Chartalism

Critcisms

Criticisms

Chartalism and Modern Monetary Theory has garnered wide criticism from a wide range of schools of economic thought. New Keynesian economist and Nobel laureate Paul Krugman has stated that the MMT view that deficits never matter as long as you have your own currency is "just not right".^[27]

The main response by MMT economists to the abovementioned criticism is to point out that the positions taken by critics betray a misunderstanding of MMT. Although critics often represent MMT as supportive of the notion that "deficits don't matter",^[27] MMT authors have explicitly stated that that is not a tenet of MMT.^[28]

Austrian school economist Robert P. Murphy states that "the MMT worldview doesn't live up to its promises" and that it seems to be "dead wrong".^[29] Daniel Kuehn has voiced his agreement with Murphy, stating "it's bad economics to confuse accounting identities with behavioral laws [...] economics is not accounting."^[30]

Murphy's critique specifically employs a hypothetical example of Robinson Crusoe living in a world without a monetary system, and shows that it is in fact possible for Robinson Crusoe to save by forgoing income, thereby illustrating that despite what MMT economists argue, government deficits are not necessary for individuals to save. However, what Murphy terms saving in his example would traditionally be called investment - to introduce saving into the example would require more than one economic agent, a unit of account money and corresponding borrowing. MMT economists have pointed out that the central tenets of MMT theory only aim to describe the economy of a society with a monetary system, that employs a fiat currency and floating exchange rate.^[28][31]

Murphy also criticises MMT on the basis that savings in the form of government bonds are not net assets for the private sector as a whole, since the bond will only be redeemed after the government "raises the necessary funds from the same group of Taxpayers in the future".^[29] In response to this, MMT authors point out that the repayment of bonds does not necessarily have to occur from taxes; a central bank attempting to hold an interest rate target must necessarily purchase government bonds. These purchases occur through the creation of currency, rather than taxation.^[32]

New Keynesian Brad DeLong has suggested MMT is not a theory but rather a tautology.^[33] Still others have said MMT "ignores the lessons of history" and is "fatally flawed."^[34]

Economist Eladio Febrero argues that modern money draws its value from its ability to cancel (private) bank debt, particularly as legal tender, rather than to pay government taxes.^[35] However, it is unclear how this is a critique, since banks rely entirely on the monetary services of the state and its chosen currency, via the central banking system.

Key Terms and Semantics*

monetizing the debt


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*previous entry.

History of the Federal Reserve at the Fed's website.

1951: The Treasury Accord

The Federal Reserve System formally committed to maintaining a low interest rate peg on government bonds in 1942 after the United States entered World War II. It did so at the request of the Treasury to allow the federal government to engage in cheaper debt financing of the war. To maintain the pegged rate, the Fed was forced to give up control of the size of its portfolio as well as the money stock. Conflict between the Treasury and the Fed came to the fore when the Treasury directed the central bank to maintain the peg after the start of the Korean War in 1950.

President Harry Truman and Secretary of the Treasury John Snyder were both strong supporters of the low interest rate peg. The President felt that it was his duty to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war. Unlike Truman and Snyder, the Federal Reserve was focused on the need to contain inflationary pressures in the economy caused by the intensification of the Korean War. Many on the Board of Governors, including Marriner Eccles, understood that the forced obligation to maintain the low peg on interest rates produced an excessive monetary expansion that caused inflation. After a fierce debate between the Fed and the Treasury for control over interest rates and U.S. monetary policy, their dispute was settled resulting in an agreement known as the Treasury-Fed Accord. This eliminated the obligation of the Fed to monetize the debt of the Treasury at a fixed rate and became essential to the independence of central banking and how monetary policy is pursued by the Federal Reserve today.

...

2006 and Beyond: Financial Crisis and Response
During the early 2000s, low mortgage rates and expanded access to credit made homeownership possible for more people, increasing the demand for housing and driving up house prices. The housing boom got a boost from increased securitization of mortgages—a process in which mortgages were bundled together into securities that were traded in financial markets. Securitization of riskier mortgages expanded rapidly, including subprime mortgages made to borrowers with poor credit records. House prices faltered in early 2006 and then started a steep slide, along with home sales and construction. Falling house prices meant that some homeowners owed more on their mortgages than their homes were worth. Starting with subprime mortgages, more and more homeowners fell behind on their payments. Eventually, this spread to prime mortgages as well. The rising number of delinquencies on subprime mortgages was a wake-up call to lenders and investors that many residential mortgages were not nearly as safe as once believed. As the mortgage meltdown intensified, the magnitude of expected losses rose dramatically. Because millions of U.S. mortgages were repackaged as securities, losses spread across the globe. It became very difficult to determine the value of many loans and mortgage-related securities. In addition, the widespread use of complex and exotic financial instruments made it even harder to figure out the vulnerability of financial institutions to losses. Institutions became increasingly reluctant to lend to each other.

The situation reached a crisis point in 2007 when these fears about the financial health of other firms led to massive disruptions in the wholesale bank lending market. As a result, rates on short-term loans rose sharply relative to the overnight federal funds rate. In the fall of 2008, two large financial institutions failed: the investment bank Lehman Brothers and the savings and loan Washington Mutual. The extensive web of connections among major financial institutions meant that the failure of one could start a cascade of losses throughout the financial system, threatening many other institutions. Confidence in the financial sector collapsed and stock prices of financial institutions around the world plummeted. Banks were unable to sell most types of loans to investors because securitization markets had stopped working. As a result, banks and investors clamped down on many types of loans by tightening standards and demanding higher interest rates—a classic credit crunch. Tight credit weakened spending on big-ticket items financed by borrowing: houses, cars, and business investment. The hit to household wealth was another factor causing people to cut back on spending as they struggled to rebuild depleted savings. With demand weakening, businesses canceled expansion plans and laid off workers. The U.S. economy entered a recession, a period in which the level of economic activity was shrinking, in December 2007. The recession had been relatively mild until the fall of 2008 when financial panic intensified, causing job losses to soar.

As short-term markets froze, the Federal Reserve expanded its own collateralized lending to financial institutions to ensure that they had access to the critical funding needed for day-to-day operations. In March 2008, the Federal Reserve created two programs to provide short-term secured loans to primary dealers similar to discount-window loans provided to banks. Conditions in these markets improved considerably in 2009. The possible failure of the investment bank Bear Stearns early in 2008 carried the risk of a domino effect that would have severely disrupted financial markets. In order to contain the damage, the Federal Reserve provided non-recourse loans to the bank JP Morgan Chase to facilitate its purchase of certain Bear Stearns assets. Following the collapse of the investment bank Lehman Brothers, financial panic threatened to spread to several other key financial institutions, potentially leading to a cascade of failures and a meltdown of the global financial system. The Federal Reserve provided secured loans to the giant insurance company American International Group (AIG) because of its central role guaranteeing financial instruments. 

In normal times, banks borrow from each other for terms ranging from overnight to several months. Starting in August 2007, banks became increasingly reluctant to make short-term loans to each other. In response, the Federal Reserve increased the availability of one- and three-month discount-window loans to banks through the creation of the Term Auction Facility. It also created swap lines with foreign central banks to increase the availability of dollar-denominated loans to banks in other countries. In the spring of 2009, the Federal Reserve, in conjunction with other federal regulatory agencies, conducted an exhaustive and unprecedented review of the financial condition of the 19 largest U.S. banks. This included a "stress test" that measured how well these banks could weather a bad economy over the next two years. Banks that didn't have enough of a capital cushion to protect them from loan losses under the most adverse economic scenario were required to raise new money from the private sector or accept federal government funds from the Troubled Asset Relief Program. 

In response to the economic crisis, the Federal Reserve’s policy making body, the Federal Open Market Committee, slashed its target for the federal funds rate over the course of more than a year, bringing it nearly to zero by December 2008. This is the lowest level for federal funds in over 50 years and effectively is as low as this key rate can go. Cutting the federal funds rate helped lower the cost of borrowing for households and businesses on mortgages and other loans. To stimulate the economy and further lower borrowing costs, the Federal Reserve turned to unconventional policy tools. It purchased $300 billion in longer-term Treasury securities, which are used as benchmarks for a variety of longer-term interest rates, such as corporate bonds and fixed-rate mortgages. To support the housing market, the Federal Reserve authorized the purchase of $1.25 trillion in mortgage-backed securities guaranteed by agencies such as Freddie Mac and Fannie Mae and about $175 billion of mortgage agency longer-term debt. These Federal Reserve purchases have reduced mortgage interest rates, making home purchases more affordable.

AV Club review of the pilot for "The Americans."

John Taylor, Post-Modern Monetary Theorist by David Glasner

John Taylor:

[I]f investors are told by the Fed that the short-term rate is going to be close to zero in the future, then they will bid down the yield on the long-term bond. The forward guidance keeps the long-term rate low and tends to prevent it from rising. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

The perverse effect comes when this ceiling is below what would be the equilibrium between borrowers and lenders who normally participate in that market. While borrowers might like a near-zero rate, there is little incentive for lenders to extend credit at that rate. 

This is much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing. Here lenders supply less credit at the lower rate. The decline in credit availability reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence of the policy.

Glasner:

When economists talk about a price ceiling what they usually mean is that there is some legal prohibition on transactions between willing parties at a price above a specified legal maximum price. If the prohibition is enforced, as are, for example, rent ceilings in New York City, some people trying to rent apartments will be unable to do so, even though they are willing to pay as much, or more, than others are paying for comparable apartments. The only rates that the Fed is targeting, directly or indirectly, are those on US Treasuries at various maturities. All other interest rates in the economy are what they are because, given the overall state of expectations, transactors are voluntarily agreeing to the terms reflected in those rates. For any given class of financial instruments, everyone willing to purchase or sell those instruments at the going rate is able to do so. For Professor Taylor to analogize this state of affairs to a price ceiling is not only novel, it is thoroughly post-modern.

Carrots for Doctors by Bill Keller

Doctors cite a number of reasons our medical treatments cost more — the high price of malpractice insurance being a favorite, and genuine, culprit. But the main reason everything costs less in other countries is that other countries tend to have one big payer — usually the government — with the clout to bargain down prices. A single-payer system has, so far, proven politically unpalatable in this country. And even Medicare, which has the power of scale and uses it to drive down prices, wields its power sparingly, because doctors threaten to stop serving Medicare patients if the reimbursements fall too low. As hospitals merge into mightier megachains, they may be able to bargain down the payments to doctors and drug companies and device-makers, and create economies of scale by standardizing treatments. (The physician and New Yorker writer Atul Gawande proposed in a provocative August article that hospitals could drastically improve productivity by studying the example of restaurant chains like the Cheesecake Factory.) But that’s not what P4P is about.

opportunistic disinflation

There Is An Inflation Problem: It's Falling Below Target by Thoma

Our Incredible Shrinking Government by Krugman

Why Have Recoveries Been So Miserable the Past 20 Years? by Matt O'Brien

Are jobless recoveries the Fed's fault? by Noah Smith

Guest Contribution: "The Myth of 'Jobless Recoveries'" (a.k.a. Okun’s Law is Alive and Well, from Econobrowser)

Key Terms and Semantics*

Part Three

I guess my genealogy and key terms posts are all about macroeconomic demand management by the government via fiscal and monetary policies. The government is reacting to financial crises like the one in 2008 brought on by long-term secular trends in income and credit/debt creation/management.

Sterilization

downward nominal wage rigidity (DNWR)

Zero interest-rate policy (ZIRP)

nominal GDP level target

Opitmal Control Path

"extend and pretend"

Part Two

Commercial Paper

Part One

Interest on Excess Reserves (IOER)

Open Market Operations (OMO)

Hot Potato Effect

Monetary Base

Floor System

____________________
Bloggily thinking out load here. Parts One and Two links.

'Zero Dark Thirty' Is Osama bin Laden's Last Victory Over America by Matt Taibbi

I liked Ben Affleck's "Argo." It tells the story of how the Shah's torture regime in Iran backfired.  It has a great cast with Alan Arkin, Kyle Chandler, Rory Cochrane, Bryan Cranston, Clea DuVall, John Goodman, and Scoot McNairy. Canada and international cooperation are celebrated too. Movies and film, if not Hollywood itself, help save the day.

"Silver Linings Playbook" was entertaining as well. It is always amusing when a crazy person is out-crazied by a crazier person.

What is the state of the banks? Is Bernanke just "extending and pretending"?

The perpetualisation of debt by Isabella Kaminska

In an equity financed model, banks would either turn into venture capitalists — lending high risk at the right price — or remain extremely cautious, opting not to lend at all if productive loans cannot be found.

Which leaves us with three important conclusions:

• The banking industry as it stands represents “government lending” in everything but name.
• Even in its implicitly state-supported form the industry is struggling to find productive loans.
• It’s unsurprising the industry is unattractive to equity investors.

Three other points to consider on the back of those:

• Any lending forced upon banks under government duress would likely be directed towards unproductive loans, thus the equivalent of uncollateralisedmoney-printing.
• If banking remains in the private sector it should be equity funded. But if there aren’t enough productive loans to be had, equity funding will simply encourage cashpiles to accumulate contracting money supply.
• In that scenario the government/monetary authority would have to compensate either with uncollateralised money-printing or debt-financed government spending and sterilisation through taxes, when needed.

Final thought:

Perhaps we’re all government employees already, we just don’t realise it?

Second final thought:

What is equity if not perpetual debt? And what is money if not national equity? Is there really any differentiation at this point?

 How are the banks in Japan?

Key Terms and Semantics

Part Two*

Commercial Paper

At the end of 2009, more than 1,700 companies in the United States issue commercial paper. As of 2008 October 31, the U.S. Federal Reserve reported seasonally adjusted figures for the end of 2007: there was $1.7807 trillion (short-scale, or 1,780,700,000,000) in total outstanding commercial paper; $801.3 billion was "asset backed" and $979.4 billion was not; $162.7 billion of the latter was issued by non-financial corporations, and $816.7 billion was issued by financial corporations.

...

Commercial paper is a lower cost alternative to a line of credit with a bank. Once a business becomes established, and builds a high credit rating, it is often cheaper to draw on a commercial paper than on a bank line of credit. Nevertheless, many companies still maintain bank lines of credit as a "backup". Banks often charge fees for the amount of the line of the credit that does not have a balance. While these fees may seem like pure profit for banks, in some cases companies in serious trouble may not be able to repay the loan resulting in a loss for the banks.

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*Part One 

There’s no such thing as base money anymore by Waldman

But maybe not. Maybe we’ll see the light and enact a basic income scheme or negative income tax brackets. Maybe we’ll restore the dark, and engineer new ways of providing fraudulently loose credit. Either sort of change could bring “full employment” interest rates back above zero.

Do we ever rise from the floor? by Steve Randy Waldman

I’m less sure about the “someday end” thing. The collapse of the “full employment” interest rate below zero strikes me as a secular rather than cyclical development, although good policy or some great reset could change that. Regardless, if and when the Fed does want to raise interest rates, I think that it will not do so by returning to its old ways. A permanent institutional change has occurred, which renders past experience of the scale and composition of the monetary base unreliable.

Secular Development:

The negative unnatural rate of interest

Right now the Fed is buying $85 billion a month in mortgage back securities and long-term treasuries, to reduce their prices and ease credit conditions. They communicated that they will do this for while and they will keep policy accomadative until unemployment levels lower to 6.5 percent or so.

Surprise Q4 GDP Decline's Not Quite As Bad as It Sounds by Yglesias

"The Bird Has Flown" by Noel Murray (AV Club review of "Justified")

Semantics and Key Terms

Currency Wars in the Era of Unconventional Monetary Policies by Menzie Chinn

The Fed Doesn't Ever Have To "Unwind" Its Balance Sheet by Yglesias

From my genealogy*

interest rate on excess reserves (IOER)

On October 3, 2008, Section 128 of the Emergency Economic Stabilization Act of 2008 allowed the Fed to begin paying interest on excess reserve balances as well as required reserves. They began doing so three days later.[3] Banks had already begun increasing the amount of their money on deposit with the Fed at the beginning of September, up from about $10 billion total at the end of August, 2008, to $880 billion by the end of the second week of January, 2009.[4][5] In comparison, the increase in reserve balances reached only $65 billion after September 11, 2001 before falling back to normal levels within a month. Former U.S. Treasury Secretary Henry Paulson's original bailout proposal under which the government would acquire up to $700 billion worth of mortgage-backed securities contained no provision to begin paying interest on reserve balances.[6]

The day before the change was announced, on October 7, Fed Chairman Ben Bernanke expressed some confusion about it, saying, "We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target. We're going to experiment with this and try to find what the right spread is."[7] The Fed adjusted the rate on October 22, after the initial rate they set October 6 failed to keep the benchmark U.S. overnight interest rate close to their policy target,[7][8] and again on November 5 for the same reason.[9]

The Congressional Budget Office estimated that payment of interest on reserve balances would cost the American taxpayers about one tenth of the present 0.25% interest rate on $800 billion in deposits:

Estimated Budgetary Effects^[10]

Year	2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016
Millions of dollars	0	-192	-192	-202	-212	-221	-242	-253	-266	-293	-308
(Negative numbers represent expenditures; losses in revenue not included.)

0.25% simple interest on $800 billion is $2 billion, not $202 million as shown for 2009. But those expenditures pale in comparison to the lost tax revenues worldwide resulting from decreased economic activity from damage to the short-termcommercial paper and associated credit markets.

Beginning December 18, the Fed directly established interest rates paid on required reserve balances and excess balances instead of specifying them with a formula based on the target federal funds rate.[11][12][13] On January 13, Ben Bernanke said, "In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed. In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors. However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate."[14] 

Also on January 13, Financial Week said Mr. Bernanke admitted that a huge increase in banks' excess reserves is stifling the Fed's monetary policy moves and its efforts to revive private sector lending.[15] On January 7, 2009, the Federal Open Market Committee had decided that, "the size of the balance sheet and level of excess reserves would need to be reduced."[16] On January 15, Chicago Fed president and Federal Open Market Committee member Charles Evans said, "once the economy recovers and financial conditions stabilize, the Fed will return to its traditional focus on the federal funds rate. It also will have to scale back the use of emergency lending programs and reduce the size of the balance sheet and level of excess reserves. Some of this scaling back will occur naturally as market conditions improve on account of how these programs have been designed. Still, financial market participants need to be prepared for the eventual dismantling of the facilities that have been put in place during the financial turmoil" [17]At the end of January, 2009, excess reserve balances at the Fed stood at $793 billion[18] but less than two weeks later on February 11, total reserve balances had fallen to $603 billion. On April 1, reserve balances had again increased to $806 billion, and on February 10, 2010, they stood at $1.154 trillion.[19] By August 2011, they had reached $1.6 trillion. 

open market operations (OMO)

hot-potato effect

monetary base

Floor System (from Waldman)

Under the floor system, a central bank sets the monetary base to be much larger than would be consistent with its target interest rate given private-sector demand, but prevents the interbank interest rate from being bid down below its target by paying interest to reserve holders at the target rate. The target rate becomes the “floor”: it never pays to lend base money to third parties at a lower rate, since you’d make more by just holding reserves (converting currency into reserves as necessary). The US Federal Reserve is currently operating under something very close to a floor system. The scale of the monetary base is sufficiently large that the Federal Funds rate would be stuck near zero if the Fed were not paying interest on reserves. In fact, the effective Federal Funds rate is usually between 10 and 20 basis points. With a “perfect” floor, the rate would never fall below 25 bps. But because of institutional quirks (the Fed discriminates, it fails to pay interest to nonbank holders of reserves), the rate falls just a bit below the “floor”.

If “the crisis ends” (whatever that means) and the Fed reverts to its traditional approach to targeting interest rates, Krugman will be right and I will be wrong, the monetary base will revert to something very different than short-term debt. However, I’m willing to bet that the floor system will be with us indefinitely. If so, base money and short-term government debt will continue to be near-perfect substitutes, even after interest rates rise.

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* a work in progress

floor system safe asset paradigm shift genealogy*

Oct. 20, 2011

What If We Paid Off The Debt? The Secret Government Report by David Kestenbaum (Planet Money)

Sept. 5, 2012

The Untold Story Of How Clinton's Budget Destroyed The American Economy by Joe Weisenthal

Jan. 2, 2013

Debt in a Time of Zero by Krugman

Jan. 7

On The Folly of Inflation Targeting In A World Of Interest Bearing Money by Ashwin Parameswaran

The end of RoRo, or is it? by Izabella Kaminska

Jan. 8

The liquidity trap heralds fundamental change by Frances Coppola

Jan. 9

Platinomics by Greg Ip

Jan. 12

On The Disruptiveness of the Platinum Coin by Tim Duy

Jan. 13

There’s no such thing as base money anymore by Steve Randy Waldman

A Trap of My Own Making by Tim Duy

Jan. 14

All Our Base Are Belong To Us (Wonkish) by Krugman

Floor Systems by Stephen Williamson

Jan. 15

Do we ever rise from the floor? by Steve Randy Waldman

All Your Base Are Belong To Us, Continued (Still Wonkish) by Krugman

Yet more on the floor with Paul Krugman by Steve Randy Waldman

Money and Debt, Continued by Tim Duy

Do sofas refute monetarism? by Nick Rowe

Currency matters, even with IOR by Scott Sumner

The Waldman-Krugman-Sumner Debate: It's the IOER Path by David Beckworth

Base money basics by Merijn Knibbe

Unifying The Fiscal And Monetary Functions: A Policy Proposal by Ashwin Parameswaran

All Your Bases and Dead Presidents Are Belong to the Government? by Cullen Roche

More on Floor Systems by Stephen Williamson

Jan. 16

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska

Understanding the Permanent Floor—An Important Inconsistency in Neoclassical Monetary Economics by Scott Fullwiler


Jan. 17

All Your Base Are Belong To Us: What Is the Question? by Krugman

All Your Dorks Are Belong to This by Cullen Roche

Krugman, Kaminska, and Waldman by Scott Sumner

Monetary Policy: From Managing the Monetary Base to Setting an Interest Rate Floor by Peter Dorman

Let’s Talk About Interest on Reserves by Josh Hendrickson

Jan. 18

A confederacy of dorks by Steve Randy Waldman

THE PERMANENT FLOOR 2004 by Scott Fullwiler

Two extreme fiscal/monetary worlds by Nick Rowe

AND NICK ROWE IS THE LATEST ECONOMIST TO JOIN THE INARTICULATE DORKS... by Brad DeLong

The Coin is Dead! Long Live the Coin! by Michael Sankowski

Furthering Understanding of the Permanent Floor by Joshua Wojnilower

Shinzo and the Helicopters (Somewhat Wonkish) by Krugman

Jan. 19

Waldman Thinks Bernanke Will Go for (Flawed) Exit #1 by Robert Murphy

Murphy of the bad inflation bet, I think.

Jan. 28

Safe Assets and Financial Crises by Carola Binder

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*provisional. Times are not sorted. Updated from Jan. 19th posting.

Safe Assets

HOISTED FROM THE ARCHIVES: THE SAFE ASSET SHORTAGE AND THE CURRENT DOWNTURN by DeLong

Safe Assets and Financial Crises by Carola Binder

Mark Thoma has shared a link to a new working paper by Gary Gorton and Guillermo Ordoñez called "The Supply and Demand for Safe Assets." The paper brings to mind a once-confidential document written by economists in the Clinton Administration called "Life After Debt" which was recently made public by the team at NPR's Planet Money. The report notes:

In the year 2000, the U.S. Treasury began actively buying back the public debt; we should all appreciate the tremendous achievement this represents for the Nation as a whole... We must realize however, that a sharp reduction in Federal debt and the possible accumulation of a Federal asset raises at least three important issues. First, investors looking for an asset free of credit risk can no longer count on an abundant supply of U.S. Treasury securities, and Treasury securities may no longer provide a reliable benchmark for other interest rates. Second, the Federal Reserve may have to change the mechanisms by which it conducts monetary policy. Third, continued surpluses after the public debt has been paid off will require the Federal. government to acquire assets; either directly or though the Social Security Trust Fund. This raises issues about what kinds of assets might be acquired, and the best way to manage this task.”

And:

For a time, the AAA-rated top tranches of these manufactured assets were considered really safe, and it was like the "normal times" in the model when lenders trust that on average, collateral quality is good enough that they don't need to pay the extra cost to check on it. But then it became apparent that the average quality was much lower, and these assets became less effective collateral, and the financial crisis began. There are at least some claims that the Clinton surplus kicked off the rise in mortgage-backed securities issuance. (I included two graphs below, made using data from FRED, in case you want to evaluate the claims for yourself.) If you decide to read "The Supply and Demand for Safe Assets," please do also look at Krishnamurthy and Vissing-Jorgensen's empirical counterpart. Or, for something lighter, listen to Planet Money'sepisode "What If We Paid Off The Debt? The Secret Government Report."

I think I should add Binder's post and Gorton & Ordoñez's working paper to my paradigm shift geneology.

DNWR

The Fed Is More Out of It Than You Thought It Was by Mike Konczal

The Fed's Real Mistake in 2007: Forgetting About Aggregate Demand by Yglesias

Under "normal" conditions, one stabilizing element of the Fed is that people think they know how the Fed will respond to future contingencies. We all know that if core inflation gets up to 3 percent for a couple of quarters in a row, the Fed will respond with tighter money. That means nobody expects that to happen. And the expectation that it won't happen helps prevent it from happening. Everyone's plans are coordinated around a no-high-inflation scenario. And for a long time, that also operated on the downside. But the Fed didn't articulate in advance any clear ideas about the zero bound to reassure people. People knew Ben Bernanke had written some old papers about this. But he wasn't publicly speaking about strategies, and we can see in the transcripts that he wasn't privately trying to build consensus either. It was a failure of contingency planning that exacerbated the problems when the bad contingency arose.

If downward nominal wage rigidity hadn't occurred to extent it did - which surprised Yellen and Krugman - we could have had deflation seeing as how the Fed as slow to react and communicate its intentions.

Larry Summers Says the Clinton Administration Didn't Have Access to Government Economic Data by Dean Baker

Okay, that is not exactly what he said, but if Chrystia Freeland's account of Summers' comments at Davos is to be believed Summers is badly misinformed about the state of the U.S. economy in 1993, when he was one of the top advisers in the Clinton administration. According to Freeland Summers said: 

"In 1993, here’s what the situation was: Capital costs were really high, the trade deficit was really big, and if you looked at a graph of average wages and the productivity of American workers, those two graphs lay on top of each other. So, bringing down the deficit, reducing capital costs, raising investment, spurring productivity growth, was the right and natural central strategy for spurring growth. That was what Bob Rubin advised Bill Clinton, that was the advice Bill Clinton followed, and they were right." 

This is not what the data say. Here's the story on real wages and productivity.

Source: Bureau of Labor Statistics. 

There are some measurement issues that would reduce the gap somewhat, but anyone who could see these two as laying "on top of each other" needs some new glasses. The sharp divergence between productivity and wages began in the 1980s. It would be really scary if Larry Summers, Robert Rubin and the rest did not know this in 1993. 

The other parts of Summers' story are also wrong. The trade deficit was less than 1.0 percent of GDP in 1993. By comparison it was almost 4.0 percent of GDP when Clinton left office in 2000. The interest rate on ten-year Treasury bonds was 6.6 percent in January of 1993. Coupled with an inflation rate of around 3.0-3.5 percent, this gave a real interest rate in the neighborhood of 3.1-3.6 percent. This is perhaps a bit higher than desirable, but actually not much different than what we saw through most of the Clinton years. 

In short, Summers is describing a history that does not exist. He either has a very poor memory or is just making things up.

Kathryn Bigelow: The Art of Darkness by Jessica Winter

Alan Blinder on the Lessons of the Financial Crisis by Binyamin Appelbaum

"The Love Song of J. Alfred Prufrock"

By chance I was thinking about T.S. Eliot's poem recently. Prufrock is paralyzed by his self-awareness. 

Perhaps the most significant dispute lies over the "overwhelming question" that Prufrock is trying to ask. Many believe that Prufrock is trying to tell a woman of his romantic interest in her,[19] pointing to the various images of women's arms and clothing and the final few lines in which Prufrock laments that the mermaids will not sing to him. Others, however, believe that Prufrock is trying to express some deeper philosophical insight or disillusionment with society, but fears rejection, pointing to statements that express a disillusionment with society such as "I have measured out my life with coffee spoons" (line 51). Many believe that the poem is a criticism of Edwardian society and Prufrock's dilemma represents the inability to live a meaningful existence in the modern world.[24] McCoy and Harlan wrote "For many readers in the 1920s, Prufrock seemed to epitomize the frustration and impotence of the modern individual. He seemed to represent thwarted desires and modern disillusionment."*

Coincidently, "30 Rock" - I think - has its finale next Thursday. For many years I wouldn't watch the show, because I had a crush on Fey - who's my age - and one shouldn't encourage that kind of lameass embarrassing thing. Friends at work would want to discuss it and insisted I would like because I have that kind of sense of humor. Eventually I gave in, there isn't much else on TV these days. And yes the show is very funny and right up my alley. Part of what's funny are the very un-selfaware and un-selfconscious characters like Tracy Jordan and Jenna Malone. In last night's show, Liz Lemon adopts 2 children who are kid-versions of the two. Larry David is in some ways un-selfconscious when some rude person transgresses one of his unwritten social rules or guidelines. And Sarah Silverman's character on her show was very un-self-aware. These kinds of people are godsends to the Prufrocks among us.
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*maybe the question is about politics and philosophy, the deep issues your average middle class American feels they should stay clear of.

Misinterpreting the history of macroeconomic thought by Simon Wren-Lewis

inequality and growth

I tend to side with Krugman here if I understand the debate correctly.

Inequality and demand by Steve Randy Waldman

Why Don't Rich People Buy More Yachts and Fewer Exotic Financial Products by Yglesias

Guest Post: “The Savings Rate Has Recovered…if You Ignore the Bottom 99%” by Andrew Kaplan, a hedge fund manager ("Naked Capitalism," 8.31.2009)

Why don't we have deflation? Increased debt? Extend and pretend?

(via Mike Sankowski who I confuse with Mark A. Sadowski. It's like with Waldman and Robert Waldmann.)

Optimal Control approach

NGDP level targeting: Yellen it from the rooftops, but nobody heard by Cardiff Garcia

(via Thoma)

Yellen Supports Explicit Guideposts by Tim Duy

I think I'm going to copy Jessica on "New Girl" and set the Pointer Sisters' "I'm So Excited" as my new ringtone.

A brief history of macro: How we got here by Matthew Klein (M.C.K.)

Macro always fights the last war by Noah Smith

Bank of Japan Disappoints With Punt On Higher Inflation Target by Yglesias

A Liberal Agenda Without Full Employment? by Dean Baker

There were numerous news stories and columns touting the liberal agenda that President Obama put forward in his second inaugural address yesterday (e.g. here and here). While the speech certainly hit on several issues that have historically been important to liberals, the failure to mention full employment was a major omission.

The fact that the economy is still more than 9 million jobs below its trend growth path implies enormous suffering. Not only are millions of people unnecessarily unemployed or underemployed, high levels of unemployment mean that most workers lack bargaining power. As a result they are unable to raise their wages and get their share of productivity growth. This means that income is likely to continue to be redistributed upward.

There are not easy political paths to full employment at this point. Government stimulus (i.e. larger deficits) is the most obvious path, but that seems out of the question in a context where deficit reduction is dominating the policy debate. If the dollar dropped, it would make U.S. goods more competitive, thereby increasing net exports, but Obama has made little committment in this direction and the process would take time in any case.

The best prospect is probably increased use of worksharing. Germany has used worksharing to lower its unemployment rate by more than 2 percentage points below its pre-recession level, even though its growth has been no better than growth in the United States. Worksharing does enjoy bipartisan support in the United States and is an option in the unemployment insurance systems in 25 states, but the takeup rate has been extremely low. It's possible that a major presidential push could substantially increase the use of worksharing.

Anyhow, it is striking that a speech that touched on many liberal themes did not make a commitment to full employment. This should have been noted in the coverage.

26 & 23 years old

How M.I.T. Ensnared a Hacker, Bucking a Freewheeling Culture

There may have been a reason for the university’s response. According to the timeline, the tech team detected brief activity from China on the netbook — something that occurs all the time but still represents potential trouble.

...
Michael Sussmann, a Washington lawyer and a former federal prosecutor of computer crime, said that M.I.T. was the victim and that, without more information, it had to assume any hackers were “the Chinese, even though it’s a 16-year-old with acne.” Once the police were called in, the university could not back away from the investigation. “After there’s a referral, victims don’t have the opportunity to change their mind.” 

China, oh noes!

A Young Publisher Takes Marx Into the Mainstream

In writing Mr. Sunkara can come on like a one-man insult-comedy squad, whether the target is regular whipping boys like the Washington Post blogger Ezra Klein (“a young liberal with a lust for properly punctuated policy memos”) or the capitalist vampire squid itself. 

But in person he’s more straightforwardly earnest and quick to emphasize that the magazine he founded in his dorm room has evolved into a collective endeavor. Jacobin’s success, he said, springs from the highly cohesive politics of the four co-editors he has recruited and their shared commitment to advancing a critique of liberalism that is free of obscurantist academic theory or “cheap hooks.” 

...

“Seth had a title with nine words and a semicolon,” he recalled. “I crossed it out and wrote ‘Burn the Constitution.’ ” 

That article, along with “Zombie Marx,” a critique of chapter-and-verse Marxist economics by Mike Beggs, a young lecturer in political economy at the University of Sydney who Mr. Sunkara met (like Mr. Ackerman) through the e-mail list of Doug Henwood’s Left Business Observer, got some pickup on blogs. But it was a packed Jacobin-organized panel on the Occupy movement, held in a downtown Manhattan bookstore three weeks after the protests began in Zuccotti Park in September 2011, that really put the magazine on the map, drawing attention from Politico and Glenn Beck.

From Beggs's "Zombie Marx":

Inflation was simply not seen as an independent phenomenon worthy of analysis, as it would become in the 20th century when the gold anchor loosened and dropped away. It was enough to know that the anchor would assert itself eventually. The problem for the state or central bank was not the value of money per se, but the convertibility of particular monies. But in our world of chronic, if low-level, inflation and floating exchange rates, we need different things from our monetary theory. We have no choice but to engage with new questions Marx could not have imagined – and here the reference point should be Keynes and the post-Keynesians.

I think there is a big point in here somewhere. The Left and Marxists have been very dismissive of monetary policy. German Marxists running their government in the 1920s were into the Gold Standard. But if there was no Fed in the 19th century, there were in fact periods of inflation and deflation. William Jennings Bryan's "Cross of Gold" speech was given in 1896.

Inequality and Growth

Inequality Is Holding Back the Recovery by Joseph Stiglitz

Inequality and Recovery by Krugman

Krugman versus Stiglitz on Inequality and Economic Growth by Dean Baker

How Inequality Holds Back Recovery by Yglesias

"Ben Affleck's intervention not even required."*

In Reversal, House G.O.P. Agrees to Lift Debt Limit

Those conversations led into Thursday morning, when Mr. Boehner and Representative Eric Cantor of Virginia, the No. 2 House Republican, opened the retreat by going through the timeline for the coming budget fights, according to aides who were there. 

They turned the floor over to Representative Dave Camp of Michigan, the House Ways and Means chairman, who delivered a blow-by-blow description of the economic disaster that could be wrought by a government default. Mr. Camp also talked through the notion held by some Republicans that the Treasury Department could manage a debt ceiling breach by channeling the daily in-flow of tax dollars to the most pressing needs, paying government creditors, sending out Social Security checks and financing the military. His message was that it would not work, the aides said.

Jonathan Chait - along with Krugman and Jonathan Cohn - admit they were wrong.

The whole key to making Obama’s extortion-squelching plan, and saving American government from endless cycles of hostage drama that would eventually end in a default, was to credibly insist that he would not trade anything for a debt ceiling hike. After he moved his red line on tax cuts, I doubted that Obama could really make this stick. But he has. 

Now, Republicans are only voting on a three-month extension. But this is a face-saving gesture, too. Once they’ve recognized that the debt ceiling isn’t leverage, they have no reason to keep taking painful votes that expose their members to attack ads. 

Letting Republicans weaponize the debt ceiling in the first place in 2011 was one of the crucial errors of Obama’s presidency. He appears to have corrected it.

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*The Coin of Freedom was sort of a complicated ploy like Affleck's fake movie production in Argo.

reading the paradigm shift genealogy

I'm currently slowly going through my paradigm shift genealogy timeline, and will add some quotes here to help me digest what they all are discussing. 

1. From Krugman on Jan. 2:

It’s true that printing money isn’t at all inflationary under current conditions— that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.

2. From Coppola on Jan. 7. Them is referring to Keynes and Krugman.

So for them, the liquidity trap is a phenomenon associated with very low nominal interest rates - an abnormal situation by any standard. And we have had very low nominal rates for five years now, so it would be reasonable to assume that the liquidity trap we now find ourselves in is due to interest rates being near-zero, and that once we have restored the economy to sufficient health to allow interest rates to rise to historic norms, normal service will be resumed. 

But that's not actually the current situation. We have interest-bearing money. Yes, interest rates on money are very low at the moment. And therefore - as I explained above - so are yields on the investments which are near-substitutes for money. But if interest rates were to rise, would this change?

I can't see any reason why it should. Because interest-bearing money is freely exchangeable with government debt - and indeed the shadow banking system constantly performs that intermediation - the equivalence between government debt and interest-bearing money would hold at any level of interest rates. We are indeed in a liquidity trap, but it's not because of economic distress and near-zero interest rates. It is because the nature of money has fundamentally changed. Money is no longer just "cash". Money is any financial asset that flows freely and is readily exchangeable for currency.

3. From Duy on Jan. 12

Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet. 

Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.

 4. Waldman on Jan. 13

What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive).

5. Duy on Jan. 13

I think what I had in mind is this (and I admit that I am not wed to this, a little open-microphone now): The Fed has a portfolio of bonds which is a indirect transfer from Treasury which in turns allows it to pay interest on reserves. Lacking such a portfolio, the Fed would need to receive a direct transfer from the Treasury to pay interest on reserves. Operationally, these are the same. As long as both have the same objective function, it makes no difference if the Treasury's transfer goes through the middleman of a bond or just directly to the Fed. But what if the Treasury does not have the same objective function, does not want higher interest rates, and thus does not want to transfer the resources to the Fed? What claim does the Fed have on the Treasury to force it to act?  

Somewhere in this space is why we have come to accept the importance of an independent central bank. Indeed, this is a concern should the Fed need to pay interest on reserves that exceed the interest earned on its bond portfolio. Then the Fed would need to turn to the Treasury and say "Remember when we paid you $89 billion? Well, we need some of that back now."    

Ultimately, though, I have to agree with Waldman when I allow for the two authorities to have the same objective function. This is another way of saying that one side effect of the zero bound is the blurring of what many thought were sharp lines between fiscal and monetary authorities.

6. Waldman on Jan. 15

If “the crisis ends” (whatever that means) and the Fed reverts to its traditional approach to targeting interest rates, Krugman will be right and I will be wrong, the monetary base will revert to something very different than short-term debt. However, I’m willing to bet that the floor system will be with us indefinitely. If so, base money and short-term government debt will continue to be near-perfect substitutes, even after interest rates rise. 

Again, there’s no substantive dispute over the economics here. Krugman writes:

"It’s true that the Fed could sterilize the impact of a rise in the monetary base by raising the interest rate it pays on reserves, thereby keeping that base from turning into currency. But that’s just another form of borrowing; it doesn’t change the result that under non-liquidity trap conditions, printing money and issuing debt are not, in fact, the same thing."

If the Fed adopts the floor system permanently, then the Fed will always “sterilize” the impact of a perpetual excess of base money by paying its target interest rate on reserves. As Krugman says, this prevents reserves from being equivalent to currency and amounts to a form of government borrowing. So, we agree: under the floor system, there is little difference between base money and short-term debt, at any targeted interest rate! Printing money and issuing debt are distinct only when there is an opportunity cost to holding base money rather than debt. If Krugman wants to define the existence of such a cost as “non-liquidity trap conditions”, fine. But, if that’s the definition, I expect we’ll be in liquidity trap conditions for a very long time! By Krugman’s definition, a floor system is an eternal liquidity trap.

Am I absolutely certain that the Fed will choose a floor system indefinitely? No. That is a conjecture about future Fed behavior. But, as I’ve said, I’d be willing to bet on it.

Historical case studies

Concerning the new paradigm discussed at my paradigm shift genealogy, what are the historical case studies of the coin option or monetizing the debt.

Krugman mentions Japan's successful policies in the first half of the 1930s:

And beyond that, the credibility of a higher inflation target in the face of the deflationary bias of central bankers may well be best established by (a) reducing the central bank’s autonomy and (b) getting the central bank in the business of supporting — indeed, monetizing — government deficits, at least for a while. Gauti Eggertsson made this point long ago (pdf), pointing to Japan’s successful polices in the first half of the 30s as a clear example. Indeed, Gauti argued that having a large government debt can be a real advantage in such circumstances: efforts to raise expected inflation gain extra credibility if the government would clearly benefit in fiscal terms, and the central bank is sufficiently subordinated to elected officials that investors believe that it will take these fiscal benefits into account.

Tim Duy discusses Bernanke on Japan and helicopter drops.

However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

Grep Ip brings up the example of the pre-1951 Accord-era of 1942-51.

Yes, the Fed has sacrificed its independence for the sake of the national interest before, such as maintaining a ceiling on Treasury yields between 1942 and 1951; but that was (initially) in wartime, and it eventually led to inflation. Would avoiding the debt ceiling be important enough to compromise the Fed's independence? Perhaps not in this one case; but it would set a precedent future presidents will happily exploit and feed the perception that America’s economic institutions are in terminal decline. America has had debt ceiling crises before (in 1957, 1985, 1996 and 2011) and survived; are the unknown risks of the platinum coin option obviously preferable to the known risks of hitting the debt ceiling?

And mentions New Zealand:

Fed staff have laboured for years on the mechanics of this exit process; they can't be sure how it will transpire, since the Fed has never had to raise interest rates with so much excess reserves in the system. But the experience of other central banks, in particular the Reserve Bank of New Zealand, “suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances,” according to a 2010 study by three Fed economists. 

What this means is that while the platinum coin option expands the Fed’s balance sheet and, ultimately, the monetary base, it has no implications for inflation, even if the Treasury never buys back the coin.

Escape velocity and exit strategy

The Japanese Economy: Both Barrels? by Ryan Avent

I think I lean toward Mr Posen's view. Fiscal stimulus is neither necessary or sufficient for Japanese recovery, and though it could enhance a new monetary expansion it also carries some potentially serious risks. But I'm not that confident in the conclusion. Japan is a strange case. I suppose that makes the big upside of the situation (for economists, not the Japanese) the possibility that we'll learn something.

I disagree and agree with Krugman.