The Real Economy
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| MMT 101 |
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The MMT fundamentals, as explained by you and the other Wiki editors Introduction Modern Money Systems The Real Economy Money, Government and Banking The Role of Government Deficits Full Employment along with Price Stability |
Contents |
Summary
This article emphasizes that the costs for the government of various policies should be thought of in real terms rather than financial, since the government financially has no constraints. What matters is the real resources that is taken away from private activity.
The "right" amount of real resources to be used by the government sector should be decided upon by the electorate.
There is then no reason to increase that amount because to stimulate the economy out of a downturn – the right tax cuts could equally well restore private sector spending power.
Government bonds outstanding is not "debt" that will have to "be paid" back by future generations, but rather financial assets that will be inherited by future generations – just like the monetary base in use in the economy.
What matters for future generations is what real resources that the current generation leaves behind.
In real terms, imports are a benefit since real goods and services increases, and exports are correspondingly a cost.
The Real Economy
The government in a modern money system is not revenue constrained (as has been discussed in the article Modern Money Systems). Therefore, various policy alternatives should be analysed in terms of real costs rather than financial. Political preferences should decide the amount of real resources that is to be transferred to the public via government spending, to support for example an army, a legal system, the legislature, the executive branch of government and so on. The judgement should be based on an analysis of real benefits and real costs, not on mistaken beliefs that the nation could "run out of money".
The real costs of running the government are the real goods and services it consumes – the labor hours, fuel, electricity, steel, carbon fiber, hard drives and so on that would otherwise be available for the private sector[1].
MMT does not make the choices over resource usage and the related conflicts any easier to resolve. What it does do is put these questions front and center, where they should be.
This frees us conceptually from the many mystifications of orthodox economics, not least of which is the unnecessarily erected financial constraints that has nothing to do with real resource limits.[2]
After having decided how much should be spent to transfer the "right" amount of real resources to the public sector, taxes are set so that most of the spent money will also be drained from the economy. Private sector demand is thus dampened down just so much that the government expenditure does not cause prices to rise, i.e to maintain the value of the currency.
Government spending will typically need to be somewhat higher than taxing in a growing economy (due to the private sector net saving, i.e not spending all their income), resulting in a budget deficit. The nominal size of the government deficit by itself is however of no particular economic consequence[1].
Consider the case of an economic downturn. If a government of "right" size (as deemed by the electorate) is in place, there is no reason to grow the size of government to stimulate the economy. Although increased government spending would end the recession, the same thing could be accomplished using the right tax cuts to restore private sector spending power.
Likewise, there is no reason to increase the size of government just because the government might find itself with a financial surplus at some point. The appropriate government size is independent of the government's financial position – what matters is the real resources it uses[1].
The Myth of the Government Debt Burden
Since the government in a modern money system is not revenue constrained, the reason for government issuing bonds can not be "borrowing to fund deficit spending". Governments issue bonds to provide the non-government sector with an interest-earning savings alternative, and to manage the interest rates in the economy.
A common misconception is that future generations will suffer under a "debt burden", and that paying back the debt will make them poorer than they otherwise would have been. This is incorrect.
Government bonds and what is called "base money" can be thought of as substitutes for each other. Both are government liabilities. Base money is liabilities with zero interest and zero maturity, while bonds are interest earning liabilities of non-zero maturity. But both are denominated in the same unit of account and are interchangeable. ("Base money" is the "definitive" money, the money issued by the government, comprised by bank reserves and physical currency. This will be further discussed in the article Money, Government and Banking.)
One can think of government bonds as nothing more than an interest earning version of base money[3]:167, much like an interest earning "deposit" in a "security account" or "savings account" at the central bank.
The base money in use today is not something that will be a burden for future generations – and neither is the bonds. Both are rather non-government sector financial assets, and will be inherited by future generations.
What is thought of as "paying off government debt" happens continuously, as bonds come due. This is always and necessarily nothing more than an internal transfer from a "securities account" to a "reserve account", both at the central bank.
What if the Government Just Paid off its Debts?
The idea that government bonds are a burden for the private sector (or future generations thereof) rests on the belief that the bonds are should be thought of "debt" in the conventional sense. Presumably this debt will have to be "paid off" at some point, and this process will be cumbersome for the government.
What would happen if the government decided to "pay off the debt"? Outstanding bonds would be replaced with bank reserves (and bank deposits). This is not something that MMT suggests necessarily should be done. There are possible consequences such as inflation or disinflation, that may be deemed undesired. Yet, it is revealing to look at this in some detail. If the expected consequences are undesired, the government should refrain from doing so. If not, the process of "paying off the debt" would not be cumbersome whatsoever. The key take-away is that government bonds and government currency are just two different forms of financial liabilities for the government -- and financial assets for the non-government sector. One is interest bearing, the other is not. Neither is going to be a "burden" for future generations.
If the future holders of the government bonds desire to hold currency instead, or if the government desires to reduce its amount of outstanding bonds, the government can stop rolling over bonds (i.e let bonds come due and not issue new ones.) Or, the central bank could simply buy back bonds outstanding. Funds would then be shifted from the "securities accounts" to non-interest earning "reserve accounts" (i.e bank reserves) at the central bank. This is done by changing electronic accounting entries (much like changing numbers in a spreadsheet).[1]
This does not alter the amount of non-government net financial assets but only the composition, as some of them are shifted from bonds (interest earning with various maturities) to currency (non-interest earning, zero maturity). Analogies sometimes used for this process are "monetizing the debt" (and even "printing money to pay off debt"), which sounds scary but is misleading. A better way to express it would be "shifting the non-government asset composition from bonds to currency". (When central banks in Japan and the U.S has performed this process during recent recessions, it has been called "Quantitative Easing").
It is sometimes believed that such an operation would be stimulatory or even highly inflationary. The idea is that holding bonds instead of currency restrain people from spending. Therefore, if the composition of financial assets held by the non-government sector shifted from bonds to currency, spending would increase which would possibly induce inflation.
MMT rejects this idea on both theoretical and empirical grounds. Comparing with a currency holder, a bond holder is not restrained from spending in any plausible way. There is always the option of selling the bonds. Alternatively, the bond holder can use the bond as collateral for a new bank loan[4] (i.e the bond can support spending out of horizontal money creation, a concept that will be discussed further in the article Money, Government and Banking).
Another issue is that bond holders -- as opposed to currency holders -- receive interest payments from the government. Over time this will increase non-government net financial assets, potentially increasing nominal aggregate demand and thus possibly contributing to inflation. Therefore, the government buying back these bonds could be less inflationary than letting them remain within the private sector. This is the opposite effect than what is commonly assumed.
As has been discussed, if the government buys back bonds funds are shifted from "securities accounts" to "reserve accounts" at the central bank. Of course, the amount of bank reserves in the banking system would thereby increase. This would cause the interbank lending rate to fall towards zero, which could cause short term interest rates in the markets to decrease. (Reserves and interbank lending rates will be further discussed in the article Money, Government and Banking.)
If lower interest rates at that point would be deemed inflationary or otherwise undesirable, that can be remedied by the central bank instead offering to pay banks an overnight interest for excess reserves[5]. (The Federal Reserve in the U.S started doing so in October 2008.) This can be thought of as the central bank offering short term "overnight-bonds" to banks.
On the other hand, if the government would buy back the bonds, the supply of secure and interest carrying savings vehicles would decrease. This could cause not only the short term interest rates to fall, but the long term rates as well. Capital searching for profitable savings vehicles could redirect towards other asset markets with rising prices (such as stock, housing or commodities), possibly contributing to asset bubbles.
Then again, longer interest rates offered in the financial markets are largely a function of market expectations of future short rates set by the central bank, rather than the availability of government bonds. And in any case, it may be difficult and even inappropriate to use monetary policy (such bond issuance) to prevent asset bubbles. One issue is how to identify what is an "asset bubble" and what is just a "rational" price rise -- the central bank would have to second guess on the rationality of market participants on that.[6]
The discussion on the hypothetical case of the government buying back bonds shows that the resulting effects are ambiguous and unclear. Shifting the composition between the two types of assets may have effects on various economic variables. Inflation or rising asset prices is a possibility but so is disinflation.
The take away point here though is that government bonds and government currency are just two different forms of financial liabilities for the government -- and financial assets for the non-government sector. One is interest bearing, the other is not. Neither is going to be a "burden" for future generations.
The Real Future Economy
It is sometimes suggested that expenditure today should be cut to "accumulate funds" that can be spent by future generations. MMT states that this is nonsensical, since funds per se is never a constraint for the government.
What should be considered is the real economy. Future generations will get to consume whatever real goods they can produce, and whether they hold government "debt" (bonds) rather than currency is of little consequence. Each year's real output is "divided up" among the living. None of the future output is sent back in time to pay down outstanding "debt" to today's bond holders, just like today's generation is not sending real goods and services back in time to "pay off" bond holders of previous generations.[1]
Consider the issue of supporting future seniors as an example. Any problems for the government to do so will have to do with real constraints, not financial. If policy makers want seniors to have more nominal income at any time, it's a simple matter of raising benefits. The real question is, what level of real resource consumption should be allocated to seniors? Giving future seniors more of goods and services means less for future workers. The amount of goods and services allocated to seniors is the real cost – not the actual payments, which are nothing more than numbers in electronical accounting entries.
Furthermore, if the population age profile changes so that there are hoards of elderly in need of support but very few workers to produce real goods, it will not matter whether the government has retired all outstanding debt and accumulated huge amounts of currency in sovereign funds – there will still be too little food to eat. Further, any accumulated currency would have been accumulated unnecessarily, as the government can issue currency at will.
Unfulfilled Potential as the Real Future Burden
Cutting back on government spending today in order to accumulate currency in funds to spend in the future is not only pointless but harmful. It sets the economy back and causes the growth of output and employment to decline. The lost opportunity from growth loss and unemployment is indeed what will become an unnecessary burden for future generations, not a "lack of funds". When economy operates below potential – at less than full employment – future generations are deprived of the real goods and services that could have been produced on their behalf. Likewise, when support of education and research is cut back, future generations are deprived of knowledge they will need.
The lost output, infrastructure, knowledge, technology and depreciated human capital is the real price paid for the current policies, hurting both the present and the future. We make do with less than what we can produce as we sustain high levels of unemployment (along with all the associated crime, family problems and medical issues), while our children are deprived of the real investments that would have been made on their behalf if we knew how to keep our human resources fully employed and productive.
Foreign Issues
Conventional wisdom regards exports as a benefit, and imports as a cost. MMT states that this is a misleading conclusion resulting from the view that a nation is like a firm that should sell as much goods and services as possible. This view should be reconsidered.
Imports mean increases in real goods and services. This is a benefit in real terms. Exports mean that a nation is shipping away real goods and services. This is a cost in real terms, as the production has consumed resources that could otherwise have been used domestically.
The reason a country can net import (import more than it exports) is that rest-of-the-world desires to net accumulate the country's currency[7]. To do this, the rest-of-the-world has to send more real goods and services to the importer than they expect in return. This imbalance provides the importer with real net benefits, for as long as it lasts.
For example, the Chinese are currently hoarding US dollars (currency and bonds). This is not only a loss of real goods and services for China. It is also highly risky. They earn those dollars from selling real goods and services to the US, yet they have no assurance that they will be able to buy real goods and services from the US in the future. Prices could go up (inflation) and the US government could legally impose all kinds of taxes on anything foreigners wish to buy. This reduces the foreigners' spending power[1][8].
Contrary to popular wisdom, it is not the case that China's accumulation of bonds in any way "finances" US government spending, or affects the US government's "solvency".[9] Foreigners do not fund the spending of a sovereign government.
At some point, the Chinese may become less interested in hoarding US dollars. The US government will still go on spending and the Chinese will hoard less assets. When foreign demand for a nations currency decreases, its foreign exchange rate declines. The US will not be able to benefit from cheap imports from China to the same degree. Prices rise to some extent for imports and US exports becomes more competitive.
The view that the importer in a trade relationship is benefited is not unconditional. It is not always the case that imports is good. It may be advisable for an importing nation to foster conditions that reduce its dependency on imports of critical goods and services.[10] At some point, foreigners may stop wanting to accumulate financial assets denominated in the importers currency, so that there will be adjustments in the importers ability to import which can be painful.[11] But the main point remains; the conventional position seeing exports as a benefit and imports as a cost is misleading.
References
- ↑ 1.0 1.1 1.2 1.3 1.4 1.5 [|Mosler, Warren] (2010). 7 Deadly Innocent Frauds. http://moslereconomics.com/2009/12/10/7-deadly-innocent-frauds/. Retrieved 24 May 2011.
- ↑ Peter Cooper; Full Employment and the Environment; http://heteconomist.com/?p=1220
- ↑ Wray, L. Randall (1998). Understanding Modern Money. Edward Elgar Publishing Limited. ISBN 978 1 84542 941 6.
- ↑ Scott Fullwiler: What If the Government Just Prints Money? http://neweconomicperspectives.blogspot.com/2009/11/what-if-government-just-prints-money.html
- ↑ Scott. T. Fullwiler. "Scott Sumner Agrees that MMT Policy Proposals Are Not Inflationary". http://neweconomicperspectives.blogspot.com/2011/07/scott-sumner-agree-that-mmt-policy.html. Retrieved 16 August 2011.
- ↑ L. Randall Wray: "A Post-Keynesian View of Central Bank Independence, Policy Targets, and the Rules-versus-Discretion Debate", 2007; http://www.levyinstitute.org/pubs/wp_510.pdf
- ↑ either as regular currency, government bonds, or other financial assets denominated in the currency
- ↑ For more discussion, see: Tom Hickey; Currencies Stay Within Their Currency Zone; http://mikenormaneconomics.blogspot.com/2011/03/currencies-stay-within-their-currency.html
- ↑ Bill Mitchell: A modern monetary theory lullaby, http://bilbo.economicoutlook.net/blog/?p=8117
- ↑ Bill Mitchell: Do current account deficits matter? http://bilbo.economicoutlook.net/blog/?p=10389
- ↑ Bill Mitchell: Current accounts and currencies; http://bilbo.economicoutlook.net/blog/?p=10389
