Credit Writedowns » Economics

Economics in the Age of Deleveraging

Guest Author — Wed, 01 Feb 2012 16:00:05 +0000

Clearly, economic policy is now far more complex than it appeared to be before the GFC. As we enter this Age of Deleveraging, the worst thing we can do is apply policies that appeared to work during the preceding Age of Leverage—but were in fact predicated on ever-rising private sector indebtedness. Politicians should be sceptical of conventional economic advice at this time; it would be much wiser to study the history of the 1930s instead

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Functional Finance and Exchange Rate Regimes: The Twin Deficits Debate

Randall Wray — Mon, 30 Jan 2012 14:00:46 +0000

In conclusion, while there are links between the “twin deficits”, they are not the links usually imagined. US trade and budget deficits are linked, but they do not put the US in an unsustainable position vis a vis the Chinese. If the Chinese and other net exporters (such as Japan) decide they prefer fewer dollar assets, this will be linked to a desire to sell fewer products to America. This is a particularly likely scenario for the Chinese, who are rapidly developing their economy and creating a nation of consumers. But the transition will not be abrupt

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Milton Friedman, Functional Finance and the Government Budget Constraint

Randall Wray — Mon, 23 Jan 2012 20:00:00 +0000

Last week we examined Milton Friedman’s version of Functional Finance, which we found to be remarkably similar to Abba Lerner’s. The only problem with Friedman’s analysis is that he did not account for the external sector: he wanted a balanced budget at full employment, but if a country tends to run a trade deficit at full employment, then it must have a government budget deficit to allow the private sector to run a balanced budget—which is the minimum we should normally expect. Somehow all this understanding was lost over the course of the postwar period, replaced by “sound finance” which is anything but sound. It was based on an inappropriate extension of the household “budget constraint” to government

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Milton Friedman’s 1948 Functional Finance Proposal

Randall Wray — Tue, 17 Jan 2012 14:00:07 +0000

Milton Friedman's 1948 article, "A Monetary and Fiscal Framework for Economic Stability" put forward a proposal according to which the government would run a balanced budget only at full employment, with deficits in recession and surpluses in economic booms. There is little doubt that most economists in the early postwar period shared Friedman’s views on that. But Friedman went further, almost all the way to Lerner’s functional finance approach: all government spending would be paid for by issuing government money (currency and bank reserves); when taxes were paid, this money would be “destroyed” (just as you tear up your own IOU when it is returned to you). Thus, budget deficits lead to net money creation. Surpluses would lead to net reduction of money

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Monetary and Fiscal Policy for Sovereign Currencies

Randall Wray — Mon, 09 Jan 2012 13:30:48 +0000

This week we begin a new topic: functional finance. This will occupy us for the next several blog posts. Today we will lay out Abba Lerner’s approach to policy

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Krugman, Tabarrok, Cowen and the bond vigilante fallacy

Edward Harrison — Tue, 03 Jan 2012 21:00:06 +0000

I don't expect any response from Paul Krugman, Alex Tabarrok or Tyler Cowen on this but they know who I am and read my articles from time to time. I am going to add my voice to a debate they have been having in the blogosphere on debt, deficits and bond vigilantes. It goes like this

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What is Modern Money Theory?

Randall Wray — Tue, 03 Jan 2012 12:45:21 +0000

OK, you might be wondering: Isn’t this a strange point at which to raise the question, “what is modern money theory?” Yes, in some important ways, it is. However in the past week there have been some really pretty extraordinary pieces in the popular media trumpeting

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What about a country that adopts a foreign currency? Part Two

Randall Wray — Mon, 26 Dec 2011 19:42:26 +0000

Yet another rescue plan for the EMU is making its way through central Europe—with the ECB acting as lender of last resort to Euro-banks. It is trying the tried-and-failed Fed method of rescue. As we now know the Fed lent and spent over $29 TRILLION trying to rescue (mostly) US banks. It did not work. The biggest banks are still insolvent, and have continued their massive frauds trying to cover up their insolvencies. You cannot paper-over insolvency through massive lending by the central bank. And the Euroland problems are compounded by the insolvencies of virtually all their member states

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Bond vigilantes and the currency relief valve

Edward Harrison — Wed, 21 Dec 2011 15:49:20 +0000

The last post by Randall Wray below is an interesting one because it points out how the world has changed since the end of the gold standard and why the sovereign debt crisis is centered in the euro zone. While I have an Austrian bias overall, for me, MMT is the best way to think about nonconvertible floating exchange rate systems as distinct from fixed exchange rate, currency board, pegged and convertible systems. The difference is policy space and what I would call the bond vigilante relief valve

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It is Krugman who has shined the headlights on the difference between a currency issuer and a currency user

Randall Wray — Wed, 21 Dec 2011 15:00:39 +0000

It seems to have been none other than Paul Krugman who made it safe for others to adopt MMT. He shined his headlights on the obvious: the reason why interest rates on government debt are not exploding in countries like Japan, the US, and the UK is because they issue their own currencies. So, Krugman shined the headlights on the difference between a currency issuer and a currency user. It is now time for everyone to follow Dean Baker—to look for the car keys under those MMT headlights

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Government Spending with Self-Imposed Constraints

Randall Wray — Tue, 20 Dec 2011 21:24:52 +0000

Let’s see how it is really done in the US—where the Treasury really does hold accounts in both private banks and the Fed, but can write checks only on its account at the Fed. Further, the Fed is prohibited from buying Treasuries directly from the Treasury (and is not supposed to allow overdrafts on the Treasury’s account)

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The Euro, Currency Sovereignty and Adopting a Foreign Currency

Randall Wray — Mon, 05 Dec 2011 13:30:00 +0000

It is apparent that adoption of a foreign currency is equivalent to running a very tight fixed exchange rate regime. It provides the least policy space of any exchange rate regime. This does not necessarily mean that it is a bad policy. But it does mean that the nation’s domestic policy is constrained by its ability to obtain the “foreign currency”. A nation that adopts foreign currency cedes a significant degree of its sovereign power

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Sovereign Currency and Government Policy in an Open Economy

Randall Wray — Mon, 28 Nov 2011 15:00:00 +0000

While the usual assumption is that current account deficits lead more-or-less directly to currency depreciation, the evidence for this effect is not clear-cut. Implications of this depend on the currency regime. According to the well-known trilemma, government can choose only two out of the following three: independent domestic policy (usually described as an interest rate peg), fixed exchange rate, and free capital flows. A country that floats its exchange rate can enjoy domestic policy independence and free capital flows. A country that pegs its exchange rate must choose to regulate capital flows or must abandon domestic policy independence. If a country wants to be able to use domestic policy to achieve full employment (through, for example, interest rate policy and by running budget deficits), and if this results in a current account deficit, then it must either control capital flows or it must drop its exchange rate peg

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National Solvency and the Special Case of the US Dollar

Randall Wray — Mon, 21 Nov 2011 15:12:57 +0000

The US can run budget deficits that help to fuel current account deficits without worry about government or national insolvency precisely because the rest of the world wants Dollars. But surely that cannot be true of any other nation. Today, the US Dollar is the international reserve currency—making the US special. Isn’t the US special? Let us examine this argument

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What if foreigners dump government bonds?

Randall Wray — Tue, 15 Nov 2011 14:00:00 +0000

when government deficit spends, some of the claims on government will end up in the hands of foreigners. Does this matter

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The money scoreboard

Edward Harrison — Thu, 03 Nov 2011 18:17:00 +0000

This post is intended to be a hopefully brief synopsis of how the monetary system works using an Austrian framing with MMT terminology. If you don’t know what that means, you’ll see what I mean as I proceed. MMTers like to say that money is like points and the government is just a scorekeeper. I

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Reserves, Governement Bond Sales, and Savings

Randall Wray — Mon, 31 Oct 2011 14:30:14 +0000

Last week we showed that government deficits lead to an equivalent amount of nongovernment savings. The nongovernment savings created will be held in claims on government. Normally, the nongovernment sector prefers to hold that much of that savings in government IOUs that promise interest, rather than in nonearning IOUs like cash. This week we will look at this in more detail

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The two-step process of saving

Randall Wray — Mon, 24 Oct 2011 15:00:51 +0000

Recipients of government spending can hold receipts in the form of a bank deposit, can withdraw cash, or can use the deposit to spend on goods, services, or assets. In the first case, no further portfolio effects occur. In the second case, bank reserves and deposit liabilities are reduced by the same amount. In the third case, the deposits shift to the sellers (of goods, services or assets). Only cash withdrawals or repayment of loans can reduce the quantity of bank deposits—otherwise only the names of the account holders change. These processes can affect prices—of goods, services, and most importantly of assets

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Effects of Sovereign Government Budget Deficits on Saving, Reserves and Interest Rates

Randall Wray — Mon, 17 Oct 2011 12:41:46 +0000

Each time the treasury spends or taxes, a complex series of steps is required that involve the treasury, the central bank and private banks. The central bank and the treasury develop such procedures to ensure that government is able to spend, that taxpayer payments to treasury do not lead to bounced checks, and—most importantly—that undesired effects on banking system reserves do not occur. While, the end result is that the treasury spending leads to bank credits, taxes lead to debits, and budget deficits mean net credits to both demand deposits and bank reserves, it is more complicated

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Paul Davidson: The State of Economics (wonkish)

Guest Author — Wed, 12 Oct 2011 15:25:50 +0000

Paul Davidson argues that a theory is the way humans describe real world observations on the basis of a model that starts with a few axioms. An axiom is an assumption accepted as a universal truth that does not need to be proved. From this axiomatic foundation, the theorist uses the laws of logic to deduce conclusions that explains what we observe in the world of experience. All theories are generally accepted in some tentative fashion. Theories are not ever conclusively established and can be replaced when events are observed that are deviations from the current existing theory. Thus, the financial crisis of 2007-2009 should have been sufficient empirical evidence to indicate that the axiomatic basis of the mainstream theory needs to be replaced

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Will internal devaluation work?

Edward Harrison — Tue, 11 Oct 2011 23:00:41 +0000

My friend Rob Parenteau doesn’t think it will. His argument against it is similar to the one I have been making about the origins of this crisis. Here’s what I said

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Currency Sovereignty

Randall Wray — Mon, 03 Oct 2011 18:18:00 +0000

This week we will begin to examine our next topic: government spending, taxing, interest rate setting, and bond issue. We will examine fiscal and monetary policy formation by a government that issues its own currency. We will bear in mind that the exchange rate regime chosen does have implications for the operation of domestic policy. We will distinguish between operational procedures and constraints that apply to all currency-issuing governments and those that apply only to governments that allow their currency to float

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Currency Revulsion

Edward Harrison — Sun, 02 Oct 2011 00:00:24 +0000

All US government obligations are substantially identical promises to repay a specific amount of the currency unit of account backed by nothing but taxing authority. So, Treasury bonds don’t ‘fund’ anything. If the Treasury were allowed to run overdrafts at the central bank, the US government could stop issuing bonds altogether and credit bank accounts with keystrokes. But what about currency revulsion, you ask? What if government deficit spends out of control

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Here’s why inverted yield curves are a leading indicator of recession

Edward Harrison — Mon, 26 Sep 2011 13:43:44 +0000

Just following up on my last post about the expectations theory of interest rates, I wanted to explain why yield curve inversion signals recession – and why it hasn't this go round in the

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IMPORTANT: Long-term interest rates are a series of future short-term rates

Edward Harrison — Mon, 26 Sep 2011 12:53:52 +0000

On how the expectations theory of interest rates explains why debt-induced depressions are fundamentally deflationary in nature

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The Unusual Case of Euroland

Randall Wray — Mon, 19 Sep 2011 15:00:52 +0000

In the next series of blog posts, we will look in more detail at fiscal and monetary operations of a nation with a sovereign currency. Before we do that, let us briefly examine the case of the Euro. Let me say that we will not address the unfolding crisis across Euroland in detail. The reason is that events are moving too quickly and we do not know where they will lead. This primer in some sense needs to be “timeless”—anything specific that we discuss will quickly become outdated. The fundamental point to be made here is that the Euro arrangement was flawed from the beginning. Crisis was inevitable—as I have been writing since the mid 1990s. There is no way the system as designed could possibly survive a significant financial crisis. And a crisis began in 2007. Due to flaws in the set-up, it was obvious (at least to those who adopted MMT) that the original arrangement was not sustainable. We could not say for sure how the resolution would turn-out, but a fundamental change would be required

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The prospects for inflation have not been smaller since 1930

Randall Wray — Wed, 07 Sep 2011 14:15:30 +0000

Just where are all those borrowers who are willing and able to borrow the $2 trillion or $20 trillion that hyperventilators believe banks want to lend? The US private sector (firms and households) have instead ramped up their net savings—they are not borrowing, they are not even spending their diminished income. They are scared. They are (rationally) tightening belts, paying down debt, and accumulating claims on government and banks. In short, the prospects for inflation have not been smaller since

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IOUs Denominated in National Currency

Randall Wray — Mon, 05 Sep 2011 14:00:38 +0000

On a floating exchange rate, the government’s own IOUs—currency—are nonconvertible in the sense that the government makes no promise to convert them to precious metal, to foreign currency, or to anything else. Instead, it promises only to accept its own IOUs in payments made to itself (mostly, tax payments, but also payments of fees and fines). This is the necessary and fundamental promise made: the issuer of an IOU must accept that IOU in payment. So long as government agrees to accept its own IOUs in tax payments, the government’s IOUs will be in demand (at least for tax payments, and probably for other uses as well)

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Commodity Money Coins: Metalism versus Nominalism, Part Two

Randall Wray — Mon, 29 Aug 2011 15:00:00 +0000

This week we examine coinage from Roman times to the present in Western society

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The Gold Standard and Fiat Currency: Metalism vs. Nominalism, Part One

Randall Wray — Mon, 22 Aug 2011 15:00:00 +0000

“Taxes drive money”—these “money things” are accepted because there are taxes “backing them up”, not because they have embodied gold. As promised, this week I will begin try to dispel the view that coins used to be commodity monies

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Paul Krugman Still Gets MMT Wrong

Randall Wray — Wed, 17 Aug 2011 19:00:30 +0000

I appreciate the role that Krugman plays. Like many of you, I enjoy reading his blogs and more often than not, I agree with him. He is almost the lone, sane, voice in a position of authority who argues against the standard deficit hyperventilation that is driving the nation into a great depression. I mean no disrespect in the following critique. And I am glad that he is writing about MMT—most of those within the Beltway simply ignore it. But there are two reasons to respond to his critique: first, there is some hope that he might change his mind and embrace MMT. That would allow him to mount a much more powerful attack on the deficit hysterians. Second, he is misleading his many readers—by misstating what MMT believes, and by his own misunderstanding of monetary operations

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Paul Krugman Still Gets MMT Wrong originally appeared on Credit Writedowns

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Why Permanent Zero is toxic and leads to depression

Edward Harrison — Tue, 16 Aug 2011 10:30:07 +0000

While rate easing and its cousin permanent zero might have some salutary effect in the short term, these policies are toxic to the financial sector and consumption demand. Likely, they will not spur the economy but lead to a deepening malaise

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Why Permanent Zero is toxic and leads to depression originally appeared on Credit Writedowns

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Alternative Exchange Rate Regimes

Randall Wray — Mon, 15 Aug 2011 15:30:09 +0000

Previous Modern Money primer blog posts were quite general and apply to all countries that use a domestic currency. It does not matter whether these currencies are pegged to a foreign currency or to a precious metal, or whether they are freely floating—the principles are the same. In this blog post we will examine the implications of exchange regimes for our analysis

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Krugman on Modern Monetary Theory

Edward Harrison — Mon, 15 Aug 2011 05:18:09 +0000

Last summer I wrote a post clarifying some points that I have learned about Modern Monetary Theory. The genesis of the post was a gross mischaracterization of Modern Money Theory (MMT) by Paul Krugman in a piece called “I Would Do Anything For Stimulus, But I Won’t Do That (Wonkish)”, which Paul Krugman had written in July of last year. Last week Paul Krugman again attempted to take on MMT in another piece called "Franc Thoughts on Long Run Issues."

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Krugman on Modern Monetary Theory originally appeared on Credit Writedowns

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The Fed and nominal GDP and income targets

Edward Harrison — Tue, 09 Aug 2011 23:42:52 +0000

I have been off the grid of late so I have limited blogging capacity. But I still wanted to present a different perspective on monetary policy here for a second given the recent Fed move to permanent zero. First, I should say that my view is that monetary policy is a blunt instrument and that low nominal rates lead to resource misallocation. However, with fiscal policy off the table in the US and Europe, what is the monetary agent to do? Post credit-crisis tight money and tight fiscal leads to depression. David Beckworth, an economics professor and blogger at “Macro and Other Market Musings”, argues the monetary agent needs to be accommodative by targeting nominal GDP and nominal income. What does that mean? I asked him to explain. Here’s what he wrote me

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