Take a look at the cover: MinskyFullCover3-14 – Minsky looking like a bit of a rougue!

Here’s a link to Amazon (cut and paste if it doesn’t work):http://www.amazon.com/Ending-Poverty-Jobs-Not-Welfare/dp/1936192314/ref=sr_1_2?s=books&ie=UTF8&qid=1364998534&sr=1-2

Chairman Bernanke insisted “It is time to throw out all the stops. We’re going for broke. We will buy anything for sale. You name it, we’ll buy it.”

He admitted that the Fed has been secretly buying equities through its dealer banks. QE4 is going straight to Wall Street. Bernanke argued “Look, if several Trillion dollars of Fed purchases of stocks won’t push the Dow to 45,000, I don’t know what would.”

Bernanke said the Fed will also stand by to purchase homes. He’s heading to Detroit tomorrow to see what’s for sale.

The NYFed is looking to buy the Brooklyn Bridge if anyone knows its current location. The Dallas Fed is bidding for the Cowboys Cheerleaders. The San Francisco Fed told the Humboldt County Pot Growers Association that it would only buy medicinal grade while it awaits a legal opinion determining whether its independence includes immunity from prosecution for felonious trafficking.

Apparently misunderstanding Bernanke’s directive, the KC Fed has offered to sell the Royals.

When questioned where the Fed would find the money to fund QE4, Bernanke responded: “We learned from the first three phases that we can’t run out. Trillions, Quadrillions, Whatever! We’ve got the Magic Porridge Pot. When we want more, we just keystroke it.”

He refused to put time limits on this new phase of QE: “No, it will never end. We’re going to buy everything. The whole damned planet. Some stars, too. I want to buy some Black Holes. Those things are dense; you can stuff a lot of money into them.”

Reflecting on a world in which the Fed owns everything, Bernanke said “Yes, that’s the logical conclusion. The end game. And here’s the best thing about it: we’re independent. We should have thought of this a long time ago.”

In other news……

This morning I saw a very nice quiz concocted by a financial markets guy. I don’t want to get him in trouble so will borrow heavily from him but without attribution. If you can get this right, then you know why Quantitative Easing One, Two, and Three is a big bunch of baloney.

Consider the following thought experiment. These are the scenarios; what is the expected result of each?

A. The Treasury decides that it will fund itself 30% more in Overnight Bills and reduce bond issuance across the curve.

B. The Fed announces it will increase QE by 30% (it will remit the net income of this activity back to the Treasury)

C. Congress announces a new tax on all passive income from USTreasuries, to holders both at home and abroad (ie Central Banks), for all new-issue USTreasuries. The tax will be equal to 30% of the return in excess of the fed funds rate

D. Treas Secty Lew pre-announces that we will ‘selectively default’ and apply a haircut of 30% on all future Treasury coupon payments of new issues in excess of fed funds rate.

What will be the likely effects of each policy? Don’t peak!

OK here is what the markets guy (rightly) says:

Here’s what’s funny. Most intelligent market participants will say things like:

A. Stocks down a few percent on fear of US debt downgrade. Economy slightly weaker or unchanged.

B. Stocks up 5-10% and economy grows another 1% for 1-2 yrs; monetary stimulus.

C. Stocks down 5-10% on tax hike (like last year) that maybe corrects. Economy slows 1-2% for a year or so because it’s a tax hike (ie fiscal consolidation).

D. Stocks down 80% and we go into a great depression on steroids. All investment dollars flee the US. I can’t tell you what happens next because my Bloomberg account gets shut down. They might even declare an Internet Holiday.

Here’s what’s craziest: THESE ARE ALL THE SAME THING. The name and the processes are different, the OPTICS are different, but the net is the same. There’s the government and there’s everyone else. The government either pays more out – in interest payments or transfer payments or vendor payments, or it takes back more in taxes or default or interest ‘savings.’ Everything the government net gets in ‘revenue’ the rest of the world loses in income. Everything the government dissaves (deficits) the rest of the world saves. Equal and opposite.

Now, there’s someone who understands monetary and fiscal policy! It’s MMT all the way.

One can only hope that someday, somehow, some way, the Fed will eventually understand what the heck it is doing.

Buying Treasuries at best has a negative impact on the economy as it reduces interest income. Buying toxic waste MBSs off the balance sheets of banks might reduce their balance sheet insolvency, but does nothing to stimulate the economy. (It also teaches banksters the wrong lesson: Uncle Ben will always clean up your mess, so make another one!)

If the Fed really did start buying houses, that could help. If it bailed out indebted households that almost certainly would help. If it started hiring the unemployed, we could end this crisis in about a week. Buying bridges, cheerleaders, or black holes would be a much less efficient way to stimulate the economy, but one could envision transmission mechanisms that would allow that to work, too.

Not that I think the Fed is actually going to do that. Because it doesn’t know what it is doing.

SESSION 1: Park 5; Saturday, May 11, 9:30-10:50 Fiscal Policy after the Crisis
Session Organizer & Chair: Pavlina R. Tcherneva, Bard College and L. Randall Wray, University of Missouri-Kansas City 1. A Meme for Money and the future of entitlements, L. Randall Wray, University of Missouri – Kansas City 2. Austerity: Will the U.S. Embrace Euro ‘Misery’?, Marshall Auerback, Institute for New Economic Thinking 3. Towards Full Employment: Rethinking the Countercyclical Stabilizers, Pavlina R. Tcherneva, Bard College 4. Growth accounting, income distribution and fiscal policy, Olivier Giovannoni, Bard College Discussant: Fatma Abdel-Raouf,Goldey-Beacom College
SESSION 2: Park 5; Saturday, May 11, 11:00-12:20 Monetary Policy after the Crisis
Session Organizer & Chair: Pavlina R. Tcherneva, Bard College and L. Randall Wray, University of Missouri-Kansas City 1. “Introduction: A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis” L. Randall Wray,University of Missouri-Kansas City 2. Monetary Policy Implementation in the Shadow Banking Era: The Transmission Mechanism and Lender of Last Resort after the Global Financial Crisis”, James A. Felkerson,University of Missouri-Kansas City 3. The New Monetary Consensus after the crisis, Yeva Nersisyan, Franklin and Marshall College, 4. Lender of Last Resort Intervention Structured through the Democratic Process, Nicola Matthews,University of Missouri-Kansas City Discussion amongst participants

Anyway, here’s my presentation for the first one.

Eastern Economics Association Presentation 11 May 2013: A New Meme for Money

I studied with Hyman Minsky in the early 1980s when he was writing his 1986 book. There are two phrases in that book that I remember him saying in class:

“Anyone can create money, the problem lies in getting it accepted”

“The need to pay taxes means that people work and produce in order to get that in which taxes can be paid”.

Most of my work on money for the first decade after my Dissertation concerned the first statement—I was one of those who developed the Endogenous Money approach most closely associated with Post Keynesians however it also drew heavily on the Franco-Italian circuit approach.

So that is all about the private money system; government enters through its Central Bank as the provider of bank reserves. My first book, “Money and Credit in Capitalist Economies” went through all of that in 1990, and I’ve continued work in that area as I examined the causes of the Thrift Crisis and later the collapse of what Minsky called Money Manager Capitalism in 2007.

However, I never forgot the other point he made: we work hard to get the government’s money because we have to pay taxes. That led me to Keynes of the Treatise and to Knapp when I was writing my dissertation with Kregel in Bologna in 1986.

I included a section on Chartalism or the State Money Approach in the 1990 book but it was very brief since I was focusing on the role of money in the private sector. So in the mid-1990s I returned to the role of the state, and discovered what I believe to be the best two articles ever written on money, by A. Mitchell Innes in 1913 and 1914. Keynes reviewed the first one and aside from some quibbles he declared it to be correct.

What struck me is that Innes was able to integrate both a State Money approach and a Credit Money approach. To understand our money, what Keynes called Modern Money, you must have both. Otherwise, to borrow a metaphor, you’ve got Hamlet without the Prince.

A group of us first at Levy and then at UMKC, but also including especially Warren Mosler and Bill Mitchell and Charles Goodhart dug deeper into this and gradually developed what is now called MMT.

Many think we claim to have invented some stand-alone entirely new approach to money.

That is false. We stand on the shoulders of giants (the third phrase I recall from Minsky)—there is no new theory in Modern Money Theory; the theory is an integration, one that integrates those two phrases from Minsky.

What is somewhat novel is updating of the description of the way the modern monetary system works in a country that issues its own currency. While I’m sure there were economists in both the Fed and the Treasury who understood all the operational details, these were not understood in academia or policy circles. They mostly still are not.

In any case, I first tried to lay out MMT in my 1998 book, Understanding Modern Money, and tried again in my most recent primer, Modern Money Theory.

I sent the manuscript of the first book to Robert Heilbroner to see if he would write a blurb. He called me on the phone—I have no idea how he got my home phone. In his soothing voice he told me he could not write the blurb, and that money is the scariest topic there is. My book would scare the hell out of readers.

And here we are a decade and a half later. In the past 2-3 years MMT has taken off, indeed, it has taken on a life of its own in the blogosphere. It is loved by many and hated by more. And as Heilbroner warned, it scares the hell out of even more.

That is why I’m shifting gears. I don’t think I can say anything more about MMT. It is as correct as a theory can be, and as good a description as we can have about real world monetary operations.

Where we continue to fail is in our explanation. We have to stop scaring people. I’ve become ever more convinced that George Lakoff is correct. The problem is not with the theory–it is with the framing. The reaction against MMT is largely moral.

That is not a back-handed slap at critics. Everything you understand is through framing, as Lakoff argues. You cannot understand without metaphors—you cannot think without stories.

Let me give you an example. Outside of the crazies, everyone knows the US government cannot run out of money. From Greenspan to Bernanke they all understand there is zero risk of involuntary default by the sovereign issuer of a currency.

And so the way that an MMTer approaches the current deficit hysteria is by pointing out that as the Federal government spends through keystrokes that credit bank accounts it can afford anything for sale in dollars.

The reaction typically goes through four stages:

1. Incredulity: That’s Crazy!

2. Fear: Zimbabwe! Weimar!

3. Moral Indignation: You’d destroy our economy!

4. Anger: You’re a Dirty Pinko Commie Fascist!

And those are my Post Keynesian friends.

Rather than winning the debate about unsustainability of debt and deficits, MMT loses the argument. How can that be? Because it’s immoral for the government to spend through the stroke of a key.

It makes no difference how accurately MMT explains the monetary operations that allow government to spend—operations that begin with budgeting by Congress, and then that involve complex procedures adopted by the Treasury, the Fed, and special private banks to ensure the Treasury has sufficient deposits in its account at the Fed so that finally some firm or household gets a credit to its bank account.

MMT will lose the argument by precisely presenting the facts. Because one can see facts only through framing.

My paper is exploring alternative framing. (here: http://www.levyinstitute.org/publications/?docid=1617) We cannot adopt the conservative, textbook framing that automatically invokes a particular market metaphor, one based on “fair exchange”. From that vantage point, there’s nothing fair about government getting something for nothing—for mere keystrokes.

Instincts prefer the “taxes pay for things” metaphor: I paid into the Social Security Trust Fund, so now I get to draw down my balance in Social Security’s lockboxes during my retirement. It makes no difference that this description is completely wrong no matter what angle of approach you take. It trumps.

And so we get self-identified progressives fighting tooth and nail against payroll tax holidays even though they completely understand the tax is regressive and that maintaining the myth means tax rates must be raised to become ever more regressive in the future which makes money’s worth calculations ever worse. Progressives prefer to destroy the program over abandoning the moral myth.

We need a new meme for money.

The meme cannot begin from markets, from free exchange, from individual choice. We need a social metaphor, a public interest alternative to the private maximization calculus. We need to focus on the positive role played by government, and its use of money to serve us well.

Government spends currency in the public interest. It promises to accept its currency in payment. The tax system stands behind our currency, and we pay taxes to keep our currency strong. Good budgeting with transparency and accountability of elected officials ensures government doesn’t spend too much.

While there is a danger that private spending could threaten price stability, our government has a range of policy instruments at its disposal to hold inflation at bay. If necessary, it can increase taxes or take other measures to cool private spending; and it can reduce its own spending as required to eliminate excess demand.

Government spending provides the currency and US bonds that we accumulate as wealth. Possession of government’s money makes us stakeholders in this great nation. The payments we receive from Social Security and other income support programs give us access to our nation’s production.

We deserve this access not because we pay taxes, but because we’re all in this together. We take care of our own. Government helps us take care of our own through its social spending—for retirement, for medical care, for food stamps, and for support of poor families.

We take care of our own.

Government cannot run out of money; it can always financially afford to take care of our own. Anything that is technologically feasible is financially affordable. It comes down to technology, resources, and political will. We’ve got the technology and the resources. We need the right meme to align the politics.

The monetary system is a wonderful creation. It allows for individual choice while giving government access to resources needed to allow it work for us to achieve a just society. The monetary system spurs entrepreneurial initiative. It finances, organizes, and distributes much of the nation’s output. It is one of the primary mechanisms used by government to accomplish the public purpose.

We need to use the monetary system to pursue the public purpose, so that we all have some success at pursuing our own individual private purposes. Together we can use money to take care of each other.

Bruce Springsteen knows something about framing:

We take care of our own

Wherever this flag’s flown

We take care of our own

When I say we should take care of our own I do not mean that in a jingoist way. Sovereign currencies are national. Rich nations have the capacity to reach beyond their borders—to take care of others. Poor nations might not be able to do that. But if they’ve got a sovereign currency they can use their monetary system to take care of their own, to the best of their ability. A rich nation, and especially a nation like the US that issues an international reserve currency, must do more than that.

The sticking point has been “crowding out”—the idea that once we get beyond the liquidity trap and return to a more “normal” ISLM world, government deficits will push up interest rates. And that will then reduce private investment, which tends to lower economic growth. Higher interest rates plus lower growth means the government’s deficit and debt ratios grow beyond “sustainable” levels.

But as I explained last week, the short term rate is completely within the control of the Fed. See here: http://www.economonitor.com/lrwray/2013/05/01/reconciling-the-liquidity-trap-with-mmt-can-delong-and-krugman-do-the-full-monty-with-deficit-owls/. Long term rates depend on the state of liquidity preference plus expectations of future Fed policy. But in any case, the Vigilantes cannot force Treasury to issue long term debt. It can stick to the short end of the maturity structure and then pay whatever rate the Fed targets.

The real danger is not that the Vigilantes go all vigilant on Uncle Sam, but rather that the Fed decides to do a Volcker (raise the overnight rate to 20%). Congress can stop that by legislating that the Fed cannot act like a Vigilante. Or, alternatively, Treasury can stay on the short end. Both of these are policy choices, completely outside the influence of Vigilantes.

By Jove, Krugman’s got it. Here’s what he wrote today:

Remember, Britain has its own currency, which means that it can’t run out of cash. Furthermore, the short-term interest rate is set by the Bank of England. And the long-term rate, to a first approximation, is a weighted average of expected future short-term rates. Unless markets believe that Britain is going to default — which it isn’t, and they won’t — this is more or less an arbitrage condition that ties down the long run rate no matter what happens to confidence. Or to be a bit more precise, it’s hard to see what would drive up long rates except a belief that the BoE will raise short rates; and why would it do that unless it sees economic recovery in prospect? http://krugman.blogs.nytimes.com/2013/05/05/george-osbornes-fear-of-ghosts/?smid=tw-NytimesKrugman&seid=auto

All he has to do is to carry that analysis beyond the current downturn. This can go on forever, of course. Keep short term interest rates low, or keep Treasury out of long maturities.

This is quite a contrast to what Krugman argued two years ago, in a critique of MMT:

And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates…. So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation… And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base… But the idea that deficits can never matter, that our possession of an independent national currency makes the whole issue go away, is something I just don’t understand. (See here: http://krugman.blogs.nytimes.com/2011/03/25/deficits-and-the-printing-press-somewhat-wonkish/; and here http://krugman.blogs.nytimes.com/2011/03/26/a-further-note-on-deficits-and-the-printing-press/.)

See also Scott Fullwiler’s nearly line-by-line take-down of Krugman’s earlier pieces here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1799068. But the important point is that he’s now got it. Let’s hope he doesn’t lose it!

And on another happy note, Larry Summers is catching on, too. See here http://mobile.reuters.com/article/idUSBRE94500720130506?irpc=932 where he argues against Reinhart and Rogoff’s misguided approach:

The extrapolation from past experience to future outlook is always deeply problematic and needs to be done with great care. In retrospect, it was folly to believe that with data on about 30 countries it was possible to estimate a threshold beyond which debt became dangerous. Even if such a threshold existed, why should it be the same in countries with and without their own currency, with very different financial systems, cultures, degrees of openness and growth experiences? And there is the chestnut that correlation does not establish causation and any tendency for high debt and low growth to go together reflects the debt accumulation that follows from slow growth.

Can anyone say “MMT” knew that all along? That was exactly the argument that Yeva Nersisyan and I made as soon as the awful book came out. See here: http://www.economonitor.com/lrwray/2013/04/17/no-rogoff-and-reinhart-this-time-is-different-sloppy-research-and-no-understanding-of-sovereign-currency/.

Here’s Krugman’s argument. To briefly summarize, historical experience has demonstrated that the “growth through austerity” argument is false. Further, the monetarists have also got it wrong: monetary policy won’t get us out of this recession trap; what we really need is a good dose of fiscal policy. Given that we are in a “liquidity trap”, we can safely expand government spending without worrying about the usual downside to deficits. And in a liquidity trap, there is really no difference between Modern Money Theory and the conventional ISLM analysis. It is only once we return to a more “normal” situation that budget deficits would “matter” in the sense that they’d cause problems.

DeLong amplifies the argument here. Once we’re out of the liquidity trap, then sustained budget deficits will push up interest rates and crowd-out private spending (especially investment). This is basic ISLM stuff. For those who have not taken intermediate macro, it is enough to know that in current conditions increasing budget deficits will not raise interest rates because the private sector welcomes all the liquid and safe government debt it can get. Further, flooding the economy through Quantitative Easing will not cause inflation because, again, everyone wants liquidity and would rather hold it than spend it. In more normal times, budget deficits and money helicopters would cause inflation and rising interest rates. And that would be bad.

Note, both of them raise additional good arguments against the R&R results and against austerity more generally. I am focusing in on the one point about the liquidity trap for the purposes of this blog simply because it seems to be the sticking point that prevents them from fully embracing MMT. From the perspective of Krugman and DeLong, MMT is fine for the liquidity trap, but wrong for the normal situation—when deficits will matter.

While many economists think the ISLM liquidity trap derives from J.M. Keynes that is actually not true. Here’s what he said (Ch 15 of the General Theory):

Nevertheless, there are two reasons for expecting that, in any given state of expectation, a fall in r will be associated with an increase in M2. In the first place, if the general view as to what is a safe level of r is unchanged, every fall in r reduces the market rate relatively to the ‘safe’ rate and therefore increases the risk of illiquidity; and, in the second place, every fall in r reduces the current earnings from illiquidity, which are available as a sort of insurance premium to offset the risk of loss on capital account, by an amount equal to the difference between the squares of the old rate of interest and the new. For example, if the rate of interest on a long-term debt is 4 per cent, it is preferable to sacrifice liquidity unless on a balance of probabilities it is feared that the long-term rate of interest may rise faster than by 4 per cent of itself per annum, i.e. by an amount greater than 0.16 per cent per annum. If, however, the rate of interest is already as low as 2 per cent, the running yield will only offset a rise in it of as little as 0.04 per cent per annum. This, indeed, is perhaps the chief obstacle to a fall in the rate of interest to a very low level. Unless reasons are believed to exist why future experience will be very different from past experience, a long-term rate of interest of (say) 2 per cent leaves more to fear than to hope, and offers, at the same time, a running yield which is only sufficient to offset a very small measure of fear.

Sorry for that. Let me translate: while the Fed can push the short term rate to a really low level (think ZIRP), there’s a limit to how low it can push the longer rates. The problem is that we “know” we will not have ZIRP forever, and when short term rates rise, there will be capital losses on longer maturity debt (that is stuck with today’s low rate). So in this environment, no matter how much QE we get, we cannot push long rates lower. It is a “liquidity trap”—banks will hold the excess reserves and earn, say, 25 basis points rather than plunging into 30 year bonds that pay, say, 2 percent, due to fear of capital losses.

Keynes’s liquidity trap argument is not relevant to the ISLM result that when the LM curve is NOT horizontal, deficits raise rates. And it is that ISLM result that is contestable.

(I won’t go into the problems with ISLM analysis; even the creator of the model, John Hicks, later rejected it. We’ve known since the 1970s that it is an incoherent mess. It really is not taken very seriously anymore and I cannot explain why Krugman clings to it. Even in its updated form—a three equation “new consensus” model—it is still a mess with real rates and Taylor rules and imagined trade-offs.)

As MMT teaches, the operational function of selling Treasuries is to offer a higher interest earning alternative to low earning reserves (recall that until the GFC reserves paid zero; now they pay a positive rate chosen by the Fed). How much higher? Well that depends on the maturity and the state of liquidity preference. As Keynes implies, when you’ve got ZIRP you’ll have to pay about 200 basis points to get banks or others to give up liquidity to hold longer maturities. When short term rates are higher and are expected to fall, the premium required on long term maturities is lower (you can even invert the yield curve structure, with short rates above long rates).

The great fear is that if the government continues to run sustained budget deficits even after recovery, it could get into a debt trap. Trying to finance those deficits supposedly pushes up interest rates paid by government, which increases debt service costs, which accelerates the growth of budget deficits and raises interest rates more. You get the picture: a vicious cycle that increases the debt-to-GDP ratio. Eventually the bond vigilantes foreclose on the US government and we’re forced to grovel like Greeks.

But that argument misses the point. Short term rates are determined by monetary policy. The Fed can pay what it wants on reserves and charge what it wants on lending at the discount window. It targets the fed funds rate and keeps it within the bounds more-or-less set by the other two rates. When the economy begins to expand, the Fed will most likely raise rates. (And while it might raise rates in response to budget deficits, that is clearly a policy decision, not something that markets do to us.)

Deficits increase bank reserves and sustained deficits will result in excess reserve positions unless countervailing action is taken. Excess reserves put downward pressure on the fed funds rate. The Fed can sell government bonds (open market sale) to relieve that pressure, or the Treasury can sell new bonds. In either case, the operational impact is to substitute Treasuries for excess reserves (it is the opposite of QE). And note that if no such action is taken, budget deficits PUSH INTEREST RATES DOWN, not up.

What interest rate will Treasury need to pay to sell those Treasuries? Well, it depends on the maturity of the issues and the state of liquidity preference at the time. The Treasury could choose to sell short term obligations (bills) at a rate that tracks the Fed’s target rate; or it can sell longer maturities. We call that “debt management”. But note that it is a policy choice. Not a bond vigilante choice. Vigilantes cannot force the Treasury to sell long maturities.

Could the Fed try to make us grovel like Greeks? Yes. It could do a Volcker—push rates above 20%. That could get the US government into a vicious interest rate-growing debt cycle. It would of course do the same to the private sector—whose debt ratio is already a lot higher than that of the federal government. Place your bets now on which crashes first: federal government that has the magic porridge pot, or the private sector that doesn’t.

You cannot completely rule out bad policy. That’s the bad part about democracy. And every other form of government. The good thing about democracy is you can throw the buggers out every now and then.

The problem is that most people think Fed independence is natural, desirable, immutable.

That’s an upcoming topic I’ll address later. The Fed is a branch of government and a creature of Congress. So the question comes down to this: Can the Fed go all vigilante on us, without Congress putting it back into its proper place?

Before presenting a quick summary of their findings, let me make two preliminary notes. First they validate what Yeva Nersisyan and I first pointed out three years ago: the crappy empirical research of Reinhart and Rogoff was driven by a small number of outliers, and by confusion of causation and correlation. Yes, some countries–Japan most notably–have high debt ratios and slow growth. R&R aggregated in such a way as to give very high weights to those countries. And those countries had high deficits and thus high accumulated debts because growth was low. Hence, there was never any support for their claim that 90% marks a causal turning point.

Second, more recently when UMASS PhD student Thomas Herndon exposed the “errors” made by R&R in their empirical work, Professor Epstein of UMASS contrasted UMASS’s economics with that of UMKC’s as follows:

“And even the “left Keynesians” of Amherst don’t go as far as some of their peers at, say, the University of Missouri – Kansas City in dismissing the possibility of high deficits leading to inflation later on. “It’s almost a talmudic claim that since no country with its own currency can go bankrupt, no deficit can be bad,” Epstein says. “They’ve made important contributions, and a lot of them are my friends, but we try to look at things more critically and not assume there are absolutes.” http://www.washingtonpost.com/blogs/wonkblog/wp/2013/04/24/inside-the-offbeat-economics-department-that-debunked-reinhart-rogoff/

Well, what do you know. UMKC students can look at things critically, too! But note that no UMKC-affiliated faculty member (and probably no student) has ever said something as silly as “no deficit can be bad”. I do not even know what that could mean. Deficits can be bad. Very bad. Very very bad. A sovereign country that issues its own currency cannot be forced into involuntary default so long as it floats its currency. That is certainly a true statement–accepted by anyone who knows anything about sovereign currencies. Whether it is talmudic I have no idea. If you’ve got the magic porridge pot, you can provide the porridge.

Can too much porridge be bad? You betcha–just read the damned story. Inflation? Yes. Currency depreciation? Probably. Leave too few resources for the private purpose? No doubt. Create a nation of couch potatoes? You’ve got it. Bury everything under a thick layer of suffocating porridge? Read the story.

Where do people like Epstein get this stuff? I have no idea.

Aside from the fact that we do not say stuff like that, I do not know why this has become the ultimate test of just how crazy MMT is. Krugman goes on and on and on about how MMT claims “deficits don’t matter”. Epstein claims we say “no deficit can be bad”. Others claim we always support deficit spending, and the bigger the better. Aside from the fact that we’ve never said anything of the sort, how is it that this has become the litmus test for “serious” or “critical” economics?

Oh, Pete Peterson, that’s why. He’s got everyone on the left just scared to death that they’ll be pegged as too dovish on deficits. Yes, we all remember those attacks back in the 1960s, on those who were just a tad bit too dovish on the pinko commies supposedly in our midst. Deficit owls–those who reject the whole Pete Peterson lie–are just too far out there. Wouldn’t want to go there! We need to retain respectability–we fear deficits, we hate them, but we’ll accept just a bit of them as the lesser of evil evils.

Here’s the reality folks. We do not argue deficits cannot be too big. Nor do we argue that government ought to try to deficit spend. Deficits are mostly nondiscretionary–the outcome of the automatic stabilizers. We could ramp up government spending today, and cut tax rates, and might find deficits actually go down. Or up. Or stay the same. Who cares? Not Moi. Functional. Finance. That is what we advocate. Sensible policy, not arbitrary deficit or debt ratios. Full employment. Low inflation. Greater equality of distribution. More democracy. Accountability of our public officials. Prison terms for banksters. What’s wrong with that?

Ok, end of rant. Here’s a summary of the great work by (probable future PhDs) Berg and Hartley:

We find that the correlation between government debt-to-GDP ratios and future growth in Reinhart and Rogoff’s (2010a and and 2010b) dataset results from outliers which come from the country most suggestive of the hypothesis that slow growth causes high levels of government debt – Japan. This evidence strengthens and reinforces criticisms recently made by Herndon, Ash, and Pollin (2013) of research suggesting a negative relationship between government debt-to-GDP ratios and real GDP growth rates. As Reinhart and Rogoff (2013) recently and quite correctly noted, “the frontier question for research is the issue of causality.” We join Reinhart and Rogoff’s call for more research illuminating this important question. To that end, we use Reinhart’s and Rogoff’s dataset, as corrected by Herndon, Ash, and Pollin (2013). Following and reinforcing Dube (2013) and Basu (2013), we use LOWESS regressions and distributed lag models and find evidence suggesting that correlation of government debt-to-GDP ratios and future growth are much more likely explained by “reverse” causation running from slow GDP growth to high government debt-to-GDP ratios than by “forward” causation running from high government debt-to-GDP ratios to slow growth. Furthermore, what little evidence there is for forward causation appears to stem almost entirely from Japanese outliers. Because – as economists generally recognize – Japan is the clearest of all cases of reverse causation, this considerably weakens the argument for forward causation. In addition, we find tremendous heterogeneity on the level of individual countries in the relationship between current government debt-to-GDP ratios and future growth. This suggests that even if substantial evidence for forward causation is eventually discovered in cross-country studies, the effect will likely be small in size and unreliable, and therefore not relevant to economic policy decisions in any particular individual country. Our findings are suggestive, but not conclusive, and more research is needed. We suggest that simultaneous equations models may offer a way forward on the “frontier question” of causality.

Read the rest over at NEP.

Here is the text of the newest interview:

Q: Around two years ago, you pointed to an economic error in R & R paper. You said (*See link at bottom) that correlation doesn’t imply causality. What do you think today in the face of the new debate on coding error triggered by a book review?

Answer: Yes, I co-authored a critique with Yeva Nersisyan that pointed to three major errors. (See here: http://www.levyinstitute.org/pubs/wp_603.pdf) First, the notion that one can simply aggregate across 800 years of data (from a variety of sources) and countries with very different monetary and fiscal policy arrangements to obtain a debt ratio threshold beyond which growth slows is highly questionable. Why should we believe the experience of a weak feudal government operating with a gold standard sheds light on a modern sovereign government that issues its own floating currency? The short answer is that we should not.

Second, the authors did not provide clear details that would allow one to separate governments that issued debt in foreign currency versus those that only issued debt in their own currency. They did not indicate which were on gold standards or had pegged exchange rates. In our view, that matters critically. A sovereign government that issues its own currency cannot be forced into involuntary default on debt denominated in that currency; it can always make payments in its own currency—a point recognized even by Alan Greenspan. On the other hand, countries that peg to gold or foreign currencies are often forced to abandon the peg, which is a technical default. And governments that issue debt in foreign currency are often forced into default. R&R simply lumped all this together because they apparently do not understand that these arrangements matter.

Third, we suspected that their results were driven by a few outliers. Further, you would need a lot more information to determine the cause and effect relation: does slow growth lead to rising debt ratios, or does high debt lead to slow growth? For example, it is quite clear that Japan’s high debt ratio today has resulted from decades of slow growth (its debt ratio was not high before it went into recession). For that reason, we wrote to them to get their data—to try to see which national experiences drove their results, and to check for “reverse causation”. They did not respond to our request.

And now we know there was a fourth problem with their results: the data they used actually did not support their results. They excluded data that conflicted with the results they reported. In other words, the results are erroneous: they have no evidence that high debt ratios lead to lower growth; the magic number—90% debt ratio—was wrong all along.

Q: Why did so many economists and politicians believe in the first place in expansionary austerity which is causing human suffering without an end in Europe today?

A: They wanted to believe it. It fit with their neoliberal ideology. Of course, this happens all the time. They should now be embarrassed. There is no such thing as expansion through fiscal austerity. It has never worked; there is no evidence to support the theory. I do believe that in some cases countries can still grow IN SPITE OF fiscal austerity. But they do not grow BECAUSE OF fiscal austerity. And, finally, R&R have not shown that high debt ratios by sovereign governments that issue debt in their own currency lead to fiscal crises. There isn’t evidence in support of this neoliberal belief, and everyone should be skeptical of the claims of deficit hysterians.

Q: What is the single most effective tool to support aggregate demand and tackle the mass unemployment in a depressed economy?

A: As Yeva and I argued in another piece (http://www.levyinstitute.org/pubs/ppb_111.pdf), in a depressed economy, you need fiscal expansion. By that I do not necessarily mean “priming the pump”—generalized spending. I think it is much better to aim the spending where it is most needed, and that usually means more jobs. Hence, I favor spending directly on job creation.

Here’s the problem. You do need fiscal policy space to engage in stimulus. Countries with their own floating currency have that space, so they can always choose to spend more to stimulate demand. Countries that peg to gold or other currencies may not have the space. And unfortunately, European countries that dropped their own currencies in order to adopt the foreign Euro currency do not individually have the policy space. So for the EMU, the fiscal expansion can only come from the center. And that is the big problem that has not been resolved. To make matters worse, the Troika still believes in expansionary austerity—a non sequitur. And so they will continue to impose austerity and suffering on the population.

http://www.ftd.de/politik/konjunktur/:neue-denker-61-randall-wray-und-der-mythos-schuldenfalle/60074210.html

However, the whole “research” method as well as the “theory” behind it was bunk anyway, as Yeva Nersisyan and I argued from the get-go. You cannot just add up across centuries, exchange rate regimes, public and private debt, and debt denominated in foreign currency as well as domestic currency. Garbage-in and garbage-out research even if they had not made statitiscal errors.

Further, they had no theory of sovereign currency. Not only is the theory in their papers and book fundamentally unsound, I know from quizzing Reinhart during one of her presentations that she’s clueless. (And you all recall Rogoff’s attempt to explain on-camera what a credit default swap is–you would probably conclude he doesn’t know much about finance, anyway. It was almost as funny as Freddie Mishkin’s attempt to explain away his fudging of the title of his research on Iceland as listed on his CV.) Like many economists, they do not understand that a sovereign government that issues debt denominated in its own floating currency cannot be forced into involuntary default. And so they make no distinction in their book–and you cannot find out from the book which supposed “sovereign default” was actually a sovereign default. I suspect that almost all of the defaults they list were by governments that issued debt in foreign currency, but they do not provide enough information to tell.

In any case, I did an interview for Canadian Business; See here for the story:

http://www.canadianbusiness.com/blogs-and-comment/economist-fight/

http://www.canadianbusiness.com/blogs-and-comment/economist-fight/

(If clicking does not work, copy and paste into your browser.)

Here’s the full interview:

1. Q: You critiqued the Reinhart-Rogoff study very early on (2010) in another paper, but there was little or no reaction then. Why has there been a reaction now to this latest critique from UMass?

A: I think there were two factors. First there was the will to believe. Everyone wanted to believe that government debt is bad. Reinhart and Rogoff seemed to have generated evidence–no matter how shoddy their research was–that supported what they wanted to believe. Second, since they had refused to provide the data, no one could check. Hence our main argument–that the method was flawed because they had no distinction between sovereign debt and nonsovereign debt–did not resonate. In other words, our critique was a bit more sophisticated–we did not accuse them of outright fraud but rather of doing something no historian would take seriously. That is, aggregating up data obtained across various types of countries (different exchange rates, different currency regimes) over hundreds of years, just leads to nonsensical results. So our critique required thinking about the subject at hand. The critique from Umass is easy to understand: they fudged the data to fit their theory. Everyone understands that. But really, if you think about it, that is a much weaker critique.

2. Q: Will the revelations about the RR study have any impact in terms of reversing or slowing the drive toward austerity? Why or why not?

A: Oh, I think so. This was the main empirical work trotted out to support austerity. It is fundamentally flawed in numerous ways. They will not be able to overcome the fact that they fudged the data. I hope people will now rethink the silly approach. Please tell me this. Suppose they really are able to “prove” that countries on gold standards 400 years ago got into trouble if their government issued too much debt that they had promised to convert to gold. Would anyone seriously believe that has any implications for a country like the USA that issues a sovereign, floating currency? You’d have to be incredibly dumb to be swayed by that. Anyone with any understanding of modern monetary relations knows that the US government (and the Japanese, UK, Australian, and Canadian governments) can always “afford” to pay interest. There is zero risk of involuntary default on government debt of such sovereign nations. Greenspan has said this; Bernanke has said it; Samuelson has said it. Rogoff and Reinhart ought to get out of their university offices now and then and confront the real world.

3. Q: Do you think the oversights/errors made by RR were innocent or planned in order to push a particular agenda? If they were deliberate, what is the agenda?

A: I do not know if they intentionally fudged the results, but the evidence points that direction. Motive? To push austerity. Can we prove intentionality? I do not think so nor do I think that is necessary. The research is crap. Ignore it and them on this topic. They do not understand sovereign debt–if they did, they would never have conducted this “research” in the first place.

Let me say that there is one piece–and only one piece–of their research that holds up. When you have a serious financial crisis–such as the Global Financial Crisis of 2008–that does lead to slow growth. However (and this is key) the crisis was set off by private debt, not sovereign debt. Learn that lesson. Forget sovereign, floating currency, debt. It is not the problem. Euro-using countries gave up their currencies and so they can get in trouble. But most of them got high government debt ratios when they tried to bail-out their private sector. That just indicates the set-up of the EMU was flawed; it tells us nothing about a country like the US that retains its own currency.

But it was all a lie. Yes, a lie. They screwed up their data analysis. Like so many times before—think Larry Summers at Harvard, Chicago’s Gene Fama, or Charles Plosser at the University of Rochester—the economists reach results counter to intuition and the real world.

Their work doesn’t pass the smell test: if it smells like nonsense it probably is nonsense.

Yeva Nersisyan (my brilliant student and coauthor) and I critiqued their book soon after it came out; see here: http://www.levyinstitute.org/pubs/wp_603.pdf. To put our conclusions as simply as possible, we concluded that they didn’t know what they are talking about.

They argued that “high” government debt ratios—say, 90% of GDP—nearly invariably lead to slow growth and to financial crisis. Our debt hysterians took that and ran—using their book as justification for austerity.

We noticed that their data just did not add up. Leave to the side the silliness of simply aggregating across 8 centuries of experience, and adding up debt ratios of countries as disparate as the USA today or, say, Greece in 1932, let alone some feudal state operating on a gold standard a couple of hundred years ago. As I’ve remarked, any real historian would find the methodology ludicrous.

More importantly, they have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency. It is not even possible to determine from their book exactly what is government debt versus private debt.

When we couldn’t make sense of their results, Yeva wrote to them to get the data. After all, their book touted their contribution to good research by proclaiming they were accumulating all this data for the good of humanity. They ignored our request. I have heard from several other researchers that Rogoff and Reinhart also ignored their repeated requests for the data.

So, finally, someone was able to obtain the data. And as we suspected, it did not add up. Rogoff and Reinhart committed the cardinal sin of academics: while their purported results fit their theory, the data they supposedly used does not. Either they fudged or they erred. It really doesn’t matter. Their results were completely, utterly wrong. And their own data proves it.

You can read a summary of the expose here: http://www.nextnewdeal.net/rortybomb/researchers-finally-replicated-reinhart-rogoff-and-there-are-serious-problems. The academic paper is here: http://www.peri.umass.edu/236/hash/31e2ff374b6377b2ddec04deaa6388b1/publication/566/

The paper confirms what we suspected: the Rogoff and Reinhart research is crap. They threw out all the high debt, good growth countries. If you put those back in, it simply is not true that high government debt leads to low growth.

Was it intentional? Who cares. Motive is not the issue. Crappy research is the problem. And this was one of the most cited papers in recent economic research. Here’s the abstract from the critical analysis of their work:

We replicate Reinhart and Rogoff and find that coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. Our finding is that when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as published in Reinhart and Rogoff. That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower. We also show how the relationship between public debt and GDP growth varies significantly by time period and country. Overall, the evidence we review contradicts Reinhart and Rogoff’s claim to have identified an important stylized fact, that public debt loads greater than 90 percent of GDP consistently reduce GDP growth.

Whoops. Do Over?

Here’s the bigger problem highlighted by Yeva and Me: they do not know what they are talking about. Sovereign countries that issue their own floating currency cannot be forced into involuntary default no matter what the debt ratio. For that reason, even if their results had not been tainted by bad research, it would have been irrelevant to the situation of any country that issues its own floating currency, such as the USA, the UK, Japan, and so on. No matter what the debt ratio, a sovereign government that issues its own currency can choose to grow the economy.

That was the lesson that should have been learned. Here’s how we ended our critique:

When it comes to a sovereign government’s budget deficit and debt there are no magic numbers or ratios that are relevant for all countries and all times. There are no thresholds that once crossed will be unsustainable or lead to lower growth. The government’s budget balance in most advanced nations is highly endogenous and is merely the other side of the coin of the nongovernment sector’s balance. The public deficit is the result of the private sector’s willingness to net save and net import.

Modern monetary theory is often interpreted as claiming that there is no real limit to the government’s ability to spend or that the government should run up deficits. Of course there is a limit to the government’s ability to spend and of course it shouldn’t spend an infinite amount. Yet, the sovereign government is not constrained financially, which means that it can never face a solvency issue. Still, it is certainly constrained in real terms meaning it can face another kind of sustainability issue: how much of the nation’s resources ought to be mobilized by government? Given the level of resources that the nongovernment sector wants to mobilize, how large should the government’s deficit be to mobilize the rest?

More than five decades ago, Abba Lerner gave the answer to this question. If there are involuntarily unemployed (we would add underemployed) people it means the deficit is too low. The government should either cut taxes or increase spending. It is certainly debatable which one is a better policy, but that’s beyond the scope of this paper. When is the deficit too large? When it’s over 3%, 7%, 10%? Again, there is no magic number and anyone who comes up with a universal number simply misunderstands the modern monetary regime and macroeconomics. In opposition to magic, Lerner proposed “functional finance”—the notion that the federal government’s budgetary outcome is of no consequence by itself, but rather, what is important is the economic effects of government spending and taxing. When total spending in the economy, including government spending, is more than what the economy is able to produce when employed at full capacity, the government should either lower its spending or raise taxes. A failure to do so will lead to inflation. So inflation is the true limit to government spending not lack of financing. Government debt is merely the result of government deficit and hence the same applies to debt as well.

Lesson to learn: ignore the Ivory Tower economists who recommend austerity and warn of “unsustainable” budget deficits in the case of sovereign currency nations. They know not of what they speak.

You see, Uncle Sam is hell-bent on generating hyperinflation through President Obama’s run-away deficits and Chairman Bernanke’s money-dumping helicopters. To protect yourself, you need to buy gold and bitcoins—like NOW!

Of course, gold sellers as well as the Winklevoss twins (you remember them from the Social Network film—they are big investors in bitcoins) love to hype the comparison of the US today with Weimar and Zimbabwa of the past. Sure, very soon you will need to take wheelbarrows of green paper money to buy a loaf of bread from your local Hannafords or Safeways. The goldbugs and bitbugs have been rushing to the safety of gold and bitcoins, respectively.

I had been encouraged to write a blog on bitcoins by commentators, and had been accumulating some research to do a column. Whoops. Too late. Bitcoins are collapsing faster than internet stocks in the dotcom collapse.

Krugman correctly fingers the problem with these “alternative” currencies: no State stands behind them. In the case of State money, as Krugman says, “paper currencies have value because they’re backed by the power of the state, which defines them as legal tender and accepts them as payment for taxes.”

Note how he slipped in MMT’s claim that “taxes drive money” (without attribution, of course, but no matter—if he gets it right, that’s good enough).

Our claim: legal tender laws are neither necessary nor sufficient to drive a currency. They are not sufficient because they are extremely hard to enforce—Kings used to heat coins fire-hot and press them into the foreheads of those who refused to accept them, but I doubt we’d let President Obama do that to our goldbugs and bitbugs today. Nor are they necessary because a legal obligation to pay taxes in the form of the currency is sufficient to drive it.

So, as we say, while taxes might not be necessary to “drive” a currency, they certainly are “sufficient”. Impose an obligation to make payments to the state in the state’s own currency and the trick is done.

Now, what drives gold and bitcoins? Well, gold does have nonmonetary value, and so only a fool would turn down an offer. The question is at what value. You know you can always resell the gold at the dentist’s office or at the jewelry. So, on the margin, you will accept gold at the value determined in the market for nonmonetary use of gold. As I recall, the total global volume of gold bullion is only something like nine meters cubed. A bit big to store in your basement, but small relative to global population. Gold will remain valuable until alchemists learn how to make it out of common elements.

What about bitcoins? Well, the supply is limited by some mathematical formula (confession: I do not know what it is, and most likely could not solve it even if I knew it so I won’t be counterfeiting it). That was supposed to be the beauty of it.

Krugman quotes Winkledinker as follows: “We have elected to put our money and faith in a mathematical framework that is free of politics and human error.” So, the supply will be kept scarce, unlike dollars that the Obama-Bernanke team is printing up by the boatload. No human errors will destroy bitcoin’s value!

For that reason, with demand continually outstripping supply, bitcoins can only go up in value. At an accelerating rate. Better buy them now!

Whoops, something happened on the way to blissful riches. Before I could write a blog, the darned speculative bubble burst.

You see, bitcoins have no use other than to circulate illegal products. And while there’s still plenty of illegality in the world, 500 euro notes work just fine to keep those illicit drugs and arms circulating.

(By the way, Uncle Sam, why not print up $1000 notes to keep abreast of the Europeans in helping to finance the drug trade? Heck, make it even more convenient with some $50,000 notes—issued through HSBC’s ATMs. Who needs trillion dollar coins to “solve” the US budget deficit problem?)

The thinking was that bitcoins are the perfect “fiat” money. No hyperinflationary government destroying their value. Let the market determine value.

But why would you accept them? Because everyone else does. I accept bitcoins because I know that BillyBob accepts them. And BillyBob takes them because BuffySue takes them. And so on. As long as we’ve got cokeheads, bitcoins have value because cokeheads will take them.

I’ve always called it the “infinite regress” argument. For the past 20 years, the critics of MMT have always argued that we’ve got it wrong. Dollars are NOT accepted because of the tax liability that stands behind them. No, they are accepted because we all believe they willbe accepted.

We don’t need no stinking taxes (or State) to back them up. It is just some sort of mass delusion that gives them value. They have value because we think they have value. And so long as we all think they have value they will be accepted. And because they are accepted they will have value. Nice circular logic there.

Indeed, that is the main alternative story about money’s origins. You see, Robinson Crusoe and Friday agreed to use seashells as a medium of exchange. The otherwise (nearly) worthless seashells were accepted because they agreed to accept them. It was more convenient, you see. And so on, up to the present day. Monetary systems rely on BillyBob and BiffySue and the trust that they will continue to accept dollars and yen and euros and marks and pesos and on and on and on.

Right. Bitcoins were the real world experiment to test the infinite regress view of money.

How’s that working for you?

Me, I’ll stick with tax driven money.