Author: Jo Michell

Associate Professor, Economics, UWE, Bristol

Developing and emerging countries need capital controls to prevent financial catastrophe

A shorter version of this letter was published in the Financial Times on 25 March 2020.

All countries currently face the unprecedented threat of a simultaneous and global health crisis, economic recession and financial meltdown. But unlike rich nations, emerging and developing countries  (DECs) lack the policy autonomy needed to confront these crises. The global currency hierarchy places DECs in the periphery of global financial markets, exposing them to sudden stops caused by triggers such as the COVID-19 crisis. The US Federal Reserve announced it would lend up to USD 60bn to the central banks of Mexico, Brazil, South Korea and Singapore. But this is not enough. Immediate capital controls, coordinated by the IMF, are needed to prevent financial disaster.

In a global financial crisis, there is a rush to hold liquid assets denominated in safe currencies, especially US dollars. This enables rich countries to respond to crises with the necessary fiscal and monetary tools. The opposite is true for DECs. Since the outbreak of the COVID-19 crisis, international investors have withdrawn large sums from DEC assets, leading to dramatic currency depreciation, especially for those exposed to falling commodity prices.

Over the past decade, ample global liquidity driven by rich country central banks, alongside sustained demand for liquid assets, has led to enormous flows of credit and equity investment into DECs, where bond and stock markets grew from about 15 trillion to 33 trillion US dollars between 2008 and 2019. ‘Frontier economies’ and DECs corporations have issued substantial volumes of foreign currency debt. With G20 encouragement, DECs opened their domestic currency bond markets to international investors. In what has been termed the second phase of global liquidity, new financial instruments and institutions, such as international funds and exchange-traded funds (ETFs), have enabled easy global trading of DECs assets, cementing the illusion of liquidity.

DECs are now confronted with a sudden stop as global liquidity conditions tighten and investors flee from risk: exposure to DECs remains a high-risk/high-return strategy, to be liquidated in times of crisis. In consequence, DECs face severe macroeconomic adjustment at precisely the moment when all available tools should be used to counter the public health crisis presented by COVID-19: some countries may be forced to tighten monetary policy in an attempt to retain access to the US dollar, while fiscal action may be constrained by fear of losing access to global markets. Foreign exchange reserves are unlikely to provide a sufficient buffer in all countries. This would have profound consequences for the global economy: DECs, both in the G20 and beyond, are now far more important for global growth and markets than even a decade ago. The failure of a large sovereign or quasi-sovereign borrower could trigger significant contagion.

There is an urgent need for action to prevent this crisis reaching catastrophic proportions in DECs. Despite long-standing calls for action, there is still no international lender of last resort. The only instruments currently available are IMF lending and foreign exchange (FX) swap lines between central banks. IMF loans typically impose fiscal tightening, which would be disastrous under current conditions. The US Federal Reserve stands ready to provide US dollars to a handful of major central banks: among DECs, only Mexico can access Fed and US Treasury swap lines under NAFTA provisions, and South Korea and Brazil have just had their arrangements re-opened. But these ad-hoc arrangements exclude a large proportion of DECs’ need for dollar liquidity.

We call for decisive action to constrain the financial flows currently transmitting the crisis to EMs. Capital controls should be introduced to curtail the surge in outflows, to reduce illiquidity driven by sell-offs in DECs’ markets, and to arrest declines in currency and asset prices. Implementation should be coordinated by the IMF to avoid stigma and prevent contagion. FX swap lines should be extended to include more DECs, in order to ensure access to US dollars. Finally, we concur with recent calls for greater provision of liquidity by the IMF using special drawing rights (SDRs) but this must take place without the imposition of pro-cyclical fiscal adjustment.

The unfolding crisis is one of the most serious in economic history. We must ensure that governments can do everything possible to protect their citizens. In our globally integrated economy, coordinated action is needed to minimise the externally-imposed constraints on developing and emerging countries as they face the triple threat of pandemic, recession and financial crisis.

Organising Signatories

Nelson Barbosa, Sao Paolo School of Economics

Richard Kozul-Wright, UNCTAD

Kevin Gallagher, Boston University

Jayati Ghosh, Jawaharlal Nehru University

Stephany Griffith-Jones, Columbia University

Adam Tooze, Columbia University

Bruno Bonizzi, University of Hertfordshire

Daniela Gabor, UWE Bristol

Annina Kaltenbrunner, University of Leeds

Jo Michell, UWE Bristol

Jeff Powell, University of Greenwich

Signatories

Adam Aboobaker, University of Massachusetts Amherst

Kuat Akizhanov, University of Birmingham and University of Bath

Siobhán Airey, University College Dublin

Ilias Alami, Maastricht University

Alejandro Alvarez, UNAM, México

Donatella Alessandrini, University of Kent

Jeffrey Althouse, University of Sorbonne Paris Nord

Carolina Alves, Girton College – University of Cambridge

Paul Anand, Open University and CPNSS London School of Economics

Phil Armstrong, University of Southampton Solent and York College

Paul Auerbach, Kingston University

Basani Baloyi, South Africa 

Frauke Banse, University of Kassel, Germany

Benoît Barthelmess, Le Club Européen

Pritish Behuria, University of Manchester

Kinnari Bhatt, Erasmus University Rotterdam

Samuele Bibi, Goldsmiths University

Joerg Bibow, Skidmore College

Pablo Bortz, National University of San Martín

Alberto Botta, University of Greenwich

Benjamin Braun, Institute for Advanced Study, Princeton

Louison Cahen-Fourot, Vienna University of Economics and Business

Jimena Castillo, University of Leeds, UK

Eugenio Caverzasi, Università degli Studi dell’Insubria

Jennifer Churchill, Kingston University, London

M Kerem Coban, GLODEM, Koc University, Turkey

Andrea Coveri, University of Urbino, Italy

Moritz Cruz, UNAM, Mexico

Florence Dafe, HfP/TUM School of Governance, Munich

Yannis Dafermos, SOAS University of London

Daria Davitti, Lund University, Sweden

Adam Dixon, Maastricht University

Cédric Durand, Université Sorbonne Paris Nord

Chandni Dwarkasing, University of Siena, Italy

Gary Dymski, University of Leeds

Ilhan Dögüs, University of Rostock, Germany

Carlo D’Ippoliti, Sapienza University of Rome

Dirk Ehnts, Technical University of Chemnitz

Luis Eslava, Kent Law School, University of Kent

Trevor Evans, Berlin School of Economics and Law

Andreas Exner, University of Graz

Karina Patricio Ferreira Lima, Durham University

José Bruno Fevereiro, The Open University Business School

Andrew M. Fischer, Erasmus University Rotterdam

Giorgos Galanis, Goldsmiths, University of London

Santiago José Gahn, Università degli studi Roma Tre

Jorge Garcia-Arias, University of Leon, Spain and SOAS, University of London

Alicia Girón – UNAM-MEXICO

Thomas Goda, Universidad EAFIT, Colombia

Antoine Godin, University Sorbonne Paris Nord

Gabriel Gómez, UNAM, México

Jesse Griffiths, Overseas Development Institute

Diego Guevara, National University of Colombia

Alexander Guschanski, University of Greenwich

Sarah Hall, University of Nottingham

James Harrison, Prof, University of Warwick

Nicolas Hernan Zeolla, National University of San Martin, Argentina

Hansjörg Herr, Berlin School of Economics and Law

Elena Hofferberth, University of Leeds

Jens Holscher, Bournemouth University

Peter Howard-Jones, Bournemouth University

Bruno Höfig, SOAS, University of London

Roberto Iacono, Norwegian University of Science and Technology

Stefanos Ioannou, University of Oxford

Andrew Jackson, University of of Surrey 

Juvaria Jafri, City University of London

Frederico G. Jayme, Jr, Federal University of Minas Gerais, Brazil

Emily Jones, University of Oxford

Ewa Karwowski, University of Hertfordshire

Y.K. Kim, University of Massachusetts Boston

Stephen Kinsella, University of Limerick

Kai Koddenbrock, University of Frankfurt

George Krimpas, University of Athens

Sophia Kuehnlenz, Manchester Metropolitan University

Ingrid Harvold Kvangraven, University of York

Annamaria La Chimia, University of Nottingham

Dany Lang, Université Sorbonne Paris Nord

Jean Langlois, Le Club Européen

Christina Laskaridis, SOAS, University of London

Lyla Latif, University of Nairobi

Thibault Laurentjoye, École des Hautes Études en Sciences Sociales (EHESS), Paris

Dominik A. Leusder, London School of Economics

Noemi Levy-Orlik, UNAM, Mexico

Gilberto Libanio, Federal University of Minas Gerais, Brazil

Duncan Lindo, Vrije Universiteit Brussel

Lorena Lombardozzi, Open University

Anne Löscher, University of Siegen, Germany; University of Leeds

Birgit Mahnkopf, Prof.i.R., Berlin School of Economy and Law

Pedro Mendes Loureiro, University of Cambridge

Victor Isidro Luna, UNAM

Jonathan Marie, Université Sorbonne Paris Nord

Norberto Montani Martins, Federal University of Rio de Janeiro, Brazil

Olivia Bullio Mattos, St. Francis College, New York, USA

Andrew Mearman, University of Leeds

Monika Meireles, UNAM

Thorvald Grung Moe, Levy Economics Institute

Lumkile Mondi, University of the Witwatersrand, South Africa

Thanti Mthanti, University of the Witwatersrand, South Africa

Susan Newman, Open University

Howard Nicholas, International Institute of Social Studies, Erasmus University Rotterdam

Maria Nikolaidi, University of Greenwich

Patricia Northover, University of the West Indies, Jamaica

Cem Oyvat, University of Greenwich

Oktay Özden, Marmara University, Turkey

Vishnu Padayachee, University of the Witwatersrand 

Rafael Palazzi, PUC-Rio, Brazil

José Gabriel Palma, Cambridge University and USACH

Marco Veronese Passarella, University of Leeds

Jonathan Perraton, University of Sheffield

Nicolás M. Perrone, Universidad Andres Bello, Viña del Mar

Keston K. Perry, UWE Bristol

Mate Pesti, UWE Bristol

Karl Petrick, Western New England University

Christos Pierros, University of Athens

Leonhard Plank, TU Wien

Jose Pérez-Montiel, University of the Balearic Islands, Spain

Hao Qi, Renmin University of China

Mzukisi Qobo, Wits Business School, University of Witwarsrand

Joel Rabinovich, University of Leeds

Dubravko Radosevic, University of Zagreb

Miriam Rehm, University of Duisburg-Essen

Marco Flávio da Cunha Resende, Federal University of Minas Gerais, Brazil

Lena Rethel, University of Warwick

Sergio Rossi, C University of Fribourg, Switzerland

Maria Jose Romero, Eurodad

Roy Rotheim, Skidmore College

Josh Ryan-Collins, UCL Institute for Innovation and Public Purpose

Alfredo Saad Filho, King’s College London

Lino Sau, University of Torino, Italy

Malcolm Sawyer. Emeritus Professor of Economics, University of Leeds

Anil Shah, University of Kassel

Dawa Sherpa, Jawaharlal Nehru University 

Hee-Young Shin, Wright State University

Farwa Sial, Global Development Institute, University of Manchester

Crystal Simeoni, FEMNET, Nairobi, Kenya

Engelbert Stockhammer, King’s College London

Ndongo Samba Sylla, Dakar

Carolyn Sissoko, UWE Bristol

Celine Tan, University of Warwick

Gyekye Tanoh, Accra

Daniela Tavasci, School of Economics and Finance, Queen Mary University of London

Andrea Terzi, Franklin University Switzerland 

Daniele Tori, Open University Business School

Gamze Erdem Türkelli, University of Antwerp

Esra Ugurlu, University of Massachusetts Amherst

Ezgi Unsal, Kadir Has University

Tara Van Ho, University of Essex 

Sophie Van Huellen, SOAS University of London

Frank Van Lerven, New Economics Foundation

Elisa Van Waeyenberge, SOAS University of London

Paolo Vargiu, University of Leicester

Luigi Ventimiglia, School of Economics and Finance, Queen Mary University of London

Apostolos Vetsikas, University of Thessaly, Greece

Davide Villani, The Open University and Goldsmiths, University of London

Camila Villard Duran, University of Sao Paulo

Pablo Wahren, University of Buenos Aires

Neil Warner, London School of Economics

Mary Wrenn, UWE Bristol

Joscha Wullweber, University of Witten/Herdecke

Devrim Yilmaz, Université Sorbonne Paris Nord

MMT: History, theory and politics

Originally published in Spanish as “¿De dónde viene el dinero?” by Política Exterior

Modern monetary theory, or MMT as it is widely known, has achieved remarkable visibility in recent years. Despite the title, MMT can resemble a political campaign as much as a monetary theory, characterised by activists promoting job guarantee schemes alongside more scholarly activity. The core ideas of MMT coalesced in the early 1990s, developed and promoted by a small group who largely bypassed academia, instead using blogs to accumulate a dedicated band of followers. As Bill Mitchell, one of the founders of MMT, said at the recent “International MMT Conference” in New York, “This is the first body of economic theory that has grown through activists”. In recent years that following has expanded substantially, leading to global prominence for key MMT figures, and widespread media coverage and commentary.

The main propositions of MMT are derived from one simple observation: a country with its own currency cannot run out of that currency. The U.S. government cannot run out of dollars because dollars are issued by the Federal Reserve, which is controlled by the U.S government. As a result, the U.S. government will never face a situation in which it cannot find the money to pay the interest on its debt, to hire workers, or to purchase goods and services. This, MMT proponents argue, turns conventional thinking on its head: mainstream economics promotes misconceptions about public debt, imposing false barriers to public spending. In contrast, it is claimed, MMT identifies the true constraints faced by currency-issuing governments, liberating policy-makers from misguided concerns about “finding the money” to pay for government spending.

The reality, as we shall see, is a bit more complicated. But first, some history. The MMT story starts with Warren Mosler, an ex-Wall Street trader who, in the 1980s, founded both a hedge fund and a supercar manufacturer, before relocating to the Virgin Islands, a Caribbean tax haven. In the early 1990s, Mosler took his ideas on sovereign debt to Donald Rumsfeld who sent him to Arthur Laffer (of “Laffer Curve” fame). Laffer told Mosler that the high priests of economic orthodoxy were unlikely to be interested in his ideas, and suggested he instead try the Post-Keynesians: a group of left-leaning non-mainstream economists. Mosler joined a Post-Keynesian email discussion list and found common ground with academics such as L. Randall Wray and his colleagues in the US, and Bill Mitchell in Australia. The group embarked on the project of developing a new synthesis of ideas on monetary economics.

Mosler convinced the group that the commonly held view that taxes provide the funds required for government spending is false. Instead, when a currency-issuing government spends, it creates new money: when the U.S. government makes a payment, new dollars are brought into existence at the point of expenditure. Discussions framed in terms such as “where will the government find the money?” are therefore based on a flawed understanding of the monetary system, Mosler argues.

According to Mosler, the purpose of taxation is instead to create the demand for government-issued currency. In the absence of taxes, Mosler contends, there would be no demand for essentially worthless pieces of paper. But in declaring and imposing the unit (the dollar) in which tax obligations must be discharged, the government ensures widespread use and acceptability of its currency.

These ideas turned out to be compatible with those of Randall Wray, an academic who was working on “Chartalist” ideas concerning the role of the state in defining and enforcing what is used as money. In the Chartalist view, money is not and has never been a commodity such as gold. Instead, money is essentially a system of IOUs that keeps track of credit and debit positions across a society too large and complex to rely on direct credit relationships. While credit theories of money have a longstanding tradition, the novelty of Chartalism lies with the claim that “money is a creature of the state”. By imposing the use of its own currency, Chartalists argue, the government, as monopoly issuer of that currency, attains powers not available to any other economic actor.

The core of MMT is a synthesis of Mosler and Wray’s ideas about government money with elements such as Abba Lerner’s “functional finance”. Lerner argues that government finances are not appropriate targets for government policy. Instead, the government should judge its actions on the basis of real outcomes, such as the level of employment. When combined with Mosler’s assertion that a currency-issuing government is never unable to service its debt, the claim that the appropriate target for macroeconomic policy is full employment appears logical. For MMT, the limit to government spending is therefore not financial but real, imposed by the physical capacity of the economic system to produce goods and services. The limit to fiscal activism is therefore the “inflation barrier” – the point at which increases in government spending generate rising prices, rather than higher employment and production.

The last piece of the MMT puzzle is the “employer of last resort” policy. Functional finance says that government spending should be used to eliminate unemployment – but there is a catch. As unemployment is reduced, inflation is likely to strengthen. It is unlikely that true zero unemployment can be achieved simply by raising government spending: at some point inflation will set in.

The employer of last resort (ELR) is MMT’s proposed solution to this problem. The policy is deceptively simple: the government should stand ready to employ all those who want work, offering a wage set at a level below the prevailing private sector wage rate. The justification claimed is twofold. First the policy will eliminate the social ill of unemployment: all those who want work will have it. Second, by setting wages below the level in the private sector, the ELR will create a “nominal anchor”: the below-market-rate ELR wage will restrain wage demands across the economy, preventing inflation, even in the absence of unemployment. When inflation sets in, the government should respond by reducing total spending, leading to lay-offs in the private sector. These laid off workers will be picked up by the ELR, at lower wages than the private sector. This increase in the “buffer stock” of ELR workers will serve to dampen wage demands in the private sector, reducing inflationary pressure.

These three elements: sovereign money, functional finance and the employer of last resort comprise the theoretical and policy core of MMT.

Before assessing whether this provides a sound basis for policy, we need to first briefly consider some history of the relationship between economic theory and macroeconomic policy. In the advanced economic nations, the post-war years were characterised by rapid growth and very low unemployment rates. By the middle of 1970s, this benign macroeconomic environment had given way to oil price hikes, the breakdown of the Bretton Woods managed exchange rate system and rising labour militancy. Policy-makers switched their focus from employment to inflation: the influence of Milton Friedman’s monetarism led to a growing belief that using macroeconomic policy for anything other than controlling inflation was futile, and that employment should be abandoned as a policy target. Through the 1980s and 1990s, academic economics coalesced around an increasingly mathematical formalisation of Friedman’s ideas (confusingly, this acquired the title of “New Keynesian economics”). While mathematically complex, this boils down to three main propositions.

First, total spending by households and businesses – what economists refer to as aggregate demand – is determined, in the short run, by the rate of interest. Since the rate of interest is assumed to be under the control of the central bank, total spending is therefore under direct policy control. Second, inflation is determined by two factors: firstly by total spending relative to the productive capacity of the economy and, secondly, by expectations about future inflation. In this view, if inflation is too high, the central bank should raise the rate of interest, reducing total spending and thus reducing inflationary pressure. The speed at which inflation will return to target will depend on the “credibility” of the central bank: if households and businesses believe that the central bank is serious about getting inflation under control, even at the cost of higher short-run unemployment, then inflation will adjust quickly. The conclusion – the third proposition – is that the optimal way to implement macroeconomic policy is for an independent central bank to adopt a policy rule, explicitly stating how it will adjust interest rates when inflation is above target. This, it is argued, is the most effective way to ensure that the central bank is credible – and is not susceptible to politicians seeking to temporarily lower unemployment as a way to improve their electoral prospects.

A small group of dissenting “heterodox” economists maintained a position of opposition to the ascendancy of monetarist ideas, arguing that Friedman’s diagnosis relied on an over-simplified view of inflation as the result of “too much money chasing too few goods”. Drawing inspiration from Keynes and his contemporaries Michal Kalecki, Joan Robinson and Nicholas Kaldor, this group adopted the term “Post-Keynesian” to distinguish their position from that of the mainstream. The Post-Keynesians rejected the key monetarist assertion that the central bank can always influence economic activity by adjusting either the quantity of money or the policy rate of interest. As Keynes put it, monetary policy is like “pushing on a string”: tighter policy will dampen economic activity, but looser policy will not automatically act as a stimulus. Fiscal policy is therefore required for macroeconomic stabilisation.

From around the mid-1970s, Post-Keynesian economics was characterised by a transatlantic division of labour. In the UK, with Cambridge at the centre, much attention was focused on growth and distribution. In the US, a closer interest was taken in monetary and financial issues. It was with members of this group of US Post-Keynesians that Mosler formed an alliance in the 1990s. Mosler’s financial backing enabled institutional support at the University of Missouri-Kansas, where several prominent MMT developers gained employment, including a PhD training programme to incubate the next generation of MMT advocates.

While the theoretical core of MMT is close to the ideas of Post-Keynesian economics, MMT stole a march on their Post-Keynesians colleagues in exploiting social media and non-academic activism. With hindsight, however, these tactics turn out to be something of a double-edged sword: success relied on the use of slogans such as “money doesn’t grow on rich people”, “taxes don’t pay for spending” and “money is no object”. These slogans, and the zeal with which advocates adopted them, arguably serve to obscure the underlying ideas, making MMT claims appear more groundbreaking than is really the case.

Take the claim that “taxes don’t pay for spending”. It has long been taught in elementary macroeconomics classes that government spending adds to total national expenditure, while taxes are a deduction. The two variables are treated as moving independently of one another: taxation doesn’t constrain government spending. Since at least the time of Keynes, it has been understood that tax plays an important macroeconomic role in limiting total private sector spending, thus ensuring that economic capacity is available for government programmes. Whether this function should be characterised as taxes “paying for” spending is perhaps semantic.

Textbooks usually explain that the gap between government spending and taxation is covered by issuance of government bonds. MMT goes further, claiming that government spending is not financed by either taxes or bond issuance: Governments first spend, creating new money, then withdraw money from circulation by imposing taxes or issuing bonds. As a result, MMT proponents claim, taxes can be cut dramatically, without affecting the ability of government to spend, while bond issuance can be eliminated entirely.

Does MMT provide a good guide for policy? MMT proponents tend to deny that MMT provides policy proposals. Instead, it is claimed, MMT is a “lens” through which one comprehends the true nature of the monetary system. MMT is not a policy package, it is argued, because MMT is simply a description of how the system already works.

This claim stretches credibility. Putting the ELR proposal aside, MMT proponents do make policy proposals (such as those already noted). The common feature of such proposals is the use of deficit monetisation: issuing central bank money directly to pay for government programmes. For example, Warren Mosler proposes abolishing all payroll taxes, while Stephanie Kelton has argued that the Green New Deal, a massive public spending programme championed by the left of Democratic Party, can be implemented without needing to tax the wealthy.

Complaints by proponents that MMT is mischaracterised as “printing money” are therefore misplaced. The suggestion that MMT claims “deficits don’t matter” likewise causes protest: MMT proponents respond that deficits matter, but what matters is the so-called “real resource constraint”. As a result, as MMT proponents correctly note, deficits can be too small as well as too large – an obvious current example is Germany, where demand clearly falls short of real constraints, and there is substantial capacity for fiscal expansion. Despits this, MMT complaints are again misleading: MMT does argue that there is no financial constraint to government deficits. While it is almost certainly the case that the US and other advanced nations still have substantial fiscal space, despite running large deficits in some cases, the MMT claim is too extreme; at some point, fiscal limits will be reached even in rich nations. For countries further down the international currency hierarchy which face binding externally-imposed constraints related to foreign exchange needs, fiscal limits are very real.

Further, despite MMT proponents emphasising the “inflation barrier” as the true limit to deficit spending, little effort is devoted to the crucial questions of how real resources are to be mobilised: how to ensure that large government spending programmes such as the Green New Deal can be implemented without hitting supply side bottlenecks, capacity limits and political resistance. In framing everything in monetary terms, rather than real economic activity, MMT therefore obscures rather than illuminates important macroeconomic relationships.

Once the esoteric use of language and the more extreme claims are stripped away, there is arguably a rather conventional core to MMT. US economists JW Mason and Arun Jayadev argue that, in policy terms, MMT effectively amounts to a reversal of the “consensus assignment”. This refers to the idea that the two main tools of macroeconomic management, fiscal policy and monetary policy, should each be assigned a single target. The consensus assignment is that monetary policy (setting interest rates and, more recently, quantitative easing) should be used to manage aggregate demand, while fiscal policy is used to maintain sustainable debt-to-GDP ratios. In contrast, MMT proposes the use of fiscal policy to manage demand, and monetary policy (in the form of deficit monetisation and zero interest rates) to manage the public finances.

MMT is usually portrayed as a left-wing economic programme: Stephanie Kelton is an economic advisor to Bernie Sanders and Alexandria Ocasio-Cortez has said that MMT should be “part of the conversation”. But although much of the MMT activist base is on the left, the relationship between MMT and politics is more complex. The line that “money doesn’t grow on rich people” can potentially play well on the right, as much as the left. As already noted, Mosler, a self-described “Tea Party Democrat” proposes the abolition of payroll taxes. Bill Mitchell argues that MMT is politically neutral, and MMT insights can inform either left- or right-wing political programmes. Care therefore needs to be taken when associating government deficits with the political left: US Republicans use deficit scaremongering to constrain public spending by Democrat administrations, but Republican governments are often less fiscally cautious in office — Trump’s tax cuts provide a recent example. Similarly, in the UK, after nearly a decade of government cuts premised on the false threat of a run on bond markets, the Conservative government has decided to embrace deficits, cutting taxes and making eye-catching spending claims.

The ideas of MMT could also be adopted by political groups that combine socially right-wing ideas with activist fiscal policy. In their recent book, “Reclaiming The State”, Bill Mitchell and his co-author Thomas Fazi note the successful use of deficit monetisation in Nazi Germany, while decrying the “tragedy” of the Left’s focus in recent decades on “identity politics”: opposition to racism, homophobia and other forms of bigotry. This, Mitchell argues, serves to radicalise the “ethnocentrism of the proletariat”. This framing of MMT in terms of national sovereignty will have obvious appeal to those wishing to implement nativist policies, such as restricting migration, while using deficit spending to ensure employment for those on the inside.

MMT has had remarkable success in opposing needless deficit hysteria and in popularising more enlightened ideas on macroeconomic management than those prevailing since the rise of monetarism in the 1970s. Recent events have demonstrated the ineffectiveness of monetary policy as a demand management tool: it is now widely accepted that fiscal policy must play a more active role. MMT activists should therefore be commended: they have succeeded where other heterodox economists have failed in popularising these important ideas. But the use of obscurantist language, oversimplification of complex issues and the tendency to make excessive claims ultimately undermines their case.

Time will tell if MMT is destined to become a passing phase or a more permanent “part of the conversation”. What seems more certain is that the days of reliance on monetary policy as the sole macroeconomic stabilisation tool are over: fiscal policy is back on the agenda.

Brexit voting patterns, education and geography

Rob Calvert Jump and Jo Michell

We have a “featured graphic” article on Brexit voting patterns and education forthcoming in Environment and Planning A. The electronic version is here, and an ungated pre-print is here.

It is by now well established that education is one of the most statistically important demographic factors in “explaining” the Brexit vote. It also has substantial predictive power. What has not been explored, to our knowledge, is the extent to which educational attainment and geography interact: scatter plots and regressions tell us how variables move together, but they don’t (usually) include information about geographical patterns.

The figure below demonstrates why such information might be important (hi-res version here). The maps show colour-coded Leave vote percentages by local authority. Black outlines denote authorities for which the proportion of the population with less than five GCSEs is below the national average of around 36%. The match between low GCSE attainment and Brexit votes is striking: only 4 of the 85 local authorities that voted Remain had lower than average high school educational attainment: Liverpool, Sefton, the Wirral, and Leicester (researchers have recently speculated that Liverpool’s Remain vote was influenced by the city’s boycott of The Sun) Conversely, there is only a single local authority, North Kesteven in the East Midlands, with better than average educational attainment and a Leave vote share of 60% or higher.

Map of Leave votes and educational attainment

Choropleth map and cartogram hex map of Leave vote share and educational attainment in England and Wales by local authority.

Areas of below-average educational attainment and strong Leave voting show a clear geographical structure: clusters extend from the east coast into Essex and Kent in the south, and into the West Midlands and the north west of England in the north. The correlation does not hold so well in Wales, Cumbria, Northumberland and County Durham, where several local authorities with below-average GCSE attainment returned Leave votes between 50% and 60%.

Simple bivariate correlations like this are of course likely to be confounded by other factors that covary with aggregate educational attainment: age is the most obvious. To test the extent to which this may be driving the result, we construct a measure of age-adjusted educational attainment, which adjusts for the age and sex structure of the local authority – the details are in the paper. The figure below shows how this measure correlates with Leave voting (hi-res version).

Map of Leave votes shares and age-adjusted educational attainment

Choropleth map and cartogram hex map of Leave vote share and age-adjusted educational attainment in England and Wales by local authority

Once age and sex are adjusted for, the extent to which low GSCE attainment is clustered strongly among parts of the east coast, the West Midlands and the North West is even more apparent. Again the match with strong Leave votes is striking. Adjusting for age and sex removes many of the local authorities returning Leave votes between 50% and 60% from the “below average” educational attainment category, although parts of Wales are still apparent “outliers”. The area of below average (adjusted) educational attainment also extends into Remain-voting East London and Manchester.

How should these patterns be interpreted in light of the various narratives seeking explain the Brexit vote? These can broadly be divided into those emphasising cultural divergence between socially liberal Remain voters and socially conservative Leave voters, and those emphasising economic drivers such as inequality, austerity, and the effects of globalisation. Since educational attainment is closely correlated with both social attitudes and economic success, our results could be invoked in favour of either set of narratives. We therefore caution against drawing any firm conclusions on the basis of these results. The distribution of strong Brexit votes and below average educational attainment does raise potential problems, however, for narratives of the vote based on an assumed North-South divide. More on this soon.

 

Kelton and Krugman on IS-LM and MMT

The MMT debates continue apace. New critiques — the good, the bad and the ugly — appear daily. Amidst the chaos, a guest post on Alphaville from three MMT authors stood out: the piece responded directly to various criticisms while discussing the policy challenges associated with controlling demand and inflation when fiscal policy is the primary macro stabilisation tool. These are the debates we should be having.

Unfortunately, it is one step forward, two steps backwards: elsewhere Stephanie Kelton and Paul Krugman have been debating across the pages of the Bloomberg and the New York Times websites. The debate is, to put it politely, a mess.

Krugman opened proceedings with a critique of Abba Lerner’s Functional Finance: the doctrine that fiscal policy should be judged by its macroeconomic outcomes, not on whether the financing is “sound”. Lerner argued that fiscal policy should be set at a position consistent with full employment, while interest rates should be set at a rate that ensures “the most desirable level of investment”. Krugman correctly notes the lack of  precision in Lerner’s statement on interest rates. He then argues that, “Lerner neglected the tradeoff between monetary and fiscal policy”, and that if the rate of interest on government debt exceeds the rate of growth, either the debt to GDP ratio spirals out of control or the government is forced to tighten fiscal policy.

Kelton hit back, arguing that Krugman’s concerns are misplaced because interest rates are a policy variable: the central bank can set them at whatever level it likes. Kelton points out that Krugman is assuming a “crowding out” effect: higher deficits lead to higher interest rates. Kelton argues that instead of “crowding out”, Lerner was concerned about “crowding in”: the “danger” that government deficits would push down the rate of interest, stimulating too much investment. Putting aside whether this is an accurate description of Lerner’s view, MMT does diverge from Lerner on this issue: since MMT rejects a clear link between interest rates and investment,  the MMT proposal is simply to set interest rates at a low level, or even zero, and leave them there.

So far, this looks like a straightforward disagreement about the relationship between government deficits and interest rates: Krugman says deficits cause higher interest rates, Kelton says they cause lower interest rates (although she also says interest rates are a policy variable — this apparent tension in Kelton’s position is resolved later on)

Krugman responded. This is where the debate starts to get messy. Krugman takes issue with the claim that the deficit should be set at the level consistent with full employment. He argues that at different rates of interest there will be different levels of private sector spending, implying that the fiscal position consistent with full employment varies with the rate of interest. As a result, the rate of interest isn’t a pure policy variable: there is a tradeoff between monetary and fiscal policy: with a larger deficit, interest rates must be higher, “crowding out” private investment spending.

Krugman’s argument involves two assumptions: 1) there exists a direct causal relationship between the rate of interest and the level of private investment expenditure, and, 2) the central bank will react to employment above “full employment” with higher interest rates. He illustrates this using an IS curve and a vertical “full employment” line (see below). He declares that “this all seems clear to me, and hard to argue with”.

250219krugman1-jumbo

At this point the debate still appears to remain focused on the core question: do government deficits raise or lower the rate of interest? By now, Krugman is baffled with Kelton’s responses:

It seems as if she’s saying that deficits necessarily lead to an increase in the monetary base, that expansionary fiscal policy is automatically expansionary monetary policy. But that is so obviously untrue – think of the loose fiscal/tight money combination in the 1980s – that I hope she means something different. Yet I can’t figure out what that different thing might be.

This highlights two issues: first, how little of MMT Krugman has bothered to absorb, and, second, how little MMTers appear to care about engaging others in a clear debate. Kelton, following the MMT line, is tacitly assuming that all deficits are monetised and that issuing bonds is an additional, and possibly unnecessary, “sterilisation” operation. Under these assumptions, deficits will automatically lead to an increase in central bank reserves and therefore to a fall in the money market rate of interest. But Kelton at no point makes these assumptions explicit. To most people, a government deficit implicitly means bond issuance, in correspondence with the historical facts.

So Krugman and Kelton have two differences in assumptions that matter here. First, Krugman assumes a mechanical relationship between interest rates and investment and thus a downward sloping IS curve, while Kelton rejects this relationship. Second, they are assuming different central bank behaviour. Krugman assumes that the central bank will react to fiscal expansion with tighter monetary policy in the form of higher interest rates: the central bank won’t allow employment to exceed the “full employment” level. Kelton assumes, firstly, that fiscal policy can be set at the “full employment” level, without any direct implications for interest rates and, secondly, that deficits are monetised so that money market rates fall as the deficit expands.

The “debate” heads downhill from here. Krugman asks several direct questions, including “[does] expansionary fiscal policy actually reduce interest rates?”. Kelton responds, “Answer: Yes. Pumping money into the economy increases bank reserves and reduces banks’ bids for federal funds. Any banker will tell you this.” Even now,  neither party seems to have identified the difference in assumptions about central bank behaviour.

The debate then shifts to IS-LM. Krugman asks if Kelton accepts the overall framework of discussion — the one he previously noted “all seems clear to me, and hard to argue with”. Kelton responds that, no, MMT rejects IS-LM because it is “not stock-flow consistent”, while also correctly noting that Krugman simply assumes that investment is a mechanical function of the rate of interest.

In fact, Krugman isn’t even using an IS-LM model — he has no LM curve — so the “not stock flow consistent” response is off target. The stock-flow issue in IS-LM derives from the fact that the model solves for an equilibrium between equations for the stock of money (LM), and investment and saving (IS) which are flow variables. But without the LM curve it is a pure flow model: Krugman is assuming, as does Kelton, that the central bank sets the rate of interest directly. So Kelton’s claim that “his model assumes a fixed money supply, which paves the way for the crowding-out effect!” is incorrect.

Similarly, Kelton’s earlier statement that Krugman “subscribes to the idea that monetary policy should target an invisible ‘neutral rate'” makes little sense in the context of Krugman’s IS model: there is no “invisible” r* in a simple IS model of the type Krugman is using: the full employment rate of interest can be read straight off the diagram for any given fiscal position.

Krugman then took to Twitter, calling Kelton’s response “a mess”, while still apparently failing to spot that they are talking at cross purposes. Kelton hit back again arguing that,

The crude, IS-LM interpretation of Keynes demonstrates that, under normal conditions, an increase in deficit spending will push up interest rates and lead to some crowding-out of investment spending. There is no room for a technical analysis of monetary operations in that framework.

Can this discussion be rescued? Can MMT and IS-LM be reconciled? The answer, I think, turns out to be, “yes, sort of”.

I wasn’t the only person pondering this question: several people on Twitter went back to this post by Nick Rowe where he tries to “reverse engineer” MMT using the IS-LM model, and comes up with the following diagram:

Rowe-IS-LM
Does this help? I think it does. In fact, this is exactly the diagram used by Victoria Chick in 1973, in The Theory of Monetary Policy, to describe what she calls the “extreme Keynesian model” (bottom right):

Chick-Theory-Monetary-Policy-scaled

So how do we use this diagram to resolve the Krugman-Kelton debate? Before answering, it should be noted that MMTers are correct to point out problems with the IS-LM framework. Some are listed in this article by Mario Seccareccia and Marc Lavoie who conclude that IS-LM should be rejected, but “if one were to hold one’s nose,” the “least worst” configuration is what Chick calls the “extreme Keynesian” version.

To see how we resolve the debate, and at the risk of repeating myself, recall that Krugman and Kelton are talking about two different central bank reactions. In Krugman’s IS model, the central bank reacts to looser fiscal policy with higher interest rates. Kelton, on the other hand, is talking about how deficit monetisation lowers the overnight money market rate. Kelton’s claim that a government deficit reduces “interest rates” is largely meaningless: it is just a truism. Flooding the overnight markets with liquidity will quickly push the rate of interest to zero, or whatever rate of interest the central bank pays on reserve balances. It is a central bank policy choice: the opposite of the one assumed by Krugman.

But what effect will this have on the interest rates which really matter for investment and debt sustainability: the rates on corporate and government debt? The answer is “it depends” — there are far too many factors involved to posit a direct mechanical relationship.

This brings a problem that is lurking in the background into sight. Both Kelton and Krugman are talking about “interest rates” or “the interest rate” as if there were a single rate of interest, or that all rates move together — the yield curve shifts bodily with movements of the policy rate. As the chart below shows, even for government debt alone this is a problematic assumption.

yc

Now, in the original IS-LM model, the LM curve is supposed to show how changes in the government controlled “money supply” affects the long term bond rate of interest. This is because, for Keynes, the rate of interest is the price of liquidity: by giving up liquidity (money) in favour of bonds, investors are rewarded with interest payments. But the problem with this is that we know that central banks don’t set the “money supply”: they set a rate of interest. So, it has become customary to draw a horizontal MP curve, allegedly representing an elastic supply of money at the rate of interest set by the central bank. But note that in switching from a sloping to a horizontal LM curve, the “interest rate” has switched from the long bond rate to the rate set by the central bank.

So how is the long bond rate determined in the horizontal MP model? The answer is it isn’t. As in the more contemporary three-equation IS-AS-MP formulation, it is just assumed that the central bank fixes the rate of interest that determines total spending. In switching from the upward sloping LM curve to a horizontal MP curve, the crude approximation to the yield curve in the older model is eliminated.

What of the IS curve? Kelton is right that a mechanical relationship between interest rates and investment (and saving) behaviour is highly dubious. If we assume that demand is completely interest-inelastic, then we arrive at the “extreme Keynesian” vertical IS curve. But does Kelton really think that sharp Fed rate hikes will have no effect on total spending? I doubt it. As Seccareccia and Lavoie note, once the effects of interest rates on the housing market are included, a sloping-but-steep IS curve seems plausible.

Now, does the “extreme Keynesian” IS-LM model, all the heroic assumptions notwithstanding, represent the MMT assumptions? I think, very crudely, it does. The government can set fiscal policy wherever it likes, both irrespective of interest rates and without affecting interest rates: the IS curve can be placed anywhere along the horizontal axis. Likewise, the central bank can set interest rates to anything it likes, again without having any effect on total expenditure. This seems a reasonable, if highly simplified approximation to the standard MMT assumptions that fiscal policy and monetary policy can be set entirely independently of each other.

But is it useful? Not really, other than perhaps in showing the limitations of IS-LM. The only real takeaway is that we deserve a better quality of economic debate. People with the visibility and status of Kelton and Krugman should be able to identify the assumptions driving their opponent’s conclusions and hold a meaningful debate about whether these assumptions hold — without requiring some blogger to pick up the pieces.

Misunderstanding MMT

MMT continues to generate debate. Recent contributions include Jonathan Portes’ critique in Prospect and Stephanie Kelton’s Bloomberg op-ed downplaying the AOC and Warren tax proposals.

Something that caught my eye in Jonathans’ discussion was this quote from Richard Murphy: “A government with a balanced budget necessarily denies an economy the funds it needs to function.” This is an odd claim, and not something that follows from MMT.

Richard has responded to Jonathan’s article, predictably enough with straw man accusations, and declaring, somewhat grandiosely, that “the left and Labour really do need to adopt the core ideas of modern monetary theory … This debate is now at the heart of what it is to be on the left”

Richard included a six-point definition of what he regards to be the core propositions of MMT. Paraphrasing in some cases, these are:

  1. All money is created by the state or other banks acting under state licence
  2. Money only has value because the government promises to back it …
  3. … because taxes must be paid in government-issued money
  4. Therefore government spending comes before taxation
  5. Government deficits are necessary and good because without them the means to make settlement would not exist in our economy
  6. This liberates us to think entirely afresh about fiscal policy

Of these, I’d say the first is true, with some caveats, the second and third are partially true, and the fourth is sort of true but also not particularly interesting. I’ll leave further elaboration for another time, because I want to focus on point five, which is almost a restatement of the quote in Jonathan’s Prospect piece.

This claim is neither correct nor part of MMT. I don’t believe that any of the core MMT scholars would argue that deficits are required to ensure that there is sufficient money in circulation. (Since Richard uses the term “funds” in the first quote and “means [of] settlement” in the second, I’m going to assume he means money).

To see why, consider what makes up “money” in a modern monetary system. Bank deposits are the bulk of the money we use. These are issued by private banks when they make loans. Bank notes, issued by the Bank of England make up a much smaller proportion of the money in the hands of the public. Finally, there are the balances that private banks hold at the Bank of England, called reserves.

What is the relationship between these types of money and the government surplus or deficit? The figure below shows how both deposits and reserves have changed over time, alongside the deficit.

uk-money-supply-deficit

Can you spot a connection between the deficit and either of the two money measures? No, that’s because there isn’t one — and there is no reason to expect one.

Reserves increase when the Bank of England lends to commercial banks or purchases assets from the private sector. Deposits increase when commercial banks lend to households or firms. Until 2008, the Bank of England’s inflation targeting framework meant it aimed to keep the amount of reserves in the system low — it ran a tight balance sheet. Following the crisis, QE was introduced and the Bank rapidly increased reserves by purchasing government debt from private financial institutions. Over this period, and despite the increase in reserves, the ratio of deposits to GDP remained pretty stable.

The quantity of neither reserves nor deposits have any direct relationship with the government deficit. This is because the deficit is financed using bonds. For every £1bn of reserves and deposits created when the government spends in excess of taxation, £1bn of reserves and deposits are withdrawn when the Treasury sells bonds to finance that deficit.

This is exactly what MMT says will happen (although MMT also argues that these bond sales may not always be necessary). So MMT nowhere makes the claim that deficits are required to ensure that the system has enough money to function.

It is true that the smooth operation of the banking and financial system relies on well-functioning markets in government bonds. During the Clinton Presidency there were concerns that budget surpluses might lead the government to pay back all debt, thus leaving the financial system high and dry.

But the UK is not in any danger of running out of government debt. Government surpluses or deficits thus have no bearing on the ability of the monetary system to function.

The macroeconomic reason for running a deficit is straightforward and has nothing to do with money. The government should run a deficit when the desired saving of the private sector exceeds the sum of private investment expenditure and the surplus with the rest of the world. This is not an insight of MMT: it was stated by Kalecki and Keynes in the 1930s.

If a debate about MMT really is at “the heart of what it is to be on the left” then Richard might want to take a break to get up to speed on MMT (and monetary economics) before that debate continues.

A belated reply to Fazi and Mitchell on Brexit

Bruno Bonizzi and Jo Michell

In a Jacobin article earlier this year, Thomas Fazi and Bill Mitchell argued in favour of a hard Brexit. We published a reply, also in Jacobin. Fazi and Mitchell (FM) responded with accusations of strawman arguments, false claims, bias and muddled thinking. We intended to write a reply at the time, but other commitments got in the way. However we believe that FM’s reply was sufficiently inaccurate – and in places, dishonest –  that a reply is required, even if belatedly.

Brexit predictions

In our Jacobin article we noted that pre-referendum predictions of immediate recession following a Leave vote were produced for political effect, while economists emphasised the likely longer run costs. FM dispute this interpretation, citing as evidence a letter signed by over 200 economists, warning of the likely economic effects of Brexit. One of us (Jo Michell) has some knowledge of this letter, having not only signed it but also having played a role in coordinating signatories – signatories which include a good cross-section of the UK heterodox economics community.

FM quote the letter as follows:

Focusing entirely on the economics, we consider that it would be a major mistake for the UK to leave the European Union …

The uncertainty over precisely what kind of relationship the UK would find itself in with the EU and the rest of the world would also weigh heavily for many years. In addition, there is a sizeable risk of a short-term shock to confidence if we were to see a Leave vote on June 23rd. The Bank of England has signalled this concern clearly, and we share it.

Compare FM’s edit with the original text of the letter below (our bold text).

Focusing entirely on the economics, we consider that it would be a major mistake for the UK to leave the European Union.

Leaving would entail significant long-term costs. The size of these costs would depend on the amount of control the UK chooses to exercise over such matters as free movement of labour, and the associated penalty it would pay in terms of access to the single market. The numbers calculated by the LSE’s Centre for Economic Performance, the OECD and the Treasury describe a plausible range for the scale of these costs.

The uncertainty over precisely what kind of relationship the UK would find itself in with the EU and the rest of the world would also weigh heavily for many years. In addition, there is a sizeable risk of a short-term shock to confidence if we were to see a Leave vote on June 23rd. The Bank of England has signalled this concern clearly, and we share it.

Can you see what they did there?

The first substantial paragraph of the letter — conveniently deleted by FM – focuses on the long-term costs. Midway through the second paragraph, is the following sentence: “In addition, there is a sizeable risk of a short-term shock to confidence…” (our emphasis). The letter is clearly worded: we believe that Brexit entails long-term costs and, additionally, a risk of negative short-term effects.

FM also comment – referring to the first line of the letter – “And nothing ‘entirely’ economics about that. They were trying to influence the Referendum outcome in favour of Remain.”

Of course we were trying to influence the referendum outcome – that was the point of the letter – because, on the basis of the economics, we believe Brexit to be a mistake.

Finally, FM state, “This letter was published in the Times newspaper and so received widespread coverage.” This is genuinely funny. The (paywalled) letter was almost universally ignored by the UK press – to the point that Tony Yates’ frustration became a running joke on UK economics Twitter.

FM then highlight a report published by NIESR shortly before the vote. Again FM edit their quote carefully, removing the qualifier “albeit not unanimous” from the sentence “there is a degree, albeit not unanimous, of consensus that leaving the EU would depress UK economic activity in both the short term (via uncertainty) and the long term (via trade).” Aside from the quotation, FM devote no attention to the actual contents of the report, which summarises various Brexit macro modelling exercises, include the Treasury’s long term forecasts and both long and “near term” forecasts from the OECD, LSE and NIESR themselves. With the exception of the LSE modelling exercise, all are produced using NIESR’s NiGEM model.

What do the projections show? First note that the “near term” projections run until 2020, while the longer term projections run till 2030. The long-run projections of a hard Brexit do indeed predict a large hit to GDP. The shorter run scenarios suggest a smaller hit to GDP, of between 2.6% and 3.3%, by 2020. Does this prove, as FM argue, that economists “catastrophically failed in relation to the short-run impacts of the Brexit vote”?

At risk of stating the obvious, 2020 is four and half years after the referendum vote and beyond the Article 50 period: Brexit will have happened (this is the assumption in the projections, anyway). A 3% hit to GDP by 2020 seems perfectly plausible. But saying something is plausible is not the same as saying it is certain. In the case of both the economists’ letter to the Times and FM’s next piece of evidence, an Observer poll of economists, FM choose to ignore a crucial word: risk. Stating that there is a risk something will happen is not the same as saying it will happen. Fazi is a journalist. But Mitchell, an economics professor, really should understand the distinction between risk and certainty.

So, what of those statements that a hard Brexit increases the risk of a negative economic shock by 2020? Is the projection of 3% hit to GDP by 2020 in the wake a no-deal Brexit a “catastrophic failure”? How is the UK doing since the referendum?

GDP growth came to a halt in the first quarter of 2018 after declining steadily in the wake of the Brexit vote. Despite a bounce back in the summer, the UK growth rate is currently the lowest of the G7 economies. Of course, we don’t have the counterfactual — and since UK growth is pretty much entirely dependent on household spending, consumer credit and retail, this slowdown could have come at almost any point. But with the household savings rate and net lending now negative — and clearly unsustainable — further reductions in consumer demand seem inevitable.

What of manufacturing – the great hope of the pro-Brexit Left? Corbyn recently made the case that pound devaluation in the wake of Brexit will lead to a revival of manufacturing. But the UK pound has been depreciating for decades — alongside a widening current account deficit and a steady decline in manufacturing. Investment spending in car manufacturing has halved since the Brexit vote. Several major manufacturers including BMW, Siemens and Airbus have warned that they will cease manufacturing in the UK in the event of a hard Brexit. The Society of Motor Manufacturers and Traders (SMMT) issued a warning that 860,000 skilled manufacturing jobs are at risk in the event of a hard brexit. Leaked government reports predict that low-income, Leave-voting ex-manufacturing areas of the UK will be hardest hit by a hard Brexit. This week, the European boss of Ford warned that a no-deal Brexit would be “disastrous” for UK manufacturing. AstraZeneca has announced a freeze in manufacturing investment in the UK. We could go on.

Booming Brexit Britain?

In our original reply to FM, we took issue with their attempt to paint the post-referendum period as a boom. FM claim we have misrepresented them: “to their discredit, Bonizzi and Michell are just making stuff up when they make that claim about us.” Here is the section of FM’s original article we referred to:

UK exports are at their strongest position since 2000. As the Economist recently put it: “Britain’s long-suffering makers are enjoying a once-in-a-generation boom,” as the shifts induced by Brexit engender a much-needed “rebalancing” from boom-and-bust financial services towards manufacturing. This is also spurring a growth in investment. Total investment spending in the UK — which includes both public and private investment — was the highest of any G7 country during 2017: 4 percent compared to the previous year.

The reader can decide if we are “just making stuff up”.

Having attacked us for our interpretation of the above quote, FM even go on, without a hint of irony, to quote the same Economist sentence – arguing that pound devaluation and growing export demand has led to a “virtuous circle” in which manufacturers are experiencing a   “once-in-a-generation boom … manufacturing is seeing its strongest growth since the late 1990s …”

This reinforces a point we made in our Jacobin article: FM seem to have trouble with the distinction between levels and growth rates. Manufacturing may have grown strongly in 2017 – before going into reverse and contracting at the start of 2018 – but this is in large part the result of “base effects”. Because UK manufacturing is now so small – output is still below pre-crisis levels – even small increases register as large percentage growth rates. This is not the same thing as a manufacturing “boom”.

FM made the same error in their original piece when discussing investment, where they incorrectly stated that “Total investment spending in the UK … was the highest of any G7 country during 2017” – actually it was the lowest. Now, we are prepared to accept that FM believed they were claiming that investment growth was highest – it was just a typo – but that isn’t what they wrote. Upon investigation, we discovered that FM’s error was in fact the result of carelessly pasting together two directly quoted half-sentences from the FT. Pointing out this error is not sleight of hand, and discussing base effects isn’t “throwing in some cloud” – whatever that means. (It is also good form to use quotation marks when cutting and pasting someone else’s text.)

Defenders of mainstream macro?

Next up, FM try and paint us as defenders of mainstream economics, arguing that “Bonizzi and Michell’s defense of the economics professions is thus very hard to comprehend.” This comes at the end of a long and incoherent section in which FM conflate DSGE modelling, gravity models of international trade, support for austerity and a number of other things – while, of course, stating that “it was obvious to Modern Monetary Theory (MMT) economists as early as the late 1990s that a crisis was brewing”.

FM appear to think that, because we find negative long term Brexit predictions to be plausible, we are defending every failure of economics modelling and policy over the last three decades. Clearly they haven’t bothered to check our views on this. When they conflate these issues by writing, “same models, same approach, same catastrophic errors”, they demonstrate their ignorance. DSGE macro models and gravity models may both have important flaws – but they are not the same.

Trade graphs, EU utopianism, nativism and the Irish border

There are multiple further sections in FM’s reply – on the interpretation of trade graphs, the importance of racism and the far-right, and whether the EU is a “utopia”. These are as incoherent and inaccurate as the points refuted above. To give just one more example, FM state that “… the contention by Bonizzi and Michell that the EU is the only thing preventing the UK from plunging into a quasi-fascist dystopia is untenable.” – a contention that is nowhere to be found in anything we have written. Elsewhere, FM abandon even the pretence of debate, and resort to throwing in statements like, “Hello! Is anyone there?”

FM claim – inaccurately – that in their articles and book, they have covered all the points we raise. But we raised one issue in our Jacobin article that FM conspicuously ignore in their reply: the Irish border. We wrote:

The UK government’s current position of aiming to leave the customs union without creating a hard border in Ireland is akin to a Venn diagram in which there is no intersection between the circles. For this reason, Theresa May is currently proposing two incompatible approaches, both of which are unacceptable to the EU.

As has since become overwhelmingly apparent, those who want to argue for a hard Brexit need to spell out a solution to the Irish border issue. Perhaps now would be a good time for FM to tell us theirs?

Finally, we note that in their incoherent attempt to conflate mainstream economics and opposition to Brexit, FM quote Ann Pettifor. In response to FM’s attack on us, Ann tweeted the following: “Bill Mitchell & Fazi need reminding that it is rise of nationalism & even fascism in Europe that is the threat. Progressives should lead – not walk away & vacate political space to the Far Right.”

Fazi and Mitchell have not engaged with our arguments in good faith. Their attack is not a serious attempt to engage in debate or respond to the points we raised. In a number of places it is transparently dishonest. Anyone who follows Fazi and Mitchell’s lead on these crucial issues should take a long hard look.

Should we fear the robots? Automation, productivity and employment

Special session at the British Academy of Management conference

Monday 3 September, 12.30-14.00, Room 2X242

Bristol Business School, UWE, Coldharbour Lane, BS16 1QY

A panel discussion on productivity, automation and employment, with

Frances Coppola, Finance and Economics Writer

Daniel Davies, Investment Banking Analyst

Duncan Weldon, Head of Research, Resolution Group

Chaired by Jo Michell, UWE Bristol.

Since the 2008 crisis, UK productivity has stagnated. At the same time, fears are growing that robots will challenge humans for an ever wider range of jobs. This panel brings together leading economists to discuss these apparently contradictory trends – and what should be done about them.

This is a special session so all are welcome. Conference registration is not required.

The full conference programme can be downloaded here

For more details please contact Jo Michell on jo.michell@uwe.ac.uk

 

 

 

Graph showing UK public sector net borrowing

Labour’s economic policy is not neoliberal

At what point does over-use of a term as an insult render it meaningless? Richard Murphy tested the boundary yesterday when he accused John McDonnell’s economic advisor James Meadway of delivering “deeply neoliberal, and profoundly conventional thinking”. This was prompted by a negative comment James made about Modern Monetary Theory (MMT).

In response, Richard posted a list of MMT-inspired leading questions which, wisely in my opinion, James declined to answer. Richard then accused James – and by implication Labour – of not standing up to “the bankers” (including Mark Carney) and remaining wedded to conventional/mainstream/neoclassical/neoliberal thinking (Richard seems to regard these as equivalent terms). Labour is therefore signed up, in Richard’s view, to deliver “more Tory economic policy” and “more austerity”.

This is, to put it politely, nonsense.

At the heart of the debate is the decision taken by Labour, early in Corbyn’s leadership, to adopt a fiscal rule. This commits a Labour government to balancing the books on current spending with a rolling five year target, subject to a “knockout” when interest rates are close to zero. The rule has been a source of contention since it was announced. (I expressed misgivings about its announcement.)

My preference would be for a bit more wriggle room. The two dangers that must be balanced when setting fiscal policy are insufficient demand and private sector unwillingness to finance public deficits. Insufficient demand results in unemployment or underemployment, weak wage and productivity growth, and inadequate social provision. The dangers on the flipside are unsustainable borrowing costs and, particularly if this is countered using the power of the central bank, inflation. The relative weighting given to financial market conditions and inflation in the UK is almost always too high. But this doesn’t mean the correct weight is zero, as less-sophisticated advocates of MMT sometimes appear to think.

The first danger arises when the desired saving of the private sector exceeds private sector investment. In such a situation, achievement of “full employment output” requires a government deficit – give or take the current account. Standard macroeconomics largely assumes this problem away by arguing that, outside of the zero lower bound, interest rates can always be set at a level which will induce the optimal level of demand. Consequently, monetary policy is the only tool required. I disagree with this view: I think it’s quite possible for economies to be demand-constrained and thus require fiscal demand management across a range of possible interest rates.

But on balance I think the fiscal rule has enough flexibility to allow a Labour government to maintain sensible levels of aggregate demand. In any recession in the foreseeable medium-term future it is hard to imagine that interest rates will not be cut to near zero. In this case the rule will be suspended and fiscal policy can be used “with all means necessary”. Second, the rule doesn’t preclude significant increases in government investment spending – a central part of the Labour policy programme. Government investment spending is likely to have strong multiplier effects and should help to rebalance demand in the UK’s consumption-driven economy. Finally, the rolling five year window allows for adapting the pace of current spending to negative economic shocks.

I can also see good political reasons for the rule. It provides an immediate rebuttal to those who try to perpetuate the deeply dishonest but highly successful Tory strategy of depicting Labour as the party of fiscal irresponsibility. As I understand it, the rule was formulated by Simon Wren-Lewis and Jonathan Portes, two highly credible progressive economists. Simon has been one of the most consistent and articulate critics of Tory austerity. To accuse them, as Richard is doing, of “delivering neoliberal thinking” is ludicrous.

Aside from the straightforward inaccuracies, there is a deeper problem with Richard’s argument. He equates, as do some MMT advocates, radical or progressive policy with fiscal policy. There is no question that Labour’s economic programme would mark a decisive shift in macro management: it would be the end of austerity. (Austerity was never really about managing demand and debt, in my opinion: it was cover for the ideological aim of shrinking the state.) But the truly radical aims in Labour’s programme – although not yet fully fleshed out – are on the supply side: structural reforms, but not of the sort pushed by the IMF.

There is merit to this approach, in my view. Yes, the UK economy is demand-constrained. Aside from the direct human costs, austerity has almost certainly done long-run damage to the supply-side. It must end. But over the longer run the UK faces profound challenges from an ageing population, wide geographical disparities, and the potential risks and benefits of automation. It makes sense to focus on the supply side: to have an industrial strategy. A progressive supply-side policy is not an oxymoron. (I remain concerned about how such a programme can be reconciled with a hard Brexit, as some on the Left advocate.)

I have more sympathy with MMT than James. I see it essentially as a US-focused political campaign based around a single policy: the job guarantee. I am not convinced by the policy, but it is the focus of progressive economic and political action in the US. Stephanie Kelton has done an excellent job of debunking simple deficit scaremongering. But to claim, as Richard is doing, that rejecting MMT means accepting wholesale neoliberal orthodoxy is silly – as are several of the views that Richard attributes, without justification, to James.

The left deserves a better standard of economics debate.

Argentina: From the “confidence fairy” to the (still devilish) IMF

Guest post by Pablo Bortz and Nicolás Zeolla, Researchers at the Centre of Studies on Economics and Development, IDAES, National University of San Martín, and CONICET, Argentina.

In recent days, it has become customary to recall the issuance of a USD 2.75 billion 100-year bond in June 2017. This was the most colourful event of the short-lived integration of Argentina into international capital markets, beginning in December 2015. Last week, Argentina returned to the front pages of the financial press when the government requested financial assistance to the IMF amidst capital flight and a run against the peso that authorities were struggling to stop.

This is the most recent episode in the typical cycle of an emerging economy entering financial markets, suffering a balance of payments crisis and adopting an IMF-sponsored stabilization program. It starts with the claim that we are now a respected member of the international community, with presence in the Davos forum, and the promise that this time, finally, the international “confidence fairy” will awaken and investment will flood the country because of all the profit opportunities this forgotten economy has to offer. When the fairy proves to be an hallucination, we find ourselves at the steps of the IMF, facing demands, as always, for fiscal consolidation and structural reform.

When explaining this story, it is important to have some background on the Argentineans’ fascination with the dollar, and on some very recent political history. Because of its history of financial crises and its underdeveloped capital markets, there are very few savings instruments available to the non-sophisticated investor: real estate, term deposits, and dollars. Real estate prices are denominated in dollars, but you need a lot of dollars (relative to income) to buy a house. So buying dollars is pretty much a straightforward investment in uncertain times, i.e. most of the time.

Added to that, Argentina has a higher degree of exchange rate pass-through than other developing countries. The main exporters also dominate the domestic market for cooking oil and flour; oil and energy prices are dollarized; and exchange rate movements are very closely followed at times of wage bargaining. Unlike other emerging countries, and despite the sneering of some government officials, in a semi-dollarized (or bimonetary) economy such as Argentina exchange-rate pass-through is alive and kicking, which discourages large devaluations.

It is important to remember that the previous administration of Cristina Fernandez de Kirchner had implemented pervasive capital and exchange controls, which led to the development of a (relatively small) parallel market, with almost a 60% gap between the official and the parallel exchange rate. As soon as the Macri government took power in December 2015, it lifted all exchange rate controls. The official exchange rate (10 pesos per dollar) moved towards the parallel (16 pesos per dollar), and it is one of the reasons for the increase in the inflation rate, from 24% in 2015 to 41% by the end of 2016.

The new authorities also made two big moves. One was cancelling all the debt with vulture funds with new borrowing. This officially marked the return of Argentina to international capital markets. The second move, by the central bank (now lead by Federico Sturzenegger, an MIT graduate and disciple of Rudi Dornbusch), was the adoption of an inflation-targeting regime, with a mind-set that preferred freely floating exchange rates, and not much concern for current account deficits[1].

But looking at the external front, one may even be forgiven for asking: why did this crisis take so long to burst? Argentina was haemorrhaging dollars for many years, and with no sign of reversal: since 2016 the domestic non-financial sector acquired an accumulated amount of USD 41 billion in external assets. During the same period, the current account deficit totalled another USD 30 billion, in the form of trade deficit, tourism deficit, profit remittances by foreign companies and increasing interest payments.

The well-known factor that allowed all these trends to last until now is the foreign borrowing spree that involved the government, provinces, firms, and the central bank, including the inflow from short-term investors for carry trade operations. In the case of debt issuance, since 2016 the central government, provinces and private companies, have issued a whopping USD 88 billion of new foreign debt (13% of GDP).  In the case of carry trade operations, since 2016 the economy recorded USD 14 billon of short-term capital inflows (2% of GDP). The favourite peso-denominated asset for this operations were the debt liabilities of the central bank called LEBAC (Letters of the Central Bank).  Because of this, the outstanding stock of this instrument has now become the centre of all attention.

It is important to understand the LEBACs. They were originally conceived as an inter-bank and central bank liquidity management instrument. Since the lifting of foreign exchange and capital controls and the adoption of inflation targeting, the stock of LEBACs grew by USD 18 billion. Moreover, the composition of holders has changed significantly since 2015: At that time, domestic banks held 71% of the stock, and other investors held 29%. In 2018 that proportion has reverted to 38% banks/62% to other non-financial institution holders, which includes other non-financial public institutions (such as the social security administration) (17%), domestic mutual investment funds (16%), firms (14%), individuals (9%), and foreign investors (5%). This is shown in Graph 1 and Table 1. That means that a large part of all the new issuance of LEBAC is held by investors outside the regulatory scope of the central bank, especially individuals and foreign investors. This represents a potential source of currency market turbulence because these holdings could easily be converted into foreign currency, causing a large FX depreciation.

LEBACs

Holders of LEBACs, May 2018 %
Financial institutions 39%
Non-financial public sector 17%
Mutual Investment Funds 16%
Firms 14%
Individuals 9%
Foreign investors 5%

Source: Authors’ calculation based on Central Bank of Argentina

What was the trigger of the recent sudden stop and reversal of capital flows? Supporters of the central bank authorities point towards the change in the inflation target last December, when the Chief of Staff Marcos Peña (the most powerful person in cabinet) and the Economy Minister Nicolas Dujovne moved the target from 10% to 15%. In light of the change in the target, the central bank started to gradually lower interest rates from as high as 28,75% to 26.5%, while inflation remained unabated, giving rise to rumours about the government’s internal political disputes. However, inflation remained stubbornly high even before the change in the target; and there were also some minor foreign exchange runs both before and after that announcement. In the meantime, the government did reduce the budget deficit. The problem is not of fiscal origin: one has to look to the external front.

Other analysts point towards the reversal of the global financial cycle of cheap credit, which has led to devaluation of emerging markets’ currencies across the board. The turning point, in this interpretation, was when the 10-year rate on US Treasury bonds reached the 3% threshold. In a similar vein, others highlight a tax on non-residents’ financial profits that was going to come into place on May 1st, that triggered the sell-off by foreign investors. Indeed, the run was primarily driven by foreign hedge funds and big banks (notably, JP Morgan) closing their positions in pesos and acquiring dollars. However, the impact on Argentina dwarfed the devaluations, reserve losses and interest rate increments in other developing countries.

Finally, some blame the patently disastrous response of the central bank to the first indicators of a capital flight. The run accelerated in the last three weeks. The CB initially sold all the dollars that foreign banks demanded, in an attempt to control the exchange rate, without increasing interest rates. Then the devaluation accelerated, and the central bank started to increase the interest rate, to 30, to 33, and finally to 42%. Its intervention in the exchange market was equally erratic.[2]

These points have some validity, but are insufficient to explain the full extent of the run.  The reason is that investors could enter the country and could leave it without no restriction whatsoever. The main problem is the total deregulation of the financial account and the foreign exchange market, for domestic and foreign investors. The government borrowed heavily in international markets and the central bank offered large financial gains, while the external front deteriorated and domestic non-sophisticated investors were demanding dollars at increasing speed. The most infamous and egregious measure of all is the abolition of the requirement that exporters sell their foreign currency in the foreign exchange market. Instead of having an assured supply of dollars, the central bank is now forced to lure them with a high interest rate. In such a context, where capital can move freely, anything and everything is an excuse to cash in and get out. It is therefore a mistake to focus only on individual issues. The problem is the setting – the whole policy framework.  Now, the central bank is caught between only two alternatives when choosing interest rates: either to encourage carry-trade operations, or to suffer steep devaluations.

The decision to ask for an IMF loan was in the offing for some time but was rushed during the run against the peso. The government’s first intention was to obtain a Flexible Credit Line, the best (or the least evil) of all the IMF facilities, because it provides a decent amount of money with few conditionalities, or at least its minor cousin, the Precautionary and Liquidity Line (PLL), with less money but still not many conditionalities. The IMF, instead, told Argentine negotiators that there was no room for the PLL, and they would have to apply instead for the dreaded Stand-By Arrangements. All the international support and “credibility” that the Argentine government claimed to have was of no use when it came to the moment for banking on it.

But resorting to an IMF loan was not an unavoidable decision.[3] There were other ways to obtain dollars and to cap the foreign exchange run. The government could have forced exporters to sell their foreign currencies; they could have negotiated a swap agreement with some major central bank; or they could have erected barriers to capital outflows.

The report also shows what is to be expected from now on. The IMF will ask for tough measures on labour market flexibility (which was already on the government table), further cuts to public employment, wages, transfers and pensions, and lifting of the greatly reduced trade barriers. The devaluation has already happened, but it should be mentioned that previous devaluations failed to encourage exports, while they only fostered inflation.

It is impossible to forecast what will happen in 2019. On the economic front, there are at least four big risks. The first is a recession, because of the negative impact of devaluation on private consumption. The second refers to an acceleration in the inflation rate and its distributive effects. Nobody expects now that the 2018 inflation rate will be below the 2017 number (25%), and with further devaluations, inflation could spiral to new highs. A third risk, which will be persistent throughout the year, is the eventual demand for dollars by the non-bank LEBAC holders. The fourth one is a possible (though not likely) bank run. Banks have USD 22 billion of deposits denominated in dollars. Any bank-run will directly hit reserves.

This very short experience is another example of the typical boom-and-bust cycle of emerging economies borrowing heavily in foreign currency with totally deregulated financial flows and foreign exchange markets, while experiencing growing current account imbalances. If one were to obtain some “new” corollaries, we would have to point to the failure of the inflation-targeting policy framework in a semi-dollarized economy with no capital controls. The IT regime did not reduce contract indexation; exchange rate flexibility did not reduce the pass-through. And relying on the “confidence fairy” is no path to development; it is rather a highway to hellish institutions. We Argentineans thought we had rid ourselves of that devil.

 

[1] The inflation target, however, was set at very optimistic levels, was never achieved in the two years since the adoption of the IT regime, and was changed last December, something that many say had an influence in recent events.

[2] Some say that this behaviour was not a bug but a feature, since it allowed foreign banks to profit in their investments and leave the country at favourable interest rates. Others, in a less conspirative but equally perverse logic of action, say that the erratic initial response was an attempt by the central bank to prove the wrongfulness of the Ministry of Economy’s approach and regain full control of monetary policy. The unfolding of events is consistent with this argument, with the caveat that even after regaining political power, the central bank proved to be still unable of stopping the run for three weeks.

[3] In fact, when the news of the SBA came, the run actually accelerated, because one of the expected IMF conditions was a devaluation of between 10 to 25%, according to the last Article 4 Consultation Report. That might help to explain why the government wasted a loan from the BIS in less than 2 weeks.

 

“A remarkable national effort”: the dismal arithmetic of austerity

Rob Calvert Jump and Jo Michell

In a recent tweet, George Osborne celebrated the fact that the UK now has a surplus on the government’s current budget. Osborne cited an FT article noting that “… deficit reduction has come at the cost of an unprecedented squeeze in public spending. That squeeze is now showing up in higher waiting times in hospitals for emergency treatment, worse performance measures in prisons, severe cuts in many local authorities and lower satisfaction ratings for GP services.”

It is a measure of how far the debate has departed from reality that widespread degradation of essential public services can be regarded as cause for celebration.

The official objective of fiscal austerity was to put the public finances back on a sustainable path. According to this narrative, government borrowing was out of control as a result of the profligacy of the Labour government. Without a rapid change of policy, the UK faced a fiscal crisis caused by bond investors taking fright and interest rates rising to unsustainable levels.

Is this plausible? To answer, we present alternative scenarios in which actual and projected austerity is significantly reduced and examine the resulting outcomes for national debt.

Public sector net debt (the headline government debt figure) in any year is equal to the debt at the end of the previous year plus the deficit plus adjustments,

jump-deficit-eqn

where PSND  is the public sector net debt at the end of financial year, PSNB is total public sector borrowing (the deficit) over the same year, and ADJ is any non-borrowing adjustment. This adjustment can be inferred from the OBR’s figures for both actual data and projections. In our simulations, we simply take the OBR adjustment figures as constants. Given an assumption about the nominal size of the deficit in each future year, we can then calculate the implied size of the debt over the projection period.

What matters is not the size of the debt in money terms, but as a share of GDP. We therefore also need to know nominal GDP for each future year in our simulations. This is less straightforward because nominal GDP is affected by government spending and taxation. Estimates of the magnitude of this effect – known as the fiscal multiplier – vary significantly. The OBR, for instance, assumes a value of 1.1 for the effect of current government spending.  In order to avoid debate on the correct size of the nominal multiplier, we assume it is equal to zero.[1] This is a very conservative estimate and, like the OBR, we believe the correct value is greater than one. The advantage of this approach is that we can use OBR projections for nominal GDP in our simulations without adjustment.

We simulate three alternative scenarios in which the pace of actual and predicted deficit reduction is slowed by a third, a half and two thirds respectively.[2] The evolution of the public debt-to-GDP ratio in each scenario is shown below, alongside actual figures and current OBR projections based on government plans.

jump-deficit2

jump-deficit

Despite the fact that the deficit is substantially higher in our alternative scenarios, there is little substantive variation in the implied time paths for debt-to-GDP ratios.  In our scenarios, the point at which the debt-to-GDP ratio reaches a peak is delayed by around two years. If the speed of deficit reduction is halved, public debt peaks at around 97% of GDP in 2019-20, compared to the OBR’s projected peak of 86% in the current fiscal year. Given the assumption of zero nominal multipliers, these projections are almost certainly too high: relaxing austerity would have led to higher growth and lower debt-to-GDP ratios.

Now consider the difference in spending.

Halving the speed of deficit reduction would have meant around £10 billion in extra spending in 2011-12, £8 billion in 2012-13, £19 billion in 2013-14, £21 billion in 2014-15, £29 billion extra in 2015-16, and £37 billion extra in 2016-17.  To put these figures into context, £37 billion is around 30% of total health expenditure in 2016-17.  The bedroom tax, on the other hand, was initially estimated to save less than £500 million per year.  These are large sums of money which would have made a material difference to public expenditure.

Would this extra spending have led to a fiscal crisis, as supporters of austerity argue? It is hard to see how a plausible argument can be made that a crisis is substantially more likely with a debt-to-GDP ratio of 97% than of 86%. Several comparable countries maintain higher debt ratios without any hint of funding problems: in 2017, the US figure was around 108%, the Belgian figure around 104%, and the French figure around 97%.

It is now beyond reasonable doubt that austerity led to increases in mortality rates – government cuts caused otherwise avoidable deaths. These could have been avoided without any substantial effect on the debt-to-GDP ratio. The argument that cuts were needed to avoid a fiscal crisis cannot be sustained.

 

[1] There is surprisingly little research on the size of nominal multipliers – most work focuses on real (i.e. inflation adjusted) multipliers.

[2] We calculate the actual (past years) or projected (future years) percentage change in the nominal deficit from the OBR figures and reduce this by a third, a half and two thirds respectively. The table below provides details of the middle projection where the pace of nominal deficit reduction is reduced by half.

jump-deficit-table