More on the Upside-Down World of MMT
I ran across a post by Robert Murphy over at the Mises Institute blog on Modern Monetary Theory. Since I have been pushing the idea that the centrality of secular debt accumulation makes some ideas from MMT and Austrian Economics compatible, it was interesting to see a Mises scholar work over MMT.
Murphy is sceptical about stressing the idea that government deficits are exactly one-for-one non-government sector surpluses. He calls it the upside down world of MMT. I, on the other hand, see the logic. This is something I covered in a post called Economics 101 on government budget deficits. But here’s what Murphy had to say:
When I first encountered such a claim — that the government budget deficit was necessary to allow for even the mathematical possibility of net private-sector saving — I knew something was fishy. For example, in my introductory textbook I devote Chapter 4 to "Robinson Crusoe" economics.
To explain the importance of saving and investment in a barter economy, I walk through a simple numerical example where Crusoe can gather ten coconuts per day with his bare hands. This is his "real income." But to get ahead in life, Crusoe needs to save — to live below his means. Thus, for 25 days in a row, Crusoe gathers his ten coconuts per day as usual, but only eats eight of them. This allows him to accumulate a stockpile of 50 coconuts, which can serve as a ten-day buffer (on half-rations) should Crusoe become sick or injured.
This is an admittedly simple story, but it gets across the basic concepts of income, consumption, saving, investment, and economic growth. Now in this tale, I never had to posit a government running a budget deficit to make the story "work." Crusoe is able to truly live below his means — to consume less than his income — and thereby channel resources into the production of more capital goods. This augments his future productivity, leading to a higher income (and hence consumption) in the future. There is no trick here, and Crusoe’s saving is indeed "net" in the sense that it is not counterbalanced by a consumption loan taken out by his neighbor Friday.
As Murphy rightly says, "of course you don’t need the government in order to save." Here’s the problem, though. There are no transactions involved in Murphy’s example.
When we talk about GDP as a measure of the size of the economy, we are talking about a statistical measure of transactions as measured by the money unit of account. I don’t really think this is very complete picture of the economy. It’s an income statement measure, when the balance sheet and cash flow statements are more telling. The balance sheet is very important – or as I have said in the past: It’s the debt, stupid.
But GDP is all about measuring transactions in currency volumes. GDP really is a sum of net financial transactions that occur in any given period that can be registered in specific unit amounts in the money unit of account. I know that sounds like a bunch of mumbo jumbo, but what I am really saying is this: If no transaction occurred, as far as GDP goes it doesn’t matter. If no money changes hands, as far as GDP goes, 99 times out of 100 it didn’t happen.
For example, Kate is a housewife, who, despite her busy schedule at home, is able to grow coconut trees in the back yard to make coconuts for food or barter. Now, Kate is unpaid despite the value of the work she is doing. So, none of her work at home is recorded in GDP because there were no money transactions to measure.
Then, what about her coconuts? Well, for 25 days in a row, Kate gathers her ten coconuts per day to feed her family as usual, but the family only eats eight of them. This allows her to accumulate a stockpile of 50 coconuts, which can serve as a ten-day buffer (on half-rations) should the family become sick or injured. Kate is saving. But this saving has nothing to do with GDP or national income and product accounts that are used to measure economic activity. Now if Kate took her 50 coconuts and sold them to her uncle, Sam, for $5 each, she would have $250. And if she gave Sam $230 in return for his goods and services, she would have saved $20 as measured in GDP. She would be net saving $20 and Sam would have a net deficit of $20. That’s how it works.
In fact, I explained exactly this in the government deficits post:
Imagine you and I are the only two people in an economy. For the sake of argument, say we use sea shells as a currency and we trade with no one else but each other. So when we do trade, we exchange goods and services with each other for the amount of sea shells these goods and services are worth. From an accounting perspective, it’s a wash; if you buy my goods, I get the sea shells and lose the goods of equivalent value and if I buy from you, you get the shells and I get the goods of equivalent value. So far, so good.
Now, let’s bring a third person into the mix, Harry. Harry is a foreigner with whom we agree to do business. Where he’s from, he uses silver as his currency. No matter; in trading with Harry, we agree to an exchange rate between our sea shells and his silver and we are ready to go. Now, we can trade with each other and with Harry. If Harry buys from either of us, we get silver and he gets an equivalent value of goods. If we buy from Harry, he gets sea shells and we get the goods, also equivalent in value to the shells…
Now, let’s introduce some deficits and debt into the scenario. For the sake of argument, let’s say that year in, year out we produce the same amount, the same value of stuff. However, in one particular year, you produce a lot of stuff – and I want to buy it. The problem is that I produce less stuff that you want to buy. What do we do? I could issue you an I.O.U. and tell you I will pay you back sometime later. You accept the deal and now I have received the goods and services and you have received an equivalent value from the two sources, currency and the I.O.U. Again, it is a wash from an accounting perspective. I have a deficit in this particular year and you have a surplus.
Now, even if we add Harry and his silver and foreign goods into the mix, it’s pretty much the same. For example, if you bought some of Harry’s services but didn’t have enough sea shells to pay for it, you could issue an I.O.U. to him for the shortfall. You would have a deficit with Harry for the year and Harry would have a surplus with you for the year. So, even when we introduce debt and deficits into an economy, the accounting is the same; there is no value leakage…
What holds in my little example for three people also holds for three groups of people too. You could have 100 million people in a group that you represent that does trade with my group and Harry’s group and the accounting would be identical. So, let’s give our groups names. I am the government, you are the non-government sector and Harry is the foreign sector. The sea shells are the domestic currency and the silver represents foreign currencies…
Notice I haven’t talked about government as the creator of currency and the private sector as the user of currency. I haven’t focused on any misallocation of resource or malinvestment issues. I haven’t raised the spectre of inflation or currency depreciation. I have simply presented the economics and accounting of budget deficits.
I wouldn’t poo-poo these accounting tautologies. They are real. They have value and they help you understand what’s happening in the economy. The reality is the non-government sectors cannot net save unless the government is deficit spending. The only way the private sector can pay down it’s debt burden is through a net negative shift in trade or government balances. The other way to reduce debt burdens is through debt forgiveness and default. With the U.S. household sector highly indebted, these are the choices. (Of course, the real debt burden can be inflated away – that’s what is happening right now in Vietnam for example. But that’s a topic for another day).
So what about government deficits. This is where it gets ideological. Here’s where Murphy is onto something. He says: "Not All Spending and Income Are Created Equal" – meaning private sector allocates capital better than the public sector. Clearly, if the government sector allocated capital well, we would all be looking to the Soviet model for pointers and China would still be a strictly communist country instead of the increasingly market-based economy it has become. Even the Cubans understand this.
So when you think of government deficits as the primary way to reduce private sector debt burdens, you really should also be thinking about the malinvestment and future slow GDP investment that a misallocation of resources would create. That’s where MMT has work to do.
For example, regarding the US stimulus, did cash for clunkers increase long-term economic growth or reduce it? Did the first time homeowner’s tax credit increase long-term productivity or reduce it? How about this one: did the bailouts of AIG, Citigroup, and Bank of America make America a more efficient global financial powerhouse? If you answered yes, the spending in those examples was good, to all of those questions, then you are going to want to see a lot more of that going forward. Most people would answer no, government is misallocating resources, to those questions.
So, the right question for policy makers then is: If we think private sector allocates capital better, in what measure, if any, is stimulus warranted to arrest a recession like the one we have had? What are the objectives of that stimulus: preventing a deflationary spiral, returning the economy to full employment? How do we prevent the Predator State from siphoning off that stimulus into crony capitalist boondoggles and bridges to nowhere? Can we? Who provides the oversight for these measures and how? And how long into a recovery should this deficit spending continue, and by what measure?
My take: the stimulus we have seen up until now has been ineffective. Too much of it was engineered to bail out reckless allocators of capital in favoured industries in the private sector. And too little of it was designed to help deleverage and return the economy to full employment. This leaves me thinking that in future the only way to prevent malinvestment is to bolster automatic stabilizers and only use these and tax cuts in order to address the shortfall in demand. There are a lot of ways to shape these automatic stabilizers and tax cuts to get the job done but having the government craft specific programs to help specific sectors of the economy like housing only insures that the economy will not be able to readjust.
What do you think? Comments appreciated.
Update: 1555EDT – I made two slight edits, adding ‘net to ‘financial transactions’ and adding ’99 times out of 100′ to ‘it didn’t happen’.