Great Leap Forward

By Jove, He’s Got It: Krugman (Finally) Adopts MMT (And so does Summers)

As you know, Paul Krugman has been inching inexorably toward MMT. The last stumbling block has been those Vigilantes. Krugman and Brad DeLong have argued that we don’t need to worry about them, now, in the depths of a liquidity trap. And now that we know that the magic 90% debt ratio of Rogoff and Reinhart was a figment of their poor empirical work, Krugman knows that there’s no trade-off of rising debt for low economic growth.

The sticking point has been “crowding out”—the idea that once we get beyond the liquidity trap and return to a more “normal” ISLM world, government deficits will push up interest rates. And that will then reduce private investment, which tends to lower economic growth. Higher interest rates plus lower growth means the government’s deficit and debt ratios grow beyond “sustainable” levels.

But as I explained last week, the short term rate is completely within the control of the Fed. See here: Long term rates depend on the state of liquidity preference plus expectations of future Fed policy. But in any case, the Vigilantes cannot force Treasury to issue long term debt. It can stick to the short end of the maturity structure and then pay whatever rate the Fed targets.

The real danger is not that the Vigilantes go all vigilant on Uncle Sam, but rather that the Fed decides to do a Volcker (raise the overnight rate to 20%). Congress can stop that by legislating that the Fed cannot act like a Vigilante. Or, alternatively, Treasury can stay on the short end. Both of these are policy choices, completely outside the influence of Vigilantes.

By Jove, Krugman’s got it. Here’s what he wrote today:

Remember, Britain has its own currency, which means that it can’t run out of cash. Furthermore, the short-term interest rate is set by the Bank of England. And the long-term rate, to a first approximation, is a weighted average of expected future short-term rates. Unless markets believe that Britain is going to default — which it isn’t, and they won’t — this is more or less an arbitrage condition that ties down the long run rate no matter what happens to confidence. Or to be a bit more precise, it’s hard to see what would drive up long rates except a belief that the BoE will raise short rates; and why would it do that unless it sees economic recovery in prospect?

All he has to do is to carry that analysis beyond the current downturn. This can go on forever, of course. Keep short term interest rates low, or keep Treasury out of long maturities.

This is quite a contrast to what Krugman argued two years ago, in a critique of MMT:

And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates…. So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation… And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base… But the idea that deficits can never matter, that our possession of an independent national currency makes the whole issue go away, is something I just don’t understand. (See here:; and here

See also Scott Fullwiler’s nearly line-by-line take-down of Krugman’s earlier pieces here: But the important point is that he’s now got it. Let’s hope he doesn’t lose it!

And on another happy note, Larry Summers is catching on, too. See here where he argues against Reinhart and Rogoff’s misguided approach:

The extrapolation from past experience to future outlook is always deeply problematic and needs to be done with great care. In retrospect, it was folly to believe that with data on about 30 countries it was possible to estimate a threshold beyond which debt became dangerous. Even if such a threshold existed, why should it be the same in countries with and without their own currency, with very different financial systems, cultures, degrees of openness and growth experiences? And there is the chestnut that correlation does not establish causation and any tendency for high debt and low growth to go together reflects the debt accumulation that follows from slow growth.

Can anyone say “MMT” knew that all along? That was exactly the argument that Yeva Nersisyan and I made as soon as the awful book came out. See here:

37 Responses to “By Jove, He’s Got It: Krugman (Finally) Adopts MMT (And so does Summers)”

FinsterMay 6th, 2013 at 9:55 am

Ok, so now we know the vigilantes can't by themselves drive up the 30year by rejecting the bonds (as long as there are buyers in the market). This does not however eliminate another dilemma:
If inflation expectations become anchored and suddenly consumption picks up dramatically (I know, everyone now says "Eureka, our problems are solved!) a near zero interst rate permits the monetization of near all future cash flows at undiscounted rates. Assets can be turned into liquidity at very high prices, resulting in rampant credit and a wash of liquidity like a tidal wave.
The usual answer to that was a raising of the interest (discount) rate to curtail future cash converted into present cash. If the treasury and the FED have painted themselves into a corner they cannot raise rates to answer this threat. This is where I detect the danger, not from a vigilante attack, but a sudden drop in liquidity preference in the face of potential M3 becoming M3.
Financial repression can keep rates low as desired, but in doing so may maneuver the fiscal position to a quadrant where raising rates to combat inflation becomes impossible without bankrupting the treasury or in preventing that through prolonging low rates a rejection of the dollar as a means of saving is risked.

L. Randall Wray L. Randall WrayMay 6th, 2013 at 11:19 am

Finster: Only the sovereign gets near zero rates (or, that is, rates near the central bank’s target rates). Unless sovereign extends its “safety net” to cover TBTF banks and firms, they don’t borrow at near-zero. And in any case, fiscal policy tightening is a much more effective boom-killer than is raising rates. If you do indeed get a euphoric boom going on, you cannot kill borrowing by raising rates; all you can do is to raise rates enough to cause massive insolvency in order to create a huge financial crisis to kill the boom.

FinsterMay 6th, 2013 at 11:54 am

Thank you, Professor Wray. Is it our predisposition to see the entire monetary transmission mechanism be administered through sovereign bonds (and those used as collateral in liquidity provision), which propels our fear of the bond vigilante? Your answer to my scenario sees the bankruptcy take place in the private sector and thus the frontrunning attack from the vigilantes hitting the private credit markets.
Also I do see a problem in implementing fiscal tightening during a boom. Tax revenues will be ample in the scenario and elected officials will not be able to sell the message. A private sector boom may be countered by massive tax hikes (which would stabilize the sovereign and preempt any vigilante attack on sovereign bonds).

And lastly, now that we assume that the central bank has full control of the short and extensive control of the long term interest rate, what is the economic impact of the imposed rate diverging significantly from the "natural rate" (in the austrian sense). How will this distort capital allocation in the wider economy.

I tend to think as the devil's advocate. Whenever we assume we have full control over an economic problem (in this case interest rates administered through the CB), the underlying conflicts within the economy (debtors vs creditors and time cost of money) tend to find a different valve and outlet, creating an inefficiency in the process.

cjenscookMay 6th, 2013 at 2:16 pm

Firstly, consumers don't have inflation expectations: only investors do, or they wouldn't invest.

Second, banks have a cost of credit which is the sum of cost of capital; operating costs; and actual default costs.

These costs have precisely nothing to do with the arbitrary interest rates set by Central Banks.

What the Fed is essentially doing is setting the cost of deposits – the input cost on top of which banks must add their other costs before they can make profits.

Financial repression is another canard ranking alongside 'inflationary expectations'.

The fact is that the world is awash in fiat currency – indirect claims via government and banking intermediaries over productive assets and people.

When these claims are set against 'risk free' productive real world assets which underpin the economy (aka land), the result is a real risk free return probably now less than 0.1% pa. If holders of fiat currency want better than that, they must take more risk.

L. Randall Wray L. Randall WrayMay 6th, 2013 at 4:24 pm

Austrian natural rate (or Wicksellian rate) is unnatural, the figment of the imagination run wild. Enters no contracts or decisions.

Yes sovereign bonds are “leveraged”–part of the horizontal supply of “credit money”.

You want automatic fiscal stabilizers. There’s the Job Guarantee yet again! It is the answer to so many vexing questions.

merijnknibbeMay 6th, 2013 at 6:36 pm

The Reinhart and Rogoff book is not that awful. It shows beyond a doubt that financial market oriented economies are not inherently stable. Exit Lucas.

jonf34May 6th, 2013 at 8:14 pm

Larry Summers says this in the WP:

"Now is not the time for austerity. Yet we forget at our peril that debt-financed spending is not an alternative to cutting other spending or raising taxes but only a way of deferring those painful acts. "

MMT ?Hmmm

L. Randall Wray L. Randall WrayMay 6th, 2013 at 9:02 pm

Don’t hold him to too high a standard! After all, look which economics department he calls home. (–

L. Randall Wray L. Randall WrayMay 6th, 2013 at 9:03 pm

Meriknob: Well, let’s hold Harvard profs to a little higher standard than pointing out the obvious!

L. Randall Wray L. Randall WrayMay 6th, 2013 at 9:03 pm

Thanks. I looked. See Scott’s comments there–first rate, nothing I could add.

MRWMay 6th, 2013 at 10:35 pm

Professor Wray,

Please excuse me asking you this dumb question, but I really need an answer to plug a hole in my understanding of MMT. I also get asked this question by people straining to understand MMT, and I sit there looking like an idiot because I don’t know the answer. I am sure you've explained this somewhere in your voluminous writings, many of which I've read (when I was dumber about MMT than I am now) and I can't find the answer. So if there is a link to something that can explain it, I would appreciate it, or maybe you could explain it here.

This brought my question to mind: "But in any case, the Vigilantes cannot force Treasury to issue long term debt."

HERE’S MY QUESTION…this is the pea under my mattress that I can’t get past:

I read a Scott Fullwiler comment on a blog–which I can't find now–where he explained that Congress has a law, presumably from the gold standard days, that says the US Treasury cannot spend into the economy if it makes its general account at the Fed negative. That this is why the government “borrows.” I took this to mean that the Treasury cannot credit the bank accounts of the people it is buying goods and services from by marking up the reserve accounts at their respective banks without also filling Treasury’s general account in order for its balance to remain positive. Otherwise, under the rules of double-entry accounting, Treasury’s general account will be negative. So Treasury must issue debt (T-bills, notes, or bonds) to create a positive balance.

Is this true? And if true, do you know what that law is?

I cannot thank you enough for answering this for me.

ChazMay 6th, 2013 at 11:36 pm

So why DID Volcker raise the rate overnight to 20%? If the US can pay whatever interest rates it wants, why did it pay such high rates in the 1970s? (Please don't say because it wanted to, I want to know why it wanted to, and why Volcker brought that desire to its knees.)

rootless2May 7th, 2013 at 12:47 am

Now Krugman needs to realize that aggregate govt. spending is not all that illuminating. For example, cutting expenses in Iraq and then dedicating half that money to domestic purchases of wind turbines is stimulative even if aggregate spending declines.

TJ ScottMay 7th, 2013 at 12:59 pm

So, keep the foot on the monetary accelerator and use fiscal policy as the brake in an MMT model where we have guaranteed income (fiscal) and a plethora of programs created by politicians wanting to get re-elected. Do you seriously think it's possible that fiscal policy can be used in a granular fashion when NO politician really wants to cut? I think this is the fallacy to this whole argument. You know what happens when you do this in a car? The brakes eventually fail. But then I may be full of it….

Anon-newcomerMay 7th, 2013 at 4:13 pm

For some of us newcomers, it would be nice to avoid jargon… please define your abbreviations, i.e what is MMT?

TrevMay 7th, 2013 at 11:28 pm

Exactly. Given history, I trust Summers no more than any other crook–and he's in the big leagues. A really model sociopath, sleek and dangerous, in good company with Geither, Dimon, Rubin, Paulsen, and Blankfein. And of course, Clinton, "Slick Willie."

TJ ScottMay 8th, 2013 at 12:13 pm

I'm not an economist so this is dangerous territory for me. An undergraduate degree from Old Dominion University does not an economist make.

It is incongruous to say the Austrian natural rate of interest is unnatural, but a CB imposed rate is. Economics has, a priori, automatic stabilizers but no one has the patience to let them work but then they would only work in a true free market, hard money scenario. And even then, there were panics…but then we continue to have them under Keynesianism…so what's changed? The money has been debased, that's all.

JDSMay 9th, 2013 at 3:46 pm

I'm far from an expert on this, but my understanding is that the Treasury is prohibited from overdrafting on its account at the Fed. If I understand Scott and Stephanie's writings correctly, this doesn't really matter because tax and loan accounts must buy Treasury new issues anyway, so the money will always be in the Treasury's account. I think this is the channel for how the Fed ensures that Treasury will always have money in their account.

I too am trying to get an understanding of these operational realities, even though the functional reality is that the central bank spends money by creditng bank accounts.

Potomac OracleMay 10th, 2013 at 5:45 pm

Prof Wray,

What, other than self imposed political constraints, prevents a monetarily sovereign central government from funding all of its political sub-jurisdictions with, say, block grants, thus bypassing bond markets?

olly100May 11th, 2013 at 1:07 pm

Looking forward to it.

You need to address those who claim "MMT is wrong" because the Treasury is supposed to have a positive balance in its account at the Fed before it spends.

Regarding Treasury/Fed overdrafts – are these really currently 'banned', or is the Treasury only 'banned' from selling bonds directly to the Fed? Or is neither 'banned', in fact?

Apparently the Fed does actually buy bonds directly from the Treasury at auction when it's current 'permanent' stock matures. It replaces the maturing bonds by buying new bonds directly at the Treasury's auction, rather than on the "open market".

L. Randall Wray L. Randall WrayMay 13th, 2013 at 12:50 am

olly: we think the fed grants treas daily overdrafts, settled at end of day. they don’t explicitly admit it. operating procedures have changed over the years. and yes there have been periods in which fed bought direct from treas.

olly100May 13th, 2013 at 5:20 pm

"we think the fed grants treas daily overdrafts"

Brad Delong (former deputy assistant Treasury secretary), in his recent post on MMT, said the following in the comments section:

"Unless the Treasury is constrained by the debt limit, if it "overdraws" its account at the Fed it simply says "my bad", prints up a bond, and sends that bond over to the Federal Reserve Bank of New York acting as its fiscal agent, and the Fed credits the Treasury's cash account with the amount of the bond. The Federal Reserve can then either hang onto that bond or sell it, as it wishes, but there is no sense in which the Treasury is constrained to spend only the cash it previously collected in taxes–unless it or the Congress decide that it is so constrained…"

I'd really like to know whether this is actually true or not. It would definitely put a big hole in the argument of those who fixate on the government's self-imposed constraints.

L. Randall Wray L. Randall WrayMay 13th, 2013 at 6:52 pm

Well as you know, Brad was Ass’t to Summers at Treasury so I suppose he knows what he’s talking about!!! Run with it. It is possible that he’s simplifying the process; I thought the Treas used to do that but was not permitted to do it directly now. But there is no doubt at all that the end result is the same because Treas can always sell to a Dealer bank, which can sell them directly to Fed. And the Dealer bank will never, ever, refuse to buy. So Brad is right that except for the silly debt limit there is no chance at all that Treas can run out of “money” to spend.

Andrewp111May 15th, 2013 at 7:06 am

Assets going to very high prices is exactly what QE is doing right now, and they will probably go higher and higher. Eventually, the prices crash, and bank deposits get wiped out.

L. Randall Wray L. Randall WrayMay 15th, 2013 at 11:49 am

yes, QE increased price of govt bonds, lowering yields. problem is that eventually fed will raise rates on short term funds and those holding long term bonds will get capital losses–that’s the crash you refer to.

Joe FirestoneMay 22nd, 2013 at 2:56 pm

I think the law says that the Fed cannot extend credit to the Treasury, except the kind of very short-term incidental credit described just above. That translates to the TGA not being allowed to go negative. However, for all the reasons mentioned by people above, that is really no absolute constraint on the Treasury, because even in the case where Treasury has reached the debt ceiling; it can always mint Platinum Coins in whatever denominations it needs to to to render the ceiling impotent. See:

Robert YoungMay 26th, 2013 at 1:23 am

— Long term rates depend on the state of liquidity preference plus expectations of future Fed policy.

Not really.

I would expect to hear that from a Friedman acolyte, but that's about it. Liquidity preference is the supply side (well, sort of). What really sets the long term rate is capital productivity, and nothing more. One explanation for the unresponsiveness of 'flation to QEx, the one that matters so far as I'm concerned, is that physical investment's return is declining. The MBA types call it as "payback periods are lengthening", but that's just the other side of the same coin.

To the extent that physical capital remains in a copy-cat loop, especially in anything compute related where the payback gets worse and product lifecycles get shorter (also, worse), it matters not that liquidity preference demands 10% return (or whatever number). There's no way to earn it in the real world, so the Coupon Clipping Class is SOL. Repeat: there's no way to earn it in physical capital. All the financial engineering the mind can conjure won't change physical reality.

Finance is not of the real world, but MBA's wet dreams. There was a time when building a steel mill or railroad guaranteed decades of return. Those days are long gone and there's nothing to be gained from assuming otherwise.

L. Randall Wray L. Randall WrayMay 28th, 2013 at 2:55 pm

Liquidity preference theory is a theory of asset pricing, including “physical capital”. See Keynes’s General Theory, Ch17. You seem to be pushing the Austrian view. As Keynes said, you might as well attribute capital’s return to “smelliness”. Anyway, all far too wonky for a blog.

Robert YoungMay 28th, 2013 at 3:24 pm

Austrian!!! Heaven's no. Yes, Keynes is said to have attempted to merge finance with physical production (or thereabouts), but the base problem remains. Unless there is real growth in an economy (out of which to pay the vig), then finance is a zero sum game; there is no investment, just serial consumption. There is no incentive to make physical investment. What we saw with The Great Recession, motivated by Greenspan's crashing of interest rates, was the triumph of finance over production. Housing is the archetype of "investment" which is merely serial consumption. Then, when currency becomes a product, we're all in trouble. Now, that's Austrian.

A business that makes nothing but money is a poor business.
— Henry Ford

L. Randall Wray L. Randall WrayMay 28th, 2013 at 4:17 pm

Uhhhmmm: I’ll take one of those businesses that makes nothing but money.

Straight from M to M’. A very good business, indeed.

Now is that good for the economy? Probably not. So you are not describing reality but rather your preferences? Don’t criticize Keynes based on your druthers. You want one of those parallel universes. That is fine–so did he!