Category Archives: SFC economics

Supply-side tax-revenue increase did not materialize

One of two nifty charts in an article in this past Saturday’s New York Times shows a decline in federal corporate, personal, and payroll tax revenues of 2.7 percent, or $83 billion after adjusting for inflation last year from the year before. The article itself, written by Jim Tankersley, also points out that these revenues were $183 billion, or 5.6 percent, below Congressional Budget Office projections made in 2017, just before the tax cuts were passed. Hence, while the Trump tax cut probably increased growth, it did not have the Laffer-curve effect of increasing tax revenues.

I should also point out that any general government deficit would generate new net wealth for the non-government sector and hence tend to increase economic growth. A higher deficit increases the rate at which nongovernment financial wealth is being generated–an implication of an accounting identity. Of course, it also matters for many reasons how an increased deficit is generated.

Tom Palley vs. MMT: current differences among heterodox notables

Tom Palley, seemingly a smart post-Keynesian economist, has argued repeatedly that Modern Monetary Theory (MMT) accomplishes nothing at all that is new. In particular, Palley argues, an apparent MMT proposition to the effect that government spending is not limited by borrowings has been incorporated in many kinds of Keynesian and Post-Keynesian models for decades.

In a post from a few years ago, the MMT economist and blogger Bill Mitchell points out that MMT makes a clear case that there is no financial restraint on government spending by a sovereign government. Moreover, it does so in a way that is not old and accepted as a matter of course by other Keynesian or Post-Keynesian schools of thought. Mitchell argues that a key Palley equation (1) is an identity only and (2) cannot in any way substitute for or do the work of the principles of MMT that are at issue in the debate. Indeed, by itself, this equation is admittedly a somewhat obvious proposition that is not a new MMT insight.

The equation in question might for example be something like this:

spending + interest – tax revenues = change in government bonds + change in banks’ deposits at the central bank + changes in currency

The left-hand side is an expression for the excess of spending over receipts, while the right-hand side states all possible ways the government can increase its liabilities.

Mitchell argues that Palley reads this identity as something of a restraint that potentially limits fiscal space to a sum of tax revenues, bond sales, and new high-powered money that is determined endogenously—a mainstream-equivalent view. In contrast, Mitchell argues, MMT’s actual claim is that there is no financial limit on fiscal space (ability to deficit spend) for a monetarily sovereign government (one with its own currency, a floating exchange rate, no debti n foreign currency, and its own interest rate).

Here is the relevant passage from Bill’s post:

 “Palley (2014: 4) prefers to express this fact within what he calls “consolidated government budget restraint relations” and there is a world of difference in that construction and the way MMT thinks about these relations.

“Palley’s depiction (in four accounting statements) is squarely in the mainstream tradition. It suggests, by language, alone that government spending decisions are‘restrained’ by its ability to raise tax revenue, issue debt to the non-government sector and/or issue new ‘money’ via the central bank.

“Independent of the capacity to issue new ‘money’ via the central bank, Palley’s construction implies that the tax revenue and bond sales to the non-government sector ‘fund’public deficit spending.

“There is an implied causality operating here – a mainstream macroeconomic causality – that the tax revenue and bond sales have to come prior to the spending, although his accounting model has limited temporal dynamics expressed.” Bill Mitchell, “Modern Monetary Theory –what is new about it? – Part 3 (long),” August 25, 2016. Link to post (not secure,according to my browser)

The causal priority attributed to Tom in Bill’s last sentence would mean in essence that spending must add up to the 3 sources of funds rather than vice-versa. A mainstream view indeed.

I am slightly troubled that Bill does not use the term identity in his post as it would make his explanatory task simpler as far as I can see.

There does exist by the way a nontrivial role for the government budget identity (in conjunction with other accounting identities) in MMT economics. In a blog post from three days ago (WordPress feed version; free website sign-up required; insecure, open version at Bill’s blog), Mitchell points out that MMT consists in part of a government debt principle stating that deficits for the consolidated government-central bank sector find their counterpart as surpluses for the combined external and private domestic sectors. The government sector, including the central bank, must run a deficit in order for the private sector plus external sector to run a surplus. In a model consistent with MMT, the government budget identity specifies the asset-accumulation implications of these surpluses for the non-domestic-government sector.

In all, the recent post proposes that MMT can be summed up in six principles. Mitchell reports that the post was written after a meeting with Warren Mosler, like Mitchell a founding expositor and proponent of MMT. In this blog and elsewhere, I have been using a different, threefold description consisting of: (1) chartalist monetary theory, (2) functional finance, and (3) the employer of last resort program. These are three component bodies of theory rather than a set economic principles.

Continue reading Tom Palley vs. MMT: current differences among heterodox notables

Non-existent budget constraint allows critique of MMT

Bill Mitchell objects (in a post I read in my blog reader) to some statements being made in a “Twitter echo chamber.” These are statements that seem in my view to distort Modern Monetary Theory (MMT), a doctrine that I support. Almost certainly, Mitchell—the author of many books and articles and a critic of the euro from the left—is objecting to is comments such as the following by Mainly Macro, a mainstream UK Keynesian macro blogger.

It is very difficult not to come across MMT followers (MMTers) if you write a blog on macroeconomics. Most recently this happened when I wrote this on Trump’s tax cuts. Now unusually this post examined how to discuss these tax cuts split into two parts: one which followed the mainstream view where monetary policy controlled inflation, and another that described an MMT view where fiscal policy controls inflation.
My post was criticised by some MMTers on twitter. Not because I had got the MMT part wrong, but because I had argued in the mainstream part that a deficit generated by a tax cut could alter the intergenerational distribution of income. Now this idea is standard, but it can confuse, because you cannot transfer real resources (output) through time in a closed economy. I show how it can be done in an overlapping generations framework here. It is much easier to see how it can happen in an individual open economy, because a generation can consume overseas goods as well as domestically produced goods.
If that all seems a bit abstract, it is also important. I have argued in the past that one of Margaret

…By giving tax cuts funded by borrowing, governments can do the opposite of creating a sovereign wealth fund: future generations inherit more government debt which they have to service.

This is not the only reason why raising government debt to GDP in the long run can be detrimental, but this one is simple because it depends only on some basic economics, algebra and logic. This and other reasons will never be enough to justify cutting deficits in recessions, not even close. But being anti-austerity does not mean we can forget about debt completely, as long as we are using interest rates rather than fiscal policy to control demand. (On why you might want to do that see here.)*

A number of questions are at issue, but I will try to address the claim that fiscal policy can transfer income from one period to another. In essence, one taxes more today and thereby can spend more in 10 years, for example in such a scenario. In a blog post from earlier this year that he linked to in his recent post, Mainly Macro claims that he can show such a transfer using an overlapping generations model. In the context of such a model, the issue would appear to have to do with intertemporal budget constraints that ensure nonexplosive paths for stocks such as debt. In essence, no such debt pathway is permissible in Mainly Macro’s, or the model would allow the government to have a Ponzi scheme. Models with such constraints are rejected by MMTers, Cambridge-School Keynesians, Kaleckians, and members of many other heterodox schools of thought.

In MMT there is no budget constraint, except for one that is a mere identity implied by the accounting. An identity is simply a statement that is always true and says nothing about causality. For example, suppose the number of jars is always equal to the number of lids. One cannot ensure that there are more jars by manufacturing more lids.

In the hands of mainstream (neoclassical) macroeconomists, the government budget identity becomes a constraint that shows how spending can be moved around in time with the addition of the no-explosive pathways condition or no-Ponzi-scheme condition that applies to all spending plans. It is an example of the idea that there is no free lunch–one that appeals to many, but seems unlikely to people who are used to the idea that we have a largely irrational world with much waste and a great deal of  preventable misery.

Continue reading Non-existent budget constraint allows critique of MMT

Are bad U.S. tax policies increasing the GDP growth rate?

Here in the U.S. there has been the usual spate of commentary following apparently strong GDP growth numbers and a drop in the most-followed unemployment rate. Numerous recent books hash over many of the same ideas about U.S. and world growth. As usual, economists’ views about the new data appear in the econ-blogosphere and are widely quoted in the press.

It seems appropriate to point out that growth skeptics—the “new normal” economy theorists and inflation hawks—appear to be wrong. (Examples include mainstream macroeconomist Robert J. Gordon.) Forecasts by the IMF and others concluded that growth saw that the Trump team, with some help from Congress, was going to succeed not only in pleasing wealthy and powerful constituencies, but also in increasing rather than reducing growth.

But as usual when cuts to investment-related taxes are implemented, growth seems to be increasing but not primarily or at first by simulating the spending that tax-cutters believe they are stimulating. Cash flows are increased, and the result is increased spending in ways that are somewhat predictable. I would argue that these models are not incorrect about the direction of the immediate effect and that many critics of the policies have been wrong, with consequences for their policy recommendations.

Hence, particularly in the absence of a stimulus plan that will work strongly, there is an element of the much-talked-about “sugar high” in the plan’s effects: the new administration’s policies will not result in new capital investment of any kind, except as a secondary effect of increased total output—a capacity utilization effect.

But if you doubt your preferred theory comes up with the same answer, observe that it is hard to get a decrease in growth out of an increase in the rate of net accumulation of government liabilities in the non-public sector. That is what one would have to do to find a growth deceleration as a broad consequence of the (nonetheless unfortunate) new reduction in taxes for the wealthy.

Some are thinking of course of the valid point that investment depends mostly on demand for final goods. But demand seems to have pushed upward on investment rather than downward. A tax reduction or spending increase is not “financed” in ways that offset increases with decreases or draw upon a given “supply” of loanable funds. The word finance is not right—sometimes in a maddening way for the MMT-uninitiated—as a way to describe bond sales by a sovereign government that increases spending or cuts taxes as sovereign-currency governments do. Namely, the latter
1) simply tell banks that people have new deposits
2) make and accept payments only in their own currency
3) do not guarantee the value of a unit of their currency in gold or another currency
4) buy and sell bonds as necessary to conduct monetary policy—including the setting of one or more interest rates.
Given an understanding of this MMT story, which seems right to me, a tax cut comes quickly down to an increase in the rate of net accumulation of financial assets by sectors other than the government—and nothing more. Hence, they stimulate the economy unless no further stimulus is possible.

Of course, I have not taken into account some important details of the policies, which will make the difference for some individual taxpayers.

Moreover, MMT in my view offers the only convincing answers from a stock-flow-consistent (SFC) Post-Keynesian perspective, as argued by L. Randall Wray and other fellow MMT proponents working with awareness of work by the late Wynne Godley and other SFC lights. As they argue, a sovereign government can and might cut taxes for 10 years in a row if political-economic forces led them in that direction. No long-run analysis can tell us that this won’t happen, as long-run theories cannot not tell us of a time in which the economy is not simultaneously in some short run.

Generally, barring implementation of the Virginia School neoliberals’ vision of a constitutional end of democracy in fiscal matters as explained in a book by Nancy MacLean** (What if I don’t agree, they ask?), there will always be forces pushing toward pro-growth policies and pushes-back against a drift in policy in favor of the rich.

One alternative theory that is truly in conflict with the above posits that increasing the profit rate really increases investment, but not a more-or-less unconditional gift to people who derive most of their income from profits and other unearned income. (While I disagree with a claim of no or negative effect, I would concur that the profit rate variable is a very important driver of decisions to invest.*)

The latest tax move on capital gains reflects staggeringly bad priority-setting and a lack of targeting to the most effective point of intervention. It is an outcome of a bad theory that investors need enhanced “incentives” to make profitable investments. But unconditional cuts for the wealthy are not anti-growth in the way some non-MMT analysts have been arguing. The next major policy initiative should probably be in the direction of efforts that redress distributional imbalances and unmet fundamental needs with new spending or even tax cuts.

Postscript: And here is more for those interested in the determinants of the growth rate—as far as GDP is from being a good measure of happiness or even income: The mainstream Richmond Fed with a new  Economic Brief on research as to the effects in the U.S. of temperature increases occurring as part of global climate change. The effects in their view of a given number of degrees warming are less serious than in developing countries. They estimate separate effects for different seasons and U.S. regions.


*In essence, if asked my views, I would advocate a Steindlian approach to investment determination, rather than those usually identified as Neo-Marxian or Robinsonian. Since Steindl was a Kaleckian and Kalecki drew much from Marx, those two modern approaches share some features and lineage.

**My link is to a previous post; colleague Matias Vernengo embeds and features an interview with the book’s author in this recent post at Naked Keynesianism.


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Research addresses gender’s effects on economy’s dynamics

Gender–and the economy? Here is an update on my attempt at a feminist macroeconomic model. Pictured above is a picture of simulation results from a model designed to look at some economic implications of the fact that the institution of gender exists. As usual my concerns related to the dynamics of the economy. For example, if men are paid higher wages than women, does that change the way GDP moves over time–and how? I present this and some other model-generated output to report on my activities, rather than to comment directly on an issue. See my fiscal-policy model page for more about the overall project of which this model is a part. See this post for my presentation of the model at an academic conference. The simulation is one of the first few whose results seems to make sense on their face after work to debug the model and code (which is in a program called PHASER). the results seem to show a model that is working as expected. My three-paragraph explanation follows in italics. I talked about the model before in this post. The x and y axes both appear as bold lines in both figures. We start with the top figure of the pair. The y-axis ranges from -2 to 2. Starting from the top variable shown at the starting point on the y axis: (1) the gross markup (m, where m times wage bill equals the price) seems to be happy around its equilibrium value; (2) capacity utilization (output divided by existing capital goods) rises quickly in response to a shortfall of production relative to demand; (3) and (4) both labor forces (male and female) gradually rise in response to moderate rates of unemployment; (5) public production drops in response to rising private-sector employment, owing the operation of the fiscal-policy equation; and (6) net investment over capital rises and then remains steady, helping to check an initial rise in capacity utilization. The initial rise in this variable accounts for part of the initial rise in overall capacity utilization. Next, the second figure in the pair above shows paths against time for two variables: This figure ranges vertically from –2 to 5. Continuing our list of the pathways started in the previous paragraph: (7) in a light blue-green color, consumer loans divided by capital rise steadily throughout the simulation period; and (8) in a dark green color, government debt divided by capital falls from a value of 1 at time zero, then turns upward, rising steadily for the rest of the simulation period. Generally, the paths of these liabilities-outstanding variables are affected by movements in the first set model variables–and vice-versa. (This is the most basic idea of stock-flow consistent modeling, as advocated by leading SFC modeler Antoine Godin in this web interview.) This scenario helps to show how the investment equation works; I have deliberately kept the cyclical dynamics turned off through my choice of parameter values, in order to be see if the program can handle a simple situation. A lot of work lies ahead to get a set of parameter values that will deliver interesting, economy-relevant results.  Also, I want to mention that I have done some work on this site’s fiscal policy model page, adding some free downloads and links. I have also pruned some pages with obsolete information and files. Moreover, I have begun the process of adding a page where readers wishing to make a donation to our effort can do so, helping to sustain this noncommercial effort. It will be here. Finally, here is a link to a page on the web for an ecological model.  A related paper by Y. Dafermos, M. Nikolaidi, and G. Galanis* and came up in this post last summer (though I seem to have left out their first initials–sorry, readers). The model combines the stock-flow-consistent (SFC), post-Keynesian approach with accounting for ecological variables, all in the same model. For example, what percentage of raw materials are recycled, and how would that affect landfills? A question such as that one is joined with careful analysis of how government spending adds to stocks of government liabilities, and similar financial processes. Antoine Godin, a scholar who is prominent in the SFC approach to macro modeling is interviewed at this link about the SFC idea and his own applied work. The inclusion of two stock variables above illustrates the main concept. Note: *’A stock-flow-fund ecological macroeconomic model’, Ecological Economics, 2017, 131, pp. 191-207

Stock-flow macro model: simplified tax “reform” changes dynamics

Continuing the narrative from this earlier post in a promised return to an analytical focus: The picture above shows estimates of the terminal pathways (limit sets) traversed by each of the four variables in a simulation of a stock-flow, constant markup version of the model mooted in this article in the economics journal Metroeconomica. (Link is to article abstract.) The four variables are, reading clockwise from the upper-left panel, u, b, p, and g.

Here is a key:
u = capacity utilization b = government securities outstanding
g = growth rate of capital stock p = public production
Note: All variables are various quantities divided by the capital stock, and in the case of p, multiplied by a constant.

In each figure, the horizontal axis measures the difference between the model’s tax rates on wage or salary income on the one hand and interest and profit income on the other.

The model assumes that the central bank sets a constant interest rate in inflation-adjusted terms and changes fiscal policy p (basically, spending on wages of public-sector workers who produce a free service) in response to values of 2 variables: (1) the current policy setting and (2) capacity utilization, or the percentage of the private sector’s capital stock that is employed.

The exact results in the figure depend on the starting point for all 4 variables, which is simply assumed somewhat at random. They are not likely to be extremely sensitive to this choice. Values on the independent (x axis) variable correspond to the gap between the tax rate on profits and interest on government debt and the corresponding rate on wage or salary income. At values on the x-axis associated with more than one point directly above, the terminal pathway for the degree of tax-rate progressivity shown on the x axis is estimated to be a cycle traversing a set of points, rather than a unique equilibrium point. (See note below.)

The vertical y axis shown at the center of each diagram divides the figure into regressive and progressive values for the tax-rate gap, where distinction depends on which rate is higher. Note for example how the terminal pathway for u (shown in the upper left panel in the figure) first falls and then rises and how it begins with convergence to a point for very regressive tax systems, changes to apparent convergence to a cycle, then reverts to convergence to a point, given the assumed initial point.

The rise in capacity utilization shown in the upper left panel above is a result of what I would consider reasonable assumptions as to the sensitivity of investment decisions to the after-tax profit rate–rather small. Given that assumption, increasingly progressive values of the tax-rate-difference parameter encountered as one moves rightward on the diagram yield higher and higher average capacity utilization, as a higher percentage of after-tax income goes to worker households, which are assumed to spend 100 percent of such cash inflows immediately.

Note the worker tax rate is assumed constant; the tax-rate-gap being varied as one moves from side to side in the figure affects only the rate for wealth holders, leaving the tax rate for labor income constant. So, in the right (progressive tax system) side of the figure, a tax reform that merely lowers the tax premium paid by interest and profit earners lowers the average capacity utilization rather than increasing it. Thus, despite Keynesian influences, the tax cut reduces the flow of private-sector production, forcing public production (shown in the lower-right panel) to be higher on average after sufficient evolution toward an estimated “limit cycle” or equilibrium point. To some extent, the inclusion of a variable for interest-bearing government debt means that one takes into account “medium run” stock-flow effects of rising interest payments when government debt accumulates during the trip to the very-long-run sets of points shown for each given tax-rate gap.

The figure reflects a minor correction to the math in the previous post mentioned earlier, which featured pathways through time. It is stock flow consistent in tracking all stocks and flows and their implications for one another, while omitting financial institutions and debt of the private sector–less SFC aspects of the model. The published journal article referred to above assumed that asset holders preferred to keep bond wealth constant in relation to its holdings of capital goods, whereas asset demands assumed in the above simulation were such as to keep bonds and state-issued monies in a constant ratio in portfolios, resulting in after-inflation interest payments that fluctuate with the passage of time–a actual stock-flow (modeling) impact to puzzle over.

So a tax cut that broadly mimics the one recently passed, cutting taxes for those who hold wealth, might have the ironic effect of cutting long run average private-sector production and causing fiscal stimulus that raises public-sector employment–provided countercyclical fiscal policy is there to pick up the slack.

Note: My results are provisional and again depend on my simplifying assumptions. Moreover, what I have called an estimate here is an estimate because it is obtained by running a simulation for a very large number of years (1000) and then graphing all points on a trajectory from that year until year 1,200 of the simulation. To get a full picture of all possible limiting sets for each value on the x axis, one would have to try more than one initial point for runs of this type.

For more details about the assumptions of this fiscal-policy model, see the journal article or this site’s page devoted to the model and its variants, which features additional links.

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Fiscal-policy scenarios with and without a tax cut

In this post, a longer version of the fiscal-policy-model simulation from last time.  My eventual aim is to consider some effects of a tax cut on income from wealth. My next move was to check that no big surprises lurk just around the corner in my “20-year” simulation of last time—surprises that might suggest correctable flaws in my analysis.

Before, in this previous post, three variables seemed to be stabilized by work of a countercyclical fiscal policy function, while a fourth—government debt divided by capital–appeared to have an upward trend as well as ongoing fluctuations. These indicated that government deficits as defined in the model changed but were positive on average.

Here again, I simulate multiple times using the program PHASER, and four variables are shown in my output: public spending divided by capital; output divided by capital, which I will call capacity utilization; government debt divided by capital; and net investment divided by capital, which is equivalent to the growth rate of the stock of goods used to produce goods—the “capital stock.” I have not run many simulations of larger versions of our model (described on this site’s fiscal policy model page) with the PHASER software package.

The model is not calibrated with serious numbers, but rather off-the-top-of-the-head guesses that make economic sense. An example would be target capacity utilization average values observed in the U.S. in recent years. The growth rate of the capital stock; public spending & employment; and capacity utilization are stabilized at nearly steady levels fairly quickly. In considering a simulation of such lengthy duration, I am in essence checking to see if a simple version of our model seems to come up with results that are consistent with the economic theory that I am using. I claim that the model is at least consistent with Modern Monetary Theory and some principles of “stock-flow consistent” economics.

This time, I run the model for 200 years instead of 20. Again, government debt divided rises steadily at first, but it clearly levels off this time, reaching a “cruising altitude” that is discernible in the longer figure. Also, the other 3  variables converge more completely. This exercise is designed to test properties of the model that are not important for analysis of the economy, which undergoes structural changes repeatedly at such a long interval—changes of expectations, institutions, political frameworks, etc. and in which numerous variables matter. My intention is not to model a long run in which the business cycle somehow ends—an impractical idea. A “long run” exercise merely teases out properties of the model, which reflect an effort to capture theory and existing economic institutions.

All pathways in the figure show stabilization. Some are even selected at later starting points; despite varied starting points, pathways for each variable all seem to approach a steady state.

The explanation for longer-run convergence lies in rising interest income from Treasury bills. These short-run government securities generate rising interest payments; these payments gradually replace net issuance of liabilities to the wealthy sector. The bills constitute a steady source of income and hence demand for consumption and investment goods—in contrast to labor income, which is cyclical—at least at first. This debt-accumulation effect occurs alongside the work of countercyclical fiscal policy to pull the public spending and capacity utilization toward a steady state.

I have assumed that wealthy households (a separate group in the model, for simplicity) put a fixed percentage of their (new) assets into the interest-bearing form and that the government keeps the real (inflation-adjusted) interest rate steady using open-market operations. A policy that holds the real rate constant is perhaps weak compared to the mainstream “Taylor rule,” if a comparison can be suggested. A Taylor rule for the nominal interest rate—oft-advocated—tries to more than offset changes in inflation.

In this model, in contrast, fiscal policy does the stabilizing work. In this model, government wage payments—and increasingly, interest payments–stabilize demand for private-sector output. Once government net liabilities to the private sector reach a sufficient quantity, steady interest payments on existing debt make up such a large part of income that the demand for goods is nearly constant. Government interest-bearing liabilities grow at a rate close to the rate of growth of the capital stock, resulting in a flattening trajectory toward the top of the diagram that wipes out the need for stabilizing fiscal policy.

Now try a cut in taxes for for the wealth-holding group of only of 5 percentage points of income, so that they now pay 15 percent while the workers pay 20 percent, the same rate as in the original model. Here is the revised output.

There does not appear to be much of an effect in the broad patterns of convergence, but b converges to a lower level, with lower tax payments in our new scenario allowing for lower interest payments in equilibrium.

Here I show the effects of a tax cut for the wealthy in a scenario based on parameter values that generate fairly steady, frequent fluctuations over a 200-year simulation period. Baseline and tax-cut scenarios are pictured in the same figure:

Again, a tax cut substitutes for interest income, resulting in a lower path for government debt b.

I have not assumed that consumption depends on assets—an effect found to be weak empirically. But the stock-flow-consistent features of the model matter throughout the simulation, causing a gradual leveling-off of the trend in b throughout the simulation period in all of the 200-year runs.

I would expect a tax cut for the workers in the model to have a different effect, as they do not collect interest income and consume a higher percentage of their disposable income.

Homegrown fiscal policy model tackles tax reform scenarios

The tax bills have not won high marks from economists or observers in the press.
Speaking at the broadest level, the concerns relate to fairness and aggregate impacts on debts, deficits, and growth:
1. The bill is mostly bad for the poor and middle classes and benefits the well-off unfairly.
2. While pro-growth effects are at best greatly exaggerated and effects on deficits underestimated by the Republican team, I see excessive concern in general with deficit levels. A normally functioning national government with a floating exchange rate and almost no debt in foreign currency has no real constraint on spending, other than possible ill macroeconomic effects (inflation, etc.) when amounts are badly chosen. Here is some model output that shows fluctuating spending in response to instability generated in private sector investment spending.

First, I show above a version starting from two different sets of starting points. For each set, three lines—representing the growth rate of the public spending, the stock of capital, and capacity utilization eventually fluctuate regularly but do not explode. The plot that rises on trend with regular downturns is government debt divided by the capital stock.

Second, in the figure above I start the model from a randomly selected set of points, and find that my results do not depend sensitively on my choice of starting points for the four variables. A related diagram at the top of the post shows two-dimensional dynamics of an inward spiral of gradually stabilizing public spending and capacity utilization.

The model is described a bit on this page of this site. I have used a version that tracks government debt generated by spending decisions.

Why is this necessary in the model—or in reality? (1) People and financial institutions with money to invest wish to accumulate the safe Treasury securities issued as the government spends. They constitute a safe investment in a manifestly risky world.

(2) The government is the only sector that can offset instability in investment by firms, as its job is to stabilize in the aggregate (in behalf of the public) and it alone has the means to do so.

The model has not been carefully calibrated but illustrates what one finds with a range of reasonable assumptions in a similar model. I have tuned the model so that fluctuations happen and are visible on the page. (Wonky note: They happen because of a nonlinearity in the model of investment by firms.) It is based on assumptions consistent with Modern Monetary Theory (MMT). Tom Palley, an MMT critic (and contemporary-great labor-oriented Keynesian), has in contrast found unstable results by trying to combine some real MMT ideas with exogenous (determined by policy) government money–not really so MMT and not so real-world. (Links to two of these papers at Palley’s website are here and here.)

The disadvantages of major deficit increases alleged by mainstreamers on the left and right—say, the New York Times and perhaps everyone in the Democratic caucus in the U.S. Senate—include a “crowding out effect,” whereby the government drives up interest rates with increased borrowing. But the model pathways churn along and level off as debt increases because as in reality the Fed (the U.S. central bank) is assumed to set the interest rate with a constant “real” interest rate policy. Hence, the key effect of rising debt is to generate rising payments to those wealthy enough to own government bonds, notes, and bills. In principle—and in practice with the pro-growth Fed Chair Powell in charge at the Fed—interest rates need not rise significantly, stifling activity fueled by private-sector debt.

The anticipated crowding out effect is related to the high deficits, high interest rate policy combination experienced under 1980s president Ronald Reagan and monetary “hawk” Paul Volcker. Notably this situation brings a capital influx of money searching for high-return, low risk financial investments, driving up the value of the dollar. Effects of a true 1980s scenario with a Volcker in charge and deficits large enough would include a higher burden to foreign debtors of debt in dollars and an increase in trade deficits. But that will depend mostly on the Fed policy.

Effects not shown in my simplified model include a portfolio-safety effect of large amounts of debt that can be paid back with no need to default ever.

Numerous issues and concerns also come up in the details of the proposal involving corporate taxes, changes to personal income tax deductions, treatment of overseas corporate cash, and more. I will leave those for another day. That was a lot to get off my chest.

Correcting GDP for big finance; A new website venture

I was in New York yesterday at the New School for Social Research to be there for an informal presentation by Jacob Assa, a stock-flow-consistent modeling enthusiast. I seek to incorporate the principles of this approach to modeling into work that I do, including my collaborative effort with Tai Young-Taft. Assa argues that the GDP concept (of course already much maligned for many reasons) relies on a standard theory of money, banking, and finance. Incorporating the SFC principles that inform SFC modeling into the construction of GDP gets us perhaps to a much more accurate picture of the size of the economy—even as other work goes on simultaneously to make this construct more relevant as a measure of something people care about, including the environment. It was good to see stock-flow consistency and endogenous money–my dissertation topic at U. of Notre Dame–introduced to this discussion at the super-cool New School campus.

SFC economics highlights the role of finance, which has been recognized as a huge macroeconomic force since the financial crisis. An increasing part of the world economy is financial; how much of this activity adds directly to income or production? How does it do so? SFC is associated with names such as Hyman Minsky, who sought to develop a financial Keynesianism.

From time to time on this blog, I have mentioned food and veganism. In other news, last week, I started a new blog called Healthy Vegan Hudson Valley at Overweightness, heart disease, and diabetes are unnecessary scourges in my view. My intended audience will be mostly people who are vegans or vegetarians and people thinking of switching to a diet free of meat and fish. They, as plant-centric eaters, will naturally be interested, and modern medicine’s lessons in nutrition offers a good way of being a vegan or vegetarian in a healthy and relatively easy way. The big scientific picture on nutrition can be found on sites like and, which draw on research beginning with the China-Cornell study whose results emerged in the 1990s. The new blog, on the other hand, will focus on the local picture in the mid-Hudson Valley. This area features an abundance of local agriculture, vegan restaurants, CSAs, and even a real civic organization that hosts an annual vegan Thanksgiving dinner.

I should mention that Duncan Foley, seated next to me at yesterday’s economics talk, has very recently won the 2017 Guggenheim Prize in Economics. The award is given for lifetime accomplishments in the field of economics. Congratulations, Duncan!

Finally making some sense of MMT, exchange rates, and the international economy

One relatively late-to-develop aspect of Modern Monetary Theory (MMT) has been the theory of the exchange rate in the economy envisioned by MMT proponents. As I have said before, the key points advocated by MMT are: 1) functional finance (fiscal policy in service of macroeconomic stabilization goals, not vice-versa); 2) chartalism; and 3) government employer-of-last-resort programs to achieve full employment and low inflation. For some readers, I should explain that chartalism argues that the value of state money comes from the imprimatur of a government, rather than an “anchor” such as gold backing.* Several points are made by MMT advocates regarding exchange rates in response to critics who argue that its tenets cannot be applied because exchange rates matter in various ways, at least in some subset of countries:

1) Flexible exchange rates, especially floating rates, permit the lack of a budget constraint in spending for a wide range of open economies. A high proportion of economies have currencies that are rather flexible. MMT advocates do not claim that their theory of no government budget constraint applies in its simplest form to countries with fixed exchange rates or to members of currency unions.

2) A worldwide system of fixed rates would not be all that desirable for a variety of reasons. Hence, what is true for an individual country is not all that likely to work even if the “collective action” problem is solved and a cooperative solution somehow reached. Even Keynes’s envisioned progressive post-World War II economic system perhaps would have been geared excessively to seeking zero current account balances.

3) Currency pegs and currency unions in fact bring the risk of currency crashes and fiscal crises. These can in turn contribute to banking crises. So, such problems do not falsify MMT as long as they occur under such non-MMT conditions, which are nonetheless well understood by MMT advocates and Post Keynesians.

4) The situation is far different in regard to the existence of fiscal constraints when a substantial amount of government debt has been issued that must be paid back in foreign currency or when the government must issue only foreign-currency-denominated bonds–circumstances that bring true constraints on spending.

5) Fiscal space is sometimes lacking in a way that seem to some observers to contradict MMT. But a central bank that does not in practice coordinate with the fiscal policymakers does not imply a different kind of system to which MMT does not apply, but rather a hawkish central bank that frustrates attempts to reach close-to-full employment. Consolidated government and central bank balance sheets, which seem to suggest to some skeptical readers of MMT that fiscal and monetary policy are perfectly coordinated, merely describe basic facts that are true regardless of the macroeconomic-policy philosophies of monetary and fiscal authorities respectively. In some economically unhappy countries, the appropriate institutions of government finance are utterly lacking, but even in many of these cases, needed institutions could be set up, given the political will to do so.

Of course, when I mention fiscal constraints, I do not mean to include mere “identities” in an economic model that say, for example, that a given deficit implies net liability issuance of one kind or another.

The so-called “policy trilemma” that would appear to require exchange rate flexibility to permit domestic policy space in the absence of capital controls is under attack and in reality “running out of reserves” may be the actual constraint for open economies, rather than the need for either a) capital controls or a b) flexible currency. I do not see MMT enthsiasts disagreeing much as this idea from stock-flow-consistent (SFC) macroeconomics gradually makes inroads on the hard-and-fast “trilemma” doctrine. I will not elaborate here but refer the reader to a previous post with some links.

I hope this defense helps to make sense of MMT as it applies to various kinds of (open) economies for some economists and others who raise profound doubts about the theory in relation to currencies and exchange rates.

Some concrete examples: Lately, Japan is an example of a country that appears to prove MMT points about interest rates and fiscal sustainability when depression conditions call for strong stimulation. Brazil is an example of the freedom afforded by a public debt largely composed of debt in the home currency. Puerto Rico, a US “territory,” is a case where debt essentially exists in a non-sovereign currency, more or less as in individual US states, but with some interesting differences, resulting in painful fiscal austerity when conditions inevitably worsened. On the other hand, Venezuela is a developing country where natural disasters and adverse developments in the energy industry have been the key causes of economic catastrophe in recent years, not built-in lack of sustainability in systems that merely rely on deficit spending and a sovereign currency as the US after all does. The ballooning of fiscal deficits there in the past 5 or 10 years has been endogenous, driven by forces beyond the fiscal policy stance. Hence, one should not blame the dire and unfortunate material situation that emerged in that country on economic populism, Keynesian economics, new fiscal laxity, or–perhaps least of all–the ideas that make up MMT. Hence it does not make the case for fiscal constraints. Finally, China is an example of a country has come close to setting its exchange rate and its key interest rates for many years but has increasingly come under “balance-of-payments pressures” whose timing is not coincidental to the gradual and partial opening of its capital markets. It still holds vast reserves. Hence, it appears to be a case that illustrates the policy trilemma to a great extent, though an article by Stefan Angrick in the post mentioned above argues convincingly that in general the East Asian post-crisis cases show that his claim of greater policy autonomy based on the “compensation principle” seems to hold, with sterilization of excess reserves occurring in various ways.

*For a recent statement of some MMT tenets with some clarifications that bear on the issues discussed above, you might take a look at “Outside Money: The Advantages of Owning the Magic Porridge Pot,” a Levy Institute working paper by L. Randall “Randy” Wray


In writing the above lines, I draw upon ideas from André Martins Biancarelli, Marc Lavoie, Jan Kregel, Claudio Sardoni, Renato de Souza Rosa, Randy Wray, and others who have spoken and written compellingly on the relevant issues in my opinion in recent years. Of course, these individuals most likely will not agree with everything said here.