In a recent post it was noted that the central bank could dictate longer interest rates if this were deemed appropriate. This deserves brief elaboration. The relevance of the observation is not that it would necessarily be a desirable policy, but rather that in a modern monetary system – one in which the government is the monopoly issuer of its own flexible exchange-rate currency – ultimately interest rates on sovereign debt are at the discretion of the central bank. The government chooses the form of debt it issues and the central bank can control the interest rates applying to that debt. It follows that the government’s risk of facing “unsustainable” interest obligations, in the neoclassical sense of causing runaway inflation, is eliminated barring deliberately self-destructive policy.
Modern Monetary Theory (MMT) indicates that unemployment corresponds to a situation in which the non-government desires to hold net financial assets to an extent that is inconsistent with full employment given the government’s fiscal settings. Demand-pull inflation corresponds to the converse situation. In terms of policy, however, non-government net-saving intentions are a moving and unobservable target. Accordingly, Modern Monetary Theorists propose the job guarantee as a more direct and effective policy approach. This has important advantages over neoliberal prescriptions when it comes to delivering desirable employment and inflation outcomes.
Economists working in distinct paradigms have focused on different questions and applied contrasting analytical methods. The questions raised within a paradigm are often strongly influenced by the historical context in which the theoretical approach is born, including the social and political circumstances of the time. Nevertheless, some central controversies and areas of difference can be identified. The present post provides a very brief introduction to the approach of the classical political economists.
The government deficit equals the non-government surplus, by definition. Although the relationship is straightforward, it often meets with resistance. Two possible reasons for this resistance spring to mind. One is the way the identities are usually presented in introductory textbooks and presumably lectures. The other is the different causation usually attributed to the variables in the identity by neoclassical economists. As with any identity, the sectoral balances equation shows a relationship that must hold by definition, but says nothing in itself about causation. It might be worth reflecting on the orthodox interpretation of the identity and the problems with that interpretation.
One of the most damaging misconceptions in the public policy debate is the likening of a currency-issuing government’s fiscal capacity to a household budget. In a sovereign currency system – i.e. one in which government issues the currency, preferably allowing the exchange rate to float – the analogy is inapplicable. Private households and firms are financially constrained. They must earn income or borrow before they can spend. A currency-issuing government, in contrast, is not revenue constrained.
When a society succumbs to the delusion that a currency-issuing government can somehow run out of what it alone creates at will – i.e. the currency – the provision of health care, education, infrastructure, and other key goods and services can fall far short not only of what is desirable but of what is possible with the current labor force, state of knowledge, and existing plant, equipment and raw materials. When a society doubly succumbs to delusion, believing activities initiated by anything other than the market to be unproductive, the trashing of education systems, media standards, other core social institutions and civilization itself is all but complete.
Throughout the history of economic thought, opposing perspectives on interest and money have created fundamental divides between the various schools. In the one camp, interest is regarded as having a real determination, with monetary policy ultimately at the mercy of the markets. In the other camp, the determination of interest is considered to be monetary, and a politically determined variable.