Modern Money Theory (MMT) in the Tropics

Paper has been published as a PERI Working Paper.

From the abstract:

Functional finance is only one of the elements of Modern Money Theory (MMT). Chartal money, endogenous money and an Employer of Last Resort Program (ELR) or Job Guarantee (JG) are often the other elements. We are here interested fundamentally with the functional finance aspects which are central for any discussion of fiscal policy and have received more attention recently. We discuss both the limitations of functional finance for developing countries that have a sovereign currency, but are forced to borrow in foreign currency and that might face a balance of payments (BOP) constraint. We also analyze the limits of a country borrowing in its own currency, because there is no formal possibility of default when it can always print money or issue debt. We note that the balance of payments constraint might still be relevant and limit fiscal expansion. We note that flexible rates do not necessarily create more space for fiscal policy, and that should not be in general preferred to managed exchange rate regimes with capital controls. We suggest that MMT needs to be complemented with Structuralist ideas to provide a more coherent understanding of fiscal policy in developing countries.

Read full paper here.

Official Reforms and India’s Real Economy

By Sunanda Sen
(Former Professor, Jawaharlal Nehru University; Guest Blogger)

That the Indian economy is currently experiencing a slowdown is more than evident, both with the deliberations in different private circles and with official statements signalling a series of remedial measures , mostly focused on the ailing financial sector! However, as we point out, the ailing Indian economy has concerns that go beyond flagging GDP growth and the ailing financial sector.

Downturn in the economy 
As for the downturn, the country’s GDP growth rate has plunged into a low of 5% in the first quarter of the current financial year 2019-20 .The drop has been accompanied by a sharp deceleration in the manufacturing output and a sluggish growth of output in agriculture. Matching both, ‘consumption growth’ has also been weak.

A fact which remains less highlighted in current official concerns includes unemployment, at 7.1% of the labour force during September-December 2018 as reported in the Labour Force Periodic Review. Unemployment has been even higher for urban youth during the period, at 23.4%. Information as is available indicates on-going spread of job cuts in different manufacturing units and wide-ranging distress in rural areas with farmer suicides, which causes added concern.

There also are recent reports of a shrinkage in labour force participation ratio (the proportion of people who are willing to work), indicating tendencies of withdrawal syndromes on part of the unemployed – which have been largely in response to the grim employment prospects. Distress is further manifested in the large numbers of poverty stricken people - both in rural and urban areas –ranging from 22 % to 29% of aggregate population according to different estimates.

The grim facts relating to unemployment and poverty in the real economy of India make it evident that a drop in GDP growth is not just a matter concerning the dampened financial markets and their volatility. Downturns also speak of the real sector – of the dearth of sustainable jobs and the related poverty.

Looking at the prevailing concerns in India for the stagnating economy, analysts often ruminate on the steep drop in stock prices in India’s secondary market which started with the end of the temporary euphoria at end of the national election in May 2019 . One may recall the shooting up of the Sensex beyond 40,000 on June 4, 2019, far surpassing 37,000 on May 13. The index, slumping back to a low of 36,855 on August 30, has , at the time of writing, abruptly shot up, nearing 39,000 , which is a response to the magic wand of the tax bonanza announced on September 20. Causes cited for the earlier downfall include the volatile net flows of Foreign Portfolio Investments (FPI) - recording outflows of Rs 3,700 crore or above in a single month of July 2019. Above went along with the simultaneous drop on India’s foreign exchange reserves by nearly $1 billion between July 20 and July 26, 2019.

Policy measures announced
Concerns relating to the stagnating GDP growth and financial markets in the country has prompted the government to announce a series of measures since the recent official announcements started on August 23, 2019 . The measures included a scrapping of the surcharges on long and short term capital gains as were earlier proposed in the last budget; in a bid to help inflows of foreign portfolio investments. A few stimulant measures as suggested include an investment package of Rs 100 lakh crores on infrastructure, a Rs 70th crore liquidity injection to recapitalize banks and cheaper loans to facilitate property market and auto sector, along with a promise of additional purchases by government departments in auto market . Corporations have also been assured of a no- penalty clause if they fail to comply with the corporate social responsibility(CSR) clause, originally designed to help the underprivileged. Included in the package are also additional roll-backs, of taxes on the ‘super rich’- as introduced in the last budget - in income slabs over Rs 2 crore and beyond Rs 5 crore.

Government announcements on August 30, in the next round, relaxed several rules on single-brand retail, contract manufacturing, coal mining and digital media for FDIs. Another important measure has been the dilution of the current 30% domestic sourcing norms for single brand retail trading in the country.

Official announcements on August 30 also related to the mergers of public sector banks , by combining the ‘bad’ ones with the stronger ones, thus reducing the total number of PSBs to 12. The move is supposed to coordinate with the promised recapitalization plan of Rs 70 th crores, as announced at end of the previous week.

Finally, a big tax bonanza, with rates cut from 30% to 22% has been mentioned on September 30. Above, according to a credit rating agency, Crisil, amounts to a tax savings of Rs 37,000 crores for the 1000 listed corporations. By the same estimates, the expected aggregate tax loss for the government amounts to Rs 1.45 crore; which, incidentally, exactly matches the sum received by the government from the Reserve Bank of India. Remedial official measures, addressed to mend the on-going regressive impact of the Goods and Services (GST) tax on the economy, are also on the cards, with several cuts in this indirect tax on specific items.

How effective to revive the economy?
Sops as above as tax relief - to portfolio as well as corporate investors within and outside the country – while effective in temporarily stimulating the secondary stock market, may not work to reverse the tendencies for the stagnation, even in the financial sector and let alone in the real economy. Contrary to what was expected, the initial response of the stock market continued to be rather non-committal over nearly a month between August 23 and September 20th when the big tax bonanza package was announced. It is possibly too early( and nearly impossible) to project the stock market movements in future. Still more doubtful is an expected positive impact of all above policy moves on capacity creation via the market for initial primary offers (IPOs) - short of which there can be no expansion in the real economy of output, investment and employment.

The stark realities relating to the contrasts between the real and the financial economy reflect itself in the low value of the initial Primary Offers (IPOs). As is well known, the latter indicate new physical investments rather than financial transfers alone as in the transactions of shares in the secondary stock market. A revival of the stagnating real economy demands additional investments in physical terms with related expansions in jobs. Little of those are likely to be fulfilled by a boom in the secondary market of stocks and the related gains on speculative and short term investments. Also in terms of simple national accounts, capital gains or losses relating to the portfolio investors in the secondary stock markets are always treated as ‘transfers’ between parties, and as such not even considered in calculating the GDP in their first round. Possibilities, however, remain of net injections/withdrawals of real sector demand by agents who face capital gains/losses , which deviates from their underlying inclinations to further speculate in the market. However, while the proposed tax benefits will further widen the inequalities within the country, little of those may finally be channeled beyond the speculative zone of stock markets and real estates.

Additions to corporate savings, if generated, will not generate real investments unless demand for the latter is forthcoming in the market. This comes as the home truth that Keynes spelt out more than 80 years back in the context of the Great Depression of 1929-30! Sops to speculation in the market and the lenient tax breaks for super rich as well as corporations may only help to invigorate the current spate of speculation, in stock markets (or even on real estates and commodities) further.

Official concerns as such for the public sector banks sound more than deserving, given the issues with the near bankrupt NDFCs (or shadow banks ) with their easy access to the formal banking sector which generated a large part of the on-going NPAs. In our judgement, the vacuum created with shrinking banking facilities and branches and the total absence of development banks will continue to provide space to the NBFCs and their malfunctioning.

Research, as available indicates how the corporations have made use of credit from banks to meet their liabilities ( as interest payments on past debt as well as payments of dividends to share-holders), replicating a typical Ponzi strategy. Simultaneously investments by corporations have switched from the real to the financial sector with offers of better earnings on financial securities. Corporations, in the process, also have often taken recourse to bankruptcy while adding further to NPAs held by banks. Finally, NPAs also resulted from the absconding and corrupt clients of banks who could run-away with their liabilities. One wonders if the change in governance as suggested by the recent mergers which aim to combine the weak banks with the stronger ones (in terms of current performance ), will help in lifting the PSBs from the current mess.

Incidentally, the soft-pedaling by the RBI with four consecutive cuts in the repo rates, while signalling a nod to expansionary monetary policies, will work to lower the lending rates of banks only if there will be a pick-up of credit demand from the public. And that in turn demands more of investment/consumption demand, especially from the real (rather than the financial) sector. This is because the growth of credit supply is determined by credit demand and not the other-way round! This does not rule out possibilities of additional borrowings at the lower rates to finance speculation in financial markets, which will not help revival of the real economy.

Pattern of stagnation in India’s real economy
As already emphasized in the preceding sections of this commentary, a country’s GDP growth alone hardly indicates the country’s level of development, which include employment, social security and absence of poverty. Recognizing above is important in the context of the ailing Indian economy that is currently subject to concerns more pressing than the plunging financial sector.

Mention can be made here of the structural changes in the Indian economy , with changing relative contributions of its three major sectors.Those include the share for services moving up to 50% and above since the early 1990s and the respective industry and agriculture shares stalling around 25% and 19% or less since then.

The employment situation as currently prevail in the Indian economy include 90% or more people struggling to eke out a survival in the informal sector while the organized formal sectors within industry and services offer 10% or less of jobs, thus pushing the majority of the working population to the dark terrains of the unorganized and informal jobs.

As for the sectoral pattern of employment, agriculture has remained the largest provider, at 48.9% of aggregate employment in the economy during 2011-12. Almost all of above are purely in an informal capacity , thus fetching little of the benefits which are usual when labour is formally recruited. As for jobs available in the industrial sector, the organized sector (dealing with the registered factories employing 10 or more workers ) provides less than 11% of aggregate employment in the country. Of above more than four-fifths are employed on a purely contractual or temporary basis with none of the benefits that normally accompany formal jobs. A recent estimate points at the low employment elasticity of aggregate output at 0.08%, which today is even lower than 0.18% during 2009-11. Much of the above is due to the lower absorption of labour in the production process due to the use of capital-intensive technology. In addition, growth rates are found to be higher in the capital as well as the skill intensive products - as compared to the average growth for industry as a whole.

The service sector, currently providing more than one-half of the GDP, has only a marginal contribution in employment. Data available from the Labour Bureau indicate that of an aggregate 140-150 million jobs in the services sector during 2015, only 26 million were with the organized sector. The remaining jobs, mostly in petty production units and self-employment, include, in our view, large numbers with disguised unemployment in the informal sector.

Services in the organized sector also include the ‘sun-rise sector’ , comprising of the Information Technology-Business Processing Organizations ( IT-BPO). Their contribution to jobs has been rather minimal , as can be expected in terms of their use of capital and skill intensive technology. Growth in India’s services sector is concentrated in activities related to finance, real estate and business services (FINREBS). It needs to be noticed that the FINREBS has a rising share, both in relation to the service sector itself , as well as relating to the GDP. In fact shares of the FINREBS not only have escalated over time but have continued to rise, even with declining GDP growth rates. Thus the growth of the service sector including the FINREBS, as can be expected, while contributing to GDP growth, have failed to contribute much in terms of employment or real activity, an aspect which helps to understand the underlying paradox of high GDP growth with unemployment.

The sectoral contributions as above brings home an explanation of the slow growth in jobs and related poverty– and that too for the majority of the labour force employed in the informal sector who are denied of sustainable wages and benefits as well as job security.

Need for an expansionary policy
While there is an urgent need for public expenditure as investments as well as social sector outlays, the Indian government abides by its self-imposed limits on fiscal deficit to GDP ratios, which restrains additional public expenditure. The dictum is provided by the Fiscal Restraint and Budget Management Act (FRBMA) of 2003 which was voluntarily enacted by the ruling government, largely to attract foreign investments.. Given that the theory of ‘austerity’ as a measure of investment revival by controlling inflation is much discredited at levels of analysis and policies, we find no reason why the country should continue to stick to such measures .

It needs to be recognized that official expenditure remains a per-requisite to stimulation of private spending, especially in the current context of a demand deficient domestic economy as in India. A departure, if effected, from the ineffective policy prescriptions of the mainstream economic theories of fiscal restraint can be expected to generate a climate of expansion within the country.

Considering the gravity of the situation, this is the moment for a call to the state to act and not just protect finance capital which include the speculators who operate in stock markets, the super-rich who are disgruntled and pose the threat to move offshore to avoid the newly imposed surcharges on higher income slabs, to provide relief to the bankers misallocating funds in search of quick and illegitimate gains, or even to protect and incentivize the corporate sector, the former for a negligence to the much too small a benevolence they were subject to in terms of their obligations to fulfill the CSR, and the latter as investment inducements.

We can conclude that it will be a limited exercise on part of the officialdom to view the financial market performance as a true gauge of performance of the economy as a whole.

Indeed, the Indian economy is in dire need for an alternate course of action. The state must focus and restore the real economy with channels to revive investment, employment and other social goals for the majority.
_________________________
An earlier version of the paper was published in Economic and Political Weekly on September 1, 2019

New Book on Roy Harrod

Esteban Pérez Caldentey has just published a new book on Roy Harrod for the collection edited by Anthony Thirlwall. From the description:

This landmark book describes and analyzes the original contributions Sir Roy Harrod made to fields including microeconomics, macroeconomics, international trade and finance, growth theory, trade cycle analysis and economic methodology. Harrod’s prolific writings reflect an astounding and unique intellectual capacity, and a wide range of interests. He became Keynes´ biographer and wrote a volume on inductive logic. At the policy level, Harrod played a central role in the formulation of the Keynes´ Clearing Union plan for international monetary reform. He also actively participated in British politics and government and gained recognition as an expert in the field of international economics. Yet, until now, Harrod has remained an underrated economist, commonly misunderstood and misrepresented. This is the first major intellectual biography of Harrod to be published.

For more and to buy it go here. 

Some brief thoughts on Argentina's ongoing crisis and the IMF's role in it

Argentina's peso depreciated significantly after the primary elections last month, with the clear victory of the opposition. The crisis has come full circle now with the re-imposition of capital controls, and with the default on domestic bonds, the latter a puzzling and clearly unnecessary measure, since it was in domestic currency (Standard & Poor's says it's a selective default, whatever that means, and Fitch called it a restricted default). So here a few things that might be useful to understand what is going on.

So how did we get here? As I noticed recently here, the collapse has nothing to do with fiscal problems. They hardly ever do, since the debt that matters is the one in foreign currency. First, let's clarify what were the problems that Macri faced in December of 2015, at the beginning of his term. Yes, inflation was high, but real wages were not low, and in many ways the persistent depreciation of the peso, during Cristina Kirchner last term, and the increases in wages explained that. Note that inflation did not cause the low growth during the last part of the previous administration. So inflation was less of a problem at that point, and one that Macri should have emphasized less (contrary to what most think, as I said even before the government started, Macri had no intention of reducing inflation, at least not initially, since the plan was to let nominal wages adjust by less than it, and reduce real wages).

The real cause of low growth was the Balance of Payments (BoP) problem. More specifically, the current account that was negative, and in the absence of reserves, imposed a constraint on growth. Imports of essential goods, basics like energy, and the service of debt, at a time that Vultures closed access to international markets, were the real problem that he faced. But there were no issues about a possible default. Reserves were low, but sufficient to face short term obligations, and low growth allowed the current account to be under control. There was NO POSSIBILITY OF A DEFAULT. What Macri proceded to do, eventually with the support of the International Monetary Fund, is what caused the current crisis.

Actually, during the governments of Néstor and then his wife Cristina, from 2003 to 2015, total debt in foreign currency fell, and the ratio of foreign denominated debt to exports, which measures the sustainability of debt, since exports provide the dollars needed to service the debt, went down significantly from about 450 to below 100 percent. This was the result of two renegotiations of debt (in 2005 and 2010), and of the recovery of the economy and exports too. But note that even after the end of the commodity boom in 2011, the ratio did not go up again.

So the problem was lack of growth and not default. And all the conventional media coverage about the fears of a return of a Populist government are evidently bogus on the face of that graph. It is clear that the borrowing in foreign currency, the one that Argentina has problems paying, were during the Macri government. He is the irresponsible one, and not because of excessive fiscal expansion for social programs, but simply for borrowing in foreign currency.

The question is then why did the Macri administration borrow huge amounts of dollars. Foreign debt went from around US$ 70 to close to 160 billion, btw. And while one can speculate about motives, the fact is that most of the money went to capital flight, in oder words, the central bank sold the dollars to try to preclude the depreciation of the currency. Mind you, Macri said back in 2016 that lifting capital controls was fine, and that contrary to the Cassandras, nothing bad happened. Yes, not immediately, but the point was exactly this. Now we are on the verge of a default.

The IMF largest package in its history, of about US$ 56 billion, was provided to Argentina in 2018, and it has essentially supported the capital flight strategy of Macri. Again, one can speculate about the IMF's motives, but the fact is that they have provided the money for the policies pursued by this administration, and given the circumstances that the next government will inherit, it will have a great deal of power in allowing the country avoid or not a default. Note that when the loan was provided, the IMF requested austerity, and did not ask about capital controls. So for all the talk about changes at the IMF, this was essentially your grandma's IMF.

Central Bank Independence: A Rigged Debate Based on False Politics and Economics

No pressure!

By Thomas Palley (guest blogger)

The case for central bank independence is built on an intellectual two-step. Step one argues there is a problem of inflation prone government. Step two argues independence is the solution to that problem. This paper challenges that case and shows it is based on false politics and economics. The paper argues central bank independence is a product of neoliberal economics and aims to institutionalize neoliberal interests. As regards economics, independence rests on a controversial construction of macroeconomics and also fails according to its own microeconomic logic. That failure applies to both goal independence and operational independence. It is a myth to think a government can set goals for the central bank and then leave it to the bank to impartially and neutrally operationalize those goals. Democratic countries may still decide to implement central bank independence, but that decision is a political one with non-neutral economic and political consequences. It is a grave misrepresentation to claim independence solves a fundamental public interest economic problem, and economists make themselves accomplices by claiming it does.

Read rest here.

50 years of the journal Problemas del Desarrollo

I'll be in Mexico, with a group of distinguished local economists for this event. In Spanish, but very likely it will be streamed. Will post more about it.