Saturday, 30 January 2021

So there’s nothing new in MMT?


One of the main ideas behind MMT, if not the main idea, is the claim that the size of the deficit and debt do not matter: that is, much the most important aim should be to minimise unemployment in as far as that is consistent with not exceeding the inflation target by too much. As to the deficit and debt needed to attain that minimum possible amount of unemployment, that is relatively unimportant


However, there are those who claim there is nothing new in MMT and that the above “D&D don’t matter” idea has always been an inherent part of standard economics. Simon Wren-Lewis (former Oxford economics prof) is one of those. Unfortunately that is not entirely consistent with a 2014 publication of SW-L’s which says the following.


“So what does macroeconomic theory tell us is the optimal level of government debt? Policy makers are desperate for guidance on this (such that what evidence there is gets too much attention e.g. R&Rs 90%), but most macroeconomists offer very little help.” (Incidentally, “R&R” refers to Kenneth Rogoff and Carmen Reinhart, two Harvard economists who over the last ten years have been about the two most vociferous and influential advocates of austerity: i.e. keeping the debt and deficit down even if that means excess unemployment.)


Plus in an article entitled “Is government debt a burden for future generations?” published in 2011 SW-L says “My own view is that it makes sense for governments to have a long run target for debt…”. That is hardly consistent with his more recent and more MMT compliant claims that the size of the D&D doesn't matter.


In contrast to the above lack of any clear ideas on what the optimum amount of debt is, MMT is crystal clear and advocates the following.


1. The deficit, to repeat, should be whatever cuts unemployment to the minimum that is consistent with hitting the inflation target.


2. That in turn will mean that the stock of base money and debt (the sum of those two sometimes being referred to by MMTers as “Private Sector Net Financial Assets”) will vary, but the exact size of the stock is unimportant: to repeat, the all important objective is minimising unemployment.


3. As to the proportion of PSNFA made of debt versus zero interest yielding base money, and the rate of interest paid on the debt, that is what MMTers call a “policy variable”: in other words government and central bank between them can arrange any rate of interest on the debt they want. To illustrate, paying no interest on the debt at all, which effectively means there is no debt, is easily arranged, at least in principle: just arrange for there to be a stock of PSNFA which is sufficient to induce the private sector to spend at a rate that brings full employment, but not so much that PSNFA holders think they have an excess stock, and try to spend away that excess stock thus causing excess demand and inflation, which in turn would require damping down via an interest rate hike (i.e. having government pay interest on PSNFA).


The reason it is reasonable to assume demand varies with the size of the stock of PSNFA is simply that PSNFA is a euphemism for “state created money”: with some of that money being instant access and normally yielding little or no interest, and some of it being locked up in the form of loans to government, and yielding a higher rate of interest. And households’ weekly spending clearly varies with the size of their stock of money.


Also you should not fall for the trap of thinking that digital state created money (i.e. state created money other than in the form of £10 notes, $100 bills etc), i.e. bank reserves, is not available to households: reason is that most state created money (aka base money) is matched by someone’s or some firm’s deposit at a commercial bank. To illustrate, if someone sells $X of government debt as part of the QE process, they’ll get a cheque from the central bank for $X which they deposit at their commercial bank, and the latter passes the cheque on to the central bank and demands that the latter credits the commercial bank’s account in the books of the central bank with $X.


To recap and summarise, one of the basic MMT claims is that the stock of PSNFA should not be so large that PSNFA holders have to be offered interest on some of their stock of PSNFA with a view to inducing them to abstain from trying to spend away what they see as their excess stock of PSNFA. Incidentally Milton Friedman also supported the latter “zero debt” or “zero interest on the debt” idea, with the exception that he thought offering interest on the debt would be a good tool to have in reserve for emergencies – an idea which seems very reasonable.





Tuesday, 26 January 2021

Like it or not, we’re moving towards full reserve banking.



There are three reasons for thinking we're moving towards full reserve. First, Central Bank Digital Currency looks like it’s now near inevitable. China is to trial CB DC in a few cities in the near future: see article entitled “Major Chinese cities plan large-scale tests of digital currency in 2021” in the Global Times.  

Second, one of the few half decent justifications for deposit insurance and hence for fractional reserve banking is that provides people with a totally safe form of money. But once CBDC is in place, there is then no need for safe money to be provided by private/commercial banks.

Third, and thanks to QE, there has been a vast expansion in the amount of central bank created money (base money) in circulation in Western countries, and under full reserve, base money is the only form of money. In fact according to this Fed chart, Fed issued money now exceeds the amount of privately created money in circulation.

This will all be a big disappointment to the opponents of full reserve, e.g. Ann Pettifor and Charles Goodhart. .


Sunday, 24 January 2021

Finance Watch


 An article published by “Finance Watch” claims the additional public money due to flow into the coffers of private banks so as to shield them against the effects of Covid is not justified. Well if OTHER firms and corporations are to receive public money to shield them from the effects of Covid, it’s hard to see why banks should not “join in the fun”, so to speak.

A better argument against giving public money to employers and corporations is perhaps that normal bankruptcy procedures cope perfectly well with Covid type disasters: firms go bust, shareholders and possibly also bondholders are wiped out, but the ASSETS of relevant firms do not of course vanish into thin air. Assuming those assets look like being a good bet in the long term, then someone will buy them up at a bargain basement price and put them to good use once the Covid problem is cracked. And there are plenty of corporations and people out there with piles of cash: after all, the enormous amounts of cash created and spent by governments and central banks so as to deal with Covid, must be out there somewhere. E.g. Apple has $192bn!!!!!

Moreover, there is a distinct downside to trying to preserve every firm and corporation in its present form, namely that patterns of employment post Covid may be very different: e.g. more people working from home. Thus there is much to be said for letting firms which cannot make it thru Covid just wither, while keeping demand as high as possible. New firms and forms of economic activity will then make use of that demand.

Unfortunately the above points about the possible merits of bog standard bankruptcy proceedings does not seem to have occurred to Finance Watch.

Monday, 18 January 2021

A simple argument for full reserve banking.


This is my latest paper. The abstract is as follows.

Deposit insurance is beneficial in that it ensures everyone has a safe method of storing and transferring money. That is a basic human right. Unfortunately deposit insurance also supports a commercial activity, namely depositing money at a bank with a view to the bank earning interest for the depositor, which a bank can only do by in effect lending out depositors’ money. That is just as commercial as depositing money with a stockbroker, mutual fund or unit trust with a view to interest or some other form of return being earned. And it is not the job of government to support commercial activities. 

As for the idea that banks create the money they lend out, rather than intermediate, that is dealt with in the opening paragraphs below. 

Preventing deposit insurance assisting the above commercial activity while retaining a form of totally safe deposits is easily done by splitting deposits into two types: first, those where the depositor simply wants money stored safely, with that money being lodged at the central bank where it earns no interest, and second, those where the depositor wants to be into commerce. Interest is earned on the latter deposits, but depositors carry the risk involved which essentially turns those deposits into equity.  And that is precisely what full reserve banking consists of.

Saturday, 16 January 2021

The Financial Times still doesn’t fully understand deficits, austerity etc.


It’s good to see the FT admitting they were wrong to advocate austerity in the aftermath of the 2007/8 bank crisis (like many newspaper economics commentators, as pointed out by Simon Wren-Lewis). That’s in a recent FT article entitled “A Fiscal Policy for all Seasons”.

Unfortunately, the FT still hasn’t totally got to grips with this subject. In particular they say their new more relaxed attitude to deficits  “….is not a reason to abandon the goal of fiscal sustainability. Governments can, usually, simply roll over their debt stock at reasonable interest rates. There is, however, an ever-present risk that the market will move against governments and the cost of borrowing will rise to such an extent that the choice will be between a painful default or vicious austerity.”

The reality is that if bond holders do demand a higher rate of interest, that is no reason for austerity, as I’ve been trying to explain for about ten years, e.g. here. Reasons (for the umpteenth time) are as follows.

First, if those holding government bonds do demand a higher rate of interest, there is very little initial effect on the amount of interest a government has to pay because the rate of interest payable on a large majority of those bonds is fixed at the date they are first issued. That is particularly true of UK government debt where the average time between the date of issue and date of maturity is about ten years.

But as regards bonds which mature in the very near future, a rise in the interest rate demanded by potential bond holders is on the face of it a problem for government: government seems to be faced with the choice of rolling over the debt and paying the higher rate or raising taxes so as to obtain the money to simply pay off debt holders and tell those seeking new bonds which yield a higher rate to go away. And certainly doing the latter would involve the “austerity” to which the FT refers.

In fact there is a third option, which the FT and the majority of economics commentators are completely unaware, and that is to create new money, pay off the old bond holders and then see what happens. Possibly the resulting increase in the money supply would not be inflationary: the vast amounts of money created so as to implement QE do not seem to have been inflationary.

But if excess inflation did rear its ugly head, there is a very simple solution, which involves no austerity, and that is to raise taxes and “unprint” or destroy the money collected. The effect of that would not, repeat not, repeat not, repeat not be austerity, i.e. deficient demand. Reason is that the sole purpose of the latter “tax and unprint” exercise would be to cut demand to the maximum level consistent with hitting the inflation target.

So assuming aggregate demand was for the sake of simplicity at that maximum level before the unprint started and at the same level after the unprint, then (hey presto and roll of drums) there’d be no effect on real household incomes!!!

At least that would certainly be the case where all government debt is domestically owned. In fact, while a majority is domestically owned, a significant proportion is foreign owned, and if those foreign or internationally mobile investors took their new found pile of cash out of the country, the relevant country’s currency would fall on foreign exchange markets, which would mean a cut in real household incomes.

However, if bond holders start demanding a higher rate of interest on the bonds issued by government X, chances are they’ll demand a higher rate on the bonds of other governments!! So taking their money out of country X probably won’t do them any good.

The only circumstance where it would pay internationally mobile investors to quit country X would be where X started to behave in a seriously irresponsible way relative to other countries.

So the conclusion is that as long as a government doesn’t do anything which is clearly more stupid than what other governments are doing, a rise in the rate of interest demanded by those holding its debt need not cause austerity.  


Thursday, 7 January 2021

“Ending the Government Subsidy” by Thomas Hoenig.

Hoenig is a former vice chairman of the Federal Deposit Insurance Corporation, and I stumbled across an odd little note about him or by him recently here, which does not seem to have an official publisher or date of publication. Anyway, he makes an interesting point, so I thought I’d reproduce it here (particularly since its not having an official publisher means it could disappear from the internet at some point). 

I’ve reproduced it in green below and also taken a screen shot of it in GIF form (see below). If you click on the GIF image, save it, and then open it, you’ll find it’s legible, but only just. At least that’s how it worked out on my PC.

His basic point is that deposit insurance is ipso facto a subsidy for banks in that it means those who fund banks, depositors in particular, are backed by an insurer with an infinitely deep pocket, whereas other lenders (of which there are many types) do not enjoy that luxury.

Those other lenders include mutual funds, unit trusts, pension funds and wealthy individuals who lend to corporations when they buy corporate bonds. Plus there are millions of people who lend to small businesses run by friends and relatives.

One of the main excuses for deposit insurance is that it results in private banks’ home made money being a totally secure form of money (as distinct from where there is no deposit insurance, in which case so called deposits are to some extent a form of equity in that depositors stand to lose money if their bank makes a mess of things.)

But that excuse is a trifle feeble, in that CENTRAL BANKS have for decades if not centuries provided anyone who wants it with a very safe form of money. First there are physical £10 notes, $100 bills etc, and second there are accounts at state run savings banks (like “National Savings and Investments” in the UK). The latter accounts amount to something not vastly different to “Central Bank Digital Currency”.

So…. given that everyone ALREADY HAS a totally safe form of money available to them, arguably we do not need deposit insurance which (as mentioned above) results in a non level playing field as between different types of lender (banks versus other types of lender, to be exact).

I actually expand on the latter point in a forthcoming article, but that’s all I’ll say on that point for the moment: the main point of this post, to repeat, is to reproduce Hoenig’s ideas.

Hoenig’s “note” is as follows…

The government safety net of deposit insurance, central bank loans, and ultimately taxpayer support provides a multibillion dollar subsidy to firms that engage in both commercial and investment banking. This government backstop means that they have cheaper access to funding and face less discipline from the market. The subsidy, in turn, creates incentives to take excessive risk directly through risky investments and greater leverage. For example, they can cover – and even double-down -- on their trading positions by using insured deposits or central bank credit that comes with the commercial bank charter. Their competitors that don’t affiliate with a commercial bank have no such access to the safety net and its subsidy, and thus no such staying power, putting them at an enormous competitive disadvantage and eventually leading to consolidation. While trading and investment banking activities are important to the success of an economy, there is no legitimate reason to subsidize them with access to the safety net. Furthermore, the excessive risk and greater industry consolidation that is brought about by the subsidy has created a more fragile economy and, therefore, greater risk for the American taxpayer.

The safety net’s protection should be limited primarily to those commercial banking activities for which it was originally intended: stabilizing the payments system and the intermediation process between short term lenders and long-term borrowers. That is, it should be confined to protecting activities essential to a well-functioning economy.

Vice Chairman Hoenig is calling for statutory changes to place noncore financial activities such as proprietary trading, market making, and derivatives outside of the commercial bank – and thus outside of the safety net. Broker-dealers would be free engage in these activities where they would be subject to the forces of market discipline and have greater incentives to innovate and thrive.

None of these reforms would be effective unless the shadow banking system is also removed from the safety net. Therefore, Vice Chairman Hoenig is calling for requiring that money funds represent themselves for what they are: uninsured investments, the value of which changes daily. And he is calling for disciplining the repo market by subjecting repo lenders that accept mortgage-related collateral to the same bankruptcy laws as other secured creditors.

Confining the safety-net to what it was intended will not eliminate crises. But it will allow the economic system to handle them, and it will return the financial services industry to a simpler, more competitive and pro-growth footing.

The GIF: