the monetary and fiscal nexus of neo-chartalism : a friendly critical look

The monetary and fiscal nexus of neo-

chartalism : A friendly critical look

Marc Lavoie

Motivations

• Neo-chartalism or modern monetary theory (MMT) has contributed to the development of monetary economics.

• MMT is very much discussed on the web and blogs, and it has given some exposure to post-Keynesian theory.

• Some observers wonder however about the relationship between neo-chartalism and post-Keynesian theory.

• My experience with my own students is that some statements by proponents of MMT are rather hard to swallow.

• Reexamination from someone who is partly an insider and partly an outsider.

IMK Conference, Berlin, October 28, 2011

Outline

• Brief intro to neo-chartalism• Some controversial statements of neo-chartalism, mainly due to

the assumed consolidation of the central bank with the Treasury• A balance sheet representation of the relationship between the

central bank and the fiscal arm of the government• Conclusions:

– neo-chartalism is indeed part of post-Keynesian theory;– The consolidation assumption, made to provide more

convincing arguments, ends up being counter-productive, and ought to be given up.


BRIEF INTRO TO MMT


Neo-chartalism orModern Monetary Theory (MMT)

• UMKC group: Randall Wray, Mat Forstater, Stephanie Bell-Kelton, Pavlina Tcherneva

• Newcastle group, Center of Full Employment and Equity (CofFEE), Australia: Bill Mitchell

• Fellow-travellers: Scott Fullwiler, Jan Kregel, Edward Nell

• Originators: Warren Mosler, Hyman Minsky, Wynne Godley, Joan Robinson (?).…

• “Others—some of whom were initially critical of certain aspects of the approach—have also contributed to development of the theory: Charles Goodhart, Marc Lavoie, Mario Seccareccia, Michael Hudson, Alain Parguez, Rob Parenteau, Marshall Auerback, and Jamie Galbraith”. [Wray, 6 June 2011]


Links with post-Keynesians• What is the relationship between neo-chartalism and the post-Keynesian

school? – ‘There seems to still be a debate within the post-Keynesian world

about whether chartalism … is in competition with or in conjuction with circuitism’ [Comment on a blog, July 8, 2010]

• Response from Scott Fullwiler in that same blog:• “Where? There is no debate, at least among actual chartalists and actual

circuitistes, that I can see, on whether bank money is endogenous/horizontal. We all agree on the monetary circuit or endogenous money. In fact, there's very little difference between the entire paradigm put forth by chartalists and circuitistes/horizontalists like Marc Lavoie and Mario Seccareccia


It is not always good to criticize MMT!

• “The Febrero [2009] paper is absolutely horrible. No chartalist takes it seriously because it is such a complete misinterpretation of chartalism. “ [Fullwiler, blog 8 July 2010]

• “This sort of poor scholarship [by Paul Krugman] was demonstrated in an 2004 article by Professor Malcolm Sawyer in the Journal of Economic Issues which attacked the concept of a Job Guarantee. He chose to represent the views of Professor Randy Wray and myself by quoting secondary sources from authors who were not only critical of our work … but also failed to understand our work ...” [Mitchell, 28 March 2011]


The main themes of MMT

• The origins of money

• The State as an employer of last resort • How to achieve full employment

• The importance of fiscal policy (relative to monetary policy)• The use of the three balances identity (à la W. Godley)• Functional finance (à la Abba Lerner)

• The mechanics of the clearing and settlement system• The links between the government and the monetary system• The definition of a « sovereign state »


The main line of neo-chartalism

• Neo-chartalists favour ELR (the State as an employer of last resort for unemployed workers: buffer stock employment (BSE) or Job Guarantee program)

• They wish to demonstrate that financing ELR programmes, or taking functional finance seriously, even if it leads to huge deficits, does not pose a problem.

• It is a response to the crowding-out argument, according to which government deficits lead to higher interest rates

• Neo-chartalists claim instead that government deficits tend to reduce overnight interest rates


Domain of validity of neo-chartalism

• Neo-chartalists don’t claim that their proposals are valid everywhere at all times.

• They claim that it applies for nations with a « sovereign currency » (USA, Canada, Japan, Australia) [Wray 2002, p. 24].

• There are degrees of sovereignty, the highest being a country where – the domestic currency is the unit of account; – taxes and government expenditures are paid in this

domestic currency;– the central bank is unhindered by regulations;– the public debt is issued in domestic currency;– and where there is a floating exchange rate regime.


My overall view in a nutshell

• As mentionned earlier by Fullwiler, I am supportive of most of the neo-chartalist arguments that deal with the monetary and fiscal nexus.

• However neo-chartalists end up making puzzling and paradoxical statements that, in my view, are not necessary to sustain the main MMT position.

• My worry is that neo-chartalists are so keen to demonstrate that there are no financial barriers to running ELR or other expenditure programs that their efforts to convince colleagues and others become counter-productive.


CONTROVERSIAL STATEMENTS


A controversial statement: ‘Government spends first’• « Government spends simply by crediting a private sector bank account

at the central bank. Operationally, this process is independent of any prior revenue, including taxing or borrowing ». [Mitchell and Muysken 2008, p. 209]

• « The government spends simply by writing Treasury cheques or by crediting private bank accounts » [Tcherneva 2006, p. 78]

• These statements are at best misleading.They skip one step. The Treasury must somehow feed its deposit account at the central bank.

• This step is often skipped because neo-chartalists, as noted by several critics, prefer to consolidate the central bank and the federal government into one entity, the State, a choice that may not be appropriate for the purpose at hand.


Consolidating the Treasury and the central bank

• « A central bank might buy treasury debt and credit the treasury’s deposit at the central bank, but this has no impact on banking system reserves until the treasury uses its deposits…. Hence, strictly internal actions involving only the central bank and treasury should be ignored, which is the main justification for consolidating their accounts …. Many economists find all this very confusing…. » [Wray 2003, p. 92]

• « The only logic that is necessary to grasp is that the state ‘spends’ by emitting its own liability … by crediting reserves to the banking system » [Wray 2002, p. 32]

• So, with the Treasury and the central bank consolidated, the first step, the sales of government securities to the central bank, is being skipped.


But this sequence is itself questioned by some neo-chartalists!

• « I have always bucked the tendency of many on the MMT side to argue that the Treasury sells bonds ex post, in order to drain excess reserves…. My position has always been more nuanced. » [Bell-Kelton, blog, 20 Nov. 2010]


Another puzzling statement:Taxes don’t finance government spending

• « The Treasury does not ‘need’ to borrow in order to deficit-spend ». [Wray 1998, p. 117]

• « Taxes do not finance spending » [Forstater and Mosler 2005, p. 538]

• «… Neither taxes nor bonds really finance government spending, on any reasonable definition of the term ‘finance’» [Bell and Wray, 2002-03, p. 269]

• « Government spends simply by crediting a private sector bank account at the central bank. Operationally, this process is independent of any prior revenue, including taxes and borrowing » [Mitchell and Muysken 2008, p. 209]

• Again, most of this is due to the assumption of consolidation.


A BALANCE SHEET REPRESENTATION


A neo-chartalist view of sovereign currency

Central bank Commercial bank

Asset Liability Asset Liability

Treasury bills +100

Government deposits +100

Treasury bills +100

Deposits of banks +100

Reserves +100 Household deposits +100

Treasury bills +19

Banknotes +10Deposits of banks +9

Treasury bills +81 Reserves +9

Household deposits +90


The government needs to deficit-spend on its civil servants.The civil servants wish to hold 10 in cash and 90 in deposits.Compulsory reserves are 10% of deposits at banks.Without open-market operations, excess reserves would drive down the overnight interest rate (unless the target rate is theinterest rate paid on reserves).

Government deficits lead to lower overnight interest rates !

• This is a consequence of the payment and clearing system.

• When the government pays for its expenditure through its account at the central bank, settlement balances (reserves) are added to the clearing system.

• This tends to reduce the overnight rate (the fed funds rate) (cf. Mosler 1994)

• Keeping the rate at its target level requires a defensive intervention of the central bank


A ‘post’-chartalist alternative account in a not so ‘sovereign’ situation



Treasury bills +100


Treasury bills +100


Treasury bills +19


Treasury bills +81 Reserves +9



Here the government needs or decides to issue its debt in the private sector. In the end, if all goes well, the final result will be Similar to that of the previous case where civil servants wish to hold 10 in cash and 90 in deposits, and with required reserves.

Which description is most likely?

• «Each view may correspond better to the existing institutional arrangements. In Europe, with the new European Central Bank, central governments just cannot sell any of their newly-issued securities to their national central bank or to the European Central Bank. They must sell their bonds or bills to the private banks. Similar rules apply in the United States….Thus, at least in Europe or in the United States, the post-chartalist view may seem to apply best on this issue» [Lavoie 2003, p. 528] .


Self-imposed political limits?

• Neo-chartalists usually give the USAas the standard example of a nation with a sovereign currency.

• However, the USA have two self-imposed limits:– First, as most people are now aware, there is a limit on the

total amount of debt of the US government, set by Congress. – Second, the Fed can only « buy directly and hold an

additional 3 billion dollars of obligations of the Government for each agreed period…» (Title 31-Money and Finance, #5301).

• Both of these limits are recognized by Bell and Wray (2002-03, p. 270), who say that « most nations have opted for self-imposed constraints. These include both ‘no overdraft’ provisions for the Treasury as well as ‘debt ceiling’ legislation ». Why then ignore these?


What truly happens!



Treasury bills +100


Government deposits +100Bank deposits −100

T-bills +100Reserves −100

Government deposits 0

Treasury bills+100


Treasury bills 0 Government deposits 0


« So, instead, the Treasury sells the treasuries to the private banks, which create deposits for the Treasury that it can then move over to its deposits at the Fed. And then ‘Helicopter Ben’ buys treasuries from the private banks…. The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly.» [Wray, blog, 4 April 2011]

Are there « sovereign » currencies?

• Canada would be a better example....• “Canada is unique among the sovereigns investigated in that the

Central Bank can participate at auction without restriction and not as an add-on”. [Department of Finance]

• The minimum purchases by the Bank of Canada is now 20% of newly issued government securities [Bank of Canada].

• Canadian primary dealers must purchase all that is being issued on the primary market, at least at a price barely lower from that of secondary markets.


How about the eurozone?• Central banks cannot make advances to national governments.• Central banks cannot purchase government securities on

primary markets.• Up until May 2010, it was thought that they could not purchase

them either on the secondary markets, but it has been done.• Central banks (normally) only take sovereign debt as collateral

for repos, as part of the main refinancing operations, that is, central banks make short-term loans to banks with sovereign debt as collateral.

• The banks can thus earn high rates of return (if there is no default) on sovereign debt, while they only pay 1.50% (currently) when they borrow at the central bank.

• The only option would be for a government to force, by law, its local banks to take in the new debt at some given yield.


The eurozone setup

National central bank (ECB) Commercial bank


Treasury bills +100


Government deposits +100Bank deposits −100

T-bills +100Reserves −100

Government deposits 0

Advances to banks +19


Treasury bills +100

Household deposits +90Advances from ECB + 19


What happens if depositors move their money away from PIIGS banks or if the PIIGS run a current account deficit?

• Normally such imbalances are absorbed by counteracting movements in the overnight or wholesale funds markets.

• However, Northern banks are now declining to provide loans to Southern banks.

• Assume Italy has a current account deficit, importing too many goods, while Germany has a current account surplus.

• The TARGET2 system will absorb all this smoothly.



Banca Nazionale del Lavoro (BNL)

Bank of Italy (BI) Deutsche Bank (DB)

Bundesbank (BB) ECB

Asset Liability Asset Liability Asset Liability Asset Liability Asset Liability

Deposit importer -10Advance from BI +10

Advance to BNL +10

Advance from BB +10

Reserves at BB +10

Deposit exporter +10

Advance to BI +10

Deposit of DB +10

Deposit importer -10Advance from BI +10

Advance to BNL +10

Due to the eurosystem +10

Deposit exporter +10Advance from BB -10

Claims on the Eurosystem +10Advance to DB -10

Debit position of BI +10

Credit position of BB +10

Neo-chartalism: conclusions

• MMT is a subset of PK monetary analysis• Its focus is on the clearing and payment system• Its analysis has been validated by the crisis of the

eurozone• But it must get rid of some of counter-productive

controversial claims, essentially based on the assumption of consolidation of the activities of the Treasury and those of the central bank.


the monetary and fiscal nexus of neo-chartalism : a friendly critical look

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