Ed Dolan's Econ Blog

What Does it Mean for Fiscal Policy to be “Sustainable”? MMT and Other Perspectives

As negotiations over fiscal policy heat up, one thing nearly everyone agrees on is that U.S. fiscal policy should be sustainable. The trouble is, there are sharp disagreements about just what sustainability means. This post explores three different meanings of fiscal policy sustainability and explores their significance for current budget debates.

Sustainability as solvency

The first, and simplest, meaning of sustainability makes it a synonym for solvency. The proposition that we do not have to worry about debts and deficits because the government can never “run out of money” has become a mantra among followers of Modern Monetary Theory (MMT). As L. Randall Wray puts it in his book Modern MoneyTheory, “When we say that [perpetual government sector deficits] are ‘sustainable’ we merely mean in the sense that sovereign government can continue to make all payments as they come due—including interest payments—no matter how big those payments become.”

Strictly speaking, we should refer to the ability to meet financial obligations in full and on time as equitable solvency to distinguish it from balance-sheet solvency, which means negative net worth. No one ever seems to worry about governments’ net worth. Discussions of fiscal solvency always center on whether a government will be able to meet its financial obligations on a cash-flow basis, or will, instead, run short of cash and be forced to default.

Is MMT correct in its claim that a government can never become equitably insolvent? Yes, as long as the proposition is limited to governments that issue their own sovereign currencies and maintain floating exchange rates.

A country like Greece could literally run out of euros because it is a user rather than a sovereign issuer of the euro. Any fiscal policy for Greece that does not include a mechanism for obtaining enough euros from some external source to meet its financial obligations would be unsustainable in the sense of being inconsistent with equitable solvency.

A country like the United States that has a fully sovereign currency and a floating exchange rate is in a fundamentally different position. The U.S. government can always issue as many dollars as it wants, provided it does not bind itself with self-imposed restraints like the federal debt limit. Under some circumstances, fiscal deficits might become large enough to have undesired consequences (more on that later) but if it wanted to ignore those consequences, it could always get the dollars it needed to meet its financial obligations.

Some countries are in an intermediate position between Greece and the United States. Take Latvia, for example. Although Latvia issues its own currency, the lats, its solvency is constrained in two ways. First, the Latvian government has borrowed large sums in foreign currency. To the extent it has done so, it is in the same position as Greece; its solvency depends on having a way to obtain the foreign currency it needs to meet those obligations. Furthermore, Latvia maintains a fixed exchange rate. That constrains its ability to meet obligations like salaries and pensions even when they are denominated in its own currency. Issuing too many new lats could put unsustainable pressure on the exchange rate, causing the government to choose between defaulting on its debts and defaulting on its commitment to maintain its peg to the euro.

Can we go so far as to say, then, that because a country with a sovereign currency and a floating exchange rate can never become equitably insolvent, its fiscal policy can never become unsustainable? In my view we cannot. Solvency is only the starting point for a discussion of sustainability, not the whole story.

Mathematical sustainability

According to a second meaning, a fiscal policy is unsustainable if it causes the ratio of debt to GDP to grow without limit. The concern here is that a debt that grew without limit would eventually become unmanageable, leading to some unpleasant consequence like default, excessive inflation, or forced austerity. I will refer to this second meaning as mathematical sustainability.

As discussed in an earlier post, a country’s structural primary budget balance is a useful indicator of mathematical sustainability. The structural primary balance is the government’s surplus or deficit, excluding interest on the debt and adjusted to take into account the state of the business cycle. In any given case, the conditions for mathematical sustainability depend on the starting debt-to-GDP ratio, the rate of interest on the debt, and the rate of growth of GDP.  (For details of debt dynamics under various scenarios, see this slideshow.)

Typically, the rate of interest tends to be higher than the rate of growth. In that case, a country that starts with any debt at all must hold its structural primary balance at a small surplus in order achieve mathematical sustainability. For example, since 1980, the interest rate on U.S. government bonds has averaged about 1.3 percentage points higher than the rate of GDP growth. If that differential were to persist in the future, the federal budget would have to maintain a primary surplus of about 0.9 percent of GDP to stabilize the debt at its current level of approximately 70 percent of GDP. If the average inflation rate were to stay at the Fed’s target of 2 percent, interest payments would consume about 2.3 percent of GDP, so the overall balance, including interest payments, would show an average deficit of about 1.4 percent of GDP.

If, given those starting conditions, the primary surplus were less than its steady-state value of 0.9 percent, the debt-to-GDP ratio would, over time, increase without limit. For example, if the primary budget were held exactly in balance, the debt-to-GDP ratio would double every 50 years. In reality, as of 2011, the U.S. structural primary balance was in deficit by 5.8 percent of GDP, according to OECD data. With a structural primary deficit of that size and given the assumed values of other parameters, the debt ratio would grow much more rapidly, doubling about every 10 years.

On the other hand, if the primary surplus were greater than the assumed steady-state value, the debt would shrink steadily as a percentage of GDP. For example, if the U.S. primary surplus were held at 2 percent of GDP, the debt would disappear in 50 years, after which the government would accumulate net assets in a steadily growing sovereign wealth fund.

Are such extrapolations of the debt-to-GDP ratio something we should really care about, or are they just a parlor game? Opinions differ as to whether it is a matter of pressing national importance to bring the U.S. structural primary balance into consistency with the conditions for mathematical sustainability.

For example, followers of MMT like to point out that the debt dynamics become much friendlier if the rate of interest is held permanently below the rate of growth. If that can be done, then regardless of the initial values of the debt and the structural primary balance, the debt-to-GDP ratio always converges to some finite value. It should be mentioned that many non-MMT economists worry that attempting to hold the interest rate below the growth rate over a long period would carry a risk of serious inflation,  but exploration of that issue will have to wait for another time.

A further, and to my mind more realistic, argument made by some MMT followers is that the debt will never “explode” because something will happen to change the parameters of the model before an explosion takes place. Wray compares the discussion of unstable debt dynamics to speculation about what would happen to a person  who constantly consumes more calories than he burns. Mathematically, such a person would eventually “explode,” yet we have never seen an exploding person. Something else always happens first.

The way I see it, mathematical sustainability is a useful benchmark for discussion of fiscal policy precisely because it causes us to focus on the changes that must take place if the current set of budget parameters implies an impossible outcome. Will they be changes for the better or the worse? Will they be changes that come about in an orderly way or changes that are forced and unpleasant?

To pick up on Wray’s analogy, suppose you step on the scales and find you are seriously overweight. You are not yet morbidly obese, but you are gaining steadily. Do the numbers on the scale mean you are at risk of literally exploding? Of course not, but they do indicate that you will have to face up to some hard choices. Will you start exercising and change the way you eat? Or will you wait until you have developed diabetes or suffered a heart attack, and then sign up for emergency gastric bypass surgery?

Functional sustainability

That brings us to the third meaning of sustainability: If a country has a set of rules and decision-making procedures that adjust fiscal parameters over time to serve some rational public purpose, we can say that its fiscal policy is functionally sustainable.

There is no one set of rules that is consistent with functional sustainability. For example, many MMT followers favor focusing fiscal policy on the goal of full employment and adjusting tax rates to moderate aggregate demand when and if a threat of inflation develops. (Such a scheme is a descendant of Abba Lerner’s writings on functional finance in the 1940s.)

At the other end of the  political spectrum, many U.S. conservatives favor an annually balanced budget, preferably enshrined as a constitutional amendment. True, such a policy would be strongly procyclical. It would require austerity during recessions and would provide little restraint on spending during booms. (See here for a detailed critique.) However, procyclical or not, a balanced budget rule would be “functional” in the sense of providing a rule that is consistent with mathematical sustainability.

In between, a variety of fiscal policy rules have been proposed. One such rule would constrain each year’s structural primary deficit to a level consistent with mathematical sustainability. Unlike proposals for annual balance of the current budget, a policy of structural balance would allow the free operation of automatic stabilizers like income taxes and unemployment benefits. Alternatively, we could allow more room for discretionary countercyclical policy by requiring the structural primary deficit to remain on target on average over the business cycle rather than on a year-by-year basis. Countries like Chile, Sweden, Germany, and Switzerland provide examples of such rules.

Note that none of these fiscal rules say anything about the size of government or the content of spending. Any of them could be adapted to a big government with a generous social safety net; a big government with a strong defense establishment; or a small government limited to protecting property and enforcing the rule of law.

The trouble is that we don’t have any workable fiscal policy rules at all. As Herbert Stein observed almost 30 years ago, “We have no long-run budget policy—no policy for the size of deficits and for the rate of growth of the public debt over a period of years.”  Each year, according to Stein, the president and Congress make short-term budgetary decisions that are wholly inconsistent with their declared long-run goals, hoping “that something will happen or be done before the long-run arises, but not yet.” It would be hard to find a better characterization of a fiscal policy that is functionally unsustainable.

What can MMT and the rest of us agree on?

In light of all of the above, where can followers of MMT and non-MMT economists find common ground? I see three potential areas of agreement.

First, we should be able to agree that there is no point in arguing over the solvency vs the mathematical version of sustainability. Both are valid. They are complementary statements about different aspects of fiscal policy. Furthermore, neither approach amounts to more than a formal truism until we add the concept of functional sustainability.

Second, everyone should be able to agree that fiscal policy does not have to be procyclical to be “sound.” Whatever theoretical framework we start with, fiscal austerity during a slump is not a good idea. That should put MMT and non-MMT economists largely on the same side during the present negotiations over the “fiscal cliff.”

Third, it should be possible to agree that just because the government can, in a solvency sense, always “afford” to spend, that does not mean more spending or lower taxes are always better. Even when the economy is operating below potential, as it is now, we need  budget procedures that set sensible national priorities and winnow out spending and tax breaks that serve only to reward favored interest groups at the expense of the broader public. Furthermore, we need to recognize that the economy will eventually return to boom conditions that will call for restraint of aggregate demand. Better to build in rules now that will ensure that fiscal prudence operates when needed than simply to “hope that something will be done before the long-run arises, but not yet.”




37 Responses to “What Does it Mean for Fiscal Policy to be “Sustainable”? MMT and Other Perspectives”

peteNovember 28th, 2012 at 11:07 am

Could you and Mr. Wray agree to speak to one another so that you can make it clearer on what points you do and do not agree on. First agree to state the points of interest in a common language. Give say 10 numbered points. Then on those that you agree note that.
Then on those that you disagree each write a statement as to your position. Then after this go thru another round of making sure you at least understand the other point of view. Continue until the alternate ideas are as clear as possible to the readers.
In the current discussion it is more like the reader is a jury and the economist lawyers for their side. The evidence is presented and it is up for the jury to decide. But juries don't seem very good at interpreting expert testimony and juries spend days if not weeks listening to the evidence. Since political action will require the consent of large portions of the population to understand it, we need some clearly stated points. Otherwise the debate will be dominated by sound bites.

Ed Dolan EdDolanNovember 28th, 2012 at 11:38 am

Pete: Very astute comment. In fact, Prof. Wray and I have corresponded extensively along the lines you suggest. This post is a direct outcome of that correspondence. I am not sure we have 10 items we agree on yet, but I think we agree on the three points at the end of the post. (It is possible, of course, that he will have some problem with the way I have formulated them, but if so, I hope he will put his remarks in a comment box here.)

I am sorry if you find the language still too technical. I try as best I can to leave the technical details for "footnote" type material like the attached sideshow. I will continue to work on this.

Let me remind you, however, that in a free society, jury duty is compulsory. You can't get out of it. Please continue to struggle with the evidence presented by the advocates as best you can, and enter your comments. The decisions of the jury, after all, are what ultimately decide the case.

ThomasGrennesNovember 28th, 2012 at 1:17 pm

The first sense of sustainability as "solvency" is both true and not useful, and it can be illustrated by any case of hyperinflation, including the recent case of Zimbabwe. To pay their bills and demonstrate solvency in the narrow sense, the Zimbabwe government had to print so much paper money that the resulting inflation tax rate made the currency unusable by Zimbabweans. What is the value of "not running out of money" if you have to ruin money to do so. The inflation tax is the inflation rate times the quantity of cash balances held by Zimbabweans. Another way of stating this principle is that governments
cannot run out of money as long as they have the power and willingness to tax, including the inflation tax. The history of paper money is filled with attempts to restrain government's ability to impose an inflation tax. It is also true that most governments that have defaulted on bonds could have raised taxes to service debt, but they chose not to.

Ed Dolan EdDolanNovember 28th, 2012 at 2:11 pm

Tom: What do you know about the Laffer curve concept as applied to the inflation tax? I have seen it asserted that the quantity of real resources that can be mobilized via the inflation tax reaches a maximum at some finite rate of inflation, then falls for still faster inflation. It has to have something to do with the fact that real money balances fall during hyperinflation, but I can't find any clear exposition of the model that leads to this result. Do you have a reference? It seems to me that result would be of relevance to the MMT view of hyperinflation (which I have some difficulties with, but am not quite ready to sound off about yet).

ThomasGrennesNovember 28th, 2012 at 4:13 pm

Ed: Here is a reference on the inflation tax and seigniorage: Feenstra, Robert, and Alan M. Taylor. 2012. International Macroeconomics, 2nd ed. Worth. It is the same as any other tax. the rate is the rate of inflation, to be approximated by the nominal interest rate that incorporates the expected rate of inflation. The base is the real money stock, M/P, and it decreases with the expected inflation rate. There exists a tax-revenue maximizing rate of inflation, which is not optimal for society as a whole. A key magnitude is the elasticity of demand for domestic real balances. This will be greater if there are good money substitutes (ex foreign money) or if residents can legally and easily move their assets abroad (no capital controls) to avoid the inflation tax. In Zimbabwe at the peak of hyperinflation, the real money stock must have diminished to something close to zero.
In some very narrow sense, the government did not run out of "money" but is that kind of
"solvency" a virtue?

AlexNovember 29th, 2012 at 10:23 am

It's important to realise that Zimbabwe wasn't printing money to pay back ZWL bonds – this was far more sinister. Zimbabwe had huge amounts of debt to the IMF in foreign currencies. Mugabe ordered the central bank to print trillions of ZWL (20.5tn to be exact), buying whatever USD they could off forex markets to pay back this debt, absolutely tanking the value of the ZWL. Worse still, Mugabe went on to conduct land reform, handing farms from the whites that knew how to operate them to blacks who did not, slashing agricultural output by 40%+. This, plus the tanked exchange rate, made up two massive supply side shocks to an economy that now has far more money in circulation than it used to.

MMT absolutely agrees with monetarists on that massively increasing the amount of money in circulation whilst *slashing* output will result in hyperinflation. Just because you print your own currency does not mean you can buy as much of other currencies as you like using printed money. MMT would *always* argue that if you have a massive supply side shock, you must remove money to keep prices stable – not add money – yet Mugabe did just the opposite.

This is *incredibly* different to when you have spare capacity in the economy. A job guarantee system, as often advocated by MMT proponents, is largely non-inflationary – even if paid for by printed money (or printed bonds, I believe MMT argues they have much the same impact on inflation). Unlike buying foreign currencies as Mugabe did, the government is competing with no one when trying to buy the unemployed at the minimum wage – this is a resource the private sector does not want, at a price the private sector cannot bid below. So there's no wage inflation at the source. Additionally the essential goods/services demanded by those working in the JG the private sector has *heaps* of capacity to produce more of, as evidenced by the high unemployment. So rather than raise prices on those goods/services, the private sector hires workers off the JG by offering better than minimum wage (which they have to by law anyway) and away they go, expanding capacity. That is the advantage of "not running out of money" – if, unlike Mugabe, you spend it in a non-inflationary manner you can maximise the size of the private sector even when tax receipts are low – without imposing an inflation tax.

Note that one thing that makes this possible is that MMT outright rejects the money multiplier theory, arguing that banking simply does not work this way in reality. That in reality, banks make loans to all credit-worthy customers irrespective of their reserve position as they know they have *unlimited* borrowings capacity on the interbank lending market at the federal funds rate. If a bank knows it can borrow any amount it needs to meet reserve requirements at a fixed rate of interest, it's obviously not going to worry about loaning to a customer it deems credit-worthy. With that in mind, that banking *already* works this way, MMT argues that there's no money multiplier theory to worry about – and hence that you only need to look at what the effect the deficit actually has. This is at least according to my understanding of the school of thought.

Ed Dolan EdDolanNovember 29th, 2012 at 12:16 pm

Alex—You make a couple of interesting points here.

1. You say “if you have a massive supply side shock, you must remove money to keep prices stable” and also “This is *incredibly* different to when you have spare capacity in the economy.”

I’m willing to admit the truth of both of these statements, at least for the sake of discussion. However, I think the case people are most concerned with is a third one—What happens if you add money to an economy that is at capacity (or at full employment, potential output, natural output, zero output gap, whatever you want to call it). It seems to me that to be consistent, as long as MMT argues that too much money causes inflation in an economy that has experienced a supply shock, it must follow that adding more money to an economy that is already at capacity can also cause inflation. Is that right, or am I missing something?

2. Your say, “banks make loans to all credit-worthy customers irrespective of their reserve position as they know they have *unlimited* borrowing capacity on the interbank lending market at the federal funds rate.” This seems to be one of the core tenets of MMT, but there is one thing I have never quite understood about it. Is it meant as a proposition about how the Fed’s monetary policy actually operates now, or a proposition about how it should operate?

Either way, the proposition is incomplete because it fails to distinguish clearly between operating targets and its intermediate targets.

At present, it is true only regarding the Fed’s day-to-day operating target, which, as MMT correctly says, focuses on a target level of the Fed funds rate. However, the Fed’s intermediate target is some kind of implicit Taylor rule that takes into account both inflation and unemployment, the two elements of its “dual mandate.” The Fed raises rates when either element rises above target. For that reason, it is not true as a proposition about the Fed’s behavior over an intermediate time framework to say that banks can borrow unlimited amounts at the Fed fund rate—at least not at a fixed rate. Instead, banks can only move along an upward sloping supply curve of reserves where they can borrow more only at an increasingly higher rate.

If you mean to say that the Fed ought to target a fixed interest rate both as an operating target and an intermediate target, you need to get into the issue of whether the Fed can successfully hold the nominal Fed funds rate below the rate of inflation as the economy approaches capacity. If I understand correctly, that was the issue in the Korean War era Fed-Treasury “accord.”

Can you offer any further comments on these issues, or provide links to some discussions in the MMT literature?

AlexNovember 30th, 2012 at 2:02 am

Hi Ed, thanks, the subject has really taken my fascination since the Euro crisis. I'm no economist mind, just sharing what I've learnt through far too many hours of leisure time spent reading ;). I'll offer more links this time, mostly to Mitchell as it's his writings I'm most familiar with.

1. MMT absolutely argues that adding money to an economy at capacity will cause inflation ( : "Inflation is caused by aggregate demand growing faster than real output capacity"). There may even be unemployment at this point as it could be a subset that is at capacity. Chasing more steel (or for Mugabe, USD) than can be produced will *always* be inflationary, rather than output/employment actually increasing. This is why the job guarantee's so integral for a lot of MMT supporters as it's guaranteed to be chasing the slack of the economy, a resource that is idle. Hiring that resource they attest will be non-inflationary.

MMT is all about identifying the real limits to our production once the fiscal constraints imposed by the monetary system are put aside. In theory, if we had complete control over our monetary system I see no reason why we ought to ever be in a position where 25%+ of the country *wants to work*, but is unable to find a job due to a shortage of spending. That to me *has* to be a case of the monetary system holding us (or Greece/Spain rather) back, it's clearly not a real constraint – the labour is there, willing, they just need the demand. MMT attests that the currency-issuing government can always employ those workers, and in doing so, it'd be growing the private sector by providing them a wage to demand goods/services with.

I'm sure you're aware of this – but it's important to emphasise that MMT is not about continual deficits, more so that the government should more freely allow the non-government to net save or net dissave according to its desires at full employment. If there's ever such eagerness for dissaving amongst the non-government that the economy is fully employed without a deficit being run, the appropriate response is to run a balanced/surplus budget as the alternatives would be inflation and/or higher interest rates, assuming an inflation targeting central bank. Strong automatic stabilisers do this largely automatically.

It may baby you a bit, but I found this MMT-inspired parable a brilliant introduction on the MMT view of the budget, gold standard, austerity etc:….

(cont. in next post)

AlexNovember 30th, 2012 at 2:02 am

2. When MMT proponents say that banks make loans and correct their reserve position afterwards, they are arguing that this is reality today.

This is probably best discussed by Mitchell here:

You're absolutely right that the federal funds rate changes, banks adjust their floating rate mortgages accordingly. By borrowing unlimited funds, I meant that banks will never find a funds shortage at the federal funds rate. Yes, if their loans are causing inflation the Fed will lift that rate, but banks now have unlimited borrowing at that new rate. I simply meant that at no point does a bank turn away a credit-worthy customer due to insufficient reserves, that the money multiplier is a myth:

So no, sorry, I did not mean to imply that central banks ought run a fixed interest rate target, just that banks are in no way limited by their reserves to make loans *today*. If they have excess reserves, these will already be on the interbank lending market accruing the federal funds rate in interest, if they do not, they can borrow an unlimited quantity at that federal funds rate (at least until the Fed changes it ;). Either way, the cost of a new loan is the federal funds rate, hence the massive impact it has on what loans go out.

That said, some MMT proponents (Mitchell/Mosler I believe, although I don't mean to speak for them) would prefer to see the Fed no longer setting rates, removing itself from the interbank lending markets. That rate setting is inefficient at its stated goals. That it's far too blunt to handle one part of the country in recession when another is in a boom. That it can only dampen demand, not create it – leaving us with widespread unemployment (and underemployment) once demand for credit is low as per today. That it's corporate welfare, most obviously when governments issue debt off the books whilst running budget surpluses – as demonstrated in Australia's recent history:,

They argue (again, I believe) that a JG supersedes the Fed in every way, as an inflation control mechanism due to being a fixed wage (best written up on the Wiki here:… that it keeps the size of the private sector maximised, that it ends permanent unemployment (what inflation control currently presents as), that it has positive effects on crime and skills, that it's far more targeted – capable of handling both the state in recession and the state with a housing boom simultaneously – that it's largely self regulating (due to the concept of the NAIBER – the economy will tend to minimise the size of the JG) and that unlike the Fed whose credit tends to go straight to the "hot" parts of the economy preventing the growth of the cold, the JG focuses on the "cold" parts – allowing for far more resources to go to work before inflation sets in (which under the Fed presents as higher rates, causing unemployment).

Essentially, we can only ever choose to fix one good or basket of goods in price. The Fed chooses to fix a basket of common goods at a 2% increase in prices year on year (among other objectives) and have everything else scale around that, a JG instead chooses to fix the price of the lowest demand labour. As such – although I'm not certain on this – I believe MMT proponents argue this will bring about more stable wages/prices than we see today as we're not specifically aiming for inflation.

With the JG and other strong automatic stabilisers controlling inflation the banking sector can return to lending out from reserves under strict regulation, no longer the sole port by which new money enters the economy.

But note, all of this is just the preferred embodiment for those supporters – it's just within the massive policy space afforded by MMT. MMT allows for central banking or not, it allows for bond printing or money printing (it sees both as perfectly sustainable, as long as bonds are assumed as safe as cash there'll be no shortage of willing buyers, ie Japan), it just makes a lot more options tenable. It's even politically agnostic, allowing for small governments (low taxing/spending in boom times) or vice versa.

.. sorry, that got a bit away from me there ;). Needless to say, I find it a truly fascinating school because if it holds up – and I believe it does – the potential it offers is quite enormous. Thanks for taking the time to read.

Ed Dolan EdDolanNovember 30th, 2012 at 7:26 pm

Hi again, Alex. I have had time to read the Bill Mitchell posts you recommend. I'm afraid I can't quite find what I am looking for there.

1. With regard to "MMT absolutely argues that adding money to an economy at capacity will cause inflation ( : "Inflation is caused by aggregate demand growing faster than real output capacity")."

The problem is that I can't find a clear statement that "adding money to an economy at capacity" will add to aggregate demand. In fact, it seems that Mitchell is saying the opposite.

2. With regard to Mitchell's discussion of the BIS paper, I see no clear distinction between central bank operating targets and intermediate targets. I will look at some of the links within the links, but those points about MMT continue to elude me.

AlexNovember 30th, 2012 at 10:58 pm

Hi Ed,

1. Hm, you're quite correct but I can see where Mitchell's coming from – it is what I was thinking, but I did not express it correctly. What he's arguing is that deficits need not be inflationary even if the economy's at capacity if they do not add to aggregate demand. This seems perfectly reasonable – taken to the extreme, if the government's running a deficit to burn money or bury it in the desert, there'd be no inflationary pressure from that deficit spend – despite that the economy was at capacity. Similarly if the government's running a deficit but the non-government's putting it straight into savings – if China's just accruing the government deficit but not spending it buying imports, it's not actually entering circulation, not actually driving up prices.

So I was incorrect before saying that adding a money to an economy at capacity, by MMT logic. It's more to do with aggregate spending in the economy – if you're increasing spending in the economy without increasing real output you're getting inflation.

As such continual deficits can be run in an economy at capacity provided that the non-government is continually removing that money from circulation as quickly as it's being added. Seems reasonable to me, how do you feel about it?

2. I'm afraid I'm not sure what you're asking here. The operating target is interest rates on the interbank lending market, the intermediate targets are unemployment/inflation etc, correct? MMT simply observes that the Fed's operating target, interest rates on the interbank lending market, means that banks are not limited by their reserves. They can borrow (or invest) an unlimited quantity at that rate, at least until the Fed changes it in an attempt to maintain its intermediate targets (unemployment/inflation etc).

Sorry, I'm not quite sure what you're asking there. This is perhaps a better description of the MMT view of banking than the ones I previously linked though (, perhaps it'd help?

Ed Dolan EdDolanDecember 1st, 2012 at 3:00 pm

I'm not sure I can deal with all the points you raise in a short comment box. I think you are not distinguishing clearly enough between "money" and "aggregate demand." Maybe you are thinking of the case where, in an economy operating at full capacity, the government tries to moderate aggregate demand by raising taxes without increasing spending. In an MMT world where the central bank and Treasury an be viewed as a consolidated entity, that would also remove money from the system.

BurkNovember 28th, 2012 at 1:20 pm

Thanks for a great discussion of MMT. But many non-MMT economists indeed are elsewhere in the current negotiations on the fiscal cliff. They focus on the debt. There was just a feature on the newshour with Paul Solmon and Simon Johnson, all about the debt, how it needs to be controlled, etc. Opened and closed with debt. With merely a whisper about current fiscal and unemployment conditions. Your own post is mostly about the debt. This focus itself is the framing that drives the debate. We need to ignore the debt for a while, and get back to it when we are seeing inflation.

ThomasGrennesNovember 28th, 2012 at 1:25 pm

Sustainability in the sense of limiting the debt/GDP ratio is related to the concept of financial repression that has been documented historically by Carmen Reinhart and various co-authors. Being able to borrow at an interest rate below the real growth rate
makes it easier to restrain the debt ratio. Governments have used their various powers
to get certain lenders to accept lower interest rates on their bonds, and the Fed's current policy of keeping interest rates on short-term government bonds near zero to 2015 is a glaring example of "financial repression". If the interest rate on government bonds would rise to its historical average, the U.S. debt/GDP ration would be much higher.

BogwoodNovember 28th, 2012 at 1:55 pm

Does this mean an agreement on the fact that all growth stops? Specifically all exponential growth stops so we can put aside growth as a goal or even a reality. The "rational" use of monetary policy lacks historical evidence. It would seem to inhibit feedback,not usually a good thing. Recessions help to limit the size of government rather than the government limiting the size of recessions. Wasn't there a lesson in the FSU?
Increasing employment sounds good but which type of employment? There is a four sector grid of employer/self vs covered/non-covered. Government naturally prefers employer/ covered. Both at present and for the last 10,000 years most employment has been self/non-covered. The attempt to resist this fact reached an extreme in the last decade and is inevitably regressing toward the mean. We need to change the incentives to make non-covered self-employment more productive and more satisfying,starting at age eight and continuing indefinitely. It is what we do. Retirement for all is an illusion not to be overcome by money printing, but it should not be a fraud.

Ed Dolan EdDolanNovember 28th, 2012 at 2:16 pm

Bogwood: Interesting comment, but please–a clarification. What do you mean here by "covered" employment? Sorry, maybe this is a term I should know.

BogwoodNovember 28th, 2012 at 6:03 pm

Covered/non-covered came from an Econtalk discussion which I took to be formal tax paying employment versus more informal grey/black market employment. Checking google it most often refers to unemployment insurance but sometimes other benefits/taxes. Historically,women, children and most men have obviously been in the informal economy. Who knows where the sweet spot is but it probably is not above 60% formal employment even for working age population. My bias is toward resource depletion leading to more informal economy,part necessity, part resiliency.

GaurangNovember 28th, 2012 at 3:51 pm

Good read, Ed. To expand on my tweet – while the broad contours of solvency and myth busting the all to common comparisons with a household, etc. serve an important function – I think the more important debate is at what point debt undermines the currency system. In that regard, you simply can't ignore Japan – with debt to the tune of 240% or so (albeit foreign exchange reserves of I believe $2 trillion or so), it enjoys the lowest yield of any country on the planet on long-term government debt. The yen has also virtually doubled in value vs the dollar over the last 7 years or so. This is perhaps as much an outcomes of the total absence of inflation for an extended period, but that is itself an interesting outcome of a country that has run sizable deficits. So, I guess the issue becomes – at what point do economic agents lose faith in the ability of a unit of currency to retain its value, such that holding onto the currency or indeed offering ones productivity for units of currency loses appeal. This is where, I would depart completely from Krugman's views on unleashing a bit of "healthy inflation". It seems to me the inflation genie is purely on a mathematical basis the greatest danger to an essentially leveraged system. MMTers may argue that rising rates aren't a necessary outcome of rising inflation since CBs can effectively curb inflation, but it seems to me that negative real rates would only compound the inflation genie if it's out of the bottle. So, perhaps what we're left with with a system facing a significant debt burden and high deficits is in fact the Reinhardt problem: sluggish growth, but also deflationary forces. Perhaps, the absence of any real transmission mechanism from QE & IOER ultimately encourages banks to devote greater resources to funding government debt, which itself brings down the multiplier. Long post: but my ultimate question is: do you see a path of "sustainability" in the true sense – one where monetary/fiscal constraints don't have a negative impact on economic activity over a prolonged period of time?

Ed Dolan EdDolanNovember 28th, 2012 at 5:24 pm

You ask . . .Do you see a path of "sustainability" in the true sense – one where monetary/fiscal constraints don't have a negative impact on economic activity over a prolonged period of time?

I would say, yes. Bad monetary policy or bad fiscal policy can obviously undermine economic activity, but I think whether you start with an MMT framework or something else, there would always be some way to thread the needle and maintain full employment with price stability (aside from temporary periods of difficulty caused by the need to adjust to external shocks). Of course, that assumes politicians focus on stability and prosperity as long-run goals, not on scoring points and winning the next elections.

GaurangNovember 29th, 2012 at 12:59 am

I guess I struggle to see the path through which the winding down of expansionary monetary and fiscal policy occurs smoothly, and I would think the shock the economy received in '08 was itself an outcome of expansionary policy. So, in my view expansionary policy contributed to a credit led expansion that in itself wasn't sustainable and to that extent has already contributed to unemployment and poor outcomes. Is that a viewpoint you agree with, or are you closer to the loose regulation + banker hubris narrative?

RKARYANovember 29th, 2012 at 5:34 am

so long as interest rates are low and inflation is not bothersome, it is easier for US to ease the debt through extra currency printed. but when the rate of interest is higher and the inflation has also the tendency to rise the debt shall be coercive in that more money has to be printed.

OliverNovember 30th, 2012 at 8:13 am

OK, so what is the causal chain and which of the parameters can be influenced, which can't and which haven't been mentioned at all?

MMTers, together with most modern Post Keynesians and Circuitists and some others, all buy into endogenous money. That means, the main cause for an expansion of the money supply (currency, bank deposits and coins) is an expansion of bank credit. The issuance of credit coincides with the payment by the bank for the fixed capital asset, financial asset or consumption good that was financed through the loan. It thus represents the marginal expansion or contraction (flow) of both supply and demand side phenomena and is therefore the main driver behind GDP. The other two drivers being net exports and net government expenditure.

So, bank credit mostly drives GDP, which in turn determines the budget outcome for any given fiscal stance (within an institutional and cultural setting). The government budget is an outcome, not a policy lever. It is thus logically unsound to begin an analysis with a statement like ' if the primary surplus were greater than the assumed steady-state value' because this implies the pirmary surplus can easily be engineered…

OliverNovember 30th, 2012 at 8:13 am

…Which begs the next question: what determines the volume of bank credit? The 'interest rate' is the standard answer. The PK, Circuit, MMT answer to that is: far too simple! Yes, interest rates will affect credit volumes in certain markets (most notably housing). But the CB interest rate can by no means be considered a simple lever, certainly not a quantitative determinant of the 'money supply', nor is it in any other way a sufficient tool by which to 'steer' an economy. On the other hand, interest rates have grave distributional implications that the mainstream choose to ignore. It does this most often by positing the existence of a 'natural' rate, thus circumventing any rational discussion about the functional implications and all the other variables that determine an economic outcome…

OliverNovember 30th, 2012 at 8:14 am

…Somewhat tangential to this is a theory of inflation. According to the aforementioned, prices are determined at the point of transaction witht the money issuing authority acting as monopolist price setter. For banks lending into capital or housing markets, this determines asset prices. This means, prices paid at emission are speculative in that they that will or won't be validated through the value of the final output financed by it. Loans (including gvt. deficits) that directly finance final output (wages) are non speculative but can be inflationary to the extent that they change over time. I.e. the same output is priced differently, say according to inflation expectations or in a secondary round through indexing, at point t1 and t2. All this can happen independently in specific markets and, especially on the asset front, must not coincide with supply side constraints. In any case, 'printing money', i.e. CB asset swaps are at best a weak and one of many levers by which to influence whatever it is one defines as inflation.

OliverNovember 30th, 2012 at 8:14 am

…The MMT specific addition is, that a monetarily sovereign government occupies a special place within this framework in that it cannot become insolvent in its own currency. There is no cut-off point, even though movemets in, say the exchange rate, can admittedly be so great and sudden as to paralyse the real economy. But is nevertheless the last man left standing in face of private financial folly, and certainly not a beast to ever be starved.

With that in mind, both discussions about mathematical sustainability as well as theoretical discussion about causes of hyper inflation are not very helpful because they mostly confuse cause and effect, fail to incorporate private credit in the government budget dynamics and rely on useless definitions of both money (reserves) and inflation (printing money).

Ed Dolan EdDolanDecember 1st, 2012 at 2:43 pm

You say "It is thus logically unsound to begin an analysis with a statement like ' if the primary surplus were greater than the assumed steady-state value' because this implies the pirmary surplus can easily be engineered… " (I am sorry, I don't quite understand if this is your own view, or your account of what MMT holds, but I will try to respond in a way that covers either case.)

I have been over this ground with MMTers before. Here is how I see it: Yes, the current budget balance is an "outcome" to the extent that automatic stabilizers operate. That is where some EU countries are getting into trouble when additional austerity only shrinks the economy and reduces revenues, therefore having little if any effect on current deficits. I have no argument with that point, and MMTers are right to emphasize it. And I agree, the argument applies just as much to the current primary balance as to the overall balance.

However, the *structural* primary balance is not an "outcome." That is because, by definition, it is the balance that obtains at full employment, taking into account the operation of automatic stabilizers as embodied in current law. If you change the laws, you can do anything you want with the structural balance (primary or overall). In fact, Greece is a good case in point. Right now it has a substantial structural primary surplus as a result of its austerity policies even though it has a very large current deficit because of its low GDP.

Sometimes MMTers write as though they think that automatic stabilizers will always move the current budget into balance when the economy reaches full employment, no matter what the structure of tax and spending laws. I am sure the wisest among them don't really think that, but still, I have seen careless writing from MMTers that could certainly be interpreted that way.

So the bottom line is, endogenous money or no, the structural primary balance is most definitely a policy lever whether you accept the MMT framework or not.

OliverDecember 3rd, 2012 at 6:28 am

Hi Ed, thanks for the reply. I think I agree with that. I guess I had the structural balance confused with the primary balance. And yes, the prior is a policy lever.

As for whether automatic stabilisers will always move the budget into balance at full employment: I don't see any MMT academics saying that nor do I believe that myself. In fact, I believe Mosler often says that that's where the 'full employment deficit', as he calls it, is at present but not where it should be. I.e., it can be different places and for a country like the US with a current account deficit, it should be in deficit.

And I myself am not sure whether the structural deficit (or full employment deficit) is a particularly helpful measure. It says nothing about how, how quickly or indeed whether full employment will ever be reached. And it seems to me there are an infinite amount of possible fiscal arrangements that fit the description. I'd posit that the important measures within any fiscal stance and irrespective of the size of government are how progressive taxes are, i.e. how automatic or responsive the stance is, who the spending is aimed at and what the money ends up being spent on. A slow or irresponsive arrangement will have effects on the supply side that will cause the full employment budget to shift further into deficit.

That squares with endogenous money to the extent that the quality of spending is not accounted for, and the endogeneity measure includes other types of financing. One could call it endogenous finance, I guess.

OliverDecember 3rd, 2012 at 6:37 am

Actually, forget that last sentence. It sounds like I'm saying endogenous money will always lead to full employment, which is obviously nonsense.

AJSDecember 2nd, 2012 at 7:13 pm

Good to see you engaging in a debate – many mainstream economist seem determined to ignore MMT without saying why they disagree.

"Is MMT correct in its claim that a government can never become equitably insolvent? Yes, as long as the proposition is limited to governments that issue their own sovereign currencies and maintain floating exchange rates."
This sounds like you're adding a qualification a overly general MMT claim – but MMT !prefaces! the claim 'governments can never be insolvent' with the criteria of sovereign currencies, floating exchange rates, (and debts denominated in their own currency – one you missed). This is the definition of modern money systems used by US, UK, Japan Australia, etc.

I don't think MMT makes any claims that fiscal policy therefore has complete freedom, just less constraint – the size of the deficit is not the constraint – but what they suggest is that fiscal policy should focus on is unemployment (spare capacity), inflation (esp wage inflation not commodity spikes) and the exchange rate. The politics lies in how you distribute money and draw off money that shapes the economy (eg carbon taxes).

The government deficit is useful for understanding the flows in the economy – ie current net financial assts held by the non government sector (households, business, foreign holdings). Do you agree or disagree with sectoral balances as presented by Mitchell, Wray, Mosler, Galbraith and of course earlier economists? This is fundamental to finding out exactly where you depart from MMT and why.

I'm not totally convinced that you agree fundamentally with the concept of (US, UK Japan etc) governments issuing currency – rather you still seem to have the idea that governments deficits have to be financed, that these governments must basically act like a household – because sovereign money is basically 'hard stuff'. I think the other point of clarification is that MMT view on the meaning of government deficits is about how the way thing are as a financial mechanism – the politics is about the distribution of the budget ie how or where spending or tax cuts are made.

OK so to test your position on the fundamental difference governments are or are not like a household in running a budget (rather than just having bigger credit limits): If the Australian central bank makes a loss of $1b (foreign exchange trades?), when it reports these losses to its owner (the government) should they then have to be covered elsewhere in fiscal budget (tax increases or spending cuts) in order so the budget still tries to meet the target (a surplus).

Something like this has just happened in Australia.


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