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comments on Krugman’s post

Posted by WARREN MOSLER on August 12th, 2011

Franc Thoughts on Long-Run Fiscal Issues

By Paul Krugman

August 11 (NYT) — Regular readers of comments will notice a continual stream of criticism from MMT (modern monetary theory) types, who insist that deficits are never a problem as long as you have your own currency.

Right, ability to pay is not an issue.

I really don’t want to get into that fight right now, because for the time being the MMT people and yours truly are on the same side of the policy debate. Right now it really doesn’t matter at all whether the United States issues zero-interest short-term debt or simply prints zero-interest dollar bills, and concern about crowding out is just bad economics.

Right.

But we won’t always be in a liquidity trap.

We don’t have one now. It’s a fixed fx concept at best.

But we won’t always be in a liquidity trap.

Someday private demand will be high enough that the Fed will have good reason to raise interest rates above zero, to limit inflation.

Yes, because they ignore the interest income channels.

And when that happens, deficits — and the perceived willingness of the government to raise enough revenue to cover its spending — will matter.

Yes, deficit spending adds to aggregate demand and nominal savings to the penny. Add too much and you get ‘demand pull inflation’

With fixed fx, that can drive up interest rates and threaten reserves. With floating fx it only causes the currency to fluctuate.

I have a specific example that illustrates my point: France in the 1920s, which I wrote about in my dissertation lo these many years ago. Like many nations, France came out of World War I with very large debts, peaking at 240 percent of GDP according to this recent IMF presentation (pdf, slide 17). And France was unable politically to raise enough taxes to cover the cost of servicing that debt. And investors lost confidence in the government’s solvency.

If it was a floating fx policy, interest rates would have been wherever the bank of france set them. If it was a fixed fx policy, rates would be market determined, as the tsy had to compete with the option to convert at the CB.

And taxes falling short of spending is the norm in most nations. Japan for example has one of the largest debts and deficits and one of the strongest currencies. So there’s more to it.

Various expedients were tried, including — late in the game — creation of monetary base, which was advocated by a finance minister on the (very MMT) grounds that the division of government liabilities between currency and short-term bills made no difference. But it turned out that it did: the franc plunged, and the price level soared.

He still hasn’t indicated whether it was a fixed or floating fx policy, and I don’t recall, so I can’t comment.

Now as it turned out this was just what the doctor ordered: because France’s budget problem was overwhelmingly the debt overhang rather than current spending, inflation eroded the real value of that debt and made possible the Poincare stabilization of 1926.

Yes, if a nation goes to a fixed fx policy at the’wrong’ price a further adjustment can address that, though it still doesn’t address the fundamental difficulties of living with a fixed fx policy.

So what does this say about the United States? At a future date, when we’re out of the liquidity trap,

that we aren’t in

public finances will matter — and not just because of their role in raising or reducing aggregate demand. The composition of public liabilities as between debt and monetary base does matter in normal times —

Yes, it determines the term structure of risk free rates.

hey, if it didn’t, the Fed would have no influence, ever.

True, and it doesn’t have much in any case, apart from shifting income between savers and borrowers and altering the interest income of the economy, which is a net saver to the tune of the govt debt, to the penny.

So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.

Only under a fixed exchange rate policy, which we don’t have.

And unlike France in the 1920s, such a hypothetical US deficit crisis wouldn’t be self-correcting: the biggest source of our long-run deficit isn’t the overhang of debt, it’s the prospective current cost of paying for retirement, health care, and defense. So such a crisis — again, it’s very much hypothetical — could spiral into something very nasty, with very high inflation and, yes, hyperinflation.

Highly unlikely. It would probably take annual deficit of well over 20% to get that kind of inflation from excess demand.

Now, all of this is remote right now. And notice too that France in the 1920s stabilized with debt of 140 percent of GDP — far higher than the numbers that are supposed to terrify us now. So none of this is relevant to the current policy debate.

But since the MMTers seem to have decided to harass those of us who want stronger action now but think there really is a long-run fiscal issue, I needed to put this out there.

MMT explains the difference between fixed and floating fx policy.

138 Responses to “comments on Krugman’s post”

  1. F. Says:

    MMT seems to understate the importance in distinguishing between the difference between floating and fixed fx constraints except for Warren Mosler. Most other proponents immediately focus on the issuer versus user differential when the only reason that is applicable is because of the floating versus fixed reality.

    Reply

    WARREN MOSLER Reply:

    there’s the issuer/user distinction, and there’s also distinctions between issuer’s policies.

    in this case K missed the latter distinction and I didn’t see any other blogger pick it up so I did a quick one on it.

    Reply

  2. Ramanan Says:

    I thought the Franc was floating in the example provided.

    Japan is a net creditor of the rest of the world!

    Reply

    Neil Wilson Reply:

    @Ramanan,

    There is some doubt as to whether it was truly floating. There were several major interventions during the period by the Central bank that cast doubt on whether there was a true float.

    The history seems to show that the Central bank wanted to go back to the Gold Standard and the fiscal authorities didn’t.

    Reply

    Ramanan Reply:

    @Neil Wilson,

    I have a theory. Wolves start dancing inside the White House, when no human is around. Why is that not a useful theory? Because at any point in time, there is always someone in White House.

    Similarly, central banks will try to do something that market forces cannot. They don’t follow some MMT principles. Most central banks intervene. Your argument that the job should be left to market forces is like invoking the free markets argument from the backdoor.

    The Bank of France may have tried to intervene in the markets – but that is just to achieve something better in an already worsening scenario.

    Reply

    Tom Hickey Reply:

    @Neil Wilson,

    Keynes commented at the time. See J. M Keynes, Essays on Persuasion, “The French Franc, II, 3, p. 105-117, available at Google Books.

    h/t Rob Parenteau

    Reply

    Tom Hickey Reply:

    @Tom Hickey,

    Winterspeak weighs in too.

    Krugman is the problem

  3. Winslow R. Says:

    Box

    “We won’t always be in a liquidity trap”

    Not sure what Krugman is doing…..

    Reply

  4. Winslow R. Says:

    “True, and it doesn’t have much in any case, apart from shifting income between savers and borrowers and altering the interest income of the economy, which is a net saver to the tune of the govt debt, to the penny.”

    I’d add the fed is very good at pushing financial intermediaries with maturity mismatch into the gutter.

    Reply

  5. Winslow R. Says:

    “So what does this say about the United States? At a future date, when we’re out of the liquidity trap,

    that we aren’t in”

    This statement, in regards to a liquidity trap, will likely create more confusion.

    If we limit the idea of a liquidity trap to the Fed, whose only tool is the purchase of U.S. Treasury Securities, at some point they will be unable to push real rates more negative, right? It seems Krugman is already confused enough…..

    Reply

    WARREN MOSLER Reply:

    no such thing as a liquidity trap with floating fx.

    Reply

    anon Reply:

    @WARREN MOSLER,

    what’s the right definition of a liquidity trap with fixed fx?

    Reply

    WARREN MOSLER Reply:

    When mkts take the interest rate down to 0 but can’t go lower to allow ‘clearing’ as people hold cash rather than receive a neg rate

    anon Reply:

    @Mosler,

    I don’t see what that has to do with fixed rates but not floating rates.

    Ramanan Reply:

    @anon,

    WM has the tendency to call all jargon/concepts in economics texts as fixed exchange paradigm

  6. Amileoj Says:

    So, if I understand correctly, the MMT view of the liquidity trap is not so much that we’re not in one now, as that the entire concept has no application to the way our economy works anymore (since say ’71).

    And that would be because the liquidity trap is a kind of temporary suspension of certain involuntary financial constraints (in the form e.g. of unwanted reserve drains and interest rate increases) that do not apply in the first place, once you have floating forex.

    So it’s almost as if MMT could say to IS/LM: You’re entirely right about how a macroeconomy works under liquidity trap conditions. Where you go wrong is just that you’re not seeing that the advent of floating forex makes those exact same conditions the norm for us now.

    Is that about right?

    Reply

    WARREN MOSLER Reply:

    about right! islm is fixed fx analysis

    Reply

    Ramanan Reply:

    @WARREN MOSLER,

    ISLM is not even right about fixed exchange.

    Reply

    WARREN MOSLER Reply:

    True, but that’s it’s intended application?

  7. Ramanan Says:

    “So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.

    Only under a fixed exchange rate policy, which we don’t have.”

    The MMT fixed-fx-rate anti-anti-analogy is weird and unproductive.

    Lets face it, there was heavy inflation in France in that period.

    This was not caused due to the expansion of the monetary base, but due to the collapse of the Franc and the inflation imported due to it and I would imagine the wage-price spiral caused due to it with fiscal expansion just making the situation worse.

    Reply

    Neil Wilson Reply:

    @Ramanan,

    So seven years of political instability and no agreement on who should pay the taxes had no effect at all?

    You are seeing what you want to see in the ink blots.

    Reply

    Clonal Antibody Reply:

    @Neil Wilson,
    Search for “poincare stabilization,” In one of the leads,- The Economic Consequences of the Franc Poincare you will find

    In this paper we reassess the cyclical performance of the French economy in the 1920s, focusing in particular on the period 1926-1931 and on France’s resistance to the Great Depression. France expanded rapidly after 1926 and, unlike the other leading industrial economies, resisted the onset of the Depression until 1931. We find strikingly little support for the conventional explanation for these events, which emphasizes an undervalued French franc and an export-led boom. While French exports as a share of GDP turned down as early as 1928, the economy continued to expand for several subsequent years. Investment, not exports, emerges as the proximate source of the French economy’s resistance to the Great Depression. And fiscal policy emerges as the major determinant of the surge in French investment spending. Previous accounts have emphasized the role of monetary policy in determining the seal and nominal exchange rates ostensibly responsible for French economic fluctuations in the decade after 1921. In contrast, we argue here for a more balanced view of the roles of monetary and fiscal policies in French macroeconomic fluctuations over that critical decade.

    Reply

    Neil Wilson Reply:

    @Clonal Antibody,

    France went onto the Gold standard in 1928 and pegged to the dollar and sterling in 1926. The float period was before that and the political instability prior to the Poincare victory.

    When Poincare got in he was able to implement the taxation policy France needed – if any of the web’s resources are to be believed.

  8. Jose Says:

    @ Neil Wilson

    “The MMT fixed-fx-rate anti-anti-analogy is weird and unproductive.”

    I agree.

    MMTers are very good at explaining the difference between currency issuers and currency users and how the U.S. abandonment of the gold standard in 1971 changed the rules in economic policy.

    However, they are not that prolific on the impact of the other piece of change in the world monetary system that occurred a bit later – the introduction of floating rates among major economies in 1973.

    Question: what are the main MMT papers on this specific topic – the implications of floating rates versus fixed rates on the monetary system and the available options for economic policy?

    I’ve made several searches and couldn’t find any…

    Reply

    WARREN MOSLER Reply:

    see ‘exchange rate policy and full employment’ on this site under ‘mandatory readings’

    Reply

  9. jown Says:

    Once again, apologies if this is idiotic:

    Some possibly relevant information as to the fx vs. non-fx question as well as the “situation” of the Franc in the early ’20s:

    Link to “Globalizing capital: a history of the international monetary system By Barry J. Eichengreen”

    NB: re Milton Friedman: “For them [Friedman and his followers], the history of the franc provides no grounds for doubting that floating
    rates can function satisfactorily when monetary and fiscal policies are sensibly and consistently set.” (p52)

    Friedman then appears to be counter the Krugman/Nurske-ian line in that he saw causality running from fiscal and monetary policy to exchange rate instability.

    My .0002 francs worth from brief review is that France of the time might not have had the internal political strength to handle a tax/spend (Lerner/Functional) line out of the Post WWI situation and that implication/analogy to our current leaders may be apt.

    Furthermore, they may have had motive not to; to “read between the lines,” is that the authorities in France at the time were to a certain extent, “captured” in that “The larger the deficits and the more rapid the inflation and currency depreciation they provoked, the stronger France’s negotiating position” (p53) as to the level of commitment Germany would make to the reconstruction effort in France.

    And take that, in conjunction with “Meanwhile, revenues were depressed by the slow pace of recovery. Disagreement over whose social programs should be cut and whose taxes should be raised resulted in an extended fiscal deadlock. The parties of the Left demanded increased taxes on capital and wealth, those of the Right reductions in social spending. As long as agreement remained elusive, inflation and currency depreciation persisted.” (p52) and you have where we are not today (with respect to inflation/currency depreciation; yes to the rest though).

    So, from France of the 20s to today: maybe more political dysfunction, capture, and internal predatory dynamics instead of “current cost of paying for retirement, health care, and defense.”

    We can always pay our bills and can take care of our own, but do we have the integrity, wisdom, foresight, and political will to do it? (well, that’s what I’m gonna work towards)

    All the more reason that those in charge need to understand MMT and that MMT is really a sort of post-political position that is designed for social and economic stability.

    (I hope I have not mis-represented MMT for I heart it so)

    Reply

    WARREN MOSLER Reply:

    :)!!!

    Reply

    Unforgiven Reply:

    @jown,

    Nicely done!

    Reply

    WARREN MOSLER Reply:

    Thanks!

    Reply

    NeilW Reply:

    @jown,

    Thanks for that. A weak government without the information with have today.

    Reply

  10. anon Says:

    “If it was a floating fx policy, interest rates would have been wherever the bank of france set them. If it was a fixed fx policy, rates would be market determined, as the tsy had to compete with the option to convert at the CB.”

    With fixed rates, the CB still sets the policy interest rate.

    E.g. it sets it at a level that balances the stock of reserve currency and avoids net accumulation or net loss in that stock. The CB’s policy interest rate is market determined in that sense, but the CB still has to set it. E.g. it would be possible for the CB to set the “wrong” policy interest rate – a rate that leads to destabilizing net inflows or outflows of reserve currency.

    So the CB takes action in accordance with the market’s pricing signal.

    This is not entirely dissimilar to the CB taking interest rate pricing action according to the price signal from CPI. The difference is that the interest rate pricing signal comes through fixed rate reserve stock flows rather than CPI.

    Reply

    anon Reply:

    i.e. the CPI is also determined by “the market” for goods and services

    so the market also determines interest rates where the CB is following a CPI rule to set the policy interest rate

    Reply

    WARREN MOSLER Reply:

    your confusing a reaction function with market forces

    Reply

    anon Reply:

    @WARREN MOSLER,

    disagree

    CB reacts to fixed fx flows and pricing forces by resetting the policy interest rate

    CB reacts to CPI pricing forces by resetting the policy interest rate

    CB “controls” the price reference stock and flow under fixed fx

    CB observes the price reference under floating fx

    CB reacts in both cases by resetting the policy interest rate

    WARREN MOSLER Reply:

    So the Russian cb could have stopped rates from going over 200% in 1998 and held the peg at 6.45?

    MamMoTh Reply:

    @Anon, you think one instrument (policy interest rate) can control two independent variables simultaneously?

    WARREN MOSLER Reply:

    Lots of evidence it doesn’t control anything

    anon Reply:

    @mammoth,

    obviously not

    comment refers to two different systems

    MamMoTh Reply:

    @anon, so what exactly is your point in a less cryptic way?

    WARREN MOSLER Reply:

    have you read ‘exchange rate policy and full employment’ on this website?

    Reply

    anon Reply:

    @WARREN MOSLER,

    yes

    Reply

    anon Reply:

    CPI is one constraint – price

    Fixed fx is two constraints
    - price (“fixed”)
    - stock/flow (reserves)

    The stock/flow constraint is redundant. CB doesn’t need to participate in stock/flow fx management in order to influence fx price longer term – it can just use interest rates, just like it does for CPI

    At the end of the day, both are done using interest rates

    WARREN MOSLER Reply:

    You aren’t saying rates in Russia wentmup over 200% because the cb hiked to that level?
    They went up because of mkt indifference levels and there was nothing the cb could do about and hold the peg

    If you let the peg go that’s floating the currency andante cb sets rates

    anon Reply:

    selling fx from reserves

    or selling virtual CPI

    the CB can default on both if it gets tired of raising interest rates

    WARREN MOSLER Reply:

    Right

    Defaulting on conversion is floating the currency

    anon Reply:

    or selling NGDP futures

    as Sumner would do for tightening

    Ramanan Reply:

    @anon,

    “or selling NGDP futures

    as Sumner would do for tightening”

    A very very very bad idea anon.

    anon Reply:

    @Ramanan,

    agreed

    but not so bad because of the idea of NGDP futures per se – it’s just another casino

    bad because the CB participates in the futures

    and horrible because of the associated OMO interest rate function

    take Krugman’s haziness on monetary operations, and multiply it by a billion for Sumner

    Ramanan Reply:

    @anon,

    Amazing ideas they come up with.

    i think he has the idea because the government promises an NGDP and the loss/gain in NGDP futures compensates for it in case the target is not met.. forgetting the fact that the man on the street has no idea of what futures is. Sumner seems to live in a world of his own where not only does he mess up the monetary aspects of economics but is completely unaware of the real aspects.

    Any link on someone bashing the idea ?

    anon Reply:

    @R,

    not offhand; very few who understand monetary operations would bother with it

    Ramanan Reply:

    @anon,

    Excellent points Anon!

    And there have been instances when currency boards have set their own interest rates unlike what is mentioned this place.

    “E.g. it would be possible for the CB to set the “wrong” policy interest rate – a rate that leads to destabilizing net inflows or outflows of reserve currency.”

    Good.

    In fact, emerging markets with floating rates also face destabilizing inflows and outflows and have to react in reaction to the more powerful nations.

    The “consensus” that in fixed rate exchange, the interest rate is “endogenous” is based on equilibrium Mundell-Fleming analysis.

    If thought carefully, the range which fixed exchange rate systems have is quite wide. There are enough items in the balance of payments to adjust instead of the interest rate adjusting.

    For example, setting the higher rate than the currency to which the peg is – will lead to some outflows but there are “inflows” – as in credits such as higher exports compared to imports.

    Biggest example – China has its own rate :)

    Reply

    Ramanan Reply:

    Marc Lavoie has some articles on it. Initially when I read them, I thought he was exaggerating. But careful thought over an extended period of time led to me believe he was right!

    In fact, when central bankers were forced to “control” the money stock because Monetarists were exerted the pressure in the late 70s and early 80s, they were arguing that they were always setting rates! (which means even in the Bretton Woods period).

    Reply

    anon Reply:

    @Ramanan,

    Volcker set the equivalent of the policy interest rate, even though he didn’t announce it

    no difference between then and now, even though everybody thinks he controlled money stock; he didn’t

    Ramanan Reply:

    @Ramanan,

    Exactly.

    they just kept increasing rates.

    Ramanan Reply:

    @Ramanan,

    Btw, Marc Lavoie has a full chapter on credit and money in his 1991 book “Foundations of Post-Keynesian Economic Analysis” where he describes the situation at Volcker’s time and also in the UK … banks rushing to the discount window .. and another thing rarely mentioned … banks refusing to roll T-bills because they didn’t want to part ways with reserves get get when they mature.

    (I think banks at that time held much more Treasury securities than these days).

    Ramanan Reply:

    As in the Fed reluctantly attempted to control the money supply as opposed to controlling it, so the daily game played was a confused strategy.

    MamMoTh Reply:

    @Ramanan,

    China has capital controls right?

    Reply

    Ramanan Reply:

    @MamMoTh,

    So do many nations.

    To be a member of the IMF, one needs to have current account convertibility but capital account convertibility is left to the nation to decide… the IMF however, “encourages” capital account convertibility

    MamMoTh Reply:

    @Ramanan, no capital account convertibility makes a difference.

    China’s currency is undervalued. Technically you can prevent your own currency from appreciating and still be able to set your own interest rate as previously discussed

    http://moslereconomics.com/mandatory-readings/full-employment-and-price-stability/#comment-55208

    Ramanan Reply:

    @MamMoTh,

    ” no capital account convertibility makes a difference.”

    No, imperfect asset substitution makes the difference.

    The US even set the yield curve briefly in the bretton woods era!

    Sorry couldn’t catch the comment you linked.

    Ramanan Reply:

    @MamMoTh,

    “China’s currency is undervalued. Technically you can prevent your own currency from appreciating and still be able to set your own interest rate as previously discussed”

    China sets its exchange rate and its short term policy rate.

    Thats a fact.

    And whats called here “fixed exchange rate paradigm” is debatable – because that implies that the neoclassical/monetarist theory is right about those regimes. However, its equally wrong.

    MamMoTh Reply:

    @Ramanan, as usual it is not clear to me what is the point you are trying to make. The link works fine. It discusses the fact a country can keep its currency undervalued and set the interest rate (e.g. China currently) but it cannot do it if its currency is overvalued (e.g. Russia and Argentina in the 90s).

    WARREN MOSLER Reply:

    Right

    Ramanan Reply:

    @MamMoTh,

    “as usual it is not clear to me what is the point you are trying to make. ”

    Sorry which point of mine was not clear earlier ? Have you figured the revaluation accounting btw ?

    “It discusses the fact a country can keep its currency undervalued and set the interest rate (e.g. China currently) but it cannot do it if its currency is overvalued ”

    Now thats a shift. First claim, one can’t set rates and then the reason overvalued/undervalued ..

    The point is that nations end up in balance of payments crises but doesn’t mean you start a description of events assuming interest rate is market-determined.

    “The link works fine.”

    Yes I know.

    WARREN MOSLER Reply:

    And my paper explains how with fixed fx mkt forces set rates and what happens if the cb intervenes in either direction

    MamMoTh Reply:

    @Ramanan, honestly I am not sure I get what your point is in this case. I assumed it is whether in the case of a fixed exchange the interest rate is market or policy determined.

    Now thats a shift. First claim, one can’t set rates and then the reason overvalued/undervalued ..

    Where’s the shift? That is my understanding of Warren’s article on exchange rates, and his answer to my question in the link I provided.

    I think technically you can say that a country with a fixed exchange can set the interest rate. But setting two prices is always a problem and one is likely to not be the equilibrium one.

    If the currency is overvalued as evidenced by an outflow of fx reserves, then the interest rate will need to be raised. It’s the equilibrium interest rate that is market determined, and the government needs to find it. In that sense it is endogenous.

    If the currency is undervalued as evidenced by an inflow of fx reserves, then there is no problem to sustain the fixed rate, and interest rate can be set exogenously at any level that does not reverse the inflow of fx.

    WARREN MOSLER Reply:

    The interest rate on tsy secs is the market finding it

    Ramanan Reply:

    @MamMoTh,

    ” honestly I am not sure I get what your point is in this case. I assumed it is whether in the case of a fixed exchange the interest rate is market or policy determined.”

    The normal MMT description of fixed exchange rate is essentially the Mundell-Fleming model. So, you hear about the monetary base shrinking etc (Billy Blog description)

    Now that is far from what actually happens and what banks and central banks do and act in fixed exchange rate regimes.

    There are examples where nations facing issues in the external sector (high current account deficits etc) end up in problems because the market gets suspicious of the central bank’s credibility of defending the exchange rate. No denying of those facts.

    However, nothing of what is described (most at Billy Blog) happens. Its not only possible for central banks to set a policy rate different from the currency to which the home currency is fixed, they have done that at various points in time.

    “If the currency is undervalued as evidenced by an inflow of fx reserves, then there is no problem to sustain the fixed rate, and interest rate can be set exogenously at any level that does not reverse the inflow of fx.”

    Not sure what you mean by undervalued ? At any case, there seems to be a denial here policy rate setting even in the “undervalued” case.

    MamMoTh Reply:

    @Ramanan,

    I guess that whatever you disagree with Bill Mitchell’s writings is better discussed on his blog.

    Here it is better to limit ourselves to discussing Warren’s description of fixed vs floating rates, as in Exchange rates policy and full employment.

    Its not only possible for central banks to set a policy rate different from the currency to which the home currency is fixed, they have done that at various points in time

    Sure. Who said the opposite?

    Not sure what you mean by undervalued ? At any case, there seems to be a denial here policy rate setting even in the “undervalued” case.

    Undervalued as evidenced by an inflow of fx. Think yuan as opposed to ruble or argentinean peso.

    Where is the denial?

    Ramanan Reply:

    @MamMoTh,

    “Here it is better to limit ourselves to discussing Warren’s description of fixed vs floating rates, as in Exchange rates policy and full employment.”

    And what he does he say ?

    “Sure. Who said the opposite?”

    The host of this blog seems to be in denial of this fact.

    “Undervalued as evidenced by an inflow of fx”

    Capital inflow ?

    Ramanan Reply:

    @MamMoTh,

    ““Here it is better to limit ourselves to discussing Warren’s description of fixed vs floating rates, as in Exchange rates policy and full employment.”

    Also, all of Chartalists description is essentially the same!

    MamMoTh Reply:

    @Ramaman,

    I guess you better read it yourself.

    You’ll find for instance that he says Hong Kong’s CB sets interest rates higher than the US interest rate, so there is no denial at all.

    Inflow of the foreign currency the domestic currency is pegged to.

    WARREN MOSLER Reply:

    Hk doesn’t normally set rates/intervene

    Ramanan Reply:

    But Bulgaria which runs a currency board setup, (pegging its Lev to the Euro, and maybe something else before the Euro zone was formed) has set its interest rate.

    WARREN MOSLER Reply:

    don’t know the details there.
    most currency boards don’t set their rates except when they want to bring their reserves to bear on policy, which technically ‘violates’ the currency board.

    Ramanan Reply:

    “fwd fx rate *is* the interest rate.

    with fixed fx it’s set by mkt forces (and a bit of credit risk now and then).

    with floating by the CB”

    The forward rate is just the result of an arithmetic operation with interest rates and the fx rate.

    China sets “the interest rate” or the markets ?

    WARREN MOSLER Reply:

    With fixed fx interest rates express the market’s indifference levels for fwd fx points

    Reply

    MamMoTh Reply:

    @WARREN MOSLER, what is a forward fx point in the case of fixed exchange?

    WARREN MOSLER Reply:

    like where the yen/dollar exchange rate trades today for delivery at some future date.
    so, for example, the price of yen/dollar for sep 1 delivery would be an fx point.

    Ramanan Reply:

    @WARREN MOSLER,

    “With fixed fx interest rates express the market’s indifference levels for fwd fx points”

    And what is that supposed to mean, please ?

    WARREN MOSLER Reply:

    exactly that?

    maybe needs a comma?

    “With fixed fx, interest rates express the market’s indifference levels for fwd fx points”

    anon Reply:

    @R,

    it means the interest rate differential between two currencies essentially equates to the forward FX premium or discount

    it’s a money market arbitrage for fully hedged international flows

    e.g. 1 per cent interest rate for currency X equals 2 per cent interest rate for currency Y minus the forward FX premium for X in terms of Y

    Ramanan Reply:

    Anon,

    Yes, that’s the standard forward/spot relation.

    But what does the original comment I quoted mean ?

    WARREN MOSLER Reply:

    the fx point drives the interest rate, vs the fed’s rate policy driving the fx point.
    it’s about causation

    anon Reply:

    @R,

    exactly that, as far as I’m concerned

    i got it right away, no problem

    anon Reply:

    @R,

    indifference means markets arb to the point where they are indifferent to an interest rate of 2 per cent in Y currency, or a rate of 1 per cent in X, plus a forward exchange contract to swap X back to Y for a pickup of an additional 1 per cent

    Ramanan Reply:

    @WARREN MOSLER,

    “the fx point drives the interest rate, vs the fed’s rate policy driving the fx point.
    it’s about causation”

    Like for fixed exchange rate ? Forward rate causes interest rate ??

    WARREN MOSLER Reply:

    fwd fx rate *is* the interest rate.

    with fixed fx it’s set by mkt forces (and a bit of credit risk now and then).

    with floating by the CB

    MamMoTh Reply:

    @WARREN MOSLER,
    like where the yen/dollar exchange rate trades today for delivery at some future date.
    so, for example, the price of yen/dollar for sep 1 delivery would be an fx point.

    I understand what it means in the case of floating exchange rates, but not in the case of fixed ones.

    WARREN MOSLER Reply:

    same.

    difference is causation. with fixed mkt forces set the fx point/interest rates, with floating fed sets rates/fx points follow

  11. Matt Franko Says:

    To get to a paradigm shift: “Psychological research shows that people’s thoughts about the causal relationships between events influences their judgments of the plausibility of counterfactual alternatives, and conversely, their counterfactual thinking about how a situation could have turned out differently changes their judgements of the causal role of events and agents.”

    http://en.wikipedia.org/wiki/Causality

    So it looks like you can get to a paradigm shift to an understanding of MMT 2 ways:
    1. You can investigate the causal relationships via the accounting relationships and if you possess Mathematical Maturity
    http://en.wikipedia.org/wiki/Mathematical_maturity
    you should be able to see how our Fiscal and Monetary systems really work and then abstract that knowledge into a new vision for policy and just/righteous economic outcomes.

    Or 2. You can become totally dissatisfied with the current economic outcomes and think of counterfactual outcomes first, and then that naturally leads to ones understanding of the true operational details of how our Fiscal and Monetary systems really work that could lead to your (counterfactual) desired economic outcomes…

    So Krugman is failing to succeed on either path.

    Warren has had focused discussions with him about the operations and he isnt getting it that way (Krugman has no mathematical maturity which is bad for an award winning Economist); and his level of dissatisfaction with current outcomes is also not leading him to see the counterfactual and associated alternative causal events and agents (which is also pretty bad for someone going around calling himself “the conscience of a Liberal”).

    Krugman has major problems with all of this… he either does not possess the math skills or he doesnt really have a conscience. Resp,

    Reply

    anon Reply:

    @Matt Franko,

    can you give a specific example of how you are invoking “counterfactual” in the context of MMT, so that I can follow your line of thought?

    i.e., in the MMT world:

    what exactly is your “actual”

    what exactly is your “counterfactual”

    Reply

    Matt Franko Reply:

    @anon, once the paradigm shift is made, ‘actual’ is govt spends first,
    Before one makes the shift, it was ‘counterfactual’ (I used to think that govt had to borrow to be able to spend)
    I personally got the shift via the 1st process (mathematics )
    Rsp

    Reply

    Neil Wilson Reply:

    @Matt Franko,

    Spending is best seen as coming first – meaning that it is best to view it that way while working with a linear model.

    In the real world spending happens concurrently in a complicated circular dance where it is impossible to see a beginning or an end.

    Both ‘borrow first’ and ‘spend first’ are valid viewpoints on the circle, but only ‘spend first’ highlights where the extra policy space is hiding.

    ‘borrow first’ leads you to run the economy with the handbrake permanently on.

  12. Ramanan Says:

    This looks good … at least from a historical perspective, not necessarily a conceptual perspective

    The Gold Standard Illusion: France, the Bank of France, and the International Gold Standard, 1914-1939 [Hardcover] – Kenneth Mouré

    http://www.amazon.co.uk/Gold-Standard-Illusion-International-1914-1939/dp/0199249040

    One more thing independent of this .. the French may have had a somewhat different historic setups such as government owned post offices accepting deposits .. government itself a bank (?) “comptes cheques postaux” ??

    Reply

    anon Reply:

    @Ramanan,

    where’s fullwiler’s response to Krugman?

    Reply

    Ramanan Reply:

    @anon,

    There are two things.

    1. Krugman pointing out to a situation where fiscal policy/expansion doesnt’ work.

    2. Krugman describing what went on.

    Only point 2 can be criticised because Krugman is not the best monetary economist.

    However, point 1 can’t be addressed and is an issue. Its bitter truth.

    One can bring in facts that the French government sector had liabilities in foreign currency.

    In the French case, however, even though the government suffered from the original sin, had debt in foreign currency, spent a lot and repaid its debt in foreign currency (and hence did not default). So they truly acted “not revenue constrained” and the markets punished them.

    Only the United States has this “exorbitant privilege”, a phrase used by a French official in the 1960s, coincidentally (may not coincidentally!). Maybe that is going to go as per Barry Eichengreen’s thesis.

    Reply

    Ramanan Reply:

    @Ramanan,

    Should add this to the previous comment.

    MMTers have this requirement “Thou shall not borrow in foreign currency” and that if a government does that, it will be constrained.

    WARREN MOSLER Reply:

    I just point out what can happen if you do

    NeilW Reply:

    @Ramanan,

    That is what you choose to see. Everybody else just sees a weak government.

    Ramanan Reply:

    @Ramanan,

    “That is what you choose to see. Everybody else just sees a weak government.”

    As in … any “strong government” you know of ? Clearly the French tried hard to grow their economy and were acting non-laid-back.

    What did I choose to see ?

    anon Reply:

    @R,

    Krugman didn’t even mention foreign currency, did he?

    Reply

    Ramanan Reply:

    @anon,

    Yeah but what is the issue there ?

    IMO, the causality is exactly backward. Nations fail to attract foreign funding in domestic currency and have to take the route of borrowing in foreign currency.

    “Most countries cannot borrow abroad in their own currencies, a fact that we refer to as “original sin.” This problem affects almost all countries aside from the issuers of the 5 major currencies – the US dollar, the euro, the yen, the pound sterling and the Swiss franc – along with a few telling exceptions that we analyze below. It has important implications for financial stability and macroeconomic policy.”

    http://www.financialpolicy.org/financedev/hausmann2002.pdf

    One anticipated criticism is that there is no need for government borrowing in their own currency and directions such as that!

    WARREN MOSLER Reply:

    Nations don’t ‘borrow abroad’ in their own currencies.

    They offer savings accts as alternatives to checking accounts at their cb

    MamMoTh Reply:

    @Ramanan,

    Interesting paper. Just skimmed through the intro.

    We provide evidence that this state of
    affairs is not easily ascribed to weaknesses in national policies and institutions[...]. We find instead that explanations based on factors
    limiting the incentives for currency diversification by global investors – transaction costs
    in a world of heterogeneous countries or network externalities – provide a better
    explanation for observed patterns.

    That’s sort of what I’ve been saying all along about the desire to net save in someone’s currency being predetermined which is why running a external debt denominated in foreign currency is rarely a policy choice.

    Ramanan Reply:

    @anon,

    Mammoth,

    “which is why running a external debt denominated in foreign currency is rarely a policy choice.”

    Exactly agree.

    And people at the Ministry of Finance and the Central Bank know that having debt to foreigners in local currency is better.

    You can find the description of currencies, exchange rates and such issues in Basil Moore’s 2004 book “Shaking the Invisible Hand” – very illuminating description of the dynamics between the central bank and the exchange market.

    WARREN MOSLER Reply:

    Basil has experience with those markets? I doubt it

    And it’s always a policy choice.

    Gary Reply:

    @anon,

    @Mammoth
    “That’s sort of what I’ve been saying all along about the desire to net save in someone’s currency being predetermined which is why running a external debt denominated in foreign currency is rarely a policy choice.”

    If there is an import that is vital to you (oil, food) – and if the country owning that import won’t sell it to you for your own currency – you have to get foreign currency. Often that means going in debt in that foreign currency.
    In this case it is not a policy choice and you are right.

    Now – if you decided to bind your currency to some other (dollar, euro) and then keep the exchange rate stable. That effective limits the amount of your own currency that you can issue (otherwise you won’t be able to defend the exchange rate). If you want or more to issue more – you have to borrow in foreign currency.
    That is a policy choice.
    Also if in this fixed rate regime you allow your citizens to go into debt denominated in foreign currency – then once they will start paying debts back they will keep selling your currency to get foreign currency.
    Again you will be forced to borrow in foreign currency. And again it is a policy choice.

    MamMoTh Reply:

    @Gary, a peg of the currency is always a policy choice, getting indebted in foreign currencies usually s not.

    A government can run a peg and sustain it as long as the budget deficit is smaller than the trade surplus without borrowing in foreign currencies. That is usually the case when the peg is undervalued enough like the Yuan.

    The problem starts when the peg is overvalued like the Argentinean peso in the 90s and you run a trade deficit in which case you need to borrow to sustain it.

    So the real constraint is the trade balance.

    We can then say that borrowing in foreign currencies is a policy choice insofar as freedom to trade is a policy choice.

    Gary Reply:

    @MamMoTh,

    “a peg of the currency is always a policy choice, getting indebted in foreign currencies usually s not.”

    if getting indebted in foreign currencies is a result of currency peg – and currency peg is a policy choice – then this foreign debt is a result of policy choice.

    like I wrote above – if the import that you need is vital and can only be bought by foreign currency, and if your country just cannot export something in order to earn it – then it is not a result of policy choice – but result of trade. Then no matter how free floating your currency will be – the country will have to borrow in foreign currency.

    Sergei Reply:

    @anon,

    Gary: “If there is an import that is vital to you (oil, food) – and if the country owning that import won’t sell it to you for your own currency – you have to get foreign currency”

    Which implies that government has to do it. However it does not need to take the fx-risk.

    WARREN MOSLER Reply:

    please give one historical example of a nation with no imports because no one wants its currency, thanks

  13. Rodger Malcolm Mitchell Says:

    All this hand-wringing about inflation — even hyper-inflation. I wonder how Krugman explains the fact that since 1971, when we ended our tie to gold, there has been no relationship between federal deficits and inflation. Instead, inflation has been related to the price of oil.

    See: http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation/

    Rodger Malcolm Mitchell

    Reply

    WARREN MOSLER Reply:

    It’s because deficits have mainly been counter cyclical

    Reply

  14. anon Says:

    @WARREN MOSLER,

    Question:

    MMT prefers to treat inflation risk in a fiat system with fiscal policy. Occasionally it refers to such inflation risk as the effective constraint – as opposed to the deficit for example.

    In a fixed rate convertible currency regime – e.g. gold or FX – why wouldn’t MMT view fixed price risk and reserve stock/flow risk in the same way? i.e. the fixed rate and the stock/flow risk constitute the constraint that is managed via fiscal policy.

    If that’s the case, why is there a basic difference between fixed and floating regimes from an MMT perspective?

    Reply

    MamMoTh Reply:

    @anon, good point. My understanding is that a fixed rate could be managed through fiscal policy if taxation can be enforced. That’s what I get from Exchange rate policy and full employment.

    So from an MMT perspective a fixed rate adds another constraint to the budget deficit, stricter than the inflation one in practice. Argentina defended for too long its fixed rate with fiscal tightening from 1998 till 2001 but eventually it wasn’t enough.

    Reply

    anon Reply:

    @MamMoTh,

    right, stricter in appearance

    but an inflation targeting CB would consider its inflation objectives/goals/targets pretty strict as well, right?

    and that should be true whether its the CB using monetary policy or an MMT government using fisal policy

    Volcker didn’t exactly back off on his objectives

    so stricter in appearance

    but stricter in reality?

    after all, consider all the fixed rate regimes that have failed

    so at that level its a question of degree rather than fundamental difference in my mind, and even then the difference in degree is debatable, depending on the determination of the CB or the government to control inflation under either regime

    hence my question – I’m not sure its the fundamental dividing line that it appears to be

    CB’s and govs can drop the fixed rate regime just as they can start using platinum coins or overdrafts

    constraints are always and everywhere a discretionary phenomenon; even fixed rate regime ones

    Reply

    MamMoTh Reply:

    @anon, stricter in the sense that deficits will need to be smaller or surpluses necessary to defend a fixed rate compared to just targeting inflation.
    I agree it is all rather a matter of degree and there is no clear cut difference between different regimes as MMT seems to suggest. Keep in mind the constraint imposed by inflation is different if you target an inflation of 2% or 50%…

    WARREN MOSLER Reply:

    You can’t always sustain full emp with fixed fx the way you can with floating

    Ramanan Reply:

    @anon,

    The real constraint is the balance-of-payments constraint. Straightforward consequence of ruthless double-entry bookkeeping.

    Follow Turkey

    anon Reply:

    @Ramanan,

    If an open economy with a fixed rate FX constraint abides by that constraint as described, balance of payments feasibility always falls out as a result.

    WARREN MOSLER Reply:

    Dropping the fix means floating

    WARREN MOSLER Reply:

    Yes, but you can’t always hold the peg and sustain full employment. It’s the old bimetal problem

    Reply

    WARREN MOSLER Reply:

    There cab be relative value shifts with the object of conversion.

    Reply

  15. Rodger Malcolm Mitchell Says:

    MMT suggests reduced money supply, with higher taxes and/or reduced federal spending, as the prevention/cure for inflation. Monetary Sovereignty agrees, except for one small detail. It’s impossible to reduce money supply in a timely and incremental fashion (i.e. which taxes to raise, which spending to cut — and by how much).

    O.K., make that two small details: Reducing the money supply leads to recessions and depressions — a heck of a way to prevent/cure inflation.

    MS suggests increasing money demand, with higher interest rates, which can be effected instantly and incrementally. MMT feels raising rates actually would exacerbate inflation, by raising business costs.

    I’ll leave it to you readers to suggest how, in fact, we have managed to keep average inflation reasonably close to target for the past 40 years, except for the later 1970′s (and how did we fight it, then?). Did we use money-supply policy or money-demand policy? Or were we just lucky?

    BTW, Congress wishes to use the money-supply method right now, to fight a non-existent inflation. We’ll see how that works.

    Rodger Malcolm Mitchell

    Reply

    Tom Hickey Reply:

    @Rodger Malcolm Mitchell,

    There are two issues here. The first is diagnosing the problem correctly and the second is treating causes rather than symptoms. Very often the distinction between demand side, or monetary inflation, and supply side, or resource shortage. The causes of the rising prices are different and must be addressed differently.

    The challenge in addressing general continuous price rise is to target inflation without also targeting employment. As far as I know, only MMT has a workable solution for achieving full employment along with price stability, and this solution is chiefly fiscal rather than primarily monetary.

    BTW, we know from recent experience that fiscal works against deflation while monetary does not. The US is not in a liquidity trap, it is in a deflationary depression, in which deflation is somewhat masked by forbearance (to put it euphemistically), on one hand, and resources scarcity, on the other. But looking at major indicators of deflation — housing and unemployment — and the US is approximating the Great Depression.

    Reply

    WARREN MOSLER Reply:

    Rates don’t alter money demand, and inflation has come from a monopolist hiking the price of crude
    And I’m getting tired of typing this when you keep posting this so please do it for me in the future thanks

    Reply

    Adam2 Reply:

    @WARREN MOSLER, Rates don’t alter money supply and money demand is endogenous to the banking sector.

    If the central bank did not control rates, what would happen? Nothing?

    By saying oil prices are controlled by the monopolist Saudis do you then disagree with the speculator hypothesis?

    Reply

    Deus-DJ Reply:

    @Adam2,

    re moslers view on oil prices and saudis….he doesn’t disagree with the speculator hypothesis but says the point of emphasis on them misses the real price setter in the saudis, as they are the swing producer. Personally I respect Moslers viewpoint with regards to his emphaasis on a monopolist(whether it be US being monopolist of currency or what not) but it simply doesn’t jive with the fact that prices are pumped regardless of supply…and there simply isn’t much evidence of saudi storing their oil in the ground(as opposed to pumping it out).

    shameless plug: http://www.nakedcapitalism.com/2011/02/guest-post-the-price-of-oil––-where-the-outrage.html

    WARREN MOSLER Reply:

    deep down it’s always been the suppliers when they have pricing power

    WARREN MOSLER Reply:

    see ’0 is the natural rate of interest’ on this website thanks

    the saudis use specs as ‘cover’

  16. Roger Erickson Says:

    Warren: “Yes, because they ignore the interest income channels.”

    Why not be a bit more forceful and say ONLY because they ignore the interest income channels?

    Reply

  17. Art Says:

    PK: “who insist that deficits are never a problem as long as you have your own currency.”

    Should we let this slide as just an “ability to pay” issue? In my experience, MMT doesn’t say what he accuses it of here. Deficits matter, and are a problem if they’re too large or too small.

    Seems important as this one opening salvo could be enough to convince a lot of people to dismiss MMT out of hand.

    Reply

  18. Clonal Antibody Says:

    Bill Black weighs in on this – Anti “MMT Types” Memes Migrate to Stage II

    Reply

    Clonal Antibody Reply:

    @Clonal Antibody,

    Also Randy Wray at the HuffPo on this – Krugman Taken to the Modern Money Cleaners

    Reply

  19. Ramanan Says:

    @WARREN MOSLER,

    Sorry reposting .. the thread is too nested.

    ““fwd fx rate *is* the interest rate.

    with fixed fx it’s set by mkt forces (and a bit of credit risk now and then).

    with floating by the CB”

    The forward rate is just the result of an arithmetic operation with interest rates and the fx rate.

    China sets “the interest rate” or the markets ?

    Reply

    WARREN MOSLER Reply:

    depends on whether they are intervening.

    china sets a domestic rate, but fx markets can price fwds/term rates away from china’s domestic rate if the boc is ‘leaning’ on the spot fx rate.

    (currency controls, and all that)

    Reply

  20. Clonal Antibody Says:

    It appears from Multiplier Effect that Krugman was in fact replying to James Galbraith’s TNR article – “Stop Panicking About Our Long-Term Deficit Problem. We Don’t Have One.” Also some reactions from Arnold Kling (JG responds briefly to the latter in comments).

    Reply

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