

      It is actually a neoclassical notion that exchange rates adjust to bring trade into balance. Even Randy Wray's "MMPrimer" accepts that.

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    21. Ramanan,

      You may be on to something but to make your case you have to show that it will be incomes and not fx that will adjust.

      You only showed that *if* imports initially grow faster than GDP (which is not a sure thing, see Germany and Japan, but let's go with that) then *something* eventually will have to adjust. Everybody agrees on that. But what will adjust?

      Say you have a guy who makes $5000 a year. He can get a bottle of beer on credit. But if he already raked up $50k of beer debt, nobody is selling him another beer on credit. He will have to start discounting his IOUs, promise IOUs equivalent to more hours of his labor worth of stuff. So here you go, this is the fx mechanism: the flow of beer to the guy in exchange for his IOUs cannot grow forever. You only get credit when your debt is small compared to your income. This analogy will admittedly break down for a country if you want to argue that income will decline (the beer drinker's income cannot decline, unless he cannot work if he doesn't drink ;)), but for now it is completely unclear why this would happen at all.

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    22. RonT,

      Germany and Japan are superstrong in the external sectors. Not all nations are Germany and Japan. Different nations have different strength in the external sector.

      "You only showed that *if* imports initially grow faster than GDP"

      I showed it for the case even when imports grows as much as GDP.

      You read up on literature on the response of imports to GDP, please instead of blindly taking me to task.

      "beer to the guy in exchange for his IOUs cannot grow forever."

      Yes, in the similar way, a growth for a weak nation comes with rising indebtedness and cannot grow forever unless it takes some action - which can be of various kinds. It doesn't automatically stabilize as you think.

      In the post you refer to I show the absurdity of some types of growth instead of handwaving and saying debts are sustainable.

      It is pure fantasy to think that currencies adjust to reduce the current account imbalance to the extent desired without adjustment to domestic output and income. That is not to deny the usefulness of floating rates but what you seem to claim is an entirely different thing. You may not like it but the burden of proof is not on me.

      It is a bit like the neoclassical argument which says wages adjust only if markets made more and more free to bring full employment.

      Anyway, I am ending it here.

      Thanks. Later.

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    23. Ramanan,

      Thanks for the debate.

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  3. Having actually worked with Wynne for two years I should note that he disliked labels. He said he was a Keynesian with no prefix.

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    1. I would have guessed. In his Levy papers, he simply had Diehard Keynesian/Unrepentant Keynesian and so on :-)

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  4. Ron, I know you didn't suggest that Wynne would say he was a MMTer. I just wanted to suggest that part of the problem with MMT is that it creates a new label, and I, like Wynne, have an uneasy relation with some labels. Mind you, I would fit more than one.

    On foreign debt (debt denominated in foreign currency) sustainability I think the rule is the debt-to-export ratio (measure of ability to pay) increases if the rate of interest grows faster than exports (or, in other words, if the financial costs of debt grows faster than the ability to repay), and if trade deficits increase incessantly. In contrast, with domestic debt, at some point default is inevitable. And depreciation may help, but not becuase it leads to more exports, but because it is contractionary and leads to less imports.

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    1. I knid of get why MMT is annoying, especially for academics, with closely aligned views. They are somewhat exclusive. "We are MMT and you are not". But otoh your views are markedly different, so there is a reason to stress that they are a separate line of thought.

      " In contrast, with domestic debt, at some point default is inevitable. "

      Say the country is isolated, it only has domestic debt in its own currency. Is default inevitable? Why?

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    2. No you don't get it at all. Has nothing to do with academia. By the way, I have been for a year and half working at the Central Bank of Argentina. Wynne worked at the Treasury for years before moving to Cambridge. the problem with labels is that they are often misleading. For example, I do agree with a lot of Post Keynesian stuff, but they tend to exaggerate in my view issues related to uncertainty, and have limited knowledge of classical political economy. I'd rather prefer to deal with principles (say I think logic and evidence suggest that Effective Demand and exogenous distribution are central for understanding the way economies work; see my post on the Meaning of Heterodox Economics).

      Default in foreign currency is inevitable if you don't have foreign currency and in contrast with domestic currency central banks cannot create ex nihilo. Exports are the only secure way of obtaining foreign currency. The evidence, and I have worked on this issues since my dissertation (Wynne was in the Committee, but was not formally the supervisor, not being a prof at the New School), is that devaluation helps, but not that much. Income elasticities tend to be larger than price elasticities.

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  5. @Ramanan: Sorry for the nagging, but at least one of us seems to be misunderstanding the other.

    In an earlier comment of yours, you wrote that you believed that the adjustment in the exchange rate may not be sufficiently strong for debts to be sustainable. It is this particular belief that I questioned, asking whether you could give some rationale for it.

    In your response you wrote that "It is actually a neoclassical notion that exchange rates adjust to bring trade into balance." This is obviously true, and I also happen to believe that this notion is correct. It's just that this notion seems to contradict what you had written earlier. Your argument about debt unsustainability was based on imports being too high relative to exports, which means you assumed that trade would not be balanced.

    So I'm confused about what you're really saying.

    Will exchange rates adjust to bring trade into balance or won't they? Are you saying that they won't? If so, why not? Or are you saying that they will bring trade into balance, but that somehow despite that, debts will not be sustainable? If so, why won't they?

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    1. Nicolai,

      When I said it is a neoclassical notion, I meant that it is incorrect since I do not believe in neoclassical economics. Sorry should have been clearer.

      So exchange rates do not do the trick is what I firmly believe. Given this, trade can become unsustainable.

      Don't ask to me defend it. For now I will just say that to believe it is to believe in the invisible hand. That is not to say floating exchange rates are not useful.

      Also I just noticed you said "Of course, if you're hell-bent on maintaining fixed exchange rates..."

      No, I am not hell-bent.

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    2. Ramanan,

      Indeed, I had read your comment regarding neoclassical notions as saying that this notion is universally agreed upon; after all, one would hope that there are some things that economists universally agree upon ;-). Thank you for clarifying what you meant.

      I'd still like to understand better where your position is coming from, but of course I'm not the one to tell you how you spend your time.

      Cheers!

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  6. On page 9 of his essay, Palley has this to say:

    "Many European governments, aided by the IMF, are seeking to return to full employment output with a budget deficit target. Broadly speaking, they appear to be looking to cut taxes to stimulate output and reduce government spending to hit the budget deficit target. That assignment is unstable".

    Well, he simply gets it wrong - totally wrong. The austerity programs being imposed on periphery Europe certainly do not have full employment as their objective. To think that they do is just laughable. And said programs also do not prescribe cutting taxes to stimulate the economy. They may include specific tax cuts for the business sector with the purpose of improving "competitiveness" (a cherished if meaningless neo classical concept) but these are always more than compensated by higher tax rates for the non business sectors of the economy.

    The whole notion of punishment for the periphery is predicated upon an anti-growth philosophy. The non core countries are supposed to impoverish themselves in order to attain a foreign trade surplus and stop living "beyond their means". Recession and emigration are seen as tools that will bring a new dawn, a situation where people will have no alternative to accepting subsistence wages or else leave their country of birth.

    That a PK economist such as Palley can completely misunderstand the story developing before our eyes in southern Europe (with Ireland as a honorary southerner) seems to me a much more serious error than any of his putative failings in analysing MMT. IMO, it's about time the comments sections of PK blogs start concentrating more on real life issues and less on the hair-splitting, never ending theoretical debates over the fine print of the many schools within the hererodox universe.

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    1. Actually from a theoretical point of view you're incorrect. Note that mainstream models do suggest that austerity does lead to the natural rate of unemployment. And Tom is discussing theory, not the political economy, in which case it is true that austerity is hardly being pushed for employment creation. Mind you, I had a debate with Colander and others (search the blog) on whether theory and methodology debates are relevant at all. Again we will agree to disagree. I think that without coherent discussion of theory, any 'real life' discussion tends to meaningless.

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