Nearly all of human life has always passed far from hot baths

January 7, 2014 § Leave a comment

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We are now in a position to demonstrate our proposition: the natural rate of interest is zero. First, to reiterate the argument thus far: Under a state money system with flexible exchange rates, the monetary system is tax driven. The federal government, as issuer of the currency, is not revenue constrained. Taxes do not finance spending, but taxation serves to create a notional demand for state money. Spending logically precedes tax collection, and total spending will normally exceed tax revenues. The government budget, from inception, will therefore normally be in deficit, which also allows the nongovernment sector to “net save” state money (this in fact has been observed in all state currencies).

The Natural Rate of Interest Is Zero
If spending is not revenue constrained, why does the government (conceived here as a consolidated Treasury and Central Bank) borrow (sell securities)? As spending logically precedes tax collection, the government must likewise spend sufficiently before it can borrow. Thus, government spending must also, as a point of logic, precede security sales. To cite a “real world” example, market participants recognize that when Treasury securities are paid for, increasing Treasury balances at the Fed, the Fed does “repos” on the same day; the Fed must “add” so the Treasury can get paid.

Since the currency issuer does not need to borrow its own money to spend, security sales, like taxes, must have some other purpose. That purpose in a typical state money system is to manage aggregate bank reserves and control short-term interest rates (over night interbank lending rate, or Fed funds rate in the United States).

In the contemporary economy, government “money” includes currency and central bank accounts known as member bank reserves. Government spending and lending adds reserves to the banking system. Government taxing and security sales drain (subtract) reserves from the banking system. When the government realizes a budget deficit, there is a net reserve add to the banking system. That is, government deficit spending results in net credits to member bank reserve accounts. If these net credits lead to excess reserve positions, overnight interest rates will be bid down by the member banks with excess reserves to the interest rate paid on reserves by the central bank (zero percent in the case of the USA and Japan, for example). If the central bank has a positive target for the overnight lending rate, either the central bank must pay interest on reserves or otherwise provide an interest-bearing alternative to non-interest-bearing reserve accounts. This is typically done by offering securities for sale in the open market to drain the excess reserves. Central Bank officials and traders recognize this as “offsetting operating factors,” since the sales are intended to offset the impact of the likes of fiscal policy, float, and so forth on reserves that would cause the Fed funds rate to move away from the Fed’s target rate.

Our main point is, in nations that include the USA, Japan, and others where interest is not paid on central bank reserves, the “penalty” for deficit spending and not issuing securities is not (apart from various self-imposed constraints) “bounced” government checks but a zero percent interbank rate, as in Japan today.

The overnight lending rate is the most important benchmark interest rate for many other important rates, including banks’ prime rates, mortgage rates, and consumer loan rates, and therefore the Fed funds rate serves as the “base rate” of interest in the economy. In a state money system with flexible exchange rates running a budget deficit—in other words, under the “normal” conditions or operations of the specified institutional context—without government intervention either to pay interest on reserves or to offer securities to drain excess reserves to actively support a nonzero, positive interest rate, thenatural or normal rate of interest of such a system is zero.

This analysis is supported by both recent research and experience.  read more

PHOTOGRAPH: Pixy Yijun Liao

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I give this book one star because the drone landed on my cat

December 3, 2013 § Leave a comment

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If the government is in surplus, it means that the government is taking in more cash than it’s spending, which is the opposite of stimulus.

It’s also well known that the US trade deficit exploded during the late 90s, which means that ‘X-M’ was also a huge drag on GDP during his years.

So the trade deficit was subtracting from GDP, and the government was sucking up more money from the private sector than it was pushing out.

There was only one “sector” of the economy left to compensate: Private consumption. And private consumption compensated for the drags from government and trade in two ways.

First, the household savings rate collapsed during the Clinton years.

And even more ominously, household debt began to surge.

So already you can see how the crisis started to germinate under Clinton.

As his trade and budget policies became a drag on the economy, households spent and went into debt like never before.

Economist Stephanie Kelton expounded further…

“Now, you might ask, “What’s the matter with a negative private sector balance?”. We had that during the Clinton boom, and we had low inflation, decent growth and very low unemployment. The Goldilocks economy, as it was known. The great moderation. Again, few economists saw what was happening with any degree of clarity. My colleagues at the Levy Institute were not fooled. Wynne Godley wrote brilliant stuff during this period. While the CBO was predicting surpluses “as far as the eye can see” (15+ years in their forecasts), Wynne said it would never happen. He knew it couldn’t because the government could only run surpluses for 15+ years if the domestic private sector ran deficits for 15+ years. The CBO had it all wrong, and they had it wrong because they did not understand the implications of their forecast for the rest of the economy. The private sector cannot survive in negative territory. It cannot go on, year after year, spending more than its income. It is not like the US government…”  read more

PHOTOGRAPH: Achille Volpe

The cessation was glibly attributed to the Great Fire: but in every other city in England the Plague ceased at about the same time

November 21, 2013 § Leave a comment

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While virtually all mainstream economists believe in a long-term Say’s Law (supply creates demand, so the ultimate constraint on long term growth comes from the supply side), the real constraint on long-term growth in a developed capitalist economy is always on the demand side. (Note that there’s nothing new in the Summers/Krugman recognition of secular stagnation; David Levy called it a “contained depression” in 1991; Wallace Peterson announced a “silent depression” in 1994; and I demonstrated in 1999 that the problem is chronically constrained demand. At a recent Levy Institute conference in Rio, Paul McCulley laid out what he called a fundamental economic principle: Microeconomics and Macroeconomics are inherently different disciplines. Macro is demand-side; micro is supply-side. For any practical time horizon, demand always drives supply.)

I know what I’m saying is heretical, even though it is fully backed by all the data. And this stagnation is not due to a liquidity trap, or to a negative “natural” rate of interest. It is in the nature of the productivity of capitalist investment in plant and equipment. To put it in simple terms, the problem is that investment is just too damned productive.  read more

PHOTOGRAPH: Antonio Olmos

It is my design to render it manifest that no one point in its composition is referrible either to accident or intuition — that the work proceeded, step by step, to its completion with the precision and rigid consequence of a mathematical problem

March 13, 2013 § Leave a comment

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Modern money is is state money. Taxation today functions to create demand for state currencies in order for the money-issuing authority to purchase requisite goods and services from the private sector. Taxation, in a sense, is a vehicle for moving resources from the private to the public domain. Government spending in sovereign currency systems is not limited by the ability of the state to ‘raise’ revenue. In fact, as it will be explained below, sovereign governments face no operational financial constraints.

To fully grasp the logic of sovereign financing, one must make the analytic distinction between the government and non-government sectors. For the private sector, spending is indeed restricted by its capacity to earn revenue or to borrow. This is not the case for the public sector, which ‘finances’ its expenditures in its own money. This is a reflection of its single supplier (monopoly) status. For example, in the USA, the dollar is not a ‘limited resource of the government’. Rather it is a tax credit to the population which is confronted with a dollar-denominated tax liability. Thus government spending provides to the population that which is necessary to pay taxes (dollars). The government need not collect taxes in order to spend; rather it is the private sector, which must earn dollars to settle its tax debt. The consolidated government (including the Treasury and the central bank) is never revenue constrained in its own currency.

If the purpose of taxation is to create demand for state money, then logically and operationally, tax collections cannot occur before the government has provided that which it demands for payment of taxes. In other words, spending comes first and taxation follows later. Another way of seeing this causality is to say that government spending ‘finances’ private sector ‘tax payments’ and not vice versa. Several other implications follow.

Deficits and surpluses
Government spending supplies high-powered money to the population. If the private sector wishes to hoard some of it – a normal condition of the system – deficits necessarily result as a matter of accounting logic. Furthermore, the government cannot collect more in taxes than it has previously spent; thus balanced budgets are the theoretical minimum that can be achieved. But the private sector’s desire to net save ensures that deficits are generated. The market demand for currency, therefore, determines the size of the deficit.

In a given year, of course, surpluses are possible, but they are always limited by the amount of deficit spending in previous years. If during the accounting period government spending falls short of tax collections, private sector holdings of net financial assets necessarily decline. The implication is that surpluses always reduce private sector net savings, while deficits replenish them. It should also be noted that, when governments run surpluses, they do not ‘get’ anything because tax collections ‘destroy’ high-powered money.  read more

PHOTOGRAPH: Hans-Peter Feldmann

You know, kids were very different then. They didn’t have their heads filled with all this Cartesian dualism

December 28, 2012 § Leave a comment

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Why on earth would Washington deliberately throw the US into yet another recession when we haven’t even recovered from the last one? They are doing so because of the so called long-term costs of the debt. They (both the Democrats and Republicans, albeit to different degrees) believe that unless we reduce the debt and deficit now, we will pay a price in the years to come, a price that outweighs the higher unemployment their actions will cause today. They are, however, dead wrong. Not only are their fears either completely unfounded or irrelevant given current circumstances, but trying to cut the deficit now would actually leave us in a situation where we would need an even larger one to extricate ourselves from the deep economic slump it will create.

To explain this, let me briefly review the long-run costs typically used to support the current efforts at deficit/debt reduction and show how each is much ado about nothing:

1. Higher debt levels raise the possibility of US default
Let’s get this one off the table right away. The US cannot possibly be forced to default on debt denominated in its own currency. This is a cold, hard fact, not a theory or conjecture. This should not be any part of the discussion whatsoever.

2. Debt burdens future generations
Not true. Government debt is a private sector asset and government deficits create private sector surpluses. Think about it this way: if there were only two people in the economy and one spent more than she earned, giving her a deficit, what must be true about the other? He must have earned more than he spent and thus has a surplus. Now replace “she” with “federal government” and “he” with “private sector” and you’ll see. Nor is there a day of reckoning when federal government debt must be reduced to zero. Thus, it will NOT be necessary to tax future generations in order to finance today’s deficit. Reducing the budget deficit reduces the private sector surplus and reducing debt destroys private sector assets.

3. Debt makes us slaves to foreign interests
First, see point 1. We cannot be forced to default. Second, when a country has net debt with respect to another nation, it’s because of a trade deficit not a budget deficit. Note further that if China does not buy our financial assets, they will no longer have a trade surplus because they will not have provided the credit necessary for us to buy more than we sold. It is therefore in their best interests to do so. And, to reiterate, debt to foreign nations has nothing to do with the budget deficit. Lowering the latter will not lower the former.  read more

PHOTOGRAPH: liluna

I must say, Amy, pretending to have intercourse with you has given me a great deal of satisfaction

December 12, 2012 § Leave a comment

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I’ll let you in on a secret: before this crisis, when I thought about the budget deficit I was like everyone else in that I paid no attention to how the government budget interacted with the private and trade sector balances. This is a big error. If you do that, you treat the government budget deficit in isolation, when the reality is that the government is an integral part of an open economy with households and businesses that trade domestically and abroad. When the government balance changes, the balances for those businesses and households change too. If you are talking about deficits then, you need to know how changes in the government balance affect the rest of the economy.

Here’s the thing: when we exchange goods and services with each other, from an accounting perspective, it’s a wash; if you buy my goods, I get money and you get goods of equivalent value. If you pay for those goods with an I.O.U., with a debt, your liability, your deficit in the year we made the transaction, is exactly equal to the asset on my balance sheet and my surplus for the year. I mean this is basic accounting, folks. There’s no hocus pocus. Any person’s, any household’s, any business’s, any group’s, any government’s debt is someone else’s asset. Any person’s, any household’s, any business’s, any group’s, any government’s deficit is someone else’s surplus. Again, it’s basic accounting.

Think of it like exchange traded options and the profit and losses on the exchange. People buy and sell oil futures or soybean futures. At the end of the option period, they either have a loss or a profit and that period’s deficit or surplus is exactly offset by the deficit or surplus of the counterparties. When you sum up these deficits and surpluses they net to zero. Again, no hocus pocus. That’s how accounting works.

The same is true for national accounts. At the end of any accounting period, then, the sum of the sectoral financial balances must net to zero. The government balance – the private balance – capital account balance = 0. The government balance = the private balance + the capital account balance. See my post Economics 101 on government budget deficits for the full write-up. I credit British economist Wynne Godley for making this identity relevant to macro economics.

What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.

Thinking about government deficits this way opens a whole new understanding of what cutting deficits means for the economy. What it should mean to you is that deficits are the effect and not the cause. Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy.  read more

PHOTOGRAPH: Francesca Woodman

reading it carelessly as if to tell you your fears were justified

November 30, 2012 § Leave a comment

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Governments are not households.  watch

PHOTOGRAPH: Dara Scully

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