Infrequently Asked Questions 1

Sometimes – not often, as my readers are amazingly intelligent – people E-mail me questions relating to points discussed here at heteconomist. Occasionally the questions arise in other discussion forums. Since I really don’t have much to say for myself at the moment, I thought I would use this post to provide responses to some of these infrequently asked questions, expressed in stylized form to protect the innocent. This will also serve as an overview of principles previously discussed.

Question 1

Are you insane? Only a complete idiot would suggest the government can print money without limit and everything will be okay. What are you thinking? Moron!

This is the most frequent of the infrequently asked questions. By some distance.

There is, of course, no suggestion in MMT that there are no limits to deficit expenditure. The argument is rather that the limits are real (resource constraints) and political, not financial in nature. In a modern monetary system – meaning one in which the government is the monopoly issuer of its own flexible exchange-rate fiat currency – the government can always create more of its own money, but this will only be appropriate if such money creation is consistent with (hopefully democratically determined) social objectives, including presumably low stable inflation.

For more on this point, see Fiat Money and its Social Significance and Krugman and Galbraith on Deficits.

Question 2

How can deficit expenditure occur without causing inflation? Do MMT economists even admit that it can cause inflation?

In the MMT view, the risk of inflation connected to deficit expenditure arises when the budget deficit exceeds the non-government sector’s desired level of net saving. Parable of a Monetary Economy provides a simple illustration of how adhering to this level of deficit expenditure enables full employment alongside price stability.

To the extent the non-government sector net saves, some income earned is not spent, and the result is unsold output. The government can purchase this unsold output without bidding up prices because it is output that is not demanded by the non-government sector. In this way, it is possible for government deficit expenditure to maintain demand at a level sufficient to absorb full-employment output at stable prices while facilitating the net saving desires of the non-government sector. Deficit expenditure at this level does not create an inflationary impulse because the deficit corresponds to the portion of created fiat money that the non-government sector demands as a form of saving rather than as a source of spending power.

If and when the non-government sector reduces its net saving desires and increases its spending, this will leave less room for government deficit expenditure and, if the economy is at full employment, require either an increase in taxes or a decrease in government expenditure to avoid inflation. For example, if foreigners start buying more goods and services produced in the domestic economy (an increase in export demand), the government will not need to spend as much to maintain full employment.

Question 3

You say the budget deficit needs to equal desired non-government net saving to maintain full employment. What is meant by “desired” net saving and how could we ever tell whether the budget deficit matches this “desire”? This sounds preposterous. Sheer lunacy!

In macroeconomics, equilibrium is often defined as a situation in which the actual outcome equals the desired or planned outcome. When the actual outcome equals the desired, there is no impetus for economic agents to alter their behavior. In contrast, if the actual outcome differs from the intended one, economic agents will have reason to do things differently.

For example, it is well known that in simple two-sector macroeconomic models (with no government or external sectors), actual investment equals actual saving by definition, but that planned investment does not necessarily equal planned saving. The reason actual investment has to equal actual saving is that actual investment is defined to include planned investment plus unplanned investment, where the latter is unanticipated changes in firms’ inventories. In these models, if firms sell less output than they expect due to weaker than expected demand (and higher than expected actual saving), inventories of unsold output accumulate and this is counted as unintended investment. But, of course, firms don’t actually intend for this degree of inventory build-up and so will tend to adjust behavior to eliminate the excess inventories, for instance by cutting back production. There will be an impetus to alter behavior until investment plans are realized.

Relating back to the current topic, by definition the actual budget deficit equals actual non-government net saving. As is explained in Budget Deficits and Net Private Saving, this is an accounting identity, true by definition:

Government Deficit = Non-Government Surplus

However, this does not necessarily mean that the budget deficit equals intended non-government net saving. If actual non-government net saving is less than intended, this will induce the non-government sector to redouble its efforts to net save. It will do this by cutting back expenditure and saving a higher proportion of income. The result will be a bigger output gap – more unsold output – unless the government steps in and purchases the remaining available goods and services.

If the government does not deficit spend sufficiently to sustain the non-government sector’s intended level of net saving, output and income will tend to fall. The lower income will frustrate non-government net saving efforts (preventing the desired increase in its net saving) and reduce tax revenues. The budget deficit will still equal non-government net saving, but not at a level of GDP that enables both intended net saving levels and full employment. That is, the budget deficit will equal actual, but not planned, non-government net saving.

We can easily tell whenever the budget deficit falls short of the non-government’s desired level of net saving. The tell-tale sign is unemployment and excess capacity. The difference between the non-government’s desired and actual level of net saving corresponds to the output gap.

Question 4

I read Parable of a Monetary Economy. Reluctantly. It was raining outdoors and I really had very little else to do. The parable makes it seem as though the government dominates everything in the economy and the non-government sector has little choice in anything. For instance, the government dictates policy objectives and all employment seems to be in the public sector. Doesn’t this misrepresent the real-world economy that we actually live in?

Before addressing this question, it may be helpful to summarize the parable very briefly for the benefit of those who live in sunnier climes and haven’t read it. The parable includes “the kids”, representing the non-government sector, and “the parents”, representing the government sector. The parents decide they would like the kids to do some work around the house in exchange for letting the kids play outdoors in the backyard. This aspect of the parable is simply a metaphor for society (represented by the members of the household) transferring some goods and services (in this case, the kid’s labor services) from the non-government (kids) sector to the public (parents) sector. To facilitate this transfer of services to the parents sector, the parents impose a toll (tax) on outdoor play denominated in the parents’ “money” (the mother’s business cards). The kids can earn business cards either by working for the parents, for which they will be paid business cards, or, once the business cards are in circulation, by transacting amongst themselves. The kids may also choose to save business cards. That way they can take a holiday every now and then and still be able to afford outdoor play.

The parable is a variation on one presented by Bill Mitchell. Warren Mosler is credited with first introducing the business-card analogy.

The impression that the government dictates social objectives in the parable is understandable, but not really the point. The central purpose of the parable was to illustrate how in a fiat-money system full employment and price stability can be maintained if deficit expenditure is consistent with non-government net saving behavior. Even so, the parable does hint at some interesting questions about the degree of compulsion in a fiat-money (or any state-money) system.

There is compulsion implicit in the parable – and also underpinning a real-world fiat-money system – but not necessarily in the way expressed in the above question. Although in the parable the parents unilaterally decide upon the social goal of an improved backyard, more generally the policy objectives could be determined democratically, for instance by all household members having a vote on various proposals. Further, although all employment in the parable is in the “parents” (public) sector, it is explained in the presentation of the parable that this is solely for reasons of simplicity. It would not change anything important to the parable if most of the employment was in the “kids” (non-government) sector.

The compulsion is in the tax obligation. By imposing a tax obligation on the kids that is payable only in the parents’ own money, the parents create a demand for their money. The kids are still free to transact if they want in their own money or through barter, but they will also need to transact with the parents in the parents’ money to the extent that this is necessary to meet their tax obligations. In this way, the parents are able to move some economic activity from the kids sector to the parents sector.

The same is true of a real-world fiat-money system. Provided the tax obligation is enforceable, the government is able to transfer goods and services to the public sector.


15 thoughts on “Infrequently Asked Questions 1

  1. Hi Peter!

    Didn’t realise your blog was still up and running. I will be sure to call in for a read.

    I feel 2011 promises to be a rather “interesting” year – austerity in Europe, the US struggling to truly recover (as in rapidly reduce unemployment/underemployment), overheating worries in China and the possible bursting of Australia’s housing bubble.

    I think you will find plenty to write about.


  2. Hi Lefty. Thanks for dropping by. Yes, the blog is here again. Had a few things get in the way on the first attempt, and thought I wouldn’t be able to continue with it. But it’s up for good this time, even if there are periods of low productivity. I don’t always have the time that I’d like to work on it.

    I think “interesting” is the operative word in 2011. Hopefully the deficit terrorists don’t get their way in the US, at least, and Europeans who are resisting the austerity drive and attack on general living conditions keep up their brave efforts. Things seem pretty bleak on the policy front at the moment. Just have to keep trying to get the word out, I guess.


  3. Excellent summary. I’m tempted to cut it and paste it! ;^)

    Thanks for your contributions.

  4. Any thoughts on our sub-debate regarding the difference between NFAs and HPM? Given the definition that pj4x proposes, I’m having a hard time reconciling with the view that the private sector cannot increase NFAs.

  5. Note for other readers: brinn’s remark is in reference to an excellent thread (initiated by brinn) at America’s Debate on budget deficits:

    brinn: My understanding is that pj4xtrader is correct and has handled the questions well. For instance, Godley includes six different financial assets, including equities, in this paper.

    If you look at the presentations of stock-flow consistent models – here is a simplified version – dividend payments are a liability of the issuer and an asset of the holder, netting to zero. If there is a revaluation due to rising share prices, this impacts not only on the asset side (a capital gain for the holder) but also on the liability/equity side (the capital-stock in the business sector is revalued upwards). As pj4xtrader notes in his recent post at America’s Debate, if the issuer of the share wants that part of the ownership of the company back, it will need to pay the higher share price.

    In aggregate, all financial assets created from within the non-government sector will have an offsetting liability. So the only way the non-government can acquire net financial assets is for them to be created by the government, with the corresponding liability in the government sector.

    This means there can be differences between the amount of high-powered money and net financial assets. These differences will arise, for example, when the central bank purchases bonds by crediting reserve accounts. This vertical transaction injects high-powered money but leaves net financial assets unaltered.

  6. Excellent! Thanks for the links. I just started reading the Godley paper and find it to be very informative and interesting! Thanks again.

  7. brinn, peterc and others, I’m halfway (page 27!) thru the mammoth of the americasdebate thread and I have to say this is sooo worth it. Thanks to patience and dedication of people like brinn and peterc and others the ideas of MMT are slowly but surely explained to people, who, as one progresses thru the pages, slowly but surely begin to “get it”, and one can clearly see the conversion process taking place in the changing wording of their comments, going from dismissive and hostile to inquiry and appreciation. This is very rewarding to a reader like myself and must have been very rewarding fro you, guys (I’ve had a similar experience on smaller scale on a forum where I tried my best to educate people about MMT).
    This makes me very optimistic about the future. Austrians may have more money and wider following for now but their dour, moralizing “purification by starvation” philosophy is not appealing to the wide majority of people out there, at least in the US, I think, and MMT will be able to gain a lot of ground with its naturally “optimistic” ideas. Neoclassical economy discredited itself in the last financial crisis. So, the people are looking for answers and MMT provides those. It’ll take time but we’ll get there. The truth is being ridiculed and violently opposed right now, but soon it will be accepted as self-evident.

  8. Glad you’re enjoying it. It takes some reading, doesn’t it? 🙂

    brinn deserves a huge amount of credit for initiating the thread and along with pj4xtrader and others (JohnFrmCleveland, an established AD member, comes to mind) shouldering most of the posting load. My own entry was rather late, and exit rather early, due to the time commitments with this blog.

    I’ve been thinking it might be worth providing a permanent link to the thread in the list of other blogs. I think it is educational both in terms of explaining MMT basics and demonstrating the types of arguments that tend to arise in opposition.

  9. Peter, I’ve been slowly trying make my way through the AD thread over the last few weeks as time permits and when my attention is brought to it via a link in one of your posts. This means I randomly click on pages since I am incapable of reading anything in sequential order.

    I especially find point-counterpoint discussions helpful, so eventually I will make my way through the entire thread. If you don’t mind, what moniker are you using there? Right now, my guess is ‘alienated’.

    Look, if I am going to internet stalk you, you need to quit confusing me like this.

  10. Then at the end of the thread after two years of posts on it, there’s this:

    “we are in danger of paying higher rates when inflation sets in. Esp if we keep spending like fools and imagine it will have no affect. look at the carter years and tell us we have nothing to worry about.

    the idea that we can just keep spending and not face the mess we see now in the EU states like Greece, Spain and others is ridiculous.”

    The stone rolled all the way back down the hill.

  11. “The stone rolled all the way back down the hill.”

    I think that feeling is familiar to anyone who has tried to discuss MMT. 🙂

  12. Trixie: Good guess. I can see that my ingenious (I had hoped) disguise failed to evade US detection. By way of explanation, when starting this blog I had been wavering over whether to use my real name or not. Most of the early posts here were originally posted on the politics page of a private message forum predominantly concerned with other stuff in which anonymity was an issue. There was a concern that I might be identified because of this blog. However, I decided that the blog would have more credence if under a real name and that disseminating MMT-related material was more important than my livelihood. 😉

  13. Jobs not recommended for an “anonymous” peterc:

    — Paid YouTube Commenter
    — Professional Texter
    — Internet Freelance Spy

  14. I can see that my ingenious (I had hoped) disguise failed to evade U.S. detection.

    I never said I was any GOOD at internet stalking. Karaoke has taught me similar lessons. Uncle, you win. Happy? Send me an email if you get a chance because I have NO idea what yours is. I have “questions”.


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