Debtwatch No. 42: The economic case against Bernanke
on January 24th, 2010 at 10:58 pm
The US Senate should not reappoint Ben Bernanke. As Obama’s reaction to the loss of Ted Kennedy’s seat showed, real change in policy only occurs after political scalps have been taken. An economic scalp of this scale might finally shake America from the unsustainable path that reckless and feckless Federal Reserve behavior set it on over 20 years ago.
Some may think this would be an unfair outcome for Bernanke. It is not. There are solid economic reasons why Bernanke should pay the ultimate political price.
Haste is necessary, since Senator Reid’s proposal to hold a cloture vote could result in a decision as early as this Wednesday, and with only 51 votes being needed for his reappointment rather than 60 as at present. This document will therefore consider only the most fundamental reason not to reappoint him, and leave additional reasons for a later update.
Misunderstanding the Great Depression
Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.
In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.
The best contemporary explanation of the Great Depression was given by the US economist Irving Fisher in his 1933 paper “The Debt-Deflation Theory of Great Depressions”. Fisher had previously been a cheerleader for the Stock Market bubble of the 1930s, and he is unfortunately famous for the prediction, right in the middle of the 1929 Crash, that it was merely a blip that would soon pass:
“ Stock prices have reached what looks like a permanently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels, such as Mr. Babson has predicted. I expect to see the stock market a good deal higher than it is today within a few months.” (Irving Fisher, New York Times, October 15 1929)
When events proved this prediction to be spectacularly wrong, Fisher to his credit tried to find an explanaton. The analysis he developed completely inverted the economic model on which he had previously relied.
His pre-Great Depression model treated finance as just like any other market, with supply and demand setting an equilibrium price. In building his models, he made two assumptions to handle the fact that, unlike the market for, say, apples, transactions in finance markets involved receiving something now (a loan) in return for payments made in the future. Fisher assumed
“ (A) The market must be cleared—and cleared with respect to every interval of time.
(B) The debts must be paid.” (Fisher 1930, The Theory of Interest, p. 495)[1]
I don’t need to point out how absurd those assumptions are, and how wrong they proved to be when the Great Depression hit—Fisher himself was one of the many whose fortunes were wiped out by margin calls they were unable to meet. After this experience, he realized that his equilibrium assumption blinded him to the forces that led to the Great Depression. The real action in the economy occurs in disequilibrium:
We may tentatively assume that, ordinarily and within wide limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium… But the exact equilibrium thus sought is seldom reached and never long maintained. New disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below the ideal equilibrium…
It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “stay put,” in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave. (Fisher 1933, p. 339)
A disequilibrium-based analysis was therefore needed, and that is what Fisher provided. He had to identify the key variables whose disequilibrium levels led to a Depression, and here he argued that the two key factors were “over-indebtedness to start with and deflation following soon after”. He ruled out other factors—such as mere overconfidence—in a very poignant passage, given what ultimately happened to his own highly leveraged personal financial position:
I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt. (p. 341)
Fisher then argued that a starting position of over-indebtedness and low inflation in the 1920s led to a chain reaction that caused the Great Depression:
“(1) Debt liquidation leads to distress selling and to
(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
(4) A still greater fall in the net worths of business, precipitating bankruptcies and
(5) A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make
(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to
(7) Pessimism and loss of confidence, which in turn lead to
(8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause
(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (p. 342)
Fisher confidently and sensibly concluded that “Evidently debt and deflation go far toward explaining a great mass of phenomena in a very simple logical way”.
So what did Ben Bernanke, the alleged modern expert on the Great Depression, make of Fisher’s argument? In a nutshell, he barely even considered it.
Bernanke is a leading member of the “neoclassical” school of economic thought that dominates the academic economics profession, and that school continued Fisher’s pre-Great Depression tradition of analysing the economy as if it is always in equilibrium.
With his neoclassical orientation, Bernanke completely ignored Fisher’s insistence that an equilibrium-oriented analysis was completely useless for analysing the economy. His summary of Fisher’s theory (in his Essays on the Great Depression) is a barely recognisable parody of Fisher’s clear arguments above:
Fisher envisioned a dynamic process in which falling asset and commodity prices created pressure on nominal debtors, forcing them into distress sales of assets, which in turn led to further price declines and financial difficulties. His diagnosis led him to urge President Roosevelt to subordinate exchange-rate considerations to the need for reflation, advice that (ultimately) FDR followed. (Bernanke 2000, Essays on the Great Depression, p. 24)
This “summary” begins with falling prices, not with excessive debt, and though he uses the word “dynamic”, any idea of a disequilibrium process is lost. His very next paragraph explains why. The neoclassical school ignored Fisher’s disequilibrium foundations, and instead considered debt-deflation in an equilibrium framework in which Fisher’s analysis made no sense:
Fisher’ s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. ” (p. 24)
If the world were in equilibrium, with debtors carrying the equilibrium level of debt, all markets clearing, and all debts being repaid, this neoclassical conclusion would be true. But in the real world, when debtors have taken on excessive debt, where the market doesn’t clear as it falls and where numerous debtors default, a debt-deflation isn’t merely “a redistribution from one group (debtors) to another (creditors)”, but a huge shock to aggregate demand.
Crucially, even though Bernanke notes at the beginning of his book that “the premise of this essay is that declines in aggregate demand were the dominant factor in the onset of the Depression” (p. ix), his equilibrium perspective made it impossible for him to see the obvious cause of the decline: the change from rising debt boosting aggregate demand to falling debt reducing it.
In equilibrium, aggregate demand equals aggregate supply (GDP), and deflation simply transfers some demand from debtors to creditors (since the real rate of interest is higher when prices are falling). But in disequilibrium, aggregate demand is the sum of GDP plus the change in debt. Rising debt thus augments demand during a boom; but falling debt substracts from it during a slump
In the 1920s, private debt reached unprecedented levels, and this rising debt was a large part of the apparent prosperity of the Roaring Twenties: debt was the fuel that made the Stock Market soar. But when the Stock Market Crash hit, debt reduction took the place of debt expansion, and reduction in debt was the source of the fall in aggregate demand that caused the Great Depression.
Figure 1 shows the scale of debt during the 1920s and 1930s, versus the level of nominal GDP.
Figure 1: Debt and GDP 1920-1940
Figure 2 shows the annual change in private debt and GDP, and aggregate demand (which is the sum of the two). Note how much higher aggregate demand was than GDP during the late 1920s, and how aggregate demand fell well below GDP during the worst years of the Great Depression.
Figure 2: Change in Debt and Aggregate Demand 1920-1940
Figure 3 shows how much the change in debt contributed to aggregate demand—which I define as GDP plus the change in debt (the formula behind this graph is “The Change in Debt, divided by the Sum of GDP plus the Change in Debt”).
Figure 3: Debt contribution to Aggregate Demand 1920-1940
So during the 1920s boom, the change in debt was responsible for up to 10 percent of aggregate demand in the 1920s. But when deleveraging began, the change in debt reduced aggregate demand by up to 25 percent. That was the real cause of the Great Depression.
That is not a chart that you will find anywhere in Bernanke’s Essays on the Great Depression. The real cause of the Great Depression lay outside his view, because with his neoclassical eyes, he couldn’t even see the role that debt plays in the real world.
Bernanke’s failure
If this were just about the interpretation of history, then it would be no big deal. But because they ignored the obvious role of debt in causing the Great Depression, neoclassical economists have stood by while debt has risen to far higher levels than even during the Roaring Twenties.
Worse still, Bernanke and his predecessor Alan Greenspan operated as virtual cheerleaders for rising debt levels, justifying every new debt instrument that the finance sector invented, and every new target for lending that it identified, as improving the functioning of markets and democratizing access to credit.
The next three charts show what that dereliction of regulatory duty has led to. Firstly, the level of debt has once again risen to levels far above that of GDP (Figure 4).
Figure 4: Debt and GDP 1990-2010
Secondly the annual change in debt contributed far more to demand during the 1990s and early 2000s than it ever had during the Roaring Twenties. Demand was running well above GDP ever since the early 1990s (Figure 5). The annual increase in debt accounted for 20 percent or more of aggregate demand on various occasions in the last 15 years, twice as much as it had ever contributed during the Roaring Twenties.
Figure 5: Change in Debt and Aggregate Demand 1990-2010
Thirdly, now that the debt party is over, the attempt by the private sector to reduce its gearing has taken a huge slice out of aggregate demand. The reduction in aggregate demand to date hasn’t reached the levels we experienced in the Great Depression—a mere 10% reduction, versus the over 20 percent reduction during the dark days of 1931-33. But since debt today is so much larger (relative to GDP) than it was at the start of the Great Depression, the dangers are either that the fall in demand could be steeper, or that the decline could be much more drawn out than in the 1930s.
Figure 6: Debt contribution to Aggregate Demand 1990-2010
Conclusion
Bernanke, as the neoclassical economist most responsible for burying Fisher’s accurate explanation of why the Great Depression occurred, is therefore an eminently suitable target for the political sacrifice that America today desperately needs. His extreme actions once the crisis hit have helped reduce the immediate impact of the crisis, but without the ignorance he helped spread about the real cause of the Great Depression, there would not have been a crisis in the first place. As I will also document in an update in early February, some of his advice has made America’s recovery less effective than it could have been.
Obama came to office promising change you can believe in. If the Senate votes against Bernanke’s reappointment, that change might finally start to arrive.
Addendum
This is an advance version of my monthly Debtwatch Report for February 2010. Click here for the PDF version. Please feel free to distribute this to anyone you think may be interested–especially people who may be in a position to influence the Senate’s vote.
Professor Steve Keen
www.debtdeflation.com/blogs
[1] This book was an untimely relaunch of his 1907 PhD thesis.
<!--start_raw--> Test 3 Test 4<!--end_raw-->Well I thought I could figure it out from WordPress at http://wordpress.org/extend/plugins/raw-html/ but I think Steve may think I’ve gone troppo and so I will leave it to the experts.
Yuk! I installed a “pretty” editor for comments yesterday and that’s the root of the problem here. I’ll de-install immediately. Sorry everyone!
Steve,Would it be possible to simply restore the previous configuration / version of WordPress comments interface? I may remember not to copy and paste from MSWord but eating newline characters is a more serious problem.
A recent conversation with someone from the RBA as well the latest anti-bubble rhetoric from the number one property bubble cheerleader got me fired up for this response (excuse the tongue in cheek – it was late
).
http://www.bubblepedia.net.au/tiki-view_forum_thread.php?forumId=7&comments_parentId=3732
Also, I’ve updated and revamped my own website http://www.homes4aussies.com and aim to have a new major report – “The Greatest Bubble in History” – up in a few days
Iconoclast
For someone with a background in controlled systems engineering, you should know that transients and steady states are not the only things that happen to systems. Systems are stable if you could control certain parameters within limits. Otherwise, there are limit cycles, strange attractors, bifurcations, catastrophes, instabilities etc.
Neoclassical economics and Chartalism are real and monetary extremes of the same flawed approaches which cannot recognize or describe disequilibrium and instabilities. Economics (as it is now) is so unscientific that no arguments between different schools are ever settled by its method of rhetoric. Hence there has been no progress for decades and there will be no progress unless new methods are used.
iconoclast
many thanks
your
“So there you go BrightSpark, I have not precluded any dynamic characteristics from such an analysis of the economic systems response, and making the statement:
a step signal of sufficient magnitude in deficit spending if applied will move the economic system to a new operating point of full capacity (full employment).”
But you do seem to claim, that one input (fiscal account) influences one output (employment), and that there is one unspecified delaying factor in the transient response . This is all invalid.
Also I can not see the connection with double entry acounting it seems to me that MMT is simply claiming a static relationship between defecits and employment rates, and only conceding that there may be a delay between cause (fiscal defecit) and effect (unemployment rate). Double entry accounting has two causes entry on one side and then the other side of the ledger.
MMT offers no cogent explanation mathematical or otherwise as to why the connection exists. There is no doubt a connection but it is not exclusive and it is not affected by only one delaying factor. There is also feedback (dole payments and tax effects). Both the transient and steady state responses may involve large changes for large inputs and the steady state may be inherently unstable. Without creating accurate models no one knows.
regards brightspark
I’ll preface my first post by thanking Dr. Keen for providing a great resource for the concerned, skeptical non-economist to sort out what’s going on.I’ve been enjoying the thought-provoking debate over Modern Monetary Theory here and elsewhere and would like to bring it explicitly back to the practical dilemma of economic recovery: once you recognize that depressions are caused by an imbalance between debt and income, is there any way to correct the imbalance?As I understand it, Dr. Keen’s analysis rules out several traditional remedies:
1. Laissez-faire. When banks deleverage, they shrink the money supply, so the price level and incomes falls with or faster than debts can be repaid. “The more debtors pay the more they owe.”
Therefore, private sector deleveraging is self-defeating unless accompanied by a issuance of currency to stabilize incomes and the price level.
2. Traditional monetary stimulus. Since most countries issue currency primarily through private bank (fractional reserve) lending, attempts by central banks to counter deflation only prop up private debt at an unsustainable level. Similarly, fiscal stimulus intended to bail out banks, prop up asset prices, and stimulate lending will only set the stage for another crisis.
3. Traditional fiscal stimulus. Fiscal stimulus just substitutes private for public debt. Used counter-cyclically to compensate for changes in private debt, this can stabilize the business cycle, but this time, the scale of private deleveraging is too large, and public debts already too high. Deficit spending of the scale required would defeat itself through a jump in interest rates (or more extreme, a run on the currency) unless monetary policy is used to push them back down.Which leaves:
4. “Quantitative Easing” AKA “printing money to pay for deficit spending” or what in a less-convoluted system would be “debt-free money” spent into existence by the Treasury.Which is to say that a country that wants to reduce its debt to GDP ratio will need to issue more of its own currency directly rather than delegating that authority to fractional reserve banks and borrowing its own money back at interest to finance public spending.
Does anyone disagree on this point?
The main debate is over the chartalist assertion that governments can print money/ run deficits without limit. Which is true but useless, since it doesn’t mean that there are no consequences to QE and its equivalents. If you dig deep on Bill Mitchell’s blog, you’ll find recognition of these consequences, but in passing, he and other chartalists can be awfully cavalier.
The potential consequences include:
A. If government expenditures do not facilitate production, monetary expansion will tend to increase the general price level
B. If government expenditures do not facilitate export production or if bondholders panic, the exchange rate will suffer. This can have big consequences for a country dependent on imported fuel or food.
C. That an injection of “high powered money” will lead to another round of non-productive lending and asset price inflation somewhere down the road unless banking regulations are seriously tightened.If these potential consequences are significant and difficult to avoid, does that mean that financial stability (a lower Debt to GDP ratio) is incompatible with high employment without a lot of structural/microeconomic changes?
I’m skeptical but willing to entertain the possibility.
Iconoclast,
We live in a mixed economy system and I am not rabidly anti-socialist just merely anti-communist. I’m anti-communist not because I hated Marx but because I saw how the system failed and how much damage it did to all the people living there including the “working class” or however you want to call them.
We have to remember there was the Bretton-Woods gold-backed currency system in place when Menzies was in power – not the system supported only by the printing press and the taxation office. Was this the ultimate “mixed system”?
The system you are advocating based on unchecked deficit spending and only targeting unemployment (this is your error signal in the control circuit if we use that language) has nothing to do with Australia under Menzies when unemployment was low and Keynesian teachings were followed. It is a neo-communist system based on the total control of aggregated demand by the government and possibly involving micro-management required to funnel funds to these sectors which are going to fail (this is the most dangerous part). This may lead to the gradual removal of financial markets and credit money (the horizontal axis in the MMT model) as the fiat money flow will then dominate. Some people think this will be great – I don’t agree.
VK has already mentioned the long-term risks when you remove any possibility of a failure. Basically the effects will be similar as removing the possibility of investment banks to fail (the case of the US under Bernanke). The result is a massive misallocation of resources and a total systemic failure one or few decades later. I am more concerned with the short-term instability.
You seem to be familiar with the control theory. You haven’t responded to my question why aggregate unemployment is the correct error signal and government spending is the correct way of controlling the economy if we know that the current system is predominantly based on horizontal flows (credit money) – unless we want to destroy the current system and replace it with a neo-communist one.
Because any macroeconomic system is strictly non linear applying usual transfer function based stability criteria is useless. I think that in the future we may be able to model what you are talking about and show the inherent instability of the model – when we include credit money, financial markets and floating foreign money exchange rates / foreign trade. Yes the simplified models are stable if you assume that stupid agents will keep saving forever at a constant rate.
My point is not that the government must never print money to prop up the aggregated demand. I don’t agree with Lord Mockton of Dark Castello in here:
http://www.smh.com.au/opinion/politics/first-the-good-news-a-baby-boom-then-the-bad-news-debt-20100202-naze.html
“The IGR is supposed to warn and alert the public to long-term pressures. It has a 40-year time frame. The idea is that an early warning system will allow us to act before it is too late. This report says that the ageing of the population and other financial pressures will open up a gap between spending and income around 3 per cent of GDP by 2050 – which is bad – but not as bad as the situation we now find ourselves in. Last year’s budget opened up a deficit of more than 4 per cent of GDP.”
Yes this is rubbish. We may need to alter the real products and services social redistribution mechanism one day. But the state is not constrained by its nominal financial obligations in domestic currency. It is constrained however by common sense.
Personally I will support voluntary euthanasia for myself so I will not be a burden to the future followers of Lord Mockton of Dark Castello if I am to listen to their complaints. We may become another overseas province of The Middle Kingdom anyway so Lord Mockton’s followers may not need to do anything in the future. The rulers of the Middle Kingdom have no problems with printing money if they wish to.
http://www.smh.com.au/national/secret-payments-to-labor-mp-listed-in-liu-files-20100202-nb49.html
I am not naive either printing money to inflate the debt or diverting income flows by hefty taxation will come at a cost. This is not necessarily a zero-sum game. But it may be inevitable to avert the disaster predicted by Lord Mockton.
My point is that we must describe the reality not just build an oversimplified toy economy model at the macro level. This is the very same mistake neoclassicals are guilty of.
Steve, agree with you thank you for the excellent analysis.
While not a trained economist, (BA Econ only, then MBA) I look at things from a common sense and cynical viewpoint. The main reason Bernanke was never at risk of not being reconfirmed is that it would have been an admission that the government was in large part responsible. Given that people, and especially politicians, are apparently interested primarily in prolonging and maximizing their power as opposed to doing what they know is right, this is not going to happen. Better to blame previous incumbents and greedy bankers (who are not really hurt as they are big contributors).
This is also why we in the US are in the position we find ourselves; we re-elect the incumbents time and time again who tell us we do not have to make sacrifices. So we now have massive deficits and debt, before even starting to recognize the unsupportable public employee pension obligations. In fact, in mid 2008, with the crisis staring us in the face, New York was improving the retirement schemes, letting public employees retire even earlier, often at 50 or so. This is of course a good way to make sure the unions will make contributions and also calls to get out the vote for the incumbents.
As far as debt deleveraging, I was only half smart, in 2005-2006, I stopped buying stocks as it was clear that a large part of demand and GDP was driven by additional debt. In the spirit of looking at things simply as mentioned above, I use the no free lunch analogy to figure that it was essentially borrowing demand/GDP from the future and therefore there had to be a substantial decrease in GDP. However I did not see the banking crisis as I figued the investment bankers would be too smart to hold the sub-prime paper they had created. (I am always being told they are smarter than I.)
I take some issue with the debt jubilee, any potential poitive effects will accrue to China as we have no manufacturing left. The first step would have to be a setting up of trade barriers and currency corrections and multi-year resurrection of the manufacturing base, probably all impossible.
Re #321 on Bernanke,
Welcome aboard David.
I agree re the other consequences of a debt jubilee. The West has unwittingly de-industrialised in the last 30 years to China’s benefit, and rebuilding that productive capacity is essential to being able to restore prosperity and full employment in the USA and elsewhere (though there are Peak Oil and climate issues to consider on that front too of course).
There is much else wrong with conventional economic analysis in addition to its monetary mundanity. The argument for free trade is another furphy that will also have to be tackled as we get ourselves out of this mess.
Steve and others,
There was some interesting data on Friday which relates to the whole question of creation / destruction of debt and money debate.
Total credit rose month on month 0.3% but the M3 measure of money supply was down 0.6% (a very large monthly drop).
So bank lending is expanding, but the level of money in the banking system is contracting. Have you had a look at this?
There looks to be a large seasonal adjustment lower in the M3 figure. Maybe this is incorrect.
But I think something else is happening.
There seems to be a shortage of cash in the system. Witness the very high deposit rates available in the market. You can get 5.50% or more at call, and above 6.00% for 6 months or 1y fixed.
At one stage recently banks were offering up to 6.80% for 1y. Westpac currently offer 7% and 8% for 3y and 5y respectively.
All very high considering the cash rate is still at 3.75%.
Banks have been relying more on the wholesale market for funding. That is, they have been issuing bonds, and much of those have been offshore.
So perhaps money has effectively been flowing out of more liquid bank deposits into less liquid bank debt securities.
What is causing this? APRA requirements: –
http://www.apra.gov.au/Policy/Enhancing-prudential-framework-for-ADI-liquidity-risk-management.cfm
This must have an effect on bank lending at some stage, probably soon.
Anyone have any thoughts to add?
Michael Pettis on reserves:
I did want to extend a short piece I wrote that was published yesterday in the South China Morning Post. This is because it is about central bank reserves, a topic that to my dismay probably generates more confused and mistaken thinking than any other topic in economics.
Never short a country with $2 trillion in reserves?
http://mpettis.com/2010/02/never-short-a-country-with-2-trillion-in-reserves/
I’ll preface my first post by thanking Dr. Keen for providing a great resource for the concerned, skeptical layman to cut through the neoclassical BS and sort out what’s going on in the economy.
I’ve been enjoying the thought-provoking debate over Modern Monetary Theory here and elsewhere and would like to bring it explicitly back to the practical dilemma of economic recovery: once you recognize that depressions are caused by an imbalance between debt and income, is there any way to correct the imbalance? As I understand it, Dr. Keen’s analysis rules out several traditional remedies:
1. Laissez-faire. When banks deleverage, they shrink the money supply, so the price level and incomes falls with or faster than debts can be repaid. “The more debtors pay the more they owe.” Therefore, private sector deleveraging is self-defeating unless accompanied by a issuance of currency to stabilize incomes and the price level.
2. Traditional monetary stimulus. Since most countries issue currency primarily through private bank (fractional reserve) lending, attempts by central banks to counter deflation only prop up private debt at an unsustainable level. Attempts to bail out banks, prop up real estate prices, and stimulate lending will only set the stage for another crisis.
3. Traditional fiscal stimulus. Running deficits and issuing bonds just substitutes public for private debt. Used counter-cyclically to compensate for changes in private debt, this can stabilize the business cycle, but this time, the scale of private deleveraging is too large, and public debts already too high. Deficit spending of the scale required would defeat itself through a jump in interest rates (or more extreme, a run on the currency) unless monetary policy is used to push them back down.
Which leaves:
4. “Quantitative Easing” AKA “printing money to pay for deficit spending” or what in a less-convoluted system would be “debt-free money” spent into existence by the Treasury. Which is to say that a country that wants to reduce its debt to GDP ratio will need to issue more of its own currency directly rather than delegating that authority to fractional reserve banks and borrowing its own money back at interest to finance public spending. Does anyone dispute this point?
The debate seems to be over the potential consequences of Quantitative Easing or its equivalents, which chartalists like Bill Mitchell recognize, if pressed, but can be cavalier in dismissing.
A. If government expenditures do not facilitate production, monetary expansion will tend to increase the general price level. MMT says that government must print money, not how that money should be spent–you could have a small government that passes most of it on as a tax credit or citizen’s dividend. However, many chartalists favor the idea of government as employer of last resort, which Skepticus and others fear will be ecologically wasteful and socially unproductive make-work.
B. If government expenditures do not facilitate export production or if negative real interest rates cause bondholders to panic, the exchange rate will suffer. This can have big consequences for a country dependent on imported fuel or food.
C. Without serious banking reform, the injection of “high powered money” will lead to another round of asset price inflation and non-productive lending somewhere down the road.
I’m sympathetic to Ellen Brown, Steve Zarlenga, and others who want to reclaim public control of their money, but I’m willing to entertain the possibility that Quantitative Easing or its equivalent will have nasty consequences if applied on the scale needed to employ everyone. Is this what critics of MMT are suggesting? Does a fall in the Debt-GDP ratio require a fall in national income?
QuantitativeEasing@325
“B. If government expenditures do not facilitate export production or if negative real interest rates cause bondholders to panic, the exchange rate will suffer. This can have big consequences for a country dependent on imported fuel or food.”
The governments over the last 35 years have actively discouraged exports (reducing tariffs even recently while the Chinese persist in full scale trade war with pegged exchange rates), while encouraging imports (gst on local service sector no gst on importeed services direct or online). The only consequence of this has been higher interest rates and a huge foreign debt (approaching 100% GDP) which no one even mentions let alone worries about. This has already reached the run away point with the imminent big consequences that you speak about.
Most notably we are also addicted to cheap crap to fuel our retail “industry”, and facilitate much employment.
I see your “B” as the most important but widely ignored problem for Australia, the US, and Europe.
Cheers
Lyonwiss@317,
“For someone with a background in controlled systems engineering, you should know that transients and steady states are not the only things that happen to systems. Systems are stable if you could control certain parameters within limits. Otherwise, there are limit cycles, strange attractors, bifurcations, catastrophes, instabilities etc.”
A multivariable non-linear control system, Lyonwiss, depending on its characteristics, may or may not be dynamically stable. A system that is dynamically stable will exhibit transients that are bounded and eventually dissipate with time, leading to the system adjusting itself to a new steady-state operating point.
Alternatively, a system that is unstable is also composed of a transient response that is unbounded, which describes a system that exhibits instability (catastrophic outcomes, bifurcations, and limit cycles).
So it is incorrect to say that a control system perturbed exhibits anything more than a transient and steady-state response, although the transient may more not be bounded. I never talked about the bounds of the transient, it was presumed that both stable and unstable transients may exist.
Both stable and unstable characteristics are known to exist and are part of the MMT. So you are misrepresenting MMT.
“Neoclassical economics and Chartalism are real and monetary extremes of the same flawed approaches which cannot recognize or describe disequilibrium and instabilities. Economics (as it is now) is so unscientific that no arguments between different schools are ever settled by its method of rhetoric. Hence there has been no progress for decades and there will be no progress unless new methods are used.”
This is not the case.
MMT is founded on Minsky’s instability theory, Lerner’s functional finance, aspects of Keynes and Marx, and is entirely stock/flow consistent.
Lyonwiss, have read any of the material that I have suggested to you? The answer is likely no.
When Einstein developed his theory of Relativity, he developed most of his theory through thought experiments. The mathematical representation of the theory came after.
That did not render Eistein’s theory invalid because he did not begin within the mathematical space, but rather through thinking.
Equally, what because MMT hasn’t developed a dynamical model of their theory does not invalidate their theory. The thinkers of MMT have followed a path followed by Einstein, they have thought deeply enough to recognise how the fiat+credit monetary system actually works, and thus arriving at novel conclusions, just like Einstein did.
It is entirely wrong, to suggest that MMT has anything at all to do with the neo-liberal gibberish. It is merely misrepresenting MMT.
iconoclast @328
While I do not believe that MMT has connections to neoclassical gibberish I do believe that it is flawed in the same way, that is no consideration of dynamics. In a dynamic system effects can be amplified attenuated and even negated by feedback effects.
Most economists think that the system can be understood by watching its behaviour then assuming that this behaviour will continue by extrapolation. Decades ago engineers tried to do the same and failed. It was not until dynamic control theory was fully developed by Nyquist and others that stable systems could be modelled, and complex machines designed. Frankly IMHO MMT resembles amateur engineering of the popular mechanics variety. The MMT lack of dynamic models does relegate it to the same category as neoclassical general equilibrium, that is invalid.
Brightspark@318,
“But you do seem to claim, that one input (fiscal account) influences one output (employment), and that there is one unspecified delaying factor in the transient response . This is all invalid.”
Brightspark, that is not quite the case. Deficit spending influences many operating points of a multivariable system, although one of them is employment. MMT does not focus on employment only, nor does it focus on any other parameter of the economic system. It is I who have personally, focused on that parameter, employment, of the economic system, since it is a parameter that is important to many. Although MMT tells us a lot more than just about employment and deficit spending.
MMT allows us to conclude that involuntary unemployment is entirely due to the fact that deficit spending is insufficient to shift the economic system to an operating point where it is able to operate at full capacity (full employment). Although, this is not the only conclusion one arrives at from MMT. MMT describes how the fiat+credit monetary system works and thus can be used in “what if” analysis to determine how the economic system at a macro-economic level respond. It doesn’t operate at the micro-economic level.
“Also I can not see the connection with double entry acounting it seems to me that MMT is simply claiming a static relationship between defecits and employment rates, and only conceding that there may be a delay between cause (fiscal defecit) and effect (unemployment rate).”
Brightspark, may I ask you what reading material on MMT have you actually read? Because, what you have written, leads me to conclude that you have not read enough to come to the conclusions that you have arrived at.
Double entry accounting ensures that one does not commit fallacies of thinking, since the double-entry accounting system, ensures consistency in the stock and flow of the monetary system. Just as Kirchoffs laws ensures consistency in electrical circuit theory.
Brightspark, do you agree that in an electrical system, that kirchoffs laws must always, but always, hold? The answer should be yes, and that is irrespective of the dynamic nature of the voltage signal or current flows within an electrical system. That is kirchoffs law is a macro-system law for the electrical system, which must always, but always hold true.
Equally, the laws that MMT has arrived at for a fiat+credit economic system are macro-system laws, which must always, but always hold true.
“Double entry accounting has two causes entry on one side and then the other side of the ledger.”
Double entry accounting ensure that the monetary system is stock/flow consistent, just as the laws of electrical circuits theory ensures that the electrical system is stock/flow consistent.
In electrical circuit theory, we have Ohms law, Kirchoffs law, Maxwells equations, etc. to ensure our analysis is stock/flow consistent.
To be blunt, in electrical circuit theory, we have flow consistency through a resistor, via Ohms law. That is, we don’t say that the current entering the resistor, of a single resistor circuit attached to a voltage source, to be different to the current leaving the resistor. That is In = Iout at each end of the resistor. That is, we don’t have resistors that, in electrical circuit theory, some how accumulate charge on one side of a resistors terminal cf. to the other side. There is a conservation of charge law in place, that ensures stock/flow consistency.
And equally, that is why MMT is using double-entry accounting to ensure the flows and the stocks in the monetary system are also consistent.
“MMT offers no cogent explanation mathematical or otherwise as to why the connection exists. There is no doubt a connection but it is not exclusive and it is not affected by only one delaying factor. There is also feedback (dole payments and tax effects). Both the transient and steady state responses may involve large changes for large inputs and the steady state may be inherently unstable. Without creating accurate models no one knows.”
Brightspark, factors that you have listed are taken into account, but the important point to understand is that kirchoffs laws must always hold, irrespective of the dynamics of the system. MMT is operating at the level of kirchoffs laws. This needs to be understood, if anything.
ak@320,
“The system you are advocating based on unchecked deficit spending and only targeting unemployment (this is your error signal in the control circuit if we use that language) has nothing to do with Australia under Menzies when unemployment was low and Keynesian teachings were followed.”
Truly unbelievable. Where do you get this stuff from – do you have someone from the days of McCarthyism that you drag out of the closet whenever you need to respond to your “reds under the bed paranoia”?
Please point to your unfounded assertion that anyone is advocating “unchecked deficit spending and only targeting unemployment”? You will not be able to find such a statement. Again a misrepresentation.
“It is a neo-communist system based on the total control of aggregated demand by the government and possibly involving micro-management required to funnel funds to these sectors which are going to fail (this is the most dangerous part). This may lead to the gradual removal of financial markets and credit money (the horizontal axis in the MMT model) as the fiat money flow will then dominate. Some people think this will be great – I don’t agree.”
ak, there is need for a balance, you seem to be seeing ghosts. A mixed economy is far more stable, than a unfettered free market disaster that neo-liberal agenda has foisted on the poor and unsuspecting majority.
Why do you think we are in the mess that we are in, and it isn’t over yet?
If you are happy that a parasitic sector (FIRE) in the economic system is able to extract the wealth of the real economic system. Because that is what your suggesting, then I’d say your on your own.
“VK has already mentioned the long-term risks when you remove any possibility of a failure. Basically the effects will be similar as removing the possibility of investment banks to fail (the case of the US under Bernanke). The result is a massive misallocation of resources and a total systemic failure one or few decades later. I am more concerned with the short-term instability.”
Please go back and read my replies to vk. The argument that vk puts forward is specious in form.
It is really hilarious, when you attempt to put forward the argument of “massive misallocation of resources”, but you seem to ignore that this exactly what has happened with the capital (class) in control, and entire missallocation of resources. I think you shooting yourself in the foot ak.
“You seem to be familiar with the control theory.”
That would be an under statment, lets just say that my area of expertise is in multi-variable non-linear control systems engineering.
“You haven’t responded to my question why aggregate unemployment is the correct error signal and government spending is the correct way of controlling the economy if we know that the current system is predominantly based on horizontal flows (credit money) – unless we want to destroy the current system and replace it with a neo-communist one.”
If you understand anything about a fiat(vertical)+credit (horizontal) monetary system, one thing that you would have understood is that a credit only monetary system implemented in the real world is unstable and will collapse. Fiat currency is mandatory to ensure that it remains stable. Nothing to do with “neo-communism” as you put it. lol. You are really good at this propaganda thing, ak, can recommend any schools?
ak, go ask the millions of people that have suffered (lost their jobs, lost their wealth) from the activities of the FIRE industry, cheered on by neo-liberal governments and the capital class all around the world, to allow the speculative activity with has bloated horizontal (credit) money for no useful purpose at all, you’ll get your answer, and it won’t be the one that you are thinking of.
“Because any macroeconomic system is strictly non linear applying usual transfer function based stability criteria is useless.”
That is factually wrong. Control system stability theory can be applied to multi-variable non-linear dynamic compensator design.
“I think that in the future we may be able to model what you are talking about and show the inherent instability of the model – when we include credit money, financial markets and floating foreign money exchange rates / foreign trade. Yes the simplified models are stable if you assume that stupid agents will keep saving forever at a constant rate.”
ak, can you explain how you have reached the above conclusions, have you developed a theory of the fiat+credit monetary system that you are keeping hidden, or did you visit a clairvoyant who provided you with your above belief?
iconolclast @330
“Brightspark, factors that you have listed are taken into account, but the important point to understand is that kirchoffs laws must always hold, irrespective of the dynamics of the system. MMT is operating at the level of kirchoffs laws. This needs to be understood, if anything.”
Do you have details of how these factors are taken into account by MMT?
Kirchoffs laws apply to currents flowing to a node, or emf’s in a closed loop, all in an electrical circuit and at a particular instant of time in the time continuum. It is in no way relevant to economics and is not dynamic. They make only a minute contribution in an electronic dynamic model design. They are usually learned in first semester Electrical Engineering.
I have not been able to find any rigorous references to time, differential equations, feedback, stability margins or dynamic control theory in anything I have read about MMT. Perhaps you could direct me to some appropriate litterature.
In the mean time I see all theories as flawed with only the work of Steve Keen relevant to the task and likely to derive some relevant solutions. MMT may make a contribution but only if its adherents learn some 3rd year university mathematics.
many thanks
Brightspark
OK iconoclast,
This is getting too heated and I suggest a break from this discussion which is certainly generating more heat than light right now.
I think you should simply accept that some highly intelligent people on this blog are nonetheless not persuaded about Chartalist analysis. I have my own reservations–not about their accounting, but about the model of the economy into which that accounting is fed–but I am restraining from commenting until I have done something Lyonwiss suggested some time earlier in this discussion, which is to put an agreed Chartalist position into an accepted dynamic model of the economy and see how it functions (I know that Bill Mitchell sees Japan as that model–so to speak–and as it happens I see Japan’s situation as supporting both Chartalist and debt-deflationary analyses).
But let’s drop this for a while now. I don’t want this to develop into a flame war, and exasperation of both sides with each other is promising to give us precisely that.
Steve,
While it’s abundantly clear that commenters here are intelligent and as of yet also not convinced regarding MMT, it’s just as clear to me and many others that they have virtually no clue what MMT is. To your credit, even as you have your own reservations, you recognize that you have not yet absorbed the entire framework; your friends here have yet to even consider this possiblity even as they are sure MMT is wrong or unscientific or whatever (lyonwiss, scepticus, brightspark, gamma, ak, etc.). While I have found ample reason (and more) to respect the intelligence of each, their understanding of MMT is quite another matter. I can fully appreciate that many (maybe even most) would be unconvinced even after fully grasping MMT, but that’s not what we have here.
From my reading, iconoclast is merely trying (rather valiantly, but to no avail) to point out misrepresentations, which are frankly ubiquitous here for whatever reason. There’s a reason why others who understand chartalism (including those who don’t necessarily agree with all or parts of it) have mostly stopped commenting here (or at least slowed significantly). The “fors” and “againsts” simply end up talking past each other, repeatedly, and with no end in site (4 months and counting as near as I can tell).
As an aside, if anyone is interested in a discussion involving non-chartalists who actually understand chartalism (albeit on a fairly small portion of the framework), the recent discussion on Steve Randy Waldmann’s “Interfluidity” blog is a case in point.
Best to you,
Signing off . . .
Scott
Steve,
There is one thing I have seen about the commenters (you have stood for). They may have opinions about transactions which change settlement balances (reserves) and their economic consequences, but I am not sure that they appreciate the transactions which need not change the settlement balances -the “horizontal” transactions, either!. I remember you frequently praise Basil Moore but I am not sure if the commenters understand the credit money part well. I am supercomfortable with mathematics and the fact that they are trained well in mathematics does not impress me too much.
I wrote to Prof. Moore to got his permission to quote the starting paragraph of his great book. I find it inspiring. I hope the commenters appreciate it.
The central message of this book is that members of the economics profession currently operate with a basically incorrect paradigm of the way modern banking systems operate and of the causal connection between wages, prices, and monetary phenomena. The standard paradigm treats the central bank as determining the monetary base and hence the
money supply. The growth of the money supply is held to be the main force determining the rate of growth of money income, wages, and prices. … This book argues that the above order of causation should be reversed. Changes in wages and employment largely determine the demand for bank loans, which in turn determine the rate of growth of the money supply. Central banks have no alternative but to accept this course of events. Their only option is to vary the short-term rate of
interest at which they supply liquidity to the banking system on demand.
- Basil Moore, Horizontalists and Verticalists: The Macroeconomics of Credit Money
Re #334 Scott,
I think it’s fair to say that people here have not read the Chartalist case as closely as they have read mine–and it’s certainly correct that I have not read key Chartalist arguments in detail.
I have however read a variety of Chartalist works, and there are elements that I find unpersuasive for a range of reasons. But I have refrained from comment because I do not wish to misrepresent an argument and then criticise a misprepresentation.
So I have a suggestion: could you provide a list of what you see as essential readings in the Chartalist tradition–ones that provide as thorough as is possible a statement of the Chartalist position?
I will then insist that people address these works when they comment on Chartalism on this site.
Now a bit of levity please: this is starting to sound like a dispute between the Judean People’s Front and the People’s Front of Judea. Remember the Romans, guys: it’s neoclassical economics that is the main “enemy” of logic in economics. Both Circuit Theory and Chartalism originated in critiques of neoclassical thinking on money. This debate which has become very doctrinaire on both sides has tended to lose sight of that.
Agreed. Thanks. Will get back to you on the readings.