More on MMT in the Tropics: or Can exchange rate instability, and zero interest rates, guarantee prosperity in the periphery?

 

Lance Taylor, Wynne Godley and myself in March 1999

Back in the 1990s (from late 1996 to early 1999 to be precise), I worked for Wynne Godley at the Levy Institute. Minsky, that I saw in Brazil once, had just passed away. Randy Wray was at the Levy at an office not far from Wynne's, where we worked on his model. I was, also, in Ed Nell's study group (Matt Forstater was a frequent visitor), that met regularly and discussed functional finance. In fact, one of the few topics that I was first exposed at the New School, rather than at my alma mater in Brazil.

Ed organized a conference on functional finance in 1997 (if memory doesn't fail me), then published as a book (see here), which in many ways was the beginning of what later would be called Modern Money Theory (note that at the core was Abba Lerner's functional finance). At dinner (at the Orozco Room) I sat at a table with Musgrave, Duesenberry, and, for a brief moment, Eisner, that had to leave early.* I think that was the first time I met Mosler.** Randy's MMT book came next year, in 1998 (I should note that I paid less attention to that book than his previous one, based on his PhD dissertation under Minsky, since I was at the time writing my own dissertation under Wynne and Lance Taylor, both pictured above on the day of my defense).

I start this, just to explain what should be obvious, that functional finance, endogenous money, and a preoccupation with full employment not only are part of my concerns, but that I learned, at least in part, some of these ideas more or less at the same time that they were being discussed and the MMT school was being formed. Mind you the notion of effective demand, and the perils of the external constraint, were things I already knew, but some of the issues with value theory and its importance for policy I also learned with Ed, and John Eatwell, at the New School. Further, on a personal note, I should clarify that while I worked for Wynne, who at the time was concerned with the growing external imbalances of the US, and the consequences for the international position of the dollar, I tended, on this topic to be closer to Randy's views, since it was clear for any one that came from the Federal University in Rio, and who had been influenced by Maria da Conceição Tavares, that the dollar was under no danger, and the US by definition didn't have an external constraint.

All of this to say, again, that in general, I do agree with the notion that autonomous spending determines income, and taxes being charged out of income, are the result of spending, and, as a result, the limit to fiscal policy is essentially political in nature. That is something that MMT has been instrumental in popularizing in the United States, and whenever I can, I do help on that (see my podcast with Stephanie Kelton, who was at Levy when I worked there, and started her PhD at the New School slightly after I did). She was here at Bucknell to discuss the documentary Finding the Money.

 

Stephanie at the Campus Theatre, Bucknell last March

This introduction, longish and winding, is to explain why it is somewhat weird to discuss this paper by Arturo Huerta, who I have met in Mexico, but do not know very well. This is difficult because it is a misrepresentation of the differences I do have with MMT. His paper is supposedly a rebuttal to some arguments that we have made with Esteban Pérez on Modern Money Theory (MMT). The paper is a mix of name calling (essentially that we are conventional or orthodox, read, neoclassical, and that we are neoliberals or aligned with them) and a series of arguments in defense of flexible exchange rate regimes as a solution for unemployment problems in peripheral countries. The title, "Exchange-Rate Stability Causes Deterioration of the Productive Sphere and Destabilizes Developing Economies," seems to go even further and advocate for exchange rate instability. For Minsky financial stability was destabilizing, for some MMT authors exchange rate stability causes underdevelopment and is also destabilizing.

In fact, this seems to be more a response to the critique, mine more than Esteban's, to Warren Mosler's proposal for Argentina (see below),* which would definitively cause more exchange rate instability,  inflation and a huge recession, than to our original discussion of MMT in developing countries. In fact, Huerta does not cite that paper, but our response to a poorly developed and somewhat misleading paper by Agustin Mario, that I discussed here, who said without any evidence that we defended supply side views of economic growth.

Mosler's plan consists of free float (which he says retains foreign reserves), a zero (yep, that is zero) interest rate irrespective of the rate of interest in the United States, and a Job Guarantee (JG) program. The rest is less relevant, at least for our purposes. I also assume some expansionary fiscal policy on top would be necessary for the JG.

 

Mosler's policy proposal for Argentina

Huerta's main point is that a flexible exchange rates would free the country to spend in domestic currency, very much like Mosler suggests, without loss of reserves, which developing should not be concerned with in the first place. He essentially argues along Wray's lines according to which: "a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate" (from Wray's Modern money theory: a primer on macroeconomics for sovereign monetary: p. 161. It is still exactly like that in the 2024 edition).

The notion is that: "a floating currency provides more policy space – the ability to use domestic fiscal and monetary policy to achieve policy goals. By contrast, a fixed exchange rate reduces policy space" (Ibid.). Of course, a fixed exchange rate is not necessarily the same that a stable one, and the notion that allowing big devaluations is counter-productive. MMTeers may say, as I'm sure they will, we do not defend big devaluations. Maybe not explicitly, but if you keep low (zero interest rates), and do not intervene in the exchange rate market, that is, unavoidably, the consequence. Doing that will not retain reserves, and central banks should be concerned about reserves. Btw, Milei was able to reduce inflation drastically because he did intervene both in the official and the parallel exchange rate markets (and the loan from the IMF is essentially about recomposing reserves; more on that in another post).

Then comes the question of why you should be concerned with reserves, and here Huerta's position is somewhat puzzling, particularly for someone coming from a developing country. I quote here, he says: "Vernengo and Pérez (2021) do not consider that purchases of imported goods are paid for in the importing nation’s currency, accepted by the exporters so that they can make investments, acquire financial assets, and make purchases in that nation." He suggests that they would accept pesos. In this view, a country that is an oil importer, that cannot function without energy, can import oil in domestic currency. Good luck with that!

But even if we leave the realm of Latin American magical realism, an the notion that developing countries can import in its own currency the basic capital and intermediary goods that they need to maintain normal levels of activity, his view is full of problems. He accepts very conventional views about the exchange rate (while claiming that I do have orthodox views, which I never did, on fiscal austerity; on that, note that The Guardian quotes me twice, here and here, as being against austerity when many heterodox economists, some even arguably MMTeers, I might add, have been for austerity in Argentina, saying that the mistake of the Kirchners was their fiscal excesses).

His main argument is that a "flexible exchange rates are important ... for increasing the competitiveness of national productivity and reducing pressures upon the external sector." He repeats it,  saying that: "A flexible exchange rate improves competitiveness and promotes economic growth, thereby reducing the current account deficit." In other words, the flexible exchange rate does solve the external problem (Randy is always more careful about that, and I have not seen that argument in his work).

He says that: "the reason for MMT’s advocacy of flexible exchange rates is so that the exchange rates may adjust to differences between domestic prices and those of the principal trading partners. By allowing those adjustments, a nation can avoid the relative-price distortions that would affect national production." *** He notes, as I suggested above, that they are not for depreciation per se (yeah, but with a zero interest rate...), but that: "the predominant exchange rate stability (achieved by maintaining high interest rates, in order to promote capital inflow) has led to exchange rate appreciation, which is detrimental to the competitiveness of national production." In this, as we noted in our original paper with Esteban, they are very similar to Bresser-Pereira's New Developmentalism. In the concern with a competitive exchange rate, but with a tolerance, if not a promotion of exchange rate instability, which is inevitable with very low interest rates.

There are many other issues, which again reveal actual use of marginalist thinking, for example, he says: "In saying that low interest rates generate inflation, these authors presuppose that low rates increase demand, and that the economy is in full employment. However, Vernengo and Pérez do not consider the fact that low interest rates favor the growth of investment, production, and productivity." First of all, that misrepresents our views. Low interest rates, leading to a negative interest rate differential (when the local rate is lower than the US rate adjusted for risk) leads to depreciation, and higher costs of imported goods, and inflation even if the economy is below full employment (I published the model in a book edited by, wait for it ... Forstater and Wray). Inflation comes from distributive conflict, and a depreciation, by affecting the costs of production and reducing real wages, stokes inflation. Second of all, his point is that lower interest rates lead to higher investment, which is a marginalist view that associates the intensity of the use of capital with its remuneration, a problem Huerta and many Post Keynesians share with Keynes.**** I follow Sraffians and prefer to abandon marginalist principles.

Huerta puts emphasis on the role of investment as central for growth, and in the need of very low interest rates for that, irrespective of their effect on exchange rate instability. He actually says several times that exchange rate stability is a problem, and argues that: "economies that give priority to exchange-rate stability cannot employ flexible monetary and fiscal policies to stimulate growth." On this, my views are closer to Ricardo Summa, that notes that investment is not so unstable, and follows the accelerator, and that autonomous demand (the non capacity generating part of it) is central for explaining growth.

So one needs a managed exchange rate, to avoid the inflationary pressures, and one needs to be concerned with reserves to be able to avoid the perils of not being able to import essential goods, that would cause bottlenecks an impede growth. But Huerta knows that, as a friend noticed (see below).

As he says in his tweets, what would Mexico do if it runs out of dollars to buy corn? Why not use pesos instead then? I mean, I get that Vernengo did not consider that, but he is an orthodox economist, isn't he?

In other words, sometimes, and certainly not always, developing countries cannot pursue expansionist fiscal policies because they do NOT HAVE DOLLARS (there is a reason every country, even China, accumulated humongous reserves of dollars after 2008-9). In order to be able to do it, sometimes, higher rates are needed in the periphery (not so much in the US). Then expansionary fiscal policy can be pursued even with higher interest rates, and the economy would be able to grow (as would investment that would respond, not to the higher interest, but to higher levels of demand). Exchange rate competitiveness is not central for growth, and Latin America did its State-led, import substitution industrialization (that Huerta cites all the time) during Bretton Woods with a stable nominal exchange rate (Mexico had a fixed rate from 1954 to 1976; they call it stabilizing development). It was a period of high growth, and relatively stable and appreciated exchange rate.

* I did co-edit a book, that had what I think was the last paper written by Eisner and can be seen as a follow up to that conference (ours what out of a few sessions we co-organized at the Easterns in DC in 2004, on functional finance issues.

** Mosler was in Argentina and presented this in several venues, including, at the University of Moreno, where someone questioned the idea that flexible rates with zero interested was feasible, and correctly noted that it would be inflationary and contractionary. He proceeded to ask if the person worked with me, as the story was related to me. As if my position on this is somewhat unique and someone that suggests that it doesn't make sense is my disciple.

*** Note that for Huerta exchange rates change relative prices and allow to fix distortions, in typical marginalist fashion. The emphasis is not on the effects on distribution and through that on quantities, as in structuralist views.

**** This blog is known for emphasizing the Sraffian critique of the marginalist theory of investment (very old post on that).

Paul Davidson (1930-2024)

 

Paul (I'm next to him) and the Brazilians at the UMKC, PK Conference in 2002

Paul has passed away a few days ago. He wasn't in good shape for a while, and this was expected. He lived a long and productive life. I wasn't personally close to him, even though I met him several times from the mid-1990s onward. He went to two conferences I co-organized at the Federal University in Rio, always with Louise, which was a central figure of Post Keynesian (PK) life, and basically run the Journal of Post Keynesian Economics (JPKE) for him.

He was more effective as an institutional organizer, and as an observer of economic reality (and his main book was called Money and the Real World) than in his theoretical endeavors. His views on Keynes stayed close to the flawed discussion of the Principle of Effective Demand in chapter 3 of the General Theory, and an insistence on the importance of uncertainty and non-ergodicity in Keynes' work, that proved to be somewhat of a dead alley for PKs. He also emphasized the ideas of Tony Thirlwall, and his export-led model of growth, as a central PK contribution to economic theory. Finally, he tended to accept the views of Robert Skidelsky on Keynes' intellectual development, who, as I noted here, accepted a conventional on interpretation of Keynes' ideas, relying on imperfections to explain unemployment, even if he provided a much needed accurate biography of Keynes (in contrast to Harrod).

JPKE, that he created with Sidney Weintraub, and help from John Kenneth Galbraith among others, was central for a generation of PKs. He was part of the Trieste Summer Conferences that, in the early 1980s, that included many heterodox groups, and was the closest to Marc Lavoie's broad tent in real life, but failed to provide a unified view, and an alternative to mainstream marginalist theory. Many thought that the PK project was sectarian, and could not incorporate other views. I tend to think that the failure resulted from the fragmentation of the mainstream, that was reflected in the fragmentation of the heterodoxy, and were part of the era. Certainly not Paul's fault, who, at least in my experience, was very open and willing to debate, even if he did stick to his views. At least, not his personal fault.

When LP (Rochon) invited me to start a new journal, more or less at the time Paul was substituted as the editor of the JPKE by Jan Kregel and Randy Wray, on PK monetary economics, I suggested we needed a journal that would bring other Keynesians into the conversation. Hence, the Review of Keynesian Economics (ROKE).* Paul wrote to me once he knew about the new name of the journal. I knew from him that they had thought of naming their journal the Journal of Keynesian Economics, but the acronym would have been JOKE, so they opted for Post Keynesian, and the name stuck to the school of thought. He wasn't happy. But he understood that our project was very different.

Ours was not a journal to propagate the ideas of the heterodox followers of Keynes, and to emphasize the notion that effective demand mattered, at times that Keynesians were under attack with the neoliberal turn, and the rise of Monetarism and New Classical economics (Paul was in the book of debaters with Milton Friedman, that included also Jim Tobin, and a few other more conventional Keynesians). Ours was an attempt to recreate a Keynesian big tent (not an heterodox one) to reinforce the commonalities with all Keynesians (in spite of the many differences).

Paul was combative, forceful in his discussions, particularly about Keynes' legacy, and a key figure in the preservation of Keynesian ideas, when those were considerably less popular, and the profession moved incorrectly away from the Keynesian Consensus. Later many would gladly talk about the return of the master. Paul never abandoned him, and he was right. A great loss for the profession.

* On that see Tom Palley here and my discussion of Bob Solow's role here.

Bernie and AOC are Functional Finance (and Socialists) but not necessarily MMT

Might not be MMT, but it isn't Socialism

So there has been a lot written on Modern Money Theory lately. There is this piece by The Economist, Jerry Epstein's paper, and Lance Taylor's one, more on the Democratic Socialist ideas than MMT per se (here). There was also this op-ed by Robert Shiller in the NYTimes, and the two posts by Tom Palley, that I reposted here on the blog. Finally, Christine Lagarde also commented on MMT during the World Bank/IMF Spring Meetings.

I can and I will not comment again on my views on this. As I said before, I'm a fellow traveller in the sense that I do agree with MMTeers on functional finance (even though Randy Wray, at the Easterns, presenting Stephany Kelton's slides suggested that functional finance was a late addition to MMT,  coming from Matt Forstater and Stephany in the 1990s; my take on that here, where I say that Ed Nell is the likely source), endogenous money, and with minor disagreements on the origins of modern money (by which I mean early transitions to capitalism) on some version of Chartalism. I also, noticed that I depart on certain tendencies to believe that capital mobility and flexible exchange rates make MMT applicable to developing countries, and about taxation (on the latter, I was criticized, and received both emails and tweets suggesting I misrepresented MMTeers views on taxes).

Here is where I think the dual nature of MMT as a theoretical school derived from Minsky and some strands of Post Keynesian economics* and a political movement connected to progressive parts of the Democratic Party becomes relevant. The thing is that MMT has been now associated with Democratic Socialism, with Bernie Sanders and Alexandria Ocasio-Cortéz (AOC). Stephany after all was and is Bernie's advisor, and he has embraced certain proposals beyond what I would call a pop-functional finance stance on fiscal policy. For example, his job guarantee proposal** (again I hope he wins, and I do hope Stephany plays an important role in a Bernie administration; one can hope).

However, it's worth noticing two things that are relevant in this more political context. First, Warren Mosler has posted his presentation at the New School (Mosler's slide pictured above) in which he defends the elimination of personal and corporate income taxes, and sales taxes (here). Mosler is in many ways the more public face of the non-academic face of MMT. Note that Warren plays a crucial role in the political movement associated with MMT. Also, Randy noted in this piece that he was "'a bit disappointed' that Ocasio-Cortez connected tax hikes to the Green New Deal." And no, please, I do not need to be lectured on how causality goes from spending to taxes (as much as from investment to savings; same effective demand logic). The point is that even if taxes are not necessarily to fund spending, taxes do allow for important changes in the economy.

And the way one taxes is as important for functional finance as the way one spends. Sure the limits what can be done are political. In that respect I should say that functional finance suggests that the limits to fiscal policy, beyond the productive capacity (which might be endogenous and demand driven, and hence difficult to reach unless the economy is growing really fast), are essentially political. But exactly for that reason how one taxes, and is a central political question.

Taxes on the wealthy are central for social democratic (Democratic Socialism) policies. At any rate, this establishes in my view were I depart from MMT, which would be on the willingness to tax the rich. I'm not for eliminating income taxes (I'm happy to reduce sales taxes on some things, but increasing on others), and I would be in favor of a wealth tax too. And I'm happy that a higher tax on the well to do is discussed and tied to a popular cause like the Green New Deal (I was for that back in 2012). It should not be a surprise then that MMT finds support in Wall Street, since they would certainly like no personal or corporate income tax.

* I assume that is correct; Randy said in that roundtable mentioned above that they were kicked out of post-Keynesianism, and they didn't leave. I assume that explains the renaming MMT, which I never quite understood. See this old post in which I was surprised about the new label, which I associated back then to endogenous money.

** Here I should note that while I'm not against a job guarantee (JG), I have nothing against regular fiscal spending, like, for example, infrastructure spending to get the economy going. Again, on the panel, when I asked Randy, suggesting that Wynne (Godley) had asked the same in the past (according to my recollections), he said that conventional fiscal policy (what he calls pump priming) was inflationary, and the JG would be better. I'm even less afraid than MMTeers on demand inflation, it seems.

MMT and its Discontents: Again (Wonkish and Longish)

Modern Monetary Theory (MMT) has been in the news again, and for good reasons. I actually had a post with the same title back in February of 2012, hence the again in the title. But now, with the irruption of Alexandria Ocasio-Cortez in the political scene ,and with the discussion of a Green New Deal (discussed here 7 years ago) and the feasibility of higher taxes (here, also long ago, among the many on the topic) taking the center of the political debate, MMT has become trendy. The rise of democratic socialist ideas, since Bernie's 2016 campaign, has brought the fiscal feasibility or responsibility, in the more conservative terminology, of such progressive  plans into the center of economic policy debates. Also, the fact that Stephanie Kelton a prominent MMTer is an advisor to Bernie, has brought significantly more attention on their views.

I have discussed Modern Monetary Theory in this blog for years (going back to April 2011, when I first found use of the term, to the most recent earlier this year after Olivier Blanchard American Economic Association presidential address last January), and have known the main MMTers going back to at least the mid-1990s, when I was at the New School and working as research assistant to Wynne Godley at the Levy Institute. I guess, I can be seen, to use the term employed by Doug Henwood in his recent Jacobin piece, as a fellow traveller (like Jamie Galbraith), even though I've been critical of some aspects, in particular when applied to developing countries (more on both Henwood and MMT issues in developing countries below).

There are many critiques, which deal with both theoretical issues, mostly concerned with the Functional Finance aspects of MMT, and with the policy and political effects of MMT advising to the left of center Democratic presidential candidates. Note that I will not try to define MMT precisely, since it is a hybrid of economic theories and policy proposals. I would assume that at core it is composed by the ideas of Chartalist and Endogenous Monetary views, Functional Finance, and an Employer of Last Resort (ELR) program as suggested by Greg Hannsgen in his recent presentation at the Eastern Economic Association (EEA), in sessions we co-organized (with the presence of Randy Wray presenting Stephanie Kelton's slides and Josh Mason; Stephanie was with Bernie at the rally in Brooklyn).

My comments will be, for the most part, directed at issues that fall within the Functional Finance part of MMT, and mostly about developed economies like the US (although, I'll have something to say about developing countries like Argentina or Brazil). I might add that Randy suggested that Functional Finance was a late addition to MMT, since this ideas were not known by MMTers in the mid-1990s or so. I think that the original source for the Functional Finance story was Ed Nell, who organized a conference at the New School back in 1997, I think, with Bob Eisner, and many other Old Keynesians. I had read Abba Lerner and Evsey Domar foundational papers in Ed's classes, and I think his influence on MMTers in this area is reasonable to assume.

Let me start with Paul Krugman's critiques of MMT, which have been clear and perhaps the most widely read (but there are many, including critiques by Tom Palley and Sergio Cesaratto here in the blog). So Krugman, in one of his most recent posts, starts by showing that there are many levels of the fiscal deficits that are compatible with full employment (not sure who thinks that this is wrong; I would add the same is true about the rate of interest, and that there is no natural or neutral rate of interest, a point that Keynes made back in the 1930s, and that is coherent with the capital debates, and, hopefully, it will be clear why this is relevant below). Then he argues more problematically, in my view, that crowding out is a serious concern, in his words: "The question then becomes one of tradeoffs: would the things the government could buy with a higher deficit be worth the lost private investment due to a higher interest rate?" But he knows well that the crowding out effect is empirically (if not theoretically) irrelevant, since investment is not particularly responsive to interest rates (he knows it's all about the accelerator); then he moves to the issue of the natural rate itself.

He seems to think two things (he can certainly correct me if I'm wrong). One, that MMT requires that you use monetary policy in order to achieve full employment. Two, that if you are in a situation of like the zero-lower bound, then the central bank cannot bring you back to full employment. That is, her assume that, using his own graph, the economy would be in position A.

Note that by his own argument you can go back to a point like B, with full employment by pursuing expansionary fiscal policy (be that an ELR or something else like traditional fiscal policy to expand infrastructure spending, for example; on this I should say that Randy suggested that he thinks traditional fiscal policy might be inflationary, and that's something perhaps would be compatible with Krugman; he noted how Minsky suggested that an ELR can be used as a buffer to control inflation). That is the IS would move up.

So it's unclear what the fuss is all about. If it is because the Fed could, in the MMT story (not sure Functional Finance authors would say that), print money to finance the deficits and bring the economy back to full employment, then the concern might be that it would be inflationary, in a Monetarist sense that printing money might be the cause of inflation. But that does not seem to be his preoccupation (I dealt with the issue of monetization of debt back in May 2011 in a reply to Krugman, who was back then, not surprisingly, criticizing MMT). His concern seems to be that the rate of interest would not go up. But of course, there could be a flat interest rate close to zero, a horizontal monetary policy (MP) line, and the expansion of the IS could be achieved bringing the economy to full employment (right below the C and B points with a zero interest rate).

But that doesn't seem to be the issue either. My guess is that he thinks that the problems is more like the one below, from an older post by him, in which the natural rate of interest is negative (my discussion of that here), and the Fed cannot lead the economy to full employment.

So his point is that the Fed cannot make it because it cannot bring the economy to the natural rate of interest, the one that is compatible with full employment and stable prices. He then goes on to criticize Stephanie on her critique of the natural rate, and tells us that: "So what purpose does claiming that the natural rate is a meaningless concept serve? It looks to me like sophistry – word games intended to confuse what should be a simple issue."

I'm not sure what Stephanie said about the natural rate, but I think it is well-established that the natural rate concept is problematic (note that on this some MMTers have said things I would disagree;  e.g. Forstater and Mosler suggest here that the natural rate of interest is zero; my discussion of that here). So I think the position that Krugman attributes to her is correct. Paul Samuelson would agree, as he did when he admitted that the capital debates had shown that neoclassical parables cannot hold (on the capital debates read this old post). So let me explain it briefly. There is no sophistry, just pure logic.

The capital debates show that with factor price reversals, when one good can be said to be capital-intensive at one level of the wage-profit ratio, and labor intensive at another level of the same ratio, there is no monotonic inverse relation between investment and the rate of interest. The investment schedule could look like the one below (my graph), with portions that have a negative slope and some in reverse, and if savings (determined by the level of income as in Keynes' principle of effective demand, rather than a Ramsey inter-temporal model) is given as in the graph below, then there might be no natural rate of interest. Keynes was explicit about that in the General Theory. That means that the monetary authority can set the rate of interest, what Keynes referred to as the normal rate, that was conventional, and that fiscal policy can be used to bring the economy to full employment. Btw, I think that overall Krugman and Kelton agree on that. Krugman says he's defending the theory, not the policy proposals, since he thinks they agree on that.

The point is NOT that the state can do whatever it wants, even though it has a lot of space, but that at the end of the day monetary policy is central for the ability to pursue fiscal policy, and the monetary authority can keep (unless it's forced by law not to do it; and that would bring up the discussion about the rise of the neoliberal idea of independent central banks) interest rates low enough to allow for fiscal expansion without debt growing at a very fast pace. Think of Marriner Eccles during the New Deal (chairman of the Fed at that time; search the blog for more on that). This is the argument that Josh Mason did, in a different way in our session with Randy at the Easterns. Note, also, that even though politically it was acceptable for the Fed to keep interest rates low, at 2.5 percent during the Depression and World War II, by the 1950s political pressures by financial markets and rentiers forced the Fed-Treasury Accord, and things changed (even though rates remained relatively low).

I'll comment briefly on two additional critiques of MMT, the one by Larry Summers, the ex-Treasury Secretary and advisor to the Clintons and Obama, and the one by Doug Henwood, an influential Marxist (see my discussion of his comments, and others, on Marx for the New York Times here), and writer of a very good book on Wall Street. I am sorry to say that both have too many arguments of authority and ad hominem attacks on some MMT authors, which I'm not interested in discussing. But there are a few substantive issues. One is the danger of inflation (that I'm glad Krugman seemed less keen on) and the others are on MMT and developing countries, and the political relevance and practicality of MMT proposals (here most critics have in mind the Bernie/Ocasio agenda of Medicare for all, cheap or free college tuition in public institutions, a jobs guarantee, and a Green New Deal).

I'll start with Henwood. His major issue is inflation, I would say. He says: "That brings us to the next problem: inflation. When the printing presses run freely, it’s not only reactionaries who think that runs the risk of spiraling prices. As I was researching this piece, many people to whom I described MMT, from Democrats to Marxists, brought it up as a worry. MMTers are coy about the topic — they never say how much is too much, and they profess great confidence in their ability to control it." Let me start by saying that inflation has not been a problem in 40 years, while wage stagnation is a central one. But if one is concerned about it, at least one should get the correct analytical tools to discuss it.

He tells us that: "The standard view of the Weimer inflation is that the German economy, severely damaged by World War I and forced to make huge reparations payments to the victors, wasn’t up to the task — it just didn’t have the productive capacity, and its citizens were both unwilling and unable to pay the necessary taxes. So instead the government just printed money and spent it, not only to pay its own bills, but to support bank lending to the private sector." First, that's NOT the standard view of the hyperinflation in Germany. You can read here the standard story, and I cite even a conservative historian like Niall Ferguson admitting that the monetarist story embraced by Henwood is NOT the dominant view among historians. The notion that the economy was at full capacity (didn't have productive capacity) and that printing money caused inflation is what Cagan thought about it. A more refined and somewhat structural story is the dominant view actually. In my view, it is clear that debt in foreign currency (not domestic), and, hence, the external problems of the current account, that forced depreciation, together with wage resistance are at the core of the hyper., German and many others.

In addition, it's worth emphasizing that the US is not Weimar Germany, in the sense that even with much larger fiscal deficits, debt would still be in domestic currency, and no significant pressure for depreciation would arise. The role of the dollar as reserve currency is not really under significant jeopardy. Certainly, there might be questions of inflation if we reach full employment, and that's a different issue (I'll come back to the topic below when I discuss Summers and the political feasibility of MMT sponsored plans). But the kind of alarmism of even suggesting that the US would be on the verge of hyperinflation is not serious. I won't comment on other primary mistakes like the notion that the rise of Nazism is associated to the hyper, when it is clearly connected to the Depression and deflation a decade later.

Henwood is on firmer ground, actually, when he discusses the external limits. Yes, indeed, for most developing countries like Argentina or Brazil, the ability to pursue expansionary fiscal policy is severely limited by the balance of payments constraint. Considerably before full employment, the patterns of consumption and investment may require too many imports, particularly of intermediary and capital goods, and even with capital controls, interest rates might be hiked to avoid capital flight and depreciation. Depreciation does solve the external problem, often by throwing the economy in a recession, and not because it stimulates exports. There is extensive discussion of that in the blog about it. Sometimes MMTers sounded like New Developmentalists in Latin American suggesting that depreciation would solve the external constraint and that capital controls were not even necessary. I don't think Randy believes that (or Stephanie), but it was certainly something that Warren Mosler believed in the past (whether he changed his mind I can't tell). But again the debate seems to be about the feasibility of MMT in the US (that's why I didn't emphasize in my comments on the roundtable the differences of debt in domestic and foreign currency, something I always do, as noted by Josh).

So that leads me to the last critique, the one by Larry Summers in his recent piece in WAPO. Summers says that: "Modern monetary theory... is the supply-side economics of our time" and that "these new ideas [about the importance of fiscal deficits] are being oversimplified and exaggerated by fringe economists who hold them out as offering the proverbial free lunch: the ability of the government to spend more without imposing any burden on anyone." He also says in Monetarist fashion that printing money would lead to hyperinflation. In his words: "As the experience of any number of emerging markets demonstrates, past a certain point, this approach leads to hyperinflation. Indeed, in emerging markets that have practiced modern monetary theory, situations could arise where people could buy two drinks at bars at once to avoid the hourly price increases. As with any tax, there is a limit to the amount of revenue that can be raised via such an inflation tax. If this limit is exceeded, hyperinflation will result." Again, emerging markets, like Germany, borrowed in foreign currency, that they cannot print. It was often the depreciation of the currency, the increase in the prices of imported goods, and the wage resistance of workers that led to hypers, and the central bank printed money afterwards, with money being endogenous. A foreign debt or external problem, not a fiscal one.

But there might be a danger of inflation (not hyper) if Bernie wins the election and manages to pass Medicare for all, free college, a Job Guarantee and actually spend some money on infrastructure, and to do something about global warming, without significant reshuffling of spending. Here is where I think the question of the supposed naïveté  of MMTers comes to play, with Henwood suggesting that they shirk the question of fiscal choices, and with Summers saying they resemble voodoo economics, the supply-side of the left (mind you supply-siders are many things, but certainly not naïve). I think, first of all, that the dangers of inflation are exaggerated, for several reasons. First, the labor market is not as tight as normally suggested. The number of people discouraged and out of the labor force is relatively large. Second, there are positive effects of growth on productivity (the Kaldor-Verdoorn effect, search on the blog too), so the supply constraint is not fixed, rigid at one given level (people said the natural rate of unemployment was 5 percent or higher just a few years back; again check past blog posts). Third, the bargaining power of unions, and workers in general, is not particularly strong, and it would take sometime to pick up.

More importantly, there is no chance that a Bernie presidency (and that's in and of itself a big if) would have both houses and could implement even a little bit of the program presented. Mind you if it happened we would probably get to full employment in a couple of years, and get increases in wages, and perhaps some inflation. But some inflation might be good, in particular if it allows for higher real wages, something sorely needed. How much inflation? Difficult to say, but the structure of the Fed is not going to vanish, and higher rates would be used to discipline the labor class, with the support of many neoliberal Dems. The limit will come probably before full employment and the capacity limit of the economy is reached (yes inflation happens before the capacity limit, because it's often cost push, and the sort of demand pull stuff Summers and Henwood are afraid about is not that common). In other words, the limits to fiscal expansion would be political, not economic, and there is no reason for the left to be up in arms against an imaginary enemy. Hyperinflation is like the the windmills for the Quijote. The giants to attack are actually the ones pointed out in the progressive agenda, like lack of spending on health, education and the environment, and MMTers have been instrumental in getting these ideas in the political discourse, and moving the Dems to the left.

But taxes matter too. Here is where the MMTers refusal to acknowledge that taxes on the wealthy are necessary is a political mistake (not all I've been told, but some for sure, as I've heard that criticism). Note that from the logical point of view they are not incorrect in suggesting that causality goes from spending to taxes, like it goes from investment to savings. It's implicit in the Keynesian/Kaleckian model in which autonomous spending (government spending is in there) determines income through a multiplier process. And taxes, like savings, grow with income. But it is important to note that politically (again this is not analytically, but politically) countries that went for a more ample Welfare State opted to tax their citizens, particularly their more wealthy citizens, at a higher rate. Tax increases on the wealthy should be (and are) part of the progressive agenda. It has an important distributive effect, and it makes the spending politically acceptable. At this juncture, however, even Blanchard says that we should just borrow, since interest rates are low, and will remain low.

The crucial point is that overall MMTers have been helpful in moving the Dems in the right direction (the right direction is to the left), and that is a good thing. The problem with Dems is not the existence of a few social democrats or socialists in their midst. In fact, even being generous there will probably be just three democratic socialists in the presidential primaries (Bernie, and, perhaps, Warren and Tulsi). The problem is the vast majority of neoliberals that still dominate the party. The same could be said about MMT. The problem is not the exaggerated propositions of MMTers, but the excessive fear of inflation when there are too many relevant problems to be concerned with.

Palley on the limitations of MMT once again

Tom Palley's new paper on MMT titled "Modern money theory (MMT): the emperor still has no clothes" is out. From the abstract:

Eric Tymoigne and Randall Wray’s (T&W, 2013) defense of MMT leaves the MMT emperor even more naked than before (excuse the Yogi Berra-ism). The criticism of MMT is not that it has produced nothing new. The criticism is that MMT is a mix of old and new, the old is correct and well understood, while the new is substantially wrong. Among many failings, T&W fail to provide an explanation of how MMT generates full employment with price stability; lack a credible theory of inflation; and fail to justify the claim that the natural rate of interest is zero. MMT currently has appeal because it is a policy polemic for depressed times. That makes for good politics but, unfortunately, MMT’s policy claims are based on unsubstantiated economics.

 The full paper is here.

A reply to Wray - Part II

By Sergio Cesaratto (guest blogger)

“The EMU could easily have self-destructed even with no current account deficits anywhere.” (Wray here)

“Trade issues within the eurozone …will remain a point of economic and political stress even with a full resolution of the liquidity issues…” (Warren Mosler)

 In part I, I reviewed the MMT view that full monetary sovereignty is the key to full employment policies in all countries, provided that those with current account (CA) troubles have safe access to alternative sources of foreign liquidity - what is not the case in reality. I also examined the MMT’s claim that the Eurozone (EZ) cannot suffer of internal balance of payment (BoP) troubles as long as fiscal transfers from a significant federal budget backed by a genuine European CB are provided - what again is not the case in reality. In this post we shall return on Wray’s denial of the BoP origin of the EZ crisis. I agree with Wray, Bell-Kelton and other MMTs that in a currency union local states are partially deprived of fiscal policy as a tool to sustain aggregate demand[1] (without forgetting that this power is anyway in many countries subject to the foreign constraint even with full monetary sovereignty), while the institutional design of the EMU is not able to assure full employment and the preservation of the traditional European welfare state in a non-OCA. As Godley 1991 pointed out:

“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. However, the collective formulation of fiscal policy would be a far more difficult business than passive ‘coordination’. Fiscal policies of the whole Community could be co-ordinated and expansionary: but they could also be co-ordinated and contractionary. How is the common formulation of fiscal policy to be achieved? By what institutions and according to what principles?”

But Godley found even:

“more disturbing … 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, particularly as it will then possess no means whereby it can (in the broadest sense) protect itself against failure” (hat tip to Ramanan).

Indeed, the crisis did not stem from an undisciplined fiscal behaviour of some peripheral countries – they knew very well that “markets” would have punished them (the EMU was designed for this purpose – but from the lose of competitiveness of some member countries, as Godley feared, and from some additional events brought about by monetary unification that nobody (with one exception) foresaw .

1. Leaps forward and back
The problem with the second post by Wray (here), in which he focuses on the nature of the EZ crisis, is that at least three explanations of the crisis are provided and the reader might be confused by the leaps forward and back from one to another without much coordination among the three. Godley’s stock-flows three balances are sometimes evoked, but as such they are national account relations deprived of causal explanations.[2]

None of the three explanations is per se wrong, what is lacking is a consistent framework, perhaps obstructed by the “Nostradamus race”. Let us examine the single explanations first, pointing out their respective limits as they are presented by Wray, trying later to coordinate them in a more coherent picture. In doing this I will refer to Frenkel (2012), which is however substantially consistent with, si parva licet, Cesaratto & Stirati (2010-11), Cesaratto (2012), Bibow (2012) and others.[3] One thing we should premise: each EZ country involved in the crisis is like Anna Karenina’s family, unhappy in its own way, so generalisations are not easy (see here for a quick glance of the country cases). The three explanations are: CA crisis; sovereign crisis; banking crisis. Let us begin from the former.

1.1. A current account crisis
Wray (here) quotes a “prescient” paper by Kregel (1999) to show that MMT has not neglected the CA problems within the EMU due to a progressive loss of competiveness of more inflation prone countries (including not really peripheral countries like France and Italy). Kregel also argue that a weaker euro cannot compensate the loss of EZ markets for the inflation prone countries. I fully agree that Kregel was “indeed looking at the potential for current account imbalances once the Euro was launched”. If I may indulge in the Nostradamus race, many people including myself (hundred of students may witness this) were sure of this outcome. Without downplaying Kregel’s warnings, this was the easiest part. No doubt Italy lost competitiveness during the EMU years and the same happened to the other peripheral countries. In spite of the enormous disinflation process endeavoured by Italy, Germany did better, playing its traditional game of pursuing though labour discipline an inflation rate below that of the partners within successive fixed-exchange-rate systems (Bretton Woods, EMS, EMU, cf. Cesaratto & Stirati 2010-11). The cause of the CA imbalances is not only, however, in the real exchange rate advantages of Germany (this is especially true for Portugal and Italy), but in the relatively higher growth rate of domestic demand in some peripheral countries, Spain, Ireland and Greece.[4] And this was caused, in Spain and Ireland, by the housing bubble financed by foreign capital inflows. (I also used to warn Spanish Erasmus students that the high rate of growth of Spain was paper-made - or rather bricks-made - and that Spain was accumulating an enormous foreign debt). In Cesaratto & Stirati (2010-11) and Cesaratto (2012) this is described in Kaleckian terms: the mercantilist country finances the absorption of its trade surplus by lending to peripheral countries, a process favoured by financial liberalizations and fixed exchange rates. Frenkel (2012) regards these events as analogous to those who have traditionally taken place in emerging economies. De Grauwe (1998) foresaw that the EMU would have led to a housing bubble in Spain. To sum up: Wray is correct to refer to the CA crisis as an aspect of the EZ crisis, although this has more complex features than those that any single economist (Kregel or De Grauwe) could foresee before the events took place, features that we cannot neglect now.

1.2. A banking crisis
So we arrive to the second explanation of the crisis: a banking crisis. No doubt that the sequence financial liberalisation cum currency unification could not but let (with the benefit of hindsight, of course) to a banking crisis, at least in some peripheral countries (as foresaw by De Grauwe), associated also to a foreign accounts crisis and to a fiscal crisis once banks’ problems were taken over by the state. Saying good bye to Kregel, Wray, however, seems to refer to a different sort of banking crisis as the main and independent cause of the European crisis. He mainly refers to the crisis that involved Irish banks that engaged in risky financial activities in a way not dissimilar to those that involved the Icelander banks, but it extends the case to Spain as well:

“it is much more than a current account problem ... Any EMU nation can be blown up by its banks even while running a current account surplus. This is the ‘financialization’ or ‘Money Manager Capitalism’ story that comes from Hyman Minsky—probably well over 90% of cross-border finance has nothing to do with the current account, and it was that part of finance that blew up countries like Ireland and Spain… So far as I know, Warren Mosler was the first to fully understand this.” (Wray here)

I may concede that tiny Ireland had a banking crisis similar to that of Iceland (which is not part of the EZ) due to a particularly risky behaviour of banks (I am not expert enough to judge this). This is, however, generalised to all the EZ in a disputable interpretation of the crisis due to “financialization”, a view that is also shared by many mainstream economists. The banking crisis is almost completely detached from the story told by Frenkel and many others that led to the housing bubbles (that are just mentioned in passing, p.9) in Spain and, according to a World Bank report also in Ireland (and Greece!) too,[5] and to the ensuing the CA troubles. Certainly, no risky banking behaviour is behind the Italian troubles.[6] So the banking crisis as told by Wray-Mosler is of very limited if not of nil value. “Financialization” is part of the EZ story, but within the precise context that, to the best of my knowledge, only De Grauwe foresaw. [7]

More in general, “financialization” fits well in a Kaleckian (rather than Miskian) story that regards it as a way to sustain aggregate demand and the realisation of capitalists’ surplus either in the domestic market (as in the U.S. autonomous consumption bubble) or in foreign markets (as in the case of the core-periphery relations in the EZ).[8] Anyway, I myself suggested a convergence between Kalecki and Minsky in the view that capitalism is debt driven (Cesaratto 2012b)

1.3. A sovereign debt crisis
Wray is certainly correct to point out that banks’ troubles are transferred to the public sector once government bails them out. The question is then if the country has or not full monetary soveregnity:

“From the MMT point of view … the main problem with current account deficits in monetarily sovereign nations is the balance sheet situation of the domestic private sector (given a government budgetary outcome). …some EMU nations also ran chronic current account deficits. And if these had been monetarily sovereign nations (in the sense that they each issued their own floating rate currency), then the worry would have been over the private sector balance. But here the EMU nations diverged significantly from one another—some with current account deficits did not run up huge private sector debts, others did. The balancing item, of course, was the government balance. And, more importantly, these were not monetarily sovereign. Each dropped its own currency in favor of a ‘foreign’ currency—the Euro. So there are two issues: a current account deficit mostly offset by a private sector deficit, versus a current account deficit offset mostly by a government sector deficit. My argument is that for a monetarily sovereign nation only the first of these is a problem; but for Euro nations, either of these can cause trouble” (Wray here, my italics).

“we already addressed the current account story—easily understood through the lens of Godley’s sectoral balance approach: a current account deficit must be offset by a combination of a domestic private sector deficit and/or a government deficit. Since these are not sovereign currency issuing governments, private and government deficits can both lead to problems.” (Wray here).

“Our argument was that separating fiscal policy from currency sovereignty would raise questions of solvency that would constrain the ability of fiscal policy to expand when necessary. That was the basis of all these early MMT arguments.”

These passages are important because they show that the ultimate factor at the origin of the EZ crisis is, in Wray’s opinion, the absence of national sovereign central banks: indeed, CA deficits (as long as they correspond to public deficits only) or the associated banking crisis (as long as monetary sovereign states bail then out) appear ancillary/derived troubles.[9] We are somehow sent back to Wray’s arguments reviewed in part 1 LINK of the present post about the thaumaturgic values of either national monetary sovereignty that backs national public finances (the “born in the US” story), or of a fully federal EZ in which the ECB back a federal budget (the “had the EZ been like the U.S. it wouldn’t had a BoP crisis” story).

Beyond doubt, the EZ crisis has eventually become also a fiscal crisis. But this outcome must be placed in a fully consistent historical and analytical account of the events, otherwise the sovereign debt crisis story might perilously resemble the conventional story (mainly by the German economists and by Alesina and his associates) that the crisis originated from the fiscal profligacy of peripheral countries, a story that with (perhaps) the partial exception of Greece (with the political coverage of the Germans) is clearly false. And indeed, everybody in the European public debate knew that with the monetary unification the financial markets (not the Maastricht Treaty) were the watchdog of “fiscal discipline”. In fact, most of the peripheral government behaved in a very “disciplined” way during the EMU years and beyond. Wray and Kelton early warnings of a pending fiscal crisis in the EZ must be intended that had troubles arose from other sources – as they did – then the absence of monetary sovereignty (or of a genuine EZ central bank) would aggravate the crisis.[10]

The differences between Wray’s and my point of views are perhaps not so substantial as it may appear, since partially depend from the angle you look at the events. He finds the origin of the EZ crisis in the lack of coordination of fiscal and monetary policy either at the EMU level, as seen in part 1 LINK or, alternatively, in the lack of full national monetary sovereignty. Being in the middle (never forget out of an explicit choice of the political designers) the EZ developed a crisis that is in the middle between the U.S. crisis – sharing in common with it the housing bubble and the banking crisis – and the traditional financial crisis of the emerging economies as described by Frenkel and many others. The EZ no-solutions also depends on this being in the middle: neither the U.S. relatively efficient solution of a domestic financial crisis, not the traditional solutions in emerging economies in which the adjustment was helped by the recovery of a competitive exchange rate. Perhaps I prefer to stress the events as they unfolded in the given design, while Wray prefers to look at the wrong design of the EMU (but strangely neglecting the importance of an ordered account of the actual events that came out from the wrong design).

2. Comprehensive views
I believe that Roberto Frenkel’s (2012) synthesis of the EZ crisis can constitute a reference point and convergence field for many of us. In short, he sees a similarity between the EZ events (and those of the Baltic and Eastern European countries that pegged their currency to the Euro here) and those that typically took place in the emerging economies till the very beginning of this century. This view particularly applies to the case of Spain, Ireland and Greece. Much less to Italy that is closer to the Kregel loss-of-competitiveness case. The Irish case should also, in addition, be interpreted through the Mosler-Wray lenses of a “pure” banking crisis. According to Frenkel, the similarity with what I called the “this time is different” story (after the otherwise confused book by Reinhart and Rogoff)[11] stops here. There are al least three differentie specificae in the EZ crisis (as also pointed out in Cesaratto 2012a). One is that the EZ nations lack a lender of last resort, so that the fiscal crisis that followed the private sector crisis rapidly acquired an inertia by its own, as Wray, Kelton and Mosler presciently warned us it could. Nonetheless, a second differentia, the Eurosystem refinancing operations have made increasingly possible to domestic banks to sustain national states, so that now the fiscal and banking crisis are intertwined in a fatal embrace, one entity bailing out the other. A third is that the Target 2 scheme, as Wray (here) also points out, let the CA, banking crisis and what are called “sudden stops” (or capital flight)[12] not to explode in generalized banking and state defaults. For how long this situation can continue is not clear. It will explode for political or social reasons. But we must stop here and let this discussion for the (near) future as events unfold. (an excellent post in this regard is by Marshall Auerback).

An even more comprehensive view - that deserves further research – would read as follows. In the pre-crisis EMU years, in the Italian and Portuguese (and French) (PIF) cases the loss of competitiveness was such that a same (albeit moderate) pattern of domestic autonomous (private and public) demand was accompanied by lower output growth and growing external imbalances (notably those countries had not an housing bubble). In other words, the deterioration of the foreign competitiveness is such that the same pattern of domestic investment, autonomous consumption and government spending is increasingly generating a larger output abroad (say in the core-countries), and correspondingly less within her boundaries. Through the lenses of sectoral balances, this means that the country is running an external deficit, and by definition the foreign sector (say, the core-countries) is lending to her, what is not surprising since at the same time the foreign sector is enjoying a higher income, and therefore higher saving. The low interest rates due both to the ECB policy stance, the temporary disappearance of devaluation risk and fiscal discipline permitted to the deficit countries to keep their fiscal accounts under relative control. Nonetheless a trend leading to the deterioration of the domestic balances was there (rapidly in the Portuguese case, slowly in the Italian case; even more slowly in the French case). Once the crisis exploded, as the result of the transmission of the American and global crisis and of the mismanagement of the Irish-Greek-Spanish (IGS) situation by the EZ authorities, in particular the absence of a truly European CB to substitute the disappeared national monetary sovereignty, led to the explosion of a sovereign debt crisis in the PI. The story of the IGS countries is partially different from that of the PIF. Although they share the same underlying events of the PIF, in their case, domestic demand grew faster sustained by foreign capital flows following the Frenkel’s style course of events. The buoyant fiscal revenues gave the impression of sound fiscal finances, while the private balances rapidly deteriorated mirrored by the mounting foreign imbalances. The explosion of the housing bubbles in Spain and Ireland, the insolvency of the Greek government, and the bail out of the domestic financial sector – in the absence of the backing of a central bank - led to the fiscal crisis. As Wray and Cesaratto (2012a) say, had the EZ similar to the U.S. the crisis would have been managed as a domestic crisis involving local banks and states (letting some of them to fail, or to downsize, but supporting the local states through transfers). Had the EZ composed by monetary sovereign states, the crisis would have been managed as the typical financial crisis that often involved the emerging economies. Being in the middle, sovereign spreads reflects the solvency (not just liquidity) risk of the peripheral countries or, what it’s the same, the risk of the break up of the currency union. Be as it may, the scale of the crisis is larger than previous cases and its management very complicated, first of all from a political point of view.[13]

Conclusions
I am sincerely admired from the pieces of prescient views about the various deficiencies of the EMU that came from people associated to the Levy Institute. Yet, I feel, as many others (I’m sure many just keep silent to avoid troubles), uncomfortable with the Nostradamus race initiated by the MMTs that has, in my opinion, impeded them to work at a more comprehensive view of the EZ crisis, one that should have taken into account other contributions from a much, much larger community of heterodox (and even open minded orthodox) scholars. My impression is that the race to show that whatever others have said, one scholar associated to the Levy said it before (likely better), has let to a self-contradictory, disordered explanation of the crisis by some MMTs. I’m ready to use, cum grano salis, the insights from MMTs, while the Levy Institute is an essential lighthouse for all heterodox economists. Hope this is reciprocal. Humility is part and parcel of the scientific enterprise, especially for heterodox economists that already suffer the arrogance of the mainstream..

Addendum:
Wray (here) uses the expression “factors of production” (“One of the goals of European integration was to free up labor and capital flows, removing barriers so that factors of production could cross borders”). This term should not be employed by heterodox economists - unless you believe that a “factor of production” called “capital” measurable independently of income distribution exist, or you think that the question is irrelevant. I believe that capital theory, or distribution theory if you like, marks the boundary between orthodox and heterodox economics, no monetary issues – in principle you can be Chartalist or believe in endogenous money and be neoclassical – let alone methodological issues. Of course, once set free from the neoclassical constraints, good monetary theories and methodologies may give their best.

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.

Notes:
[1] Partially because the balanced budget theorem and the possibility of redistributive fiscal policies from the wealthier to the poorer citizens suggest that some space is left to expansionary fiscal policies.

[2] This is not to lessen the important educative role that the “sectoral balances approach” has had on all us in telling macroeconomic stories that take into account the simultaneous evolution of the three balances. The “sectoral balances” must, however, be part of a consistent story. Here (fn 21) I commented a passage by Wray (2009: 6-7): “‘It is the deficit spending of one sector that generates the surplus (or saving) of the other; this is because the entities of the deficit sector can in some sense decide to spend more than their incomes, while the surplus entities can decide to spend less than their incomes only if those incomes are actually generated. In Keynesian terms this is simply another version of the twin statements that ‘spending generates income’ and ‘investment generates saving’. Here, however, the statement is that the government sector’s deficit spending generates the nongovernment sector’s surplus (or saving)’. The Keynesian multiplier is clearly alluded to, but Wray’s preference goes to the ‘stock-flow consistent framework’ (SFCA). The emphasis on the accounting identities may lead to overlooking the Keynesian mechanisms that lead from one equilibrium to another hiding the fact that when the balance of one sector changes, output is also changing. It might thus convey the impression that the argument is carried out for a given level of output. Despite this I do not deny the disciplinarian role that the SFCA has on our way of thinking, obliging us to always keep in mind the necessary interrelations between the three institutional sectors.”

[3] See, inter alia, World Bank (that quotes approvingly Bibow 2012) IMF, EU Commission, Federal Reserve Bank of St. Louis, Merler and Pisani-Ferry.

[4] I frankly felt some annoyance to read this: “How could anyone—let alone an Italian economist—attribute Italy’s problems to profligate consumption of imports? Heck, back in the bad old days before the EMU (when Italy had its “high” inflationary Lira) it actually ran current account surpluses. It was the set-up of the EMU that killed Italy’s exports—exactly as Jan Kregel had predicted.” No heterodox “Italian economist” has indeed accused Italy of profligacy. Had Wray the patience (or humility) to read Cesaratto (2012a), the Italian experience has precisely been illustrated along Kregelian lines. Incidentally, Wray cites several times the German Mercantilism. He could have perhaps learnt something about its nature from my papers (in turn, I was inspired by Marcello De Cecco, the senior Italian international monetary economist, and by the nationalist/mercantilist/political realist tradition in International Political Economy and development studies). It should also be said that, according to many experts, the Italian exports did not fare badly in the last years - and the case is the same for Spain. The problem was likely on the import side. For Spain that was certainly due to the relatively high growth of domestic demand due to the construction boom, and for both likely to the loss of competiveness in the sectors were they were already weak.

[5] “The crisis in Ireland is essentially one of a boom and bust of a real estate bubble. Encouraged by the fall in interest rates that went along with the adoption of the euro, banks obtained funding from British, German and US banks, usually in the form of short-term debt, foreign-owned bank deposits, or foreign-owned portfolio equity, to expand credit to the private sector. …

Fuelled by a rapid expansion of credit, Ireland‘s housing market began to expand in 2000, resulting in a boom in property investment and construction. The wealth effect from this boom spurred higher levels of consumption and helped sustain high growth rates. Boosted by the real estate boom, Ireland's banking system ballooned to five times the size of the economy, and its external debt to over 1000 percent of GDP at the end of 2010. When in the wake of the crisis funds from the US and Britain dried up, the banking system experienced a liquidity crunch, thus slowing credit to the real estate market. As borrowing became more expensive, the demand for housing started to decline, resulting in a fall in prices and an oversupply of housing. This put pressure on the balance sheets of banks many of which had relied extensively on profitable mortgage loans to boost their earnings. The authorities‘ extensive support as well as access to emergency support from the Central Bank was vital to address financial stability concerns. Yet, the bailout or purchase of failing banks also led to a crisis of confidence, as the government bailout package reached 20 percent of GDP and the budget deficit shot to 32 percent of GDP in 2010, leading to outflows of foreign assets.” (World Bank: 17:8). The interpretation of the EZ crisis advanced by this WB report is in line with those of Roberto Frenkel (2012), Cesaratto (2012a), Bibow (2012) and others: “Overall, at the heart of the euro debt crisis is an intra-area balance of payments crisis caused by seriously unbalanced intra-area competitiveness positions and the—largely private—accompanying cross-border debt flows. And as discussed above, the common currency was central to this outcome with its impact on interest rates (both for sovereigns and for credit to the private sector), financial integration and the encouragement of export-led growth in core countries and consumption-led growth in non-core countries.” (15).

[6] Italian banks have not been involved in risky international activities with the exception of lending to Eastern European countries that pegged their currency to the Euro, particularly Hungary, with the standard dire consequences.
[7] Paul De Grauwe’s foresaw in 1998 that financial liberalisation and monetary unification in the EZ would bring about a housing bubble followed by a banking crisis in Spain: the “future euro financial crises … will in one crucial aspect be different from the financial crises recently experienced in Asia. They will not lead to speculative crises in the foreign exchange markets. Thus, if Spain is confronted by a banking crises this will not spill over into the Spanish foreign exchange market because there will be no such market. One source of further destabilisation of the markets will, therefore, be absent. The founders of EMU have taken extraordinary measures to reduce the risk of debt default by governments. Maastricht convergence criteria and a stability pact have been introduced to guard EMU from the risk of excessive government debt accumulation. The Asian financial debacle teaches us that excessive debt accumulation by the private sector can be equally, of not more, risky. This has escaped the attention of the founders of EMU, concerned as they were by the dangers of too much government debt. In the meantime the EMU-clock is ticking, while the institutions that should guard EMU from financial and banking crises have still to be put into place.” This is the standard “this time is different story” of the financial crisis in emerging economies with, as we shall see, an important novelty in the EZ crisis.

[8] Non conventional economists are divided over the deep causes of the crisis that set off in 2007-8 (Palley 2010). Minskian authors, associated to the Levy Institute in the US, tend to see it as the result of periodic cycles of financial exuberance. Many conventional economists also share this view, as suggested by their rediscovery of Hyman Minsky’s lesson. Other heterodox economists go behind the financial excesses and find their origin in the necessity of capitalism, particularly in the US, to sustain aggregate demand after the big change in income distribution that occurred over the last thirty years, from the working and middle classes in favour of an affluent thin minority of capitalists (and relative attaches) (e.g. Barba, Pivetti 2009, Cynamon, Fazzari 2008). A few of open-minded mainstream economist also share this view (e.g. Rajan; Fitoussi, Saraceno).

[9] If, as in the MMT view, public debts backed by a sovereign CB are never a problem, why should the private debts be a problem as long as they can be transferred to the public sector?

[10] As Mosler suggests: “the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place. All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system”

[11] I do not like this book, but it is not a case that Wray has critically reviewed it (here), while I simply believe that the “this time is different” story is analytically better told by Frenkel and the Latino-American tradition including the seminal paper by Diaz-Alejandro.

[12] That is the refusal by foreign capital to roll over public or private debts. To this capital flights from residents should be added.

[13] So I am very far from the naive views Wray attributes to me: “an Italian economist, Sergio Cesaratto called the MMT victory ‘spurious’. I’ll try to focus in on the main complaint, which seems to be that MMT missed the true cause of the Euro mess: current account deficits run up by some profligate EMU members” (here). Or (here): “Sergio (Remember him? …) sees all this as a current account imbalance. Those Irish and Icelander consumers just bought too many imports. Living the high life up north.” I never wrote this kind of things (let alone that Iceland is part of the EMU).

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.