US National Debt Does Not Matter?

[sle]

I like the back and forth between to well-informed parties here. Sle and Srinir. Thank you guys. What we see manifest in this dialog is that what makes good sense on paper may run headlong into our human nature. When that happens only our intellect and education can bail us out. And that is a rather scary thing to have to fall back on, especially when it comes up against instinct.

I am not a doctor nor do I play one on TV

This all said, some of the ideas from MMT like unification of church and state, sorry, I mean of the central bank and the treasury makes a lot of sense. Some of the countries already have gone down that road cause it removes a lot of futzing around when implementing monetary policy. In the US, the Treasury needs the Congress' approval to issue debt, while the Fed, on the other hand, can issue debt freely except that it's a very special kind of debt, the bank overnights. That put's a certain S&M twist on the whole process - it's debt and it's signed by the treasury, but only the member banks can buy it.

Here is an example. Imagine (as in the recent past) that the monetary policy called for a flatter yield curve. The solution is to issue short-term debt and buy long term debt, and now you want to unwind it. So if the monetary authority was the US Treasury and they had done this, the unwind can be done in a thousand ways. They don't have to rummage around their book "Hey, what did we buy ten years ago? We have to sell that to unwind." They buy back securities which just disappear.

But when the FOMC wants to unwind the portfolio, they're turning around, opening the safe (probably Powell himself, he looks the kind *) and go "shit, if we wanna unwind, it's gotta be the shit we bought years ago".

* actually it's called the SOMA = system open market account

 

[piezoe]

I am not a doctor nor do I play one on TV

This all said, some of the ideas from MMT like unification of church and state, sorry, I mean of the central bank and the treasury makes a lot of sense. Some of the countries already have gone down that road cause it removes a lot of futzing around when implementing monetary policy. In the US, the Treasury needs the Congress' approval to issue debt, while the Fed, on the other hand, can issue debt freely except that it's a very special kind of debt, the bank overnights. That put's a certain S&M twist on the whole process - it's debt and it's signed by the treasury, but only the member banks can buy it.

Here is an example. Imagine (as in the recent past) that the monetary policy called for a flatter yield curve. The solution is to issue short-term debt and buy long term debt, and now you want to unwind it. So if the monetary authority was the US Treasury and they had done this, the unwind can be done in a thousand ways. They don't have to rummage around their book "Hey, what did we buy ten years ago? We have to sell that to unwind." They buy back securities which just disappear.

But when the FOMC wants to unwind the portfolio, they're turning around, opening the safe (probably Powell himself, he looks the kind *) and go "shit, if we wanna unwind, it's gotta be the shit we bought years ago".

* actually it's called the SOMA = system open market account

You have caused me to think about something I simply overlooked and that is the question of whether MMT is compatible with political incentives, and if not, what kinds of problems are going to crop up, and can they be overcome?

MMT economists have pointed out that when one looks at both Treasury and Fed balance sheets in a composite view, it is clear that the overall operation is coordinated, as you noted. The Fed is required to buy and sell their bonds on the secondary market, and I had always assumed, though I have never read it anywhere, that that is because it exposes their bond dealing to price discovery. But it also cuts in the Primary Dealers, i.e., the big banks, who buy at the Treasury Auctions. Perhaps this mechanism is an artifact of Banking and Fed History. It is true that the Private Banks, from 1913 until the Banking Acts of the 1930s, once had far more influence over central bank operation . Today, of course, the Fed has kept its hybrid structure, but policy is most definitely in control of the Governors and the FOMC, where the Governors dominate the vote.

What has concerned me greatly as of late is some misinformation regarding MMT that has been picked up and is being repeated by people who should know better. The claim is that MMT economists say "Deficits Don't Matter." That's a distortion of their more nuanced position. They would say, "sometimes deficits don't matter, depending on the size of the deficits and the economy." In fact, they would be quick to point out that often deficits are needed, even large deficits!

Three major factors, can affect inflation. One is productivity (GDP), one is Demand, and the other is Money Supply (Credit). The relationship between inflation and these factors is nuanced. We know that deficits do pump additional money into the private sector beyond what is withdrawn via revenue. That additional money won't necessarily show up as inflation, however, but it might at some point. So when someone implies MMT economists have concluded "Deficits Don't Matter," it makes me cringe, because I know that the MMT position is far more nuanced than that. Such an ill advised, oversimplified statement is going to show up in a media headline or a poorly informed opinion piece, and we'll be off to the races with more misinformation.

MMT economists have correctly pointed out that small deficits are the normal state and can be carried more or less indefinitely. They also point out correctly that we can't run consistent surpluses without throwing the economy into recession. That would definitely be deflationary. What I think is very important, for those wanting to gain a grasp of MMT, is to understand the relationship between deficits and savings. And that is somewhat nuanced as well and requires a little study. But that relationship is important.

The MMT economists, by their examination of the composite balance sheets, have proven that we regularly spend before we borrow, and we don't have to borrow to spend in excess of revenues. And they have thrown new light on the roles played by Taxes and Treasury Bonds; they've shown how absurdly silly this annual fight over the debt ceiling is. I'm afraid politicians don't come off looking very bright when compared to the MMT economists.

 

[piezoe]

This is from todays bloomberg: https://www.bloomberg.com/opinion/a...-three-keys-to-understanding-its-significance "
Three Things to Keep in Mind About the MMT Debate

An interesting commentary from El-Erian , the forme PIMCO CEO and Economic advisor to Allianz . He's a common contributor to Financial Times.

When we get to his point "2.", 2nd paragraph, where he brings up "risks", I sense a bit of arm waving. Makes me tend to believe that El-Erian, like so many other prominent economists, has been ignoring the work of MMT economists for a decade too long and has just woken up to the reality that these folks have a real handle on Treasury-Central Bank interaction and monetary and fiscal policy. They have gained some important insight while others were dozing. It's time for the others to wake up and catch up.

 

[sle]

Just remembered what I wanted to add here. One of the key issues with MMT is that it fails to model that inflation levels are largely driven by inflation expectations and monetary credibility. Credibility is a tricky thing, you are credible for a while; then one day you fuck up and it's gone forever. So we can increase the national debt (MMT proponents like to point to Japan which has debt of 200+ percent of GDP) and for a while nothing would happen, but if that fiscal credibility fails for some reason the results could be truly catastrophic. IMHO, of course.

 

[srinir]

Just remembered what I wanted to add here. One of the key issues with MMT is that it fails to model that inflation levels are largely driven by inflation expectations and monetary credibility.

Is there any examples of this in the modern economy where both happened?

Closest is probably UK in 1976. But at that time UK didn't have free floating currency. It was pegged to the dollar

https://en.wikipedia.org/wiki/1976_IMF_Crisis

 

[TommyR]

for mmt they do not matter due to the increased productivity and the nature of the exponential function. would you prefer to split up the regional banks again maybe with different currencies or not do that? aoc can count the money as far as im concerned. scrap em.

 

[piezoe]

Is there any examples of this in the modern economy where both happened?

Closest is probably UK in 1976. But at that time UK didn't have free floating currency. It was pegged to the dollar

https://en.wikipedia.org/wiki/1976_IMF_Crisis

If you'll forgive an interruption to this nice thread, I shall throw in a curious aside. Wilson, who resigned due to the IMF-Crisis, was preceded by Tory Prime Minister, Ted Heath. Heath was beset with problems in the economy and a virtual war with labour unions. These difficulties presaged the IMF-Crisis caused when investors became convinced that the pound would soon lose more value relative to the dollar. Dennis Healey, a classmate of Heath's at Balliol, was chancellor of the Exchequer during the crisis.

Here is what Michael J.S. Dewar, never one to mince words and also a classmate at Balliol of both Heath and Healey, had to say about the two men. (I met Dewar and his wife Mary when they were briefly guests in my home, and Dewar told me several interesting stories. Here I'll directly quote Dewar's pithy remarks that he included in a later memoir. [see a "Semiempirical Life," M.J.S. Dewar, American Chemical Society, 1992, Pg. 19.])

Several contemporaries of mine at Balliol later became major political figures in Britain; the most Notable was Ted Heath. When I say most notable, I mean that he later became the most notable. At Balliol, he seemed to us nice but not at all impressive and not really up to the intellectual standards of the place. The general view was that he could not possibly have got into Balliol had he not won a scholarship to play the organ in chapel. The next most notable, Dennis Healey, was very different, an extremely brilliant man with wide interests whom everyone liked. I think Britain would now be much a much better place if Dennis had become prime minister and Ted had languished on the back benches. (underlining is mine.)​

I still chuckle when I think of these so very Dewar-like remarks and probably quite accurate too!

 

[sle]

Is there any examples of this in the modern economy where both happened?

It happen recently in smaller economies (Israel and their Lira/debt debacle years ago, for example). Most of the recent credibility losses are in the emerging markets and relate to currencies, of course, where it is usually shaky to begin with.

 

[srinir]

Modern Monetary Theory Finds an Embrace in an Unexpected Place: Wall Street
https://www.nytimes.com/2019/04/05/business/economy/mmt-wall-street.html

But M.M.T., as it’s known, is attracting a conspicuous number of fans in an unexpected place: Wall Street. Money managers, chief executives and business analysts maintain that the approach offers several important and overlooked insights, and far from finding it fanciful or deranged, they are using M.M.T. to build economic forecasts and even trading strategies.

“I don’t look at labels in terms of what’s on the left and the right,” said Jan Hatzius, the chief economist at Goldman Sachs. “I try to look at what makes me have a better chance of getting the forecast right, and I do find some of the ideas useful.”

Paul A. McCulley, a former chief economist at the behemoth asset firm Pimco. Ideas like M.M.T. that rub against the grain of conventional economics, he said, have “for all of my career been a very useful framework for analysis.”

That framework helped produce billion-dollar gains for the company after the 2008 financial crisis. Dismissing alarms about outsize government debt and white-knuckle interest rates, Pimco instead bet successfully that rates would remain low. When it came to decision-making during this period, Mr. McCulley said, M.M.T. and other unorthodox approaches helped him “get it right.”
...
In an article posted on Wednesday on the website of Grantham, Mayo, Van Otterloo & Company, known as GMO, the strategist James Montier wrote: “For me an economic approach must help me understand the world, and provide me with some useful insights (preferably about my day job — investing). On those measures, let me assure you that M.M.T. thrashes neoclassical economics, hands down.”
..
https://www.nytimes.com/2019/04/01/...ntry=US&blockId=home-featured&imp_id=40456182

And Daniel Alpert, a managing partner of the investment bank Westwood Capital, credited the theory with preventing him from panicking that rates would soar when the Federal Reserve set off a brief “taper tantrum” in 2013 and announced it was easing its stimulus program.

Over the past couple of years, he said, the Fed tried everything — “it did a belly dance to get long-term interest rates up” — and it didn’t work.

M.M.T., Mr. Alpert said, “successfully debunks 40 years of misassumptions of how markets and public credit work.”
..

Lot more interesting material in that article

 

[ironchef]

Modern Monetary Theory Finds an Embrace in an Unexpected Place: Wall Street
https://www.nytimes.com/2019/04/05/business/economy/mmt-wall-street.html

But M.M.T., as it’s known, is attracting a conspicuous number of fans in an unexpected place: Wall Street. Money managers, chief executives and business analysts maintain that the approach offers several important and overlooked insights, and far from finding it fanciful or deranged, they are using M.M.T. to build economic forecasts and even trading strategies.

“I don’t look at labels in terms of what’s on the left and the right,” said Jan Hatzius, the chief economist at Goldman Sachs. “I try to look at what makes me have a better chance of getting the forecast right, and I do find some of the ideas useful.”

Paul A. McCulley, a former chief economist at the behemoth asset firm Pimco. Ideas like M.M.T. that rub against the grain of conventional economics, he said, have “for all of my career been a very useful framework for analysis.”

That framework helped produce billion-dollar gains for the company after the 2008 financial crisis. Dismissing alarms about outsize government debt and white-knuckle interest rates, Pimco instead bet successfully that rates would remain low. When it came to decision-making during this period, Mr. McCulley said, M.M.T. and other unorthodox approaches helped him “get it right.”
...
In an article posted on Wednesday on the website of Grantham, Mayo, Van Otterloo & Company, known as GMO, the strategist James Montier wrote: “For me an economic approach must help me understand the world, and provide me with some useful insights (preferably about my day job — investing). On those measures, let me assure you that M.M.T. thrashes neoclassical economics, hands down.”
..

And Daniel Alpert, a managing partner of the investment bank Westwood Capital, credited the theory with preventing him from panicking that rates would soar when the Federal Reserve set off a brief “taper tantrum” in 2013 and announced it was easing its stimulus program.

Over the past couple of years, he said, the Fed tried everything — “it did a belly dance to get long-term interest rates up” — and it didn’t work.

M.M.T., Mr. Alpert said, “successfully debunks 40 years of misassumptions of how markets and public credit work.”
..

Lot more interesting material in that article

Thank you for the link. I have several questions/comments:

1. Intuitively I can accept that in a close society, Government deficits really does not matter, it takes from one pocket and put it into another. As long as society as a whole can balance its book everything should come out OK - a zero sum. It is even positive if the country/society runs a surplus with others.

2. What if the society/country runs a deficit with the rest of the world? This is the situation with the US. Same outcome as #1?

3. Where are the limitations, i.e., as some engineers would say, in the limit what gives? If the Government prints 2x, 4x, 8x... eventually what happen? Is it self correcting or a run away feed back loop?

Thanks again.