Tuesday, July 19, 2011

Can and Can't vs. Should and Shouldn't

Greg Mankiw, an economist at Harvard known for his textbook and his blog, wrote an article in the NY Times a while back expressing his concern about the debt and the government "living beyond its means" by imagining the president's address to the nation in 2026. Despite his supposed expertise he makes many errors and overlooks key factors. Warren Mosler responded to his article by exposing these mistakes.

I am posting it because I think it's important for you to understand what almost everyone is thinking about the debt debate (Mankiw's article) and what people should be thinking about the debate (Mosler's response). If nothing else, you should at least be given a chance to understand an alternative that does not get any air time on tv or radio, and is not really even given a chance by most economists and politicians who wave it off like mere nonsense.

I have studied the arguments and believe very strongly that Mosler's arguments seem much more plausible than Mankiw's and the rhetoric we see and hear on tv; I also feel very strongly that you should be able to decide for yourself, but this is not possible if not given all the arguments.

Understanding government finance does not mean that government must necessarily be large (there is still much room for that debate), but it is so necessary to move beyond what the government can and can't do to what the government should and shouldn't do.

Mankiw's article (Mosler's comments in red):
The following is a presidential address to the nation — to be delivered in March 2026.

My fellow Americans, I come to you today with a heavy heart. We have a crisis on our hands. It is one of our own making. And it is one that leaves us with no good choices.

For many years, our nation’s government has lived beyond its means.

A rookie, first year student mistake. Our real means are everything we can produce at full employment domestically plus whatever the rest of the world wants to net send us. The currency is the means for achieving this. Dollars are purely nominal, and not the real resources.

We have promised ourselves both low taxes and a generous social safety net. But we have not faced the hard reality of budget arithmetic.

The hard reality is that for a given size government, there is a ‘right level’ of taxes that corresponds with full domestic employment, with the size of any federal deficit a reflection of net world dollar savings desires.

The seeds of this crisis were planted long ago, by previous generations. Our parents and grandparents had noble aims. They saw poverty among the elderly and created Social Security.

Yes, they decided they would like our elderly to be able to enjoy at least a minimum level of consumption of goods and services that made us all proud to be Americans.

They saw sickness and created Medicare and Medicaid. They saw Americans struggle to afford health insurance and embracedhealth care reform with subsidies for middle-class families

Yes, they elected to make sure everyone had at least a minimum level of actual health care services.

But this expansion in government did not come cheap. Government spending has taken up an increasing share of our national income.

The real cost of this ‘expansion’ (which was more of a reorganization than an expansion of actual real resources consumed by the elderly and consumed by actual healthcare needs) may have consumed an increasing share of real GDP, but with continued productivity this would have been at most a trivial amount at current rates of expansion.

Today, most of the large baby-boom generation is retired. They are no longer working and paying taxes, but they are eligible for the many government benefits we offer the elderly.

Yes, they are consuming real goods and services produced by others. The important consideration here is the % of the population working and overall productivity which he doesn’t even begin to address.

Our efforts to control health care costs have failed. We must now acknowledge that rising costs are driven largely by technological advances in saving lives. These advances are welcome, but they are expensive nonetheless.

Still no indication of what % of real GDP he envisions going to health care and real consumption by the elderly.

If we had chosen to tax ourselves to pay for this spending, our current problems could have been avoided. But no one likes paying taxes. Taxes not only take money out of our pockets, but they also distort incentives and reduce economic growth. So, instead, we borrowed increasing amounts to pay for these programs.

At least he gives real economic growth a passing mention. However, what he seems to continuously miss is that real output is THE issue. Right now, with potential employment perhaps 20% higher than it currently is, the lost real output, which compounds continuously, plus the real costs of unemployment- deterioration of human capital, broken families and communities, deterioration of real property, foregone investment, etc. etc. etc.- are far higher than the real resources consumed by the elderly and actual health care delivery. Nor does he understand what is meant by the term Federal borrowing- that it’s nothing more than the shift of dollar balances from reserve accounts at the Fed to securities accounts at the Fed. And that repayment is nothing more than shifting dollar balances from securities accounts at the Fed to reserve accounts at the Fed. No grandchildren involved!!!

Yet debt does not avoid hard choices. It only delays them. After last week’s events in the bond market, it is clear that further delay is no longer possible. The day of reckoning is here.

This morning, the Treasury Department released a detailed report about the nature of the problem. To put it most simply, the bond market no longer trusts us.

For years, the United States government borrowed on good terms. Investors both at home and abroad were confident that we would honor our debts. They were sure that when the time came, we would do the right thing and bring spending and taxes into line.

But over the last several years, as the ratio of our debt to gross domestic product reached ever-higher levels, investors started getting nervous. They demanded higher interest rates to compensate for the perceived risk.

This is all entirely inapplicable. It applies only to fixed exchange rate regimes, such as a gold standard, and not to non convertible currency/floating exchange rate regimes. This is nothing more than another rookie blunder.

Higher interest rates increased the cost of servicing our debt, adding to the upward pressure on spending. We found ourselves in a vicious circle of rising budget deficits and falling investor confidence.

With our non convertible dollar and a floating exchange rate, the Fed currently sets short term interest rates by voice vote, and the term structure of interest rates for the most part anticipates the Fed’s reaction function and future Fed votes. Nor is there any operational imperative for the US Government to offer longer term liabilities, such as 5 year, 7 year, 10 year, and 30 year US Treasury securities for sale, which serve to drive up long rates at levels higher than otherwise. That too is a practice left over from gold standard days that’s no longer applicable.

As economists often remind us, crises take longer to arrive than you think, but then they happen much faster than you could have imagined. Last week, when the Treasury tried to auction its most recent issue of government bonds, almost no one was buying. The private market will lend us no more. Our national credit card has been rejected.

As above, the US Government is under no operational imperative to issue Treasury securities. US Government spending is not, operationally, constrained by revenues. At the point of all US govt spending, all that happens is the Fed, which is controlled by Congress, credits a member bank reserve account on its own books. All US Government spending is simply a matter of data entry on the US Governments own books. Any restrictions on the US government’s ability to make timely payment of dollars are necessarily self imposed, and in no case external.

So where do we go from here?


Yesterday, I returned from a meeting at the International Monetary Fund in its new headquarters in Beijing. I am pleased to report some good news. I have managed to secure from the I.M.F. a temporary line of credit to help us through this crisis.

This loan comes with some conditions. As your president, I have to be frank: I don’t like them, and neither will you. But, under the circumstances, accepting these conditions is our only choice.

Mankiw’s display of ignorance and absurdities continues to compound geometrically.

We have to cut Social Security immediately, especially for higher-income beneficiaries. Social Security will still keep the elderly out of poverty, but just barely.

We have to limit Medicare and Medicaid. These programs will still provide basic health care, but they will no longer cover many expensive treatments. Individuals will have to pay for these treatments on their own or, sadly, do without.

We have to cut health insurance subsidies to middle-income families. Health insurance will be less a right of citizenship and more a personal responsibility.

We have to eliminate inessential government functions, like subsidies for farming, ethanol production, public broadcasting, energy conservation and trade promotion.

The only reason we would ever be ‘forced’ to make those cuts would be real resource constraints- actual shortages of land, housing, food, drugs, labor, clothing, energy, etc. etc. And yes, that could indeed happen. Those are the real issues facing us. But Mankiw is so lost in his errant understanding of actual monetary operations he doesn’t even begin to get to where he should have started.

We will raise taxes on all but the poorest Americans. We will do this primarily by broadening the tax base, eliminating deductions for mortgage interest and state and local taxes. Employer-provided health insurance will hereafter be taxable compensation.

He fails to recognize that federal taxes function to regulate aggregate demand, and not to raise revenue per se, again showing a complete lack of understanding of current monetary arrangements.

We will increase the gasoline tax by $2 a gallon. This will not only increase revenue, but will also address various social ills, from global climate change to local traffic congestion.

Ok, finally, apart from the revenue error, he’s got the rest of it sort of right, except he left out the part about that tax being highly regressive.

As I have said, these changes are repellant to me. When you elected me, I promised to preserve the social safety net. I assured you that the budget deficit could be fixed by eliminating waste, fraud and abuse, and by increasing taxes on only the richest Americans. But now we have little choice in the matter.

Due entirely to ignorance of actual monetary operations.

If only we had faced up to this problem a generation ago. The choices then would not have been easy, but they would have been less draconian than the sudden, nonnegotiable demands we now face. Americans would have come to rely less on government and more on themselves, and so would be better prepared today.

What I wouldn’t give for a chance to go back and change the past. But what is done is done. Americans have faced hardship and adversity before, and we have triumphed. Working together, we can make the sacrifices it takes so our children and grandchildren will enjoy a more prosperous future.

Okay, so Modern Money does get a little airtime. Here is Warren Mosler on Fox News a year ago (you can see the total lack of disbelief in the host):

What do you think?


  1. What do you think?

    To be bluntly honest -- Mosler comes off sounding like a flake yipping at the heals of an establishment figure. Generally speaking, there's a reason why fringe movements within an academic discipline remain fringe. In the case of MMT, the difficulty seems to be that over enthusiastic proponents take an essentially descriptive theory and imagine that they can apply it proscriptively without taking into account the bounds set by reality and expectation.

  2. Darwin--

    Thank you for your comment and your honesty! I appreciate having you as a reader and your frequent input.

    I agree that there is a reason why fringe movements remain on the fringe, though I probably disagree with you on what those reasons are. It is quite perplexing to me why there are so many learned economists and politicians who think that our government's finances work like a household's--namely that we can go bankrupt and that therefore we should have a balanced budget amendment. I have my guesses to why that is, but no clear answers.

    I agree that MMT is essentially descriptive, though I do think that proponents are aware of the constraints set by reality and expectation. I believe that the the point of their seemingly overenthusiastic proscriptions (including my own) is so that others understand MMT and remove the constraints of misunderstanding (for the constraints are set not by how the money system really works, but rather by people's understanding of the money system).

    You didn't really address any of the theory however. You simply pointed out that it has remained on the fringe, something that many others before you have pointed out and has led, I think at least partially, to it remaining on the fringe. If fringe movements are always disregarded because they are on the fringe, than no fringe movements will become mainstream.

    Catholicism was once a fringe movement that became quite widespread partially because of the enthusiasm and firm belief of its proponents. I strongly believe that a proper understanding of MMT can help us achieve a greater prosperity for the common good of our nation and others. But that ultimately still rests on the charity and solidarity of peoples, of us living out the Gospel.

    If the reality is that people don't understand MMT and therefore disregard it as merely a fringe movement, then my goal is to help others understand it, just as I desire for others to understand Catholic Social Teaching better so that it too is not constrained by reality and misunderstanding.

    If I missed what you meant by "the bounds of reality and expectation" then please explain further, so that I don't misunderstand you. Thank you again for your input.

  3. Alex,

    Thanks for your irenic reply. I'll shoot to be more verbose and less blunt (as in object) this time around. :-)

    I agree that there is a reason why fringe movements remain on the fringe, though I probably disagree with you on what those reasons are.

    Well, FWIW, I think there tend to be various reasons, though it seems one commonality is that partisans of fringe movements often argue that they are kept on the fringe because those in the mainstream are afraid of the disruption they could cause and are keeping them out in order to maintain their own positions. (The folks I am most often very frustrated by who think along these lines are the Intelligent Design movement, who insist that evolution is a house of cards if only anyone would notice.) In academic fields, I think this is often one of the least plausible explanations. Often, I think, the true reason is simply that the beliefs of the fringe group do not in fact have huge amounts of explanatory power, if they are not outright wrong.

    It is quite perplexing to me why there are so many learned economists and politicians who think that our government's finances work like a household's--namely that we can go bankrupt and that therefore we should have a balanced budget amendment. I have my guesses to why that is, but no clear answers.

    FWIW, the economists and politicians are probably very different groups in this regard. Many politicians seem to have very simplistic ideas of economics, but Harvard PhDs like Mankiw, not so much.

    From what I've read of Mankiw's stuff, I don't at all get the impression that he supports a balanced budget amendment. He seems to follow the basic consensus that in periods of economic trouble the government should run a deficit and that in good times it should move towards balance or surplus. What he does seem to hold, however, is that there is a serious limit to how large a deficit a country should run for how long, and his concern in the quoted editorial is that the US seems to be pursuing a policy of spending significantly more than it takes in long term.

    If I'm following the stuff that I've read over at New Economic Perspectives right, it seems like for many MMT folks the idea is that you never want to run a surplus and it almost doesn't matter how big you let your deficit get, so long as you have a sovereign currency. I think Mankiw is basically staking out the ground that although we have a sovereign currency (and one which is pretty much the world reserve currency at that) we can't behave like Greece long term and expect that to work out.

  4. I believe that the the point of their seemingly overenthusiastic proscriptions (including my own) is so that others understand MMT and remove the constraints of misunderstanding (for the constraints are set not by how the money system really works, but rather by people's understanding of the money system).

    I'll try to dig a bit more into this in a minute, but I think the response I want to float to this is that it might well be that one of the constraints on the money system (at least in avoiding effects that we might not much enjoy) is that those responsible for managing the currency behave in a way more or less in line with the more traditional understanding of what a currency is. In this sense, while MMT may be descriptively accurate as a method of analysis (I should be really clear here and elsewhere that being self taught and dealing with pricing, I feel comfortable with micro questions in a way that I simply don't on macro, so I tend to have an approach of trusting authorities I understand to some extent rather than arguing from first principles) if the Fed and government behaved as if it were, this might actually cause it to behave in some other way.

    You didn't really address any of the theory however. ... If I missed what you meant by "the bounds of reality and expectation" then please explain further, so that I don't misunderstand you.

    I'm not unconscious of the difficulties of going up against a PhD student fan of MMT in an attempt to express objections to the theory, but here it goes:

    Reading through the MMT Primer being put up at New Economic Perspectives and at overview posts such as "MMT Explained to Mums", it seems to me that part of the argument here is that since the government issues currency, that it doesn't need to worry about where money "comes from" in issuing currency. It seems to me that so long as there is a basic expectation that a government intends to maintain a balance between its revenues (via taxation) and it's spending, this is probably true. However, if it basically says, "Look, we control the currency and we're simply going to spend how we like, pay for it via debt, and if you ask how we'll pay for debt we'll simply print you dollars," it will pay a steep price in both the interest rates that lenders will demand on bonds and the demand for dollars in general (inflation.)

  5. Reading through all the talk about why things are budgeted the way they are, it seems to me there are two arguments being put forward for why we should decide that deficits and debt simply don't matter for the government:

    1) Full employment will be achieved via the government employing everyone to do useful stuff, and this will create so much value that it will pay for itself.

    2) The wealthy are keeping a lid on inflation to benefit themselves, but if we spent like crazy without worrying about how to pay for it and inflation resulted, this would basically just have the effect of depreciating the wealth of the wealthy and making us all more equal.

    Of these, 1) strikes me as engaging in some weak form of the socialist calculation problem -- in other words, it assumes that the government guaranteeing to employ everyone would result in enough useful work being done to actually make us better off because of the value of the work done would equal the value spent in employing everyone. I would tend to think that's highly unlikely, in that I don't think any one really knows what it is that everyone is most valuably employed doing. As such, I think the value produced would be less than the value spent, and it might even be worse than useless in some cases in that people might be payed to do things less valuable than what they would have been doing otherwise.

    On 2), it strikes me that while the kind of chaos caused by high inflation (something which seems to be denied would result if the government only spent to the point of full employment, but I have real trouble imagining would not result from the policies advocated, and is the only thing which would have the advertised effect of taking down the value of the holdings of the wealthy) does in fact hurt the wealthy, it hurts the poor a whole lot as well.

  6. Excellent replies, I had to look up irenic (I appreciate your ireny as well) and I'm not sure what FWIW stands for, but hopefully I'll have time tomorrow to draft a response.

  7. FWIW = For What It's Worth

    Now that I think about it, years ago I responded calmly to a terse and somewhat rude comment on my blog and the person came back, thanked me for my irenic response, and wrote a thoughtful reply. Having had to look the word up myself -- I thought it suited the circumstances pretty well. :-)