Neo-Chartalism Reconsidered

I was forwarded a link to recent paper by post-Keynesian Marc Lavoie. I was forwarded it in part because my blog is cited in the paper as an outside observer (totally true) - which is pretty cool.

I must admit, it has me taking a second glance at MMT theory, frankly, because his paper is the first to calmly explain (at least one piece of) MMT in a way that doesn't alienate, and in a way that bridges some of the language gaps and misleading or just factually wrong (given common usage of terms) statements by MMTers. Ahh the power of words....

Some 'aha!' passages:

Another problematic statement is that the government has to run deficits, at least over the long run, for the public to get access to larger cash balances (high powered money). As Wray (1998, p. 123) puts it, “persistent deficits are the expected norm”, that is, “normally, taxes in the aggregate will have to be less than total government spending due to preferences of the public to hold some reserves of fiat money” (Wray 1998, p. 81). If the government was running persistent surpluses, the public would “run out of net money hoards” (Wray 1998, p. 79). While I would certainly agree that government deficits in a growing environment are appropriate, as it provides the private sector with safe assets, which can grow in line with private, presumably less safe, assets, it is an entirely different matter that government deficits are needed because there is a need for cash.

Even if the government keeps running balanced budgets, central bank money can be provided whenever the central bank makes advances to the private sector. Wray (1998, p. 79-80) himself recognizes this, as he later adds that “a surplus on the Treasury’s account is possible as long as the central bank injects reserves through purchases of assets or through loans of reserves”. Presumably, what he has in mind, as we will see soon, is that total government expenditures include “spending” by the central bank, when the central bank purchases private assets or claims on the private sector and adds them to the asset side of its balance sheet. But this is an odd way to define government spending.While this terminology problem is easy to solve, things may not be so simple with the oft-made statement that “government spends first”, a statement that, of course, has some relationship with the causal sequence mentioned when discussing the links of neo-chartalism with circuit theory. This expression comes back like a leitmotiv on many of the blogs devoted to modern monetary theory, but it can also be found in academic writings: “Government spends simply by crediting a private sector bank account at the central bank. Operationally, this process is independent of any prior revenue, including taxing or borrowing” (Mitchell and Muysken 2008, p. 209); “The government spends simply by writing Treasury cheques or by crediting private bank accounts” (Tcherneva 2006, p. 78). These statements are at best misleading. They skip one fundamental step that makes incomprehensible the leitmotiv sentence that “government spends first”. Any agent must have funds in a banking account. Before being able to spend, the Treasury must somehow replenish its deposit account at the central bank (or at private banks).

This step is often skipped because neo-chartalists prefer to consolidate the central bank and the federal government into one entity, the State. Now, in itself, such a consolidation is not illogical. Other authors, such as Godley (1999B), have on occasion consolidated the central bank with the government. But such an integration may not be appropriate for the purpose….

The purpose of this whole exercise is to show that there is no point in making the counter-intuitive claim that securities and taxes do not finance the expenditures of central governments with a sovereign currency. Even in the case of the US federal government, securities need to be issued when the government deficit-spends, and these securities initially need to be purchased by the private financial sector….

...neo-chartalism carries some excess baggage, which must be gotten rid of. In trying to convince economists and the public that there are no financial constraints to expansionary fiscal policies, besides artificial constraints erected by politicians or bureaucrats that believe in mainstream theories and in the principles of sound finance, neochartalists end up using arguments that become counter-productive. There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account; tha tgovernment expenditures must precede tax collection; that the creation of high powered money requires government deficits in the long run; that central bank advances can be assimilated to a government expenditure; or that taxes and issues of securities do not finance government expenditures. All these counter-intuitive claims are mostly based on a logic that relies on the consolidation of the financial activities of the government with the operations of the central bank, thus modifying standard terminology. I believe that such a consolidation leads to the avoidance of crucial steps in the analysis of the nexus between the government activities and the clearing and settlement system to which the central bank partakes, and hence leads to confusion and misunderstandings. And so do references to a leveraged vertical component of the money supply.

It's important to note that Lavoie's paper focuses only on the fiscal/monetary settlements relationship with MMT. Some of the other ideas of MMTers (like a government-mandated and set fully employed workforce - employment targeting) are still quite a bit harder to swallow, but I'll continue to keep an open mind.

Finally, Lavoie's paper is an exercise in positive economics, not normative economics. For me, it is still an altogether different (and potentially more important) question whether we should be using strong fiscal policy tools to guide an economy, regardless of whether or not there are any direct financial constraints, as there most certainly are other constraints that need be considered, not the least of which are logistical (politics) and the reality that fiscal policy has been shown to be very messy in practice, and one need to be very careful about discussing fiscal policy in the vacuum of a research paper. That is, at the end of the day we will likely still have the debate about the merits of functional finance.