Today’s article is a continuation of my last concerning the mainstream’s zero lower bound and loanable funds fantasies with a look at fiscal rules and other shenanigans.
Fig. 1: A Mainstream Economist
Coupled with the debunked Loanable Funds Theory is the mainstream assumption that the national government experiences a hard financial constraint and must fund its spending with taxation or borrowing. MMT demonstrates the opposite: When the federal government types a number in a bank account, it is creating net financial assets and spending at the same time. In short, when the federal government spends, it is spending net financial assets into existence. Thus, if the government spends net financial assets into existence, then it has no supply of currency on hand first before it spends. Hence, it neither taxes or borrows to fund spending. The mainstream claims that “everyone knew this already”. However, if “everyone already knew this” then why is the mainstream asserting that the national government has a hard financial constraint? It makes no sense. The mainstream continues to argue that US Dollars are not only finite for the non-government sector, but also finite for the national government too. Such nonsense begs the question: Then where the hell do US Dollars come from? Do we dig them out of the ground? Do they magically appear in the private sector when GDP increases? Nonsensical thinking, but that’s another 8,000 word discussion entirely. Anyway, following the mainstream along its derailed logic to its absurd train wreck of a conclusion, should the national government then expand its deficit, it will cause a greater demand for the finite savings in the private sector, raising interest rates which then crowds out the private sector’s investment activities, not to mention horrific inflation. Therefore, we need fiscal rules to prevent such an interference with the market’s will.
There isn’t a finite savings in the private sector, because the currency that the private sector desires to net save comes from the national government through its fiscal operations, not through mystical market activities as loanable funds suggests. Monetary policy does not add net financial assets to the domestic economy, fiscal policy does. When the national government spends, it merely credits a bank account with its IOU. When the crediting of accounts with its IOU are greater than that which it destroys through taxation, it is deficit spending. When the national government expands its deficit, it is creating and then adding net financial assets to the private sector, which the private sector can then use to increase its savings. Through deficit spending, pressure on consumer savings is then relieved, allowing consumers to increase their spending. If you create a fiscal rule, whether it be extreme such as banning deficits entirely, or go austerity lite by spending now and in five years covering current spending with taxes, you end up strangling the domestic economy. It is like tying a string around your arm thinking that your hand already has enough blood to survive. John McDonnell’s fiscal rule, which Simon Wren-Lewis called a “better fiscal rule”, is nothing more than letting the blood flow to the hand for five years, then suddenly tying the string tight around the arm. It’s a ridiculous idea. The end result of such a policy is that taxation will only reduce spending power, thus erasing any gains made.
I: Employment and Wages
The market is completely incapable of creating full employment and sustaining it, because it relies on the federal government to supply enough currency to consumers enabling the condition. But, the mainstream’s focus is on the market as the creator of full employment, not the federal government and so, with 7.8 million people unemployed but willing and able to work, they declare victory anyway. This is why the mainstream’s version of full employment is vastly different from reality. It’s either the market adjusts in the short run and we always have full employment, or prices and wages get a bit sticky in the short run and full employment is delivered by the market later on in the magical long run. Both explanations are ludicrous, because the mainstream ideologically shuns the federal government’s central role. Rather than accept the federal government as the centerpiece, they fit its fiscal policy with voluntary constraints borrowed from defunct fixed exchange regimes, then propagandize and terrorize the public about the so-called “dangers” of fiscal policy: crowding out, accelerating inflation, ratings downgrades and government bankruptcy, thus preventing reality from consigning their religious mysticism to oblivion. If you still do not understand me, then I’ll provide a simple analogy:
Consider ten large, starving dogs in a garage. There is only enough food on the floor for three of the dogs. There is also a 1,000 pound bag of dog food just outside the garage. Mainstream economists would urge that you not dip into the bag and add enough food for all of the dogs to eat, citing the dangers of over feeding. Instead, mainstream economists would model the complex interactions of these dogs in an effort to uncover the hidden secrets of the mystical forces resulting from those complex interactions that will surely ration the finite supply of dog food, bringing aggregate demand to equal aggregate supply of dog food on the floor, thus enabling full stomachs for all ten dogs. One group would argue that behavioral adjustments by the dogs to the finite supply of food are enough to achieve the goal of full stomachs in the short run. The other group would argue that in the short run things are sticky, so a little encouragement from the owner of the dogs is needed to help in the short run, because the goal of full stomachs can only be achieved in the long run.
Now, to a normal individual, such a thing is absolutely preposterous. In fact, a rational individual would also most likely see it as animal abuse. Yet these are precisely the sort of bullshit academic games that mainstream economists play with you and with your economy. You cannot have full employment unless the federal government deficit spends for that purpose and continues to run deficits to maintain the situation indefinitely. The federal government both creates unemployment and is the only entity that can eliminate the condition through fiscal policy. It chooses the unemployment rate. If we want a situation where anyone who is willing and able to work can find a job, then the federal government has to choose for such a situation to exist and it demonstrates that choice through net spending its own currency. This is the foundation on which a new economics of scientific rigor is built. Employment though is not enough. There must be higher wages as well.
Since decent wages are the most stable means to guarantee what a nation produces can be sold to consumers, then it follows that maintaining low wage environments coupled with fiscal rules which stifle desperately needed injections of net financial assets and instead, relying on monetary policy to “encourage” bank lending to ensure consumption of production is patently ludicrous economic policy. It amounts to operating an economy on payday loans. More on this subject in section III. Again, we will take note that private debt levels meant nothing to the mainstream prior to the financial crisis of 2008. Today, only after everyone is in debt up to their eyeballs is there some acknowledgement by orthodoxy in the wake of the crisis, but little in the way of any useful analysis as they simply run the financial sector through DSGE and other nonsensical models. As long as the mainstream relies upon fantasy models and loanable funds is assumed to be reality, then no amount of modeling that considers the financial sector will result in anything that is meaningful. DSGE, IS-LM and other mainstream tinker toys of the like along with loanable funds need to be thrown onto the scrap heap of history.
II: Deficit Spending and the Inflation Barrier
The US government issues the US Dollar that we in the non-government sector use. Now because of this, it means that the US government is the price setter. How it achieves that distinction is really quite simple. The federal government lays a tax that is payable only in US Dollars which it alone issues, thus causing a demand for US Dollars in order to pay the tax. In other words, the tax causes people to need to obtain US Dollars. To obtain US Dollars, people then sell goods and services to the US government in exchange for its US Dollars. Whatever the price is that the US government pays for those goods and services with its US Dollars is the price. Therefore, prices are exogenous. Because we use the government’s currency, the federal government has the absolute power to determine the price of goods and labor. When you finally are able understand this simple, basic reality, then it will become clear to you that mainstream ideas concerning inflation are highly questionable.
Silly mainstream theories abound concerning inflation. My personal, all-time favorite is M(V) = P(Q), better known in heterodox circles as the amusing “Oh My God, We’re All Trapped on a Runaway Train That’s On Fire and Loaded with Dynamite, Heading Straight for a Canyon Filled with Nuclear War Heads called “Zimbabwe” at 300 Miles Per Hour and We’re All Going to Die!” equation. In honor of the late Robin Williams, I’ve renamed the expression as the “We’re Riding a Psychotic Horse Towards a Burning Stable” equation. There’s also the “Spare a Trillion for a Cup of Coffee, Brother?” equation, or the “Plague of Nations” equation. But, overall, I do not find them amusing enough. One simply has to make it clear that we aren’t taking the mainstream seriously and to do that, you need absurd humor that equals or exceeds their absurd fantasy.
The public worries about “money”, because a household cannot issue US Dollars, so it must have an income in order to buy goods and services. The federal government has no worries about an income, because it is the issuer of US Dollars. In short, the federal government is the ultimate income source of all US households. So, the point here is that if goods and services cannot be produced for you to buy, then what use are the dollars? Since there is only a finite supply of goods and services that can be produced, it is impossible for spending beyond that limit to result in more goods and services. The goods which you can buy with your dollars can’t just magically appear. So, the actual question when it comes to federal deficit spending is the real resources within the nation. That is the federal government’s concern. Should the government decide to add more US Dollars (deficit spend) than the U.S. economy can respond to with increased production, consumers will try to spend those additional dollars on goods and services, but no further goods and services can be produced and so, the price level must rise. In other words, inflation will occur. The inflation barrier then is the limit of the nation’s actual production capacity. Integral to this capacity is the labor supply of the nation.
In normal conditions, if there is an idle supply of labor that is willing and able to work, then increasing federal spending will decrease the pool of idle labor. In other words, assuming that the nation has the raw material and the infrastructure necessary to increase the production of goods and services, then if any involuntary unemployment exists and deficit spending is targeted at reducing unemployment, then the unemployment level will be reduced. The additional dollars available will reduce pressure on consumer savings. Consumers will increase their spending, thus increasing pressure on firms to produce more and so, firms will hire the idle labor to help meet production demands, output will increase and unemployment will drop. So, if the nation has the raw material and the infrastructure necessary to increase the production of goods and services, then when no idle labor remains that is willing and able to work to meet consumer demand, the inflation barrier has been reached. Federal spending before this barrier will not result in accelerating inflation, because the spending is able to result in increased output.
However, when discussing accelerating inflation and hyperinflation, just like the mainstream ignored the financial industry prior to the financial crisis, the mainstream also ignores realities like political turmoil, war, chronic supply issues and currency pegs, focusing exclusively on deficit spending. If our goal is to uncover reality, we simply cannot ignore these issues and the impact that they have on the inflation barrier. If the nation in question has a devastated infrastructure like Zimbabwe had, where increased output was not possible, then the inflation barrier is reduced substantially. But, look around the US. Do you see an inability to produce food? Do you see an inability to transport goods to market? No. This is why claims of federal deficit expansion turning the US into Zimbabwe are silly. We must ask why is the US is growing crops for fuel instead of food, why is it ignoring infrastructure work, why is it leaving vast production resources idle and why is it tolerating an unemployment rate of 9.7%? Why is the US acting like it is Zimbabwe when it clearly is not Zimbabwe? The answer is that the mainstream will not allow the US to behave like it is anything but a potential Zimbabwe just waiting to happen. One good thing about Zimbabwe, however, is that it offers a key insight which calls mainstream views on currency origination into question.
The US government is the monopoly issuer of currency. Zimbabwe was too at the time of the hyperinflation episode. Like the US government, Zimbabwe experienced no hard financial constraint on its spending. If the government of Zimbabwe had no “money” of its own and had to tax or borrow to fund spending, then how did the government of Zimbabwe manage to produce and spend a $100 trillion note? Are we to believe that the private sector of Zimbabwe always had $100 trillion laying around somewhere and the government managed to find and confiscate it through taxation? And if so, why didn’t the private sector make use of that $100 trillion building schools, infrastructure, cell phones, computers, hospitals, medical supplies, on and on before the government got ahold of it? Why just sit on it? The answer is, because the private sector never had it to begin with. It didn’t have $100 trillion until the government of Zimbabwe gave it $100 trillion. In fact, the private sector of Zimbabwe didn’t have any Zimbabwe dollars until the government of Zimbabwe gave it Zimbabwe dollars. The reality of the Zimbabwe hyperinflation was that the government destroyed the food supply and infrastructure causing a catastrophic drop in production and in turn, also causing a dramatic increase in unemployment. The government of Zimbabwe reduced the inflation barrier significantly. Even so, the government still had no hard financial constraint on its spending. It still did not have to tax or borrow to fund spending. Zimbabwe’s mistake was not deficit spending, but laying waste to its supply capacity. Instead of rectifying the situation by addressing its supply concerns, the government instead persistently deficit spent beyond the new inflation barrier as though its former capacity for output was still intact. That is why accelerating inflation occurred even though there were high unemployment levels. Because it created a chronic supply issue, the additional dollars made available through deficit spending could not result in increased output and the price level began to rise dramatically. Nothing to do with so-called monetization or deficit spending alone. It had everything to do with a government that irresponsibly destroyed its supply capacity.
In the case of the U.S. and U.K. governments who experience no hard financial constraints and are well-endowed with real resources and intact production capacities, designing fiscal rules, whether extreme or slight, to address non-existent budgetary concerns will only leave millions unemployed and vast resources idle. Such a thing is nothing short of criminal behavior. Imposing fiscal rules is a declaration of war by that national government on its own people. It is my opinion that fiscal rules are a violation of human rights. If such a national government makes its citizens dependent on its own currency to obtain basic goods and services and then restricts their access to the very thing needed to obtain those necessities when no real production cause warrants such an action (war or a natural disaster, for instance), that is a crime against humanity. You might as well wall citizens up behind an electrified fence and barbed wire with armed guards at the gates and starve the them to death.
III: Encouraging Consumer Borrowing
Attempting to manipulating consumer spending through borrowing from banks rather than through government spending is a major no-no. It is not customer deposits that are being borrowed and spent, it is bank IOUs. This means actual US Dollars (net financial assets) – the thing that people can actually net save in – are intentionally left in short supply in the domestic economy. What happens with encouraging consumer borrowing is that you increase private debt levels to increase consumer spending in order to decrease unemployment. It does work, but all bank credit is debt, so in other words, you’re financing job creation with credit cards and loans. But what happens when consumers become so indebted that they cannot take on any more bank credit to keep spending? They reduce spending, unemployment rises and you get a recession unless the federal government is willing to cut taxes or increase its spending to decrease the pressure on consumer savings. The population that makes up the domestic economy is one, great big saving community. They have a desire to net save. If that desire goes unmet, a spending gap occurs. Filling it with private debt is insane, yet, that is how we do things and it is exactly how mainstream purveyors of anti-knowledge such as Paul Krugman like it. The mainstream isn’t balancing savings and investment. It is heaping enormous amounts of private debt onto consumers with the only benefits going to the financial industry in the form of enormous profits, whether mainstream economists realize this or not.
Clearly, it would be far more preferable to address deficient consumer spending levels through fiscal policy measures and not bank lending. In other words, rely more on bank credit for production and rely more on federal spending for consumption of that production.
Again, the problem here with the mainstream is the non-existent Loanable Funds. If you want to boil everything down into the simplest explanation possible, it would be that the mainstream behave as though US Dollars are a product of the private sector, there is enough “money” in the economy to do everything that needs doing and monetary policy can help persuade people to do the right thing with it. Commercial banks stand ready to bring people together for this purpose. So, if the Federal Reserve does what it’s supposed to do, monetary policy will induce borrowing and spending as well as investment of customer deposits, thus generating and sustaining full employment. Caveat: As long as we aren’t in the zero lower bound. If we aren’t, then monetary policy is all that we need. If we are in the zero lower bound, that means monetary policy has lost its juicy fruit flavor and become ineffective, or in mainstream-speak, it has simply run out of ammunition. NIRP or perhaps a slight fiscal nudge is needed at this point. If it’s a fiscal nudge, then it will have to be “paid for” later on with taxes.
Fig. 2: The Zero Lower Bound interfering with the loanable funds market, producing stagnation and blocking full employment
In normal times, the dastardly federal government cocks things up with fiscal policy. Should the government increase its deficit spending, then the Fed will have to make room for the federal government’s irresponsible spending by raising rates. By raising rates, the Fed harmfully curbs private investment to make room, hence, deficit spending “crowds out” the almighty private sector’s use of customer deposits for investment activities.
In layperson’s terms, the federal government is viewed as a giant fifty-foot tall demon weighing 20,000 pounds who is playing irresponsible games by trying to squeeze into an already full elevator. He manages to squeeze his foot in and the act crowds out people who actually need the elevator. In the end, he manages to squeeze enough of himself into the elevator that his weight causes the cables to snap and the elevator falls. Therefore, we need some “fiscal rules” to restrain the federal government’s fiscal policy (keep it on a leash), thus preventing the damn government from sending the economy spiraling into ruin. Put a match to an eyedropper’s worth of gasoline and a small flame occurs and quickly dies out. But NAIRU almighty: Apply that same match to several gallons of gasoline and we all go up in flames, don’t you know! So, it’s just like gasoline and we’ve got to have some fiscal rules in place to avoid economic ruin.
Fig. 3: Extreme Fiscal Rules
Fig. 4: An example of a New Keynesian “much better fiscal rule”
IV: Junk academics
The mainstream tells you that there is always something bad lurking in the shadows, that we are always on the edge of ruin, that there is always something to fear, that we simply cannot do this or that, that we are dependent on the market to provide and when it cannot, then we all must sacrifice. Ever notice that about mainstream economics? It is the prophecy of doom, privation and terror. Such is the product of a deep, fundamental confusion and an unwavering dedication to defending “the faith” from scientific scrutiny.
As an example, this past weekend on Twitter, there was this statement by an “assistant professor of economics”:
“… and LT [the liquidity trap] can explain USA and Japan today just fine without MMT.”
What this deeply confused defender of the faith is saying is that a concept dreamed up, untested in any real scientific way but which enjoys a consensus among certain mainstream economists (whom he identifies with) as “valid”, explains why both Japan and the USA experience stagnation. Therefore, we can trust the explanation without question because it is an explanation. My response to that “reasoning” is simple: And astrology can explain everything today just fine without science. And the Theory of Humours can explain human illness just fine without science. And God can explain why it rains just fine without science. As to the last item, there are many people who believe in God, yet understand that the statement “The reason why it rains is because God makes water fall upon the Earth” isn’t good enough. They want a scientific explanation of the mechanics causing the phenomenon. Then, there are others who reject the scientific explanation for rain entirely, adhering to the belief that God alone causes rain and that’s all we need to know. This assistant professor of “economics” would belong in the latter camp. His statement concerning the liquidity trap is all about belief over science and about defending that deeply held belief at all costs. Want to see the liquidity trap excuse evaporate into oblivion? Deficit spend, targeting full employment and prosperity. Naturally, the mainstream wants to prevent any evidence from surfacing that threatens their deeply held religious beliefs, so they will warn that deficit spending in a liquidity trap is inflationary. Belief over scientific rigor doesn’t wash. But then again, what is scientific rigor to a man that amounts to little more than an astrologer?
Astrology is thoroughly discredited by science, but has that stopped people from consulting astrology? No. Look at Ronald Reagan and his wife Nancy. In the same way, mainstream economists will adhere to their hocus-pocus, divination and magical market god. Mainstream economists purposefully build models that are in keeping with their deeply held religious beliefs and they either refuse to hear arguments to the contrary, or if they do engage in debate and find themselves pressed into a corner, they will simply resort to disingenuous tactics saying, “we already knew that”, “we have no idea what that means”, or they will endlessly ask “what’s your point?” when they know what your point is.
There is nothing academic or professional about mainstream economics. Its models and viewpoints have no place in either government or institutions of higher learning. There, I said it. I’d say it again if I had to.
Fig. 5: DSGE with the addition of a financial sector post-GFC
In summary then, it is on the grounds of these nonsensical, delusional mainstream arguments that I questioned the “fiscal rules should target the deficit” statement. I could have done so with an examination of monetary policy, but what good would that do? As I’ve demonstrated in previous articles, I do not need an in depth examination of monetary policy to conclude that fiscal rules are entirely pointless. If you know beforehand that fiscal policy is the only way to inject net financial assets and you know that consumer spending drives the economy, then it’s really not that difficult to look at the U.K., the U.S., or Japan over the last several years and put two and two together – it’s not a liquidity trap; it is a lack of appropriate fiscal action. For New Keynesians, maybe it is difficult to understand because their views are permanently stuck in the zero lower bound of reality, but it shouldn’t be too difficult for the public to digest.
So, yes, I am blunt and I am harsh at times. But why wouldn’t I be? Were this paleontology, I wouldn’t care as much. I would care about getting it right, but then again, there is time to get it right as human lives do not depend on what anyone is trying to do. Human lives are at stake in macroeconomics. They hang squarely in the balance of what mainstream economists say and think. Their words directly influence policy.
The end result of neo-liberalism coupled with the mainstream’s market-oriented shenanigans is high unemployment, high private debt levels, poverty, persistent recessions and social collapse. Now, if that is what you want, if that is what you believe to be sound economics, then feel free to join the Orthodox Dungeon Masters Guild with Paul Krugman and add a financial sector to your Dungeons and Dragons model.
I, on the other hand, have no patience for this kind of nonsense. Patience is not a luxury that we have here, nor is it a virtue in this context and in my opinion, attempting to evangelize mystics is a waste of time. Take the case to the people and let the people evangelize the lost: “The time has come to make a choice, Mr. So-Called Economist Man. Either you choose to abandon fiscal rules and market-oriented nonsense from this day forth, or you choose to find yourself another job.”