Monetary Sovereignty

Continuing the topic of the previous post and adding the work of Fadhel Kaboub (which you may listen to an interview on Bloomberg here), I want to develop the notion of monetary sovereignty and its importance for the political decisions within a country.

Doctor Kaboub explains the concept of monetary sovereignty as a spectrum, where a country achieves it totally if:

  1. Has its national currency;
  2. On which it levies a tax on its citizens;
  3. Has a flexible exchange rate;
  4. Doesn’t have debt in foreign currencies.

Most developed countries achieve a perfect 4/4 (except Eurozone countries ..), but emerging and mostly, developing countries fail the pre-conditions. That will, in some cases, undermine their convergence with developed countries and sustainable development.

I would like to develop a little bit further the concept of monetary sovereignty (which is maybe one of the most important concepts in macro theory).

  1. A government in an autarkic country is “always” perfectly sovereign, but as it deprives itself from the gains of “global specialization”, it will probably face low levels of development or even poverty.. (cough North cough Korea). So, let’s discard this one.
  2. A government that fails 3 and 4 can still be “sovereign”. But it must be “Rich”, which means, it must have A LOT of foreign currency. Just like a household must have a lot of money to be able to buy something outside its “family”. Saudi Arabia fits this category. However,…oil doesn’t last forever.
    1. In this category the government doesn’t have to spend foreign currency per se, but if it wants to expand expenditures in national currency it must be able to defend the foreign exchange rate if the receivers of national currency rather have foreign currency.
  3. Finally, a country that is a 4/4 is totally sovereign.

Or is it?

I would like to add another condition to have full monetary sovereignty. This one probably invalidates the notion that several countries are sovereign.

5. Lack of foreign debt.

Why is this any different from original point 4?

Let’s take the United States. Its government has been able to buy everything inside the US as it’s payable in USD and it also has been able to sustain constant external deficits (without massive USD depreciation). Why?

Well, because as someone wrote recently (but I can’t remember whom) the USDollar and US securities are probably the best export product that America has. It’s really an “exorbitant privilege” to have the currency that is:

  1. The medium of exchange internationally
  2. The unit of account internationally
  3. And most important, the reserve of value internationally.

But…imagine in the future, Donald Trump does something REALLY stupid and suddenly all the foreign owners of USDollars figure out they are sick and tired of holding USDollars (and US securities).

What happens next? Two (?) options:

  1. Either they sell USD (buying other currencies), which leads to a depreciation of USD that “impoverishes” USDollar holders internationally (but increases exports…)
  2. Or Exports increase (selling USD and buying US goods).

What? Only this? We made it! Exports are great! We made America great again! We have a HUGE surplus! No more trade deficits!

Sure about that? When exports increase massively (in a floating exchange rate regime, and with previously accumulated exports) there is not enough goods and services for the American citizens and foreign citizens. That will lead to scarcity and eventually inflation!!

INFLATION I TELL YOU!!! (start to shout Venezuela and Zimbabwe at the same time)

 

In conclusion, are we all doomed?

No. Of course not. This is a pretty unrealistic scenario.

The main lesson I want to draw from this post is (excluding being autarkic/poor or being in a monetary union):

  1. If a country wants to maintain a fixed exchange rate, the country must accumulate a lot of foreign reserves to be sovereign (or maybe some capital controls?)
  2. If a country wants to have floating exchange rates, it must convince its trading partners (or its trading partners’ trading partners) to hold its national currency as foreign reserves.

But at the end of the day, unless the country is a military superpower (and therefore force its currency on other countries, just like a sovereign country does to its citizens), the notion of monetary sovereignty is a utopia. It is a worthwhile battle to try to converge to it, but still a utopia.

 

 

 

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Modern Monetary Debates

First, as a disclaimer, I must say I haven’t read everything written by economists associated with MMT. However, I think I can qualify myself as reasonably knowledgeable about the school. I did it, simply by reading the stuff that is online, starting probably two and a half years ago. No big deal…You can find books, papers, blog posts, videos. (Most of the recent criticism however doesn’t seem to care about academic work though…). Also, I would like to thank Warren Mosler (the “founder” of MMT) for being always helpful and kind concerning my doubts.

What is MMT and why the fuss about it?

Modern Monetary Theory is a school of economic thought related with the Post-Keynesian school, so it fits almost completely as a heterodox camp and therefore probably never heard off by most of economics students (and professors…).

Warren Mosler, Randall Wray, Bill Mitchell, Stephanie Bell Kelton, Scott Fullwiler, Pavlina Tcherneva are among the most important contributors to the school nowadays. Their work is inspired by previous literature of Knapp, Innes, Keynes, Kalecki, Lerner, Minsky, Godley and I should add Basil Moore.

Therefore, my short definition of MMT is a chartalist theory of outside money leveraged by a credit theory of inside money (endogenous). That infrastructure of the monetary system leads to macroeconomic impacts best described by sectoral balances (and T accounts) which could lead to financial disruptions. At the end of the day, it’s the Governments’ job to guarantee a stable macroeconomic environment, following functional finance (and being an employer of last resort).

So basically, just a bunch of monetary cranks that appear twice every century saying banks are “making money making money” and that the government must give everyone a pony. What’s the big fuss?

I guess it was probably because Alexandria Ocasio Cortez, a young American politician that has been making a splash by some of her ideas in the Democratic party, mentioning MMT as one of the backbones of her ideas. (I must admit I am not familiarized with most of AOC proposals, including the Green New Deal details).

Ever since then, there was an avalanche of criticism by economists, political commentators and almost everybody.

If you follow Twitter you probably have witnessed blood in certain debates.

Well, before you start losing interest on my post…

  1. I think MMT as a debate instigator for the economics profession is a breath of fresh air following the crisis “that nobody saw coming”.
  2. As someone that works at a central bank, I think it is essential their insistence on getting the operational details right (by accounting identities and T accounts) instead of focusing only on hard theory.

I would like now to offer my contribution to the “Great Modern Monetary Debate”.

Almost every criticism unjustly (as said before) starts by saying that MMT is a mix of “old and wrong ideas” and accept with this equation:

MMT= Lerner’s Functional Finance

Therefore I shall take that path too (while recognizing all the other MMT).

A sovereign government does not face financial constraints when budgeting, as a family does. To Abba Lerner the conclusion follows that the budget has the function of equilibrating the economy, reversing the “sound finance” policy prescription.

Afterwards, the government must “finance” its position with a composition of money and bonds. If it finances it by money, the interest rate will tend to fall, stimulating investment, leading to a smaller need of a deficit. This is the “crowding in” proposition, against the  mainstream crowding out theory.

Lerner then goes on saying that the public debt is only a reflex of macroeconomic factors. As Mosler puts it nicely the public debt is nothing more than an “interest rate maintenance account” as it is a reserve drain to all deficit spending.

What is different then between Lerner (and MMT) and the “Keynesian mainstream” (let’s say.. Krugman)?

  1. Lerner says that the government job is to pursue full employment by fiscal policy. Krugman wants central banks to follow a Taylor rule and only use fiscal policy when the central bank faces the zero lower bound.
  2. Lerner would say that deficit spending decreases interest rates, Krugman says that interest rates increase following deficit spending.
  3. Lerner says that government debt does not impose a burden on our children. Well.. Krugman agrees, but lots of other economists disagree (like Simon Wren Lewis, Nick Rowe,…).

My answers to these are:

  1. Scott Fullwiler explains (better than anyone else I can recall) that monetary policy works through changes in liquidity (by expanding reserves and/or deposits or by changing interest rates), fiscal policy works through changes in equity (private vs public) as a government deficit is a private surplus.
    1. Therefore, while fiscal policy “works directly”, monetary policy works by increasing liquidity and therefore stimulating private leverage (by either increasing money by debt or by increasing “velocity”).
    2. However, the “libertarian me” will say, indeed that is true. But monetary policy is fairer because it involves voluntary swaps of assets while fiscal policy envolves a combination of theft (taxes) and subsidies (gov. spending). Should we base macroeconomic management on so corruptible instruments?
  2. A government deficit means: more spending than taxes. Simply that.
    1. That means a net add of reserves on the banking system (coming from the Treasury account at the central bank). This addition to reserves puts downward pressure to short-term interest rates due to the increase in liquidity.
    2. That means a net add to private equity (saving) that may increase NGDP putting upward pressures on longer term interest rates.
    3. Usually the government “finances” the deficit by bond issuance, therefore sterilizing the liquidity increase (but not the increase in private equity). That neutralizes the short-term interest rates impact.
    4. The central bank MAY (should?) respond to the Government action by raising rates (I guess this is the Scott Sumner critique)
    5. But by the end of the day, one must conclude that Government spending corresponds ALWAYS (initially)  in an increase in the money stock (this stock may mean reserve balances and deposits depending on the cases).
  3. The debt burden…oh boy, this one is a hard one. Maybe next time? But I agree with Lerner. I think the sustainability issue is a “socio-political” and not economic.

I would like to add also:

  1. The “the government must spend first” and the “no overdrafts” debate is also very interesting. Scott Fullwiler’s work on this is great but I can simplify by saying:
    1. Imagine there are no excess reserves in the system. How can banks/private sector “finance” the government?
    2. If the Treasurys account is Zero, the way for the Government to issue debt (to deficit spend) is to have the central bank do a repo (temporarily expanding reserve balances)
    3. For more info about a country without bank reserves (Canada) check also Brian Romanchuck book “Understanding Government Finance”
  2. Also important is to classify as stupid all the criticism shouting Venezuela! Weimar! Hyperinflation! If a deficit is “funded” by bonds or money issuance is mainly irrelevant (at least today with IOER) as Scott and Stephanie wrote on the financial times once ago. (more on this in another post)
  3. The “taxes will tame inflation” debate also is something that I want to speak on. (Even though I know that taxes are not MMT’s favourite tool to fight inflation, but this works for every tool)
    1. Some criticism focus on the: So prices are rising and you want to raise taxes?
    2. I guess MMT here may form an unholy alliance with a completely different school of economic thought. Let’s see if you know who says this:

“Now suppose that, instead of saying inflation was too low in mid-2010, Bernanke had announced that we needed to boost the incomes of Americans in order to have a healthy recovery — and that the Fed would therefore try to boost the growth rate of national income from 4.3% to 6.3%. This message would have sounded much more appealing to the average voter than a call for higher inflation.”

 

Yap, I would say that MMT would gain by adopting a kind of NGDP targeting, to avoid supply/demand side inflation confusions led to criticism.

 

P.S.: To MMT scholars, I would really like to see a comparison between the Job Guarantee proposal and the Earl Thompson/David Glasner Labor Standard proposal.

Money Multiplier in a fixed exchange regime framework

Even though it seems I had lost interest on my blog, it was my master’s dissertation fault…which you can find here, with the abstract below:

“This study provides a new empirical approach about the money multiplier process, using monthly monetary data from Angola since January 2012 until June 2018. The use of an ARDL model allows to test the long run relationship of both the money multiplier and the reserve to deposit ratio and consider the short-term adjustments from monetary shocks. The analysis focuses mainly on the level of concentration of the banking system, the degree of liquidity of banks’ liabilities and the interest rate as determinants of the long-term ratios. Other country specific factors such as the foreign exchange rate spread and the non-performing loans ratio have been included to the analysis, to consider Angola’s macroeconomic challenges. It was concluded that according to monetary theory, both the interest rate and the level of concentration of the banking system affect the long-term ratios. However, the non-statistical significance of banks’ liabilities liquidity opens a policy recommendation for Angola’s monetary policy.”

 

Wicksellian Exchange Rate

Remember Wicksell?

What about Frankel?

Let’s combine both of them, shall we?

Two countries, Russia and Angola are petro-dependent. While Russia has flexible exchange rates, Angola had a fixed (but adjustable) peg, until December 2017.

That meant that as Russian ruble was depreciating almost pairwise with oil, Angolan kwanza was slow to adjust to its “equilibrium value”.

What now?

Well, since the semi-administered floating starting in 2018, it lost more than 20% against the US Dollar, being now in counter cycle with oil prices, as can be seen below comparing the total variation against the US dollar since January 2014, of the Ruble, the Kwanza and Brent.

angola brent

So, imagine that Angola had Pegged to its Export Price, like Frankel said, its official exchange rate would be close to equilibrium (as it would move with oil prices).

But, as the gap between the official and the equilibrium rate started to widen, bigger desiquilibriums appeared, which would widen still further the equilibrium exchange rate gap. Just like a Wicksellian process when the market rate is set above equilibrium rate.

How can we know that? Well, the black market rate is still enormous (the informal rate stands today at USDAOA 415, when the official is USDAOA 213) which means we are still a long way from equilibrium.

But is that equilibrium about?

That’s the topic for the next  two posts..

In the long run we are all DUMB

Economics textbooks are chewed economic theory.

We can learn from them, but we shouldn’t learn from them.

Because they give us a stupid sense of superiority. They usually belittle the great minds of the past.

Ricardo believed the value of things resided in labor. How stupid he was…

Say said supply created its own demand. How naive he was…

Keynes said that in the long run we are dead. How inconsiderate he was..

Friedman wanted to target the money aggregates. Really??

 

If we read through the original ones, usually we will get a much sharper description of their reality that the one that is portrayed in textbooks.

But my point is not to belittle textbook and textbook writers, my point is concerns Keynes’ long run.

How much ink has been spilled denigrating the man, for saying that in the long run we are all dead.

You can read DeLong post and be shocked!

We all know why “they” offended Keynes, because he was a Keynesian, duh!

But Keynes wasn’t a Keynesian, at least in his Tract (the book where we can find the cursed sentence). Keynes “became a Keynesian” in 1936 with the publication of his General Theory, up until then he was a Monetarist. And a pretty damn good one.

So…what about the sentence?

The sentence is about the Quantity Theory of Money (although Keynes formulates it in another way). Here is what Lord Keynes says:

keynes

What Lord Keynes is saying is: If we put a whole lotta money in the economy, prices won’t respond accordingly. The parameters may shift (Brad deLong considers it a foreshadowing of Lucas Critique).

(This time what changed was r – the reserve ratio)

Who would say that Keynes was just forecasting the ridicule statements of all the hyperinflationists almost ninety years after. Oh! And the ones that were slamming for being childless..and gay.

History sometimes has this twists.

Except that this isn’t a twist.. just a bunch of uneducated people..

The Art of Central Banking

This is not about a book I wish I could have..

This one is a risky one.

I will question “everything”.

I will question the fundamental “fundamental propostition of monetary theory”, first stated by Keynes then by Friedman and afterwards greatly explained by Leland Yeager.

I will also question Nick Rowe, who is the champion of monetary disequilibrium analysis nowadays (and probably my favourite blogger).

Hell… I will even attack one of my favorites Classical Economists, Claude-Frédéric Bastiat.

(I can get off my high horse right now, I will not dispute anyone, just try to add something – except for Bastiat)

I do believe money is special. Money is the medium of exchange. The fundamental proposition of monetary theory is true. The supply of money (unlike other “goods”) determines its demand and therefore its stock. (this sentence doesn’t contradict the “endogenous money” theory, but that is for another day)

But I do believe Central Banks somehow have a higher level of “specialness” than money.  (Well, if I am trying to be “against” so many great economists, this one will also go against George Selgin and the Free Banking School also).

So, how would I do that?

I will tell a story of course!

Imagine a society. Workers, producers, capitalists, everything normal.

The medium of exchange is fiat money, created by the Central Bank at its own discretion.

We have full reserve backing, therefore banks are not “creators of money”.

The Central Bank has a mandate to keep prices stable, it issues money when deflation is expected. It destroys money when inflation is coming. Assume no productivity shocks.

But this Central Bank has a peculiar way to conduct monetary policy. It buys/sells art. Yes, the Chairman is a very sophisticated guy.

Paintings are generally produced and traded amongst citizens, but every once in a while Mr. Chairman buys a new panting and prints new money. (We can assume that paintings’ value will increase as time goes by, so it’s a type of seigniorage that increases CB’s capital).

Somehow, one day there was a change in “animal spirits”, increasing the general demand for money. As the money stock remained constant, Walras Law states that the excess demand for money will be reflected in an excessive supply of goods, a recession.

For simplicity, we will assume that poor old Joe the Window Maker, was the only one affected by this glut. To stop the Keynesian multiplier on its beginning, I assume that the general increase in money demand “only eats up” the desired saving of Mr. Joe, by allowing him to work only enough to keep his consumption stable.

Therefore we have an increase in unemployment. It’s not a big increase (only less hours worked for Mr. Joe, I could complicate the story but I won’t).

Up high in Valhalla, Thor was being annoyed by Claude Bastiat. He was continuously stating that Norse Gods worship was a waste of his time and therefore THEFT!

Thor just to annoy Bastiat released a thunderstorm that destroyed the big and beautiful Vitrail of the Central Bank.

Mr. Chairman despaired and as the Vitrail was essential for the Central Bank credibility, hired Mr. Joe to repair it.

As it charged 100 units, Mr. Joe was confronted by an embarrassed Chairman saying the rolling press was temporarily malfunctioning (talk about credibility) and therefore it would have to pay him with one of his paintings. He showed him how nice was the painting, but Mr. Joe was suspicious.

Mr. Joe was a simple man, but not stupid. He called his friend Vincent, the Art dealer, which told him that the painting was worth 200 units, but he had just told Mr. Chairman that it was only worth 100. Mr. Chairman truly was beloved among the citizens…

Mr. Joe gladly accepted it! Not because he wanted to hold it but because it could easily trade it for money, with profit!

He accepted art as a medium of exchange not because he wanted to hold it, but because he could sell it for profit. The Central Bank, unlike a private institution, can operate with loss  after loss, so it could “afford” to be mislead.

Oh well, enough with this dumb story…

What just happened?

There was an excessive money demand that should had led to a deflationary rot (not so big..) unless the Central Bank created more money. But the central bank unwillingly did not increase the money supply. Nevertheless it increased the money velocity, as the art dealer decreased its money demand by 200 (which indirectly paid for the extra demand). But in the end, all was paid by a big loss in the Central Bank capital position…

So, what’s the fuss all about? Three points.

  1. Bastiat’s Broken Window Fallacy does not apply when we have an excessive demand for money and the destruction is directed to a (non-convertible money issuing) Central Bank
  2. A Central Bank is not profit oriented so it can afford to have a loss. Therefore in a way, its loss was an non-injecting money helicopter drop.
  3. When we have a general depression, an increase in velocity (as seen) will do the job as well as an increase in the supply of money (so stupid CB actions like this one or smart Government Deficits could do the trick)

Attention attention! I am not advocating acts of destruction against money issuing Institutions.

As Keynes said, we can bury a bunch of notes and make people look for them.

But aren’t there more productive ways to do it?

You just got Sumnered

Sometimes one forgets how great an economist Scott Sumner is.

One may disagree with the feasibility of some of his NGDP targets proposals.

One may disagree with some of his “the banking sector is not essential”.

But one can’t deny he is (probably) one of the best monetary economists of our generation.

The following post on currency manipulation would speak higher than any other compliment I can make:

http://www.themoneyillusion.com/?p=32622

 

(And yes, David Glasner is probably even higher in my top favorite monetary economists)

 

 

Unwinding QE

The New York Fed blog wrote a great post yesterday, explaining the process of How should the Quantitative Easing revert.

I think it was a great lesson on monetary policy and mainly on Central Bank Balance Sheet monetary operations.

But… I think it could be better.

Let me try to give my humble contribution.

In the post there is an implicit assumption that the Treasury General Account interacts directly with the Reserves Account (both liabilities of the Federal Reserve) only in one way.

When the Treasury Bonds are issued there is a drain of reserves and an increase in the TGA.

When the Bonds mature, the Treasury pays its due, depleting the TGA and increasing Bank Reserves.

 

I think we should add another interaction between both accounts.

How is it possible for the Treasury to pay its debts? By having a (temporary) surplus. Therefore the Treasury must drain more Reserves (by taxes) than it injects (by Government Spending). This “destruction” of Monetary Base (Fed´s liability) is accompanied by a decrease in its assets (Treasury bonds).

If, the Treasury issues bonds, it must be to “finance” its deficit (Sorry Mrs. Kelton). This operation (deficit) injects more Reserves (Gov. spending) than it drains (taxes). If the Fed wants to keep its Balance Sheet constant, it must buy some of the new bonds (increase in its assets) by injecting Bank Reserves (liabilities).

This was general proceeding of Monetary/Treasury operations up until 2008 (as we can see in the chart below). Afterwards we live in a strange world where the Treasury issues bonds to help the Fed and not only to fund themselves.

 

Sem Título

Stop “employing” unemployment

Economists waste too much time “employing” the unemployment rate concept.

Oh boy..

The unemployment rate.

Do we really have to go all over this again?

Why are people continuing discussing about Full Employment? The natural rate of unemployment? NAIRU?!!?

Economists sound like those annoying children yelling during the trip (the economic recovery):

– Are we there yet? Are we there yet?

No. We are not.

Forget about the theory that says if the unemployment rate is below the “natural rate” we must have inflation. It´s not incorrect, it’s only half true. The NAIRU story is incomplete.

The NAIRU story states that if inflation isn’t rapidly increasing, the unemployment rate must be above the natural unemployment rate.

However, I believe the United States most probably has the unemployment rate below its “natural” ratio, the one that pushes wages up. When workers increase their bargaining power. Yes, the Phillips curve story, Marx’s reservation army, …

Just look at the data, we are seeing one of the lowest unemployment rates recorded (since the hippies).

United States Unemployment Rate

But…that does not mean, we are already there.

Just look at the data, the US has suffered a big decrease in employment since the Crisis and its still a great deal behind the curve.

United States Employment Rate

The Labor Force Participation is still recovering.

United States Labor Force Participation Rate

Of course, some part of the decrease in participation is due to demographics…

But, in my opinion, we must probably watch this sequence of events in the proceeding recovery, a convergence to the natural rate of unemployment combined with low inflation from (drums…) BELOW:

  1. As the economy expands and the unemployment rate contracts, more people that were out of the Labor Force will return as they perceive an increase in the demand for labor
  2. The rise in the participation rate will lead mathematically to an increase in unemployment and/or employment
  3. As long as the ratio of the increase in unemployment to the increase in participation is lower than the official unemployment rate, the Unemployment rate will continue to decrease (just do the math)
  4. But eventually it will come a time when the increase in participation will not totally be reflected in new employment and the inflection time will initiate
  5. The unemployment rate will start to increase (but the employment rate is also increasing (remember?), as the participation rate is increasing)
  6. Eventually we will reach a ratio of employment which will cause pressure on wages
  7. We will start to see the “white in the eyes” of inflation
  8. Finally the Federal Reserve will definitively remove the “punch bowl” by pursuing a contractionary policy
  9. Will we have a recession next?
  10. Are we there yet?

The lazy theory of Monetary Disequilibrium    

Don’t worry, I am not going to “Yeager” you a long lesson on Monetary Disequilibrium Theory.

Just a quick one.

Laziness reigns supreme in a monetary world. Laziness is the “ugly” counterpart of specialization.

You don’t just specialize in the things you like (or have an advantage). You also de-specialize in things you don’t (or that you are too lazy to perform).

Therefore laziness allows specialization. It allows innovations. It allows productivity. It allows the Wealth of Nations.

Let’s imagine now, we live in a world of Monetary Disequilibrium.

There is an excess of Money Demand or an excess of Money Supply.

If there is excessive money demand, by definition there will be a lack of aggregate demand for output. We will have a general depression. We shall have unemployment all around.

If there is excessive money supply, by definition there will be an excessive aggregate demand for output. We will have an (unsustainable) expansion. We shall have inflation all around.

Unemployment and Inflation are not bad things per se (despite what your casual economist would say).

Unemployment in a sector of activity may be a sign of a shift in consumer preferences.

Inflation in a sector of activity may be a sign of scarcity of the “good” exchanged.

They symbolize what the “market” wants and what the “world” provides.

But if we experience General Unemployment (excessive demand of money), we as workers will spend too much time trying to find a Job. Time we could, should and would be producing whatever the market demanded.

But if we experience a General Inflation (excessive supply of money), we as consumers will spend too much time trying to find a Reserve of Value (to “protect” us from inflation). Time we could, should and would be producing whatever the market demanded.

We shouldn’t be forced to desperately look for Jobs and Reserves of Value.

We should specialize in supplying whatever the market demands (and we are good at) and demanding whatever our distorted minds may want.

Don’t force us to do extra, unproductive work.

Give us Monetary Equilibrium.