Monday 17 January 2011

Randall Wray, the state’s money and price control by government.



While I basically support Modern Monetary Theory (MMT), I don’t agree with the idea put by some MMTers, namely that government’s control of money enables governments to control prices.

One advocate of this idea is Randall Wray (Prof. of Economics at the University of Missouri-Kansas City). See here.

The argument put by advocates of this price control idea is along the following lines.1. In a country where government issues its own currency, the private sector must acquire this money, the state’s money, in order to pay taxes. 2.The private sector can only do this by supplying the state with goods and services. 3. The fact that the state is a monopoly issuer of currency means the state can determine the price of goods or services supplied to the state. 4. This can be of assistance in controlling inflation.

There is of course an obvious and flippant answer to the above argument, namely “try telling that to any bureaucrat responsible for procurement”. They’ll fall off their chairs laughing. But the real flaw in this price control argument is thus.

This price control idea is certainly valid in a non-democratic or dictatorial regime. Indeed, advocates of the idea often illustrate their arguments by reference dictatorial regimes or slave economies.* Unfortunately the implication that this idea translates directly to democracies just doesn’t stand inspection.

Obviously a dictator can determine what constitutes money in their economy, plus the dictator can determine the price at which goods and services are supplied to the dictator.

Incidentally, this power to control prices is INDEPENDENT of the fact that the dictator decides to issue a currency. That is, in a small country dictatorship which used say the US dollar, the dictator would still be able to control prices (e.g. by threatening to shoot anyone buying or selling goods at other than stipulated prices). But this is not the scenario we are concerned with here.

The price control argument, to reiterate, is that the private sector MUST supply government with goods and services in order to acquire the state’s money, which (in turn) the private sector needs to pay taxes. But in the real world, as distinct from the “price control” theoretical world, employers have a range of customers other than government to choose from. If government does not offer the market price for goods and serves, the relevant firms just won’t supply government with said goods and services. What happens then?

What happens is that the private sector runs short of state’s money. The effect of that is deflationary. Unemployment rises, and government just has to do something about it: it increases the private sector’s supply of state’s money!

There are different ways government can do this. A currently popular one is quantitative easing. Second, there is the standard MMT solution to unemployment, namely have government increase its net spending. A third possibility is to cut interest rates – and this is effected by government buying its own bonds: which increases the private sector’s stock of state’s money! The whole price control argument collapses!

Moreover, it is arguable that the latter flaw in the price control idea applies even in dictatorships. That is, it is not even in the interests of a dictatorship or semi-dictatorship to have high unemployment levels. The latter involves a lower GDP than would otherwise obtain. Why would any dictator want a lower than achievable GDP?

4 comments:

  1. It does work if you have a job guarantee programme in place - in other words if the private sector refuse the government price then the system will dump a load of workers onto the job guarantee system until they do.

    But there is another problem - what government programmes are sufficiently optional that they can say "no the price isn't good enough. We'll shelve this programme until deflation forces you to accept the price".

    You couldn't do it with paracetamol for the Health service for example.

    Having said that you could set up 'buffer programmes' that firms can drop back onto if the real world gets too tough. Arguably a lot of the central reservation replacement on the motorways that is going on at the moment is that sort of public contract. I hope they demanded a good price for it :)

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  2. Gold served the same function. Why fiat money is different? Only because government can issue it in unlimited quantities? But then we talk about abuses and not economic logic. And as Neil says price stability should only be viewed together with job guarantee. At the end of the day labour is the simple most important resource in any economy.

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  3. Neil, I agree with your first sentence apart from the last three words. In fact you are not saying anything much different to my third last para above. That is, I am saying that if the private sector refuses to abide by the state’s price, unemployment rises. You are saying that assuming JG is in place, the number of JG people rises. Agreed. But this is hardly optimum. That is in a situation where it is feasible to raise employment and create normal regular jobs, creating JG type work instead is a second best solution.

    Re the “last three words” (“until they do”), why should the private sector EVER employ the relevant JG people, assuming all relevant factors remain constant? That is, if the private sector at a given level of demand and given quality of JG labour and given potential output per head from such labour regards such labour as not being worth employing in year X, then the same will apply in year X + Y.

    Re the rest of your comment, I think you are agreeing with me, but I’m not 100% sure. I.e. I agree that if there is excessive unemployment amongst paracetamol producers, motorway contractors etc etc, because these producers wont abide by the state’s price, government is just not going to stand back and watch unemployment rise (or watch the number of JG employees rise) for ever. The reality is that government will step in with extra demand, i.e. issue more “state’s money”. Although given the response to the credit crunch, governments will do it in a thoroughly chaotic manner.

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  4. The reality is that governments are not needed to create the credit necessary for the circulation of goods and service and the creation of new productive assets. Or any other credit come to that.

    Credit clearing systems such as VISA; the Swiss WIR and proprietary barter systems; and the Ecuadorean invoice clearing system known as FactoRepo all bypass fiat money, using it only as a unit of account or numeraire.

    Too many economists ignore or misunderstand the role of trade/retail credit in the financial system.

    I am observing the emergence of new decentralised and dis-intermediated 'Peer-to-Peer' systems which potentially cut out both the State and Shareholders as intermediaries.

    My view of the endgame for networked financial systems is here

    http://www.policyinnovations.org/ideas/innovations/data/000085

    and here

    http://www.slideshare.net/ChrisJCook/economic-systems-thinking230710

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