James Pethokoukis criticises MMT.

That’s in an article in “The Week” entitled “Why Modern Monetary Theory is an unserious idea for an unserious time.”

Pethokoukis deals with an MMT idea namely that the state (government and central bank) can fund public spending simply by printing money, and then collect whatever amount of tax is needed to counteract the inflationary effect of that “print and spend” policy. He claims that idea is fine, except for one flaw, namely that politicians cannot be relied on to collect sufficient tax.

Actually that criticism is exactly the same as the criticism made by Matt O’Brien in the Washington Post, and which I dealt with here a few days ago. 

So that’s the Pethokoukis criticism dealt with.
 
Here endeth the lesson.

A flaw in deposit insurance.

An alleged merit of deposit insurance is that it encourages saving (in the form of accumulating a stock of money held in banks), which in turn encourages banks to lend, which allegedly increases investment. There are several flaws in that idea. James Tobin in his paper “The Case for Preserving Regulatory Distinctions” pointed to several flaws. But the flaw I wish to highlight (not spotted by Tobin, far as I can see) is as follows. 

Absent deposit insurance, so called deposits held at banks are actually more in the nature of shares, in that those so called deposits can lose some or all their value (a third of all deposit money in US banks in the 1930s went up in smoke). So deposit insurance in effect turns shares into what might be called “genuine money”.

But assuming that prior to the introduction of deposit insurance everyone has their desired stock of genuine money (in the form of genuinely safe state issued money, i.e. base money) then after the introduction of deposit insurance, the “saver / lender” section of the population will have more than its desired stock of genuine money. Thus those people will try to spend away the excess, which will cause inflation, assuming the economy is already at capacity. That will cause government to impose some sort of deflationary measure, like raising taxes and confiscating a portion of peoples’ stock of base money.

But that means the “non saver / lender” section of the population will then have less than its desired stock of genuine money, thus it will resort to borrowing money.

To summarise, to a significant extent, the additional lending and debts that arise as a result of deposit insurance is caused by a perceived shortage of money which is caused by deposit insurance! To put that more starkly, a proportion of pay day borrowers paying a thousand percent, do so precisely because of a misguided attempt by the great and the good to encourage lending and debt.

American Enterprise Institute article by Stan Veuger criticises MMT.

Veuger says, in relation to the MMT claim that governments and their central banks create money, that “…it is not a controversial claim among economists that countries can create money…”. That’s in his article entitled “MMT’s central idea is neither new nor helpful.”

Well actually at the start of the 2007/8 crisis Bernanke was very evasive on the question as to whether the Fed created money. See article published by the American Monetary Association entitled “Are You or Aren’t You Printing Money, Mr. Bernanke?”

Thus MMTers were right to underline the fact that central banks can and do in fact create money from thin air.

Veuger tries to defend his position by citing a couple of economists who are obviously aware that central banks do in fact create money (one of them being Greenspan). Well my answer to that is that the fact that SOME individuals apart from Galileo five hundred years ago agreed with Galileo that the Earth revolves round the Sun does not prove that Galileo’s heliocentric idea was not then controversial. (It’s surprising what a poor grasp of basic logic many economists have.)

Moreover, Bernanke was not the only one apparently not clear on whether central banks create money: the IMF apparently does not understand this issue either. (Actually my guess is that Bernanke has always known perfectly well that central banks create money, whereas the IMF is genuinely clueless.)

My reason for saying that is that the IMF has long adhered to the barmy “fiscal space” idea: that’s the idea that if a country has too much debt, that constrains its ability implement stimulus, come a recession, because (according to the IMF) stimulus can only be implemented by having government borrow money and spend it. I.e. the IMF seems to be unaware that (as pointed out by Keynes almost a hundred years ago) that a government and its central bank can simply create new base money and spend it (and/or cut taxes).

For articles by two MMTers demolishing the IMF’s fiscal space idea  (me and Bill Mitchell), see here and here.

Matt O’Brien criticises MMT in the Washington Post.

An article in the Washington Post by Matt O'Brien explains what every ten year old knows, namely that excessive money printing leads to inflation. The article’s title is: “Everything you need to know about the theory that deficits don’t matter”. I’m eternally grateful to WaPo.

Matt O’Brien criticises MMT on the grounds that it involves relying on politicians to raise taxes by enough to damp down any excess inflation. That’s a point which arguably has some validity, though it is not really supported by UK experience. That is, prior to 1997 when the Bank of England was granted independence, UK politicians (the finance minister in particular) effectively had the power to print money willy nilly, since the finance minister controlled the BoE.  That did result in SOME irresponsible pre-election booms, but did not result in hyperinflation.

And apart from the UK, there seems to be no relationship between central bank independence and inflation according to the first chart here – you need to scroll down quite a bit.

However, there’s an easy solution to the “politician problem” to which O’Brien draws attention: it’s to have some sort of independent committee of economists determine how much money to create / print: and could easily be some existing central bank committee, e.g. the BoE’s Monetary Policy Committee. Indeed, one of the advocates of Overt Money Creation, namely Positive Money advocates just such a committee.

So O’Brien’s criticism of MMT is not totally invalid. But it’s a criticism that MMTers can very easily deal with, and indeed ought to deal with by mentioning something along the lines of Positive Money’s independent committee in MMT literature.

The logical connection between overt money creation and full reserve banking.

The phrase “overt money creation” (OMC) is often taken to mean a system where government and central bank implement stimulus by running a deficit by simply creating base money and spending it  (and/or cutting taxes with public spending remaining approximately constant). And that is the meaning attached to the phrase here. Effectively that means merging fiscal and monetary policy: i.e. there is clearly a fiscal effect there, for example if the additional money is spent on more education, there is an immediate effect in the form of more teachers being employed. Plus there is a monetary effect (a somewhat delayed effect) in that the additional money increases the private sector’s stock of base money.

OMC is advocated by a variety of economists and groups of economists. For example it is advocated by Modern Monetary Theory and these authors, plus Ben Bernanke and Adair Turner gave the idea an approving nod. (For Bernanke, see para starting “A possible arrangement…” here, and for Turner, see his article entitled “Adair Turner in defence of helicopter money”).

Merging fiscal and monetary policy has some logic, in that the purpose of both is to adjust stimulus, and normally (both in economics and other areas) there is one best method of achieving any given objective, rather than two, three or more. I.e. having two, three or more smells of duplication of effort.

As for increasing the private sector’s stock of base money, that also has some logic, as follows. Inflation is constantly eroding the real value of the existing stock of base money, plus economic growth is constantly eroding the value of that stock relative to real GDP. Plus it is reasonable to assume that the stock of base money that the private sector wants to hold relative to GDP will remain approximately constant in the long term. Ergo that stock will, over the long term, have to be steadily increased in both nominal and real terms.

Incidentally I’m treating base money and government debt as the same thing, which is arguably what they are. That is, both of them are liabilities of the state (government and/or central bank). Certainly base money and government debt merge into each other in that base money is a liability (or at least an ostensible liability) of the central bank which pays no interest, whereas a tranche of government debt which matures in say one week’s time, and which pays a very low rate of interest amounts to all intents and purposes as the same thing as pointed out by Martin Wolf. (See Wolf’s para starting “The purchases of equities…” in his article entitled “Warnings from Japan for the eurozone.”)

That is why advocates of Modern Monetary Theory sometimes treat base money and government debt as being the same thing and refer to the sum of the two as “Private Sector Net Financial Assets”.

To summarise so far, OMC has a certain logic behind it, and it effectively amounts to saying that given a need for stimulus, that stimulus should come in the form of increasing the private sector’s stock of base money.


Full reserve banking.

Full reserve banking is the idea that the only form of money should be state created money (i.e. base money): that is, that commercial banks should not be allowed to print / create money as well.

Now that meshes rather nicely with OMC, doesn’t it? OMC says that stimulus should come in the form of the state creating and spending more state created money (rather than cut interest rates and thus enabling commercial banks to create and lend out more of their own home made money).

Just to expand on that “mesh” a bit, take a hypothetical economy which switches from barter to using money for the first time (or if you like, a hypothetical Eurozone country which quits the Eurozone and reinstates its pre-EZ currency (say the Drachma in Greece)). The advocates of full reserve would recommend issuing just state issued money and OMCers would advocate the same. It would of course be possible to do what the existing bank system in most countries involves, namely have the state stand behind those “promises to pay” which are issued by commercial banks and which constitute money. But if the state does that, it is subsidising the money lending activities of commercial banks. And subsidies do not make sense, unless there is a very good social case for a subsidy.

That above claim that there is a connection between OMC and full reserve banking certainly needs fleshing out, but the above is my first stab at the idea.

Scott Sumner’s flawed criticisms of Modern Monetary Theory.

Scott Sumner is a former economics prof at Bentley University. He penned an article entitled “Tax-and-spend progressives put faith in flawed policy theory” published by The Hill yesterday, which criticises MMT.

His first criticism is this:

“The basic problem is that MMT proponents mix up the roles of fiscal and monetary policy. They argue that monetary policy should play a supporting role, holding down interest rates to reduce the cost of public borrowing.”

Well the first problem there is that several other organisations and economists are also guilty of the latter “mix up”. For example the UK Labour Party’s new fiscal rule basically claims that if interest rates are significantly above zero, then interest rate cuts should be used to provide stimulus, whereas if interest rates are near zero, the fiscal stimulus should kick in. So in that scenario, interest rates will often bump along a small amount above zero. I.e. it’s not just MMT which is guilty of “holding down interest rates”: the Labour Party is guilty as well.

Incidentally the latter Labour Party rule was composed by Simon Wren-Lewis, former Oxford economics prof.

Another economist guilty of “mixing up” was Milton Friedman. In his 1948 American Economic Review paper he advocated a system where government did nothing to artificially raise interest rates (he advocated zero government borrowing). Plus Friedman advocated (much as MMTers do) so called “overt money creation”: i.e. a system where government and central bank simply create base money and spend it into the economy as needed. That system which would mean commercial banks would never particularly short of reserves and thus would not be induced to raise interest rates. Ben Bernanke also gave an approving nod in the direction of the latter “print and spend” policy: see para starting “A possible arrangement…” here.

 
Only monetary policy influences inflation?

Next, Sumner makes the bizarre claim that a cut in fiscal stimulus will not reduce inflation because it’s only monetary policy which influences inflation. To be exact, he says:

“Unfortunately, there is a long history suggesting that this approach will not work. In 1968, President Johnson raised taxes and balanced the budget, in the hope and expectation that this would hold down inflation. Instead, inflation got even worse, as monetary policy was still highly expansionary. It is monetary policy that determines the price level, not fiscal policy.”

The answer to that point by Sumner is that it is widely accepted by economists that BOTH fiscal and monetary policy can be stimulatory or “anti-stimulatory”. It is also widely accepted that the likelihood of getting cancer is related to age, diet and genetic factors. The fact that there is one instance of someone getting cancer while young, does not disprove the claim that age and cancer are related.

Why, you might ask, is it necessary to give lessons in basic logic to economics professors?

Sumner’s next mistake comes where he says “If MMT proponents are right that fiscal policy determines inflation….”. Well MMTers do not say or imply that fiscal policy alone DOES determine inflation.

As explained above, MMT supports what is sometimes called “overt money creation”: that is, and to repeat, where stimulus is needed, government and central bank simply create new base money and spending it. Since that, pretty obviously, increases the private sector’s stock of base money, there is clearly a monetary effect there.


Monetary policy is “powerful”?

Next, Sumner claims “at the zero bound for interest rates, monetary policy is still more powerful than fiscal policy. A dramatic $500 billion reduction in the budget deficit did not lead to the growth slowdown…”.

Unfortunately Sumner doesn’t say how he is measuring “power”. But if he’s referring to “number of increased jobs created per dollar of monetary or fiscal stimulus”, the fact that there was about $3.5trillion worth of QE between 2008 and 2014 (that’s seven times the above $500 billion) rather casts doubt on his claim that monetary policy is particularly “powerful”.

But in any case, “power” or what is sometimes called “bang per buck” is irrelevant, and for the simple reason that stimulus dollars cost nothing to create. As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances." (That’s from Ch3 of Friedman’s book “A Program for Monetary Stability”.

I.e. government is not like a household which quite rightly looks at the benefit per dollar spent on any consumer item.

Was the Vickers Commission remotely concerned about the amount of private debt?

The UK’s “Independent Commission on Banking”, the so called “Vickers Commission” was the official UK government response to the 2007/8 bank crisis. I’ve just word searched it for the words “debt” and “social”. Nowhere does there seem to be any concern whatever about the size of private debts or the social costs of what may be an excessive amount of private debt.

That is, the basic message of the commission was that the banking industry (aka the money lending industry, aka the debt creation industry) forms a sizeable part of the UK economy which is a jolly good thing, and anything that can be done to expand it, and thus create even more debt, must also be a jolly good thing as well. Or at least the commission’s policy was certainly that the bank industry, which has expanded a massive TEN FOLD relative to GDP since 1970 cannot possibly be allowed to contract. See in particular the commission’s sections 3.21 and 3.22.

You’d think the commission would at least put in a token sentence to the effect that we need to bear in mind the possible down side of more lending and more debt, wouldn’t you?

Paul Krugman tries to criticise MMT.

Normally I agree with Krugman, but his article entitled “MMT, Again” in the New York Times isn't up to much. Incidentally that article was published some time ago, in 2011, so why bother with it now? Well one reason is that the article was cited as some sort of authority in a Zero Hedge article published very recently (entitled “The Disturbing Rise Of Modern Monetary Theory (MMT)”).

Anyway, Krugman’s argument is a joke. He claims that if government plans to have public spending make up a particular percentage of GDP (Krugman choses 27% as an example), but taxes only  amount to 17%, then according to MMTers (so Krugman claims) government and central bank can simply print and spend money to make up the difference, rather than borrow.

Well that is what’s known as a “straw man argument”: i.e. attributing an absurd idea to someone else, demolishing it, and then claiming you’re smarter than the someone else.

The reality is that MMTers have actually cottoned onto the very obvious fact that simply funding public spending via money printing can lead to excess inflation (gasps of amazement). Thus, MMT (just like Keynes) advocates enough stimulus (in the form of “print and spend”) to reduce unemployment as far as possible without inflation rising above the 2% target. 


Conclusion.

If the best criticism that a leading economist and economics Nobel  laureate can put against MMT is a straw man argument, then speaking as an MMT supporter, I am much encouraged….:-)

However, to repeat, I normally agree with Krugman. Ironically he once said that while there are a selection of economists for whom he has plenty of respect, in the case of each of them he said he occasionally sees each of them going right off the rails. The above straw man point was an unusual instance of Krugman going off the rails.

Banks are not intermediaries?

It has become fashionable recently to claim banks are not intermediaries, i.e. apparently they don’t collect savings from savers and lend on those savings to borrowers. E.g. see here, here, and here.

If that’s the case, one has to wonder why banks have dished out billions over the last fifty or hundred years to depositors and bond-holders by way of interest: the object of the exercise is to attract money from depositors and bond holders isn't it? But if banks do not need that money before making loans, why dish out those billions?

It could perhaps be argued in the case of depositors that the object of the exercise is to grab customers with a view to then selling those customers the other services, like supplying credit cards, mortgages, administering current accounts (“checking accounts” in US parlance). I.e. the interest paid on some current accounts is perhaps a loss leader.

But that argument is doubtful. Supermarkets go in for the loss leader trick, but the actual loss leader items change from one year to the next and from supermarket to supermarket. That is, in one year supermarket A may offer cut price baked beans, while supermarket B offers cut price fruit. Then next year A will try “buy one get one free” for some items, while B will try cut price beer.

In contrast, while some banks have paid no interest on instant access accounts in recent years because of the fall in interest rates over the last twenty years or so, they INVARIABLE pay interest on one or two month term accounts. That makes it look like the latter interest is not just some sort of cheap trick designed to pull in new customers.

Plus in the case of bond-holders, the loss leader idea is as good as irrelevant. That is banks do not sell bonds with a view to turning bond-holders into purchasers of other products.

The reality is that a bank cannot simply lend out millions willy nilly without somehow or other having money FLOWING IN, otherwise the bank will run short of reserves and will have to go cap in hand to other banks or the central bank with a view to borrowing reserves.

But that’s not to say a bank has to have exactly $X dollars flowing in for every $X flowing out in the form of loans. I.e. banks do have some leeway. That is, to a limited extent, they can lend money without having any corresponding amount of money flowing into their coffers. But if a bank goes too far in that direction, that means, to repeat, it will have to borrow reserves, something banks do almost every day. But amounts borrowed that way are small compared to their total assets or liabilities.

So I suggest that rather than claim banks are not intermediaries, it would be more accurate to say that basically they are intermediaries, but that they have limited scope for acting in what might be called a  “non intermediary” fashion

The flaw in deposit insurance.

Those who place money with a bank with a view to the bank lending on their money so as to earn them interest are protected by taxpayer backed deposit insurance, which is nice for them. But if people who want to lend out their money via banks are protected against loss gratis the taxpayer, why shouldn’t those who place their money with other investment intermediaries (e.g. unit trusts, mutual funds, private pension schemes, etc) enjoy the same privileges (where that’s what investors want)?

Unless other investment intermediaries enjoy the same luxury, deposit insurance is a form of discrimination in favour of, i.e. a subsidy of banks.

Moreover, the argument put for the existing bank system and deposit insurance by the UK’s Independent Commission on Banking (sections 3.20 – 3.24) namely that deposit insurance encourages lending and investment applies equally to other investment intermediaries.

On the other hand, the availability of a totally safe method of storing and transferring money is a basic human right, so it’s fair enough to have taxpayers stand behind THAT system. So what to do?

Well I suggest there is a very simple and widely accepted principle that helps sort this out: it’s the widely accepted principle that it is not the job of governments or taxpayers to stand behind COMMERCIAL ventures or transactions (as I argue here).

Depositing money with an investment intermediary with a view to earning interest is clearly a COMMERCIAL transaction, and should therefor not be protected by taxpayers / governments.

In contrast, the simple act of storing money and transferring it is not necessarily commercial in nature. But even where it is commercial in nature, the country’s money storage and transfer system cannot possibly be allowed to collapse. Thus there is a case for taxpayer / government insurance of that system.

And what d’yer know? That’s exactly what full reserve banking achieves. That is, under full reserve, those who want their money to be loaned out so as to earn interest are not protected, while those who simply want money STORED without earning interest are protected.

And as for any deflationary effect of the cut in lending that full reserve would bring, that’s easily countered by standard stimulatory measures, e.g. the suggestion made by Keynes in the early 1930s, namely that in a recession, government should simply create new money and spend it (and/or cut taxes). The net effect would be less lending and thus less debt, and given that the great and the good and every windbag in the country keeps going on about the excessive amount of private debt, what’s the problem?

Why QE green bonds?

Richard Murphy and Colin Hines propose a “National Investment Bank” in the Guardian which issues “Green Bonds” which the Bank of England then “QEs”: i.e. the BoE prints money and buys up those bonds.

The trouble there is that having government or any nationalised institution (like a National Investment Bank or government itself) issue bonds with the BoE then buying back those bonds is that that all nets out to “government prints money and spends it” (sometimes known as “overt money creation” – OMC).  So why not do the latter and not bother with the investment bank or green bonds?

In contrast, I can see the point of green bonds which are not QEd: people with money to spare might be prepared to do a bit for the environment by lending to green projects at a rate of interest below the going rate on bog standard government debt.

A brief 200 word history of banking.

Several centuries ago, bankers thought up a trick, namely to accept deposits from customers and lend on relevant money, while telling depositors their money was 100% safe.

That of course is fraudulent: reason is that loaned out money is never totally safe. And indeed that fraud becomes blatantly obvious when the inevitable happens: banks fail, or the entire bank system looks like failing.

But the latter fraud brings bankers great riches, and as long as you’re rich, the establishment will see you as respectable. You can earn your millions from drug dealing, extortion, or a chain of brothels. It really doesn’t matter: long as you’ve got loads of dosh, the establishment (i.e. politicians, bank regulators, academic economists, the British royal family, the Church of England, etc) will see you as respectable. For example the going price for a seat in the UK House of Lords is about a million pounds.

So instead of clamping down on the above fraud, the establishment comes to the rescue of commercial banks and assists in the above fraud. That is, commercial banks are rescued, plus they are  protected via deposit insurance, the “too big to fail” subsidy, and so on.

“Generous” donations by bankers to politicians’ “election expenses” assist politicians to see sense in connection with the above matters.

Net result:  bankers laugh all the way to the bank, if you’ll excuse the pun.