Reverse-engineering the MMT model

I'm trying to keep this as simple as possible, so it's accessible to second-year economics undergraduates.

Many theoretical papers I read are full of impenetrable (to me) thickets of math. So I reverse-engineer the model. I try to figure out what the underlying model must be in order for the paper's conclusions to make sense.

Many Modern Monetary Theory posts I read are full of impenetrable (to me) thickets of words. So I have reverse-engineered the model (with the help of Steve Randy Waldman's blog post and Scott Fullwiler in comments on that post). I think I have figured out what the underlying model must be in order for MMT's conclusions to make sense.

I don't think my model is a straw man. It is a stick-figure. A very simple caricature that shows only the bare bones, but is still recognisable.

Start with the standard textbook ISLM model:

In the background, off-camera, is a Phillips Curve. The Long Run Phillips Curve is vertical, at the natural rate of unemployment. Yn represents the natural rate of output associated with the natural rate of unemployment. It is sometimes (misleadingly) called "full-employment output".

Where the IS curve crosses the vertical "full-employment" line determines the natural rate of interest rn. That's the (real) rate of interest at which desired savings equals desired investment at "full employment output".

I have assumed for simplicity that expected inflation is zero, so I don't need to insert a vertical "expected inflation" wedge between the IS and LM curves. Nominal and real interest rates are equal, and the equilibrium {r0,Y0}is where IS and LM intersect.

I have drawn this equilibrium where Y<Yn and r>rn. The economy is in recession. The central bank should increase the money supply to shift the LM curve right, lowering r to rn, and get the economy back to full employment. Or, the government should use fiscal policy to shift the IS curve right, raising both r and rn, and making them equal at full employment.

Also off-camera is an AD curve. The AD curve slopes down, because a fall in the price level increases the real money supply and shifts the LM right.

Now look at the New Keynesian (or Neo-Wicksellian) version:

The only difference is that the central bank is now thought of as choosing the rate of interest, rather than the money supply, so the LM curve is horizontal. The supply of money is perfectly interest-elastic at the rate of interest chosen by the central bank.

I have drawn this equilibrium where the central bank has set the rate of interest above the natural rate, so the economy is in recession. The central bank should shift the LM curve down and reduce the rate of interest to equal the natural rate. Or fiscal policy should be used to shift the IS curve right to raise the natural rate of interest to equal the rate set by the central bank.

Off-camera, the AD curve is vertical. A fall in the price level will reduce the demand for money, but the central bank will accommodate by allowing the stock of money to fall proportionately, to keep the rate of interest constant.

This vertical AD curve means that the central bank must actively adjust the interest rate to keep the price level determinate. If it keeps the interest rate permanently above the natural rate, output demanded will be less than full employment, and the result will be accelerating deflation. If it keeps the interest rate permanently below the natural rate, output demanded will be above full employment, and the result will be accelerating inflation. On average, the central bank must set an interest rate equal to the natural rate (plus target inflation, to allow for the difference between real and nominal rates of interest).

Finally, look at the MMT version:

It's exactly the same as the New Keynesian version, except that the IS curve is vertical. The IS is assumed vertical because the rate of interest is assumed to have no effect on either desired savings or desired investment.

There is no natural rate of interest in the MMT version. It's undefined. If the IS curve lies either to the right or to the left of full-employment output, there exists no interest rate such that desired savings equals desired investment at full employment output. If, by sheer fluke (or by skillful fiscal policy) the IS curve is exactly at full employment, any rate of interest will make desired savings equal desired investment at full employment.

The MMT AD curve is vertical. A fall in the price level will not increase the real money supply and reduce the rate of interest (just like in the New Keynesian version, unless the central bank responds actively). But even if the rate of interest did fall, it would not increase output demanded. So, the AD curve is doubly vertical.

Monetary policy has no effect on AD. Fiscal policy can be used, and must be used, because this model, with its vertical AD curve, has no inherent tendency towards "full employment" output. The price level is indeterminate, unless active fiscal policy makes it determinate.

Since monetary policy has no role to play in determining AD, the central bank can set any interest rate it feels like setting. Indeed, it might as well set a nominal interest rate near zero, since this reduces the transactions costs of people converting between currency and bonds to try to avoid the opportunity costs of holding zero interest currency. (This is Milton Friedman's "Optimum Quantity of Money" argument in a new setting, except the central bank can set a 0% nominal rate even if positive inflation means that the real rate is negative).

The rate of interest plays no allocative role in savings and investment. It does not coordinate intertemporal consumption and production plans of households and firms. It merely re-distributes wealth between borrowers and lenders.

In a standard model, the government has a long run budget constraint. The present value of taxes must equal the present value of government spending (plus the existing national debt). The government can't borrow, and borrow to pay the interest, indefinitely, because the debt/GDP ratio would grow without limit. But this long run budget constraint only applies if the rate of interest on government bonds is above the long run growth rate of output. If the nominal/real rate of interest is less than the growth rate of nominal/real GDP, the government can run a stable Ponzi scheme. It can borrow, then borrow again to pay the interest, and the debt/GDP ratio will still fall over time, because the debt is growing at the rate of interest, which is lower than the growth rate of GDP.

If the central bank can set any interest rate it likes, it might as well set a rate of interest below the growth rate of GDP. So the government debt becomes a stable Ponzi scheme, and there is no long run government budget constraint in the normal sense. The only constraint on fiscal policy is that if the government runs too big a deficit and/or allows the debt to grow too large this would cause the IS to shift to the right of full employment output, and so causes accelerating inflation.

Actually, the ISLM framework is overkill in this context. The whole point of the ISLM framework was to reconcile two competing theories of the rate of interest: loanable funds ("the rate of interest adjusts to equalise desired savings and investment"); and liquidity preference ("the rate of interest adjusts to equalise the demand and supply of money"). IS shows the loanable funds answer, and LM shows the liquidity preference answer, and the ISLM model show that both answers depend on the level of income. So both are partly true. (Except in the long run where income is determined by full-employment, so only loanable funds determines the natural rate of interest). But if savings and investment are both perfectly interest-inelastic, we might as well revert to the simple Income-Expenditure Keynesian Cross model to show the underlying MMT macro model.

MMTers have a liquidity preference (LM) theory of the rate of interest, and a loanable funds (IS) theory of the level of income.

Comments

[Andy Harless]

I remain puzzled as to how one should distinguish between MMT and "Keynesian economics" in its original form (i.e. The General Theory). Your caricature resembles the caricature of Keynesian economics that I learned in Ec 10 circa 1980, and in both cases it will be acknowledged that the caricature is not quite accurate: neither Keynes nor the MMT people believe(d) that the IS curve is literally vertical (just as Milton Friedman didn't believe that the LM curve was literally vertical). MMT seems to prefer to talk in terms of financial variables, whereas Keynes perhaps preferred to talk in terms of real variables, but I don't see much difference in the substance. And Jamie Galbraith, who is usually associated with MMT, has on at least one occasion classified himself as an "Old Keynesian." Is MMT merely an attempt to "dot the i's and cross the t's" accounting-wise on the ideas in The General Theory?

[Nick Rowe]

Andy: I lean towards agreement with your comment. (Except I would say that Keynes in the GT had income in the money demand function, and the rate of interest in the investment function; all that was missing is that he failed to complete the circle by relating the two in simultaneous equilibrium, as Hicks did in ISLM. Ms and Md determine r, and r determines I, and I and S(Y) determine Y, with the feedback from Y to Md left out.)

It is very much like the ECON 101 model, with more accounting and institutional detail, and focussing more on financial flows. In 1950's and 1960's British Keynesianism it was referred to as "elasticity pessimism". They didn't literally believe the interest elasticities were zero. Just too small to rely on.

[Warren Mosler]

Interesting!

One comment: changes in interest rates matter to the extent the propensities to consume differ between borrowers and savers.

And with the govt a net payer of interest, that adjustment needs to be made as well.

And let me also add that the islm model is a fixed exchange rate model.

Warren Mosler
www.moslereconomics.com

[Nick Rowe]

Thanks Warren. And welcome to WCI!

"One comment: changes in interest rates matter to the extent the propensities to consume differ between borrowers and savers."

Understood. And if borrowers have a higher marginal propensity to spend than lenders, that would tend to make the IS curve slope down a bit.

"And with the govt a net payer of interest, that adjustment needs to be made as well."

And, (unless you believe in Ricardian Equivalence, which would be very un-MMTish) that would tend to make the IS curve slope up.

Both effects of course ignored in my very simple model.

If the IS curve did slope up or down through those effects, it might, in some sort of sense, be possible to define a "natural rate of interest" if that IS curve cut full-employment output. But, since it would be so very different from the usual sense, I would hestitate to do so. And if the IS sloped up, monetary policy would need to be conducted in the *opposite direction* to the standard New Keynesian way. If the central bank wanted to reduce AD, it would need to lower interest rates. Which would make me even more hesitant to use the natural rate concept, because the standard savings/investment loanable funds model would have an unstable equilibrium.

[Nick Rowe]

Forgot to add: "And let me also add that the islm model is a fixed exchange rate model."

I would prefer to say it's a closed economy model, because it may or may not be possible for the central bank to set the rate of interest and the exchange rate independently, depending on the BP curve. So let's think of this as my version of the closed economy MMT model.

[G]

"Is MMT merely an attempt to "dot the i's and cross the t's" accounting-wise on the ideas in The General Theory?"

That's probably accurate. I don't think there's anything in the MMT canon that's truly at odds with the GT. If I recall correctly, Keynes was aware of chartalist thought and wrote of it approvingly.

[Andy Harless]

From Warren Mosler's comment:

"changes in interest rates matter to the extent the propensities to consume differ between borrowers and savers....And with the govt a net payer of interest"

Really, those are the only ways in which interest rates matter in the MMT model? You don't allow for anything like the marginal efficiency of investment? I can sort of buy the argument that MEI may not be very empirically important, but I think it would be hard to argue empirically that distribution effects of interest rates are important enough to consider while MEI is not. Surely if you raise interest rates enough, it renders a lot of projects unprofitable that otherwise would be profitable, regardless of the other effects on aggregate demand. Can you seriously rely on distribution effects to explain how US monetary policy was able to drive the world into recession in 1981-82?

[Nick Rowe]

To be fair, I am trying to think of how I would caricature myself in this framework. If I get out of bed on the monetarist side, I could be caricatured as believing the IS is horizontal and the LM vertical!

[Senexx]

How about we start with there is no such thing as a limit to loanable funds since we're off the gold standard and Bretton Woods. Now there's something Keynesians and MMT (which is post-keynesian) disagree about.

Also worth noting there's descriptive MMT (accurate description of how money works) & prescriptive MMT (policy recommendations)

I don't know how you cannot intuitively grasp MMT through their blog posts. I have zero background in economics and it makes perfect logical sense. Unlike all these "curves" that are not curves at all. I broke down mostly Bill Mitchell's posts into bite size pieces for the layman (hopefully).

So how can someone with an economics background not get it? I don't get that at all.

Beyond that Warren has all ready made the point I was initially going to make.

[Scott Sumner]

What determines the price level in this model? (Note, I'm not asking what determines the rate of change in the price level, I'm asking what determines the level of the price level.)

[pcle]

I thought MMT was a subset of Minsky post-Keynesianism. In which case this exposition is nothing to do with the theory. It suffers from the over-aggregation problem. One of Minsky's critiques of Keynesian macro was its failure to take account of the complex inter-relationships of balance sheets across myriad entities. Casting it into Hicksian framework is "bastard post-Keynesianism" to echo Joan Robinson. Surely you've got to exposit the theory in a stock-flow consistent framework as laid down by for example Godley-Lavoie or its not worth doing at all.

[RSJ]

Time, plus the rate of change of the price level, determines the price level at any point in time. There is an initial degree of freedom at the start of the world.

I think the biggest conceptual difference between the stock flow consistent models and the equilibrium models is how they embed the economy in time. IS-LM has only a single stock -- the stock of money. But if the (current period) IS curve is not just a function of the short rate, r, but also of dr/dt, or of {capital goods prices}x{the quantity of capital goods}, then it's not that they believe the curve is vertical, but rather you don't have enough information to describe the curve, and the missing variables -- e.g. dr/dt, wealth, etc -- may dominate the short rate over the periods of interest.

[Luis Enrique]

this question might not make sense, but where is the connection to the idea that deficit spending creates (and taxation destroys) private sector financial assets, which I thought was important to MMT?

[Nick Rowe]

Senexx: are you sure you understand MMT? "Also worth noting there's descriptive MMT (accurate description of how money works) & prescriptive MMT (policy recommendations)"

What about *explaining* how the economy works? There's more to any economic theory than descriptive accounting. For example, how would the explanation of how r and Y are determined change if desired S and desired I depend on r? Do you understand the difference between desired and actual S and I, and why it matters? Do you understand the relevance of whether r is less than or greater than the growth rate of Y for the government budget constraint?

Nobody ever understands their own theories as well as they ought. Try reading an intermediate macro text, and you would learn useful stuff about those "curves", and get some alternate perspectives as well.

Scott: hope you are enjoying your well-deserved blogging sabbatical!

If P and W were perfectly flexible, the price level would be indeterminate in my MMT model, just as it would be indeterminate in the Neo-Wicksellian model. Because the AD curve is vertical, so there's no intersection of the vertical AD and vertical LRAS. P is only determinate if P adjusts slowly to excess demand/supply, and the fiscal authorities adjust AD more quickly (just as the monetary authority has to adjust i more quickly than P to make P determinate in the Neo-Wicksellian model).

pcle: I disagree. First you have to understand the interaction between r and Y, which is what this simple model does. Later you can disaggregate and add the stock of bonds and capital as things that shift the position of the IS curve, if you wish.

RSJ: OK. They are not going to go to the wall in defence of the proposition that the IS is literally vertical. I treat the vertical IS as a working assumption that gives the basic flavour of the model.

Luis: the IS curve implies S-I=G-T (closed economy version). So the growth of net private financial claims on the government must equal the growth of net government financial liabilities to the private sector. That's true in any model. Divide the economy into any two sectors -- say men and women. What men owe women must equal what women are owed by men. But that accounting identity doesn't get you very far. You need to add some behavioural assumptions too.

[JKH]

“The only constraint on fiscal policy is that if the government runs too big a deficit and/or allows the debt to grow too large this would cause the IS to shift to the right of full employment output, and so causes accelerating inflation.”

I think that approaches what they may think of as the limiting case, although the size of the debt would be viewed as a secondary effect, with the primary focus being aggregate demand associated with fiscal stimulus.

“MMTers have a liquidity preference (LM) theory of the rate of interest, and a loanable funds (IS) theory of the level of income.”

My impression is they have neither. They believe monetary policy as normally constructed is ineffective, and by implication that liquidity preference is a near useless concept. They reject loanable funds theory as a relic of the gold standard.

They believe aggregate demand is a function of income rather than money, and that fiscal policy is required to manage the level of income and demand.

They doubt the effectiveness of monetary policy because of its ambiguity – possible tightening effects of higher rates based on differing borrower/lender propensities but possible stimulative effects due to increased income on net financial assets held by non government. Both you and Mosler have alluded to that ambiguity here.

Their concept of a “zero natural rate of interest” accords with institutional evidence for the operation of governments, central banks, and the monetary system. Declaring ground zero for rates cleans the slate for managing aggregate demand entirely through fiscal policy, without conventional monetary policy at all.

You can reverse engineer this to ISLM, but you’re reverse engineering something that is implicitly and fundamentally a rejection of that engineering framework.

[Nick Rowe]

JKH:

"I think that approaches what they may think of as the limiting case,.."

Not sure I understand what you mean here.

"They believe monetary policy as normally constructed is ineffective, and by implication that liquidity preference is a near useless concept."

The liquidity preference theory of the rate of interest says that the rate of interest is determined by, and adjust to equalise the demand and supply of money. Anyone who says that the central bank (as supplier of money) can set the rate of interest where it chooses is, to my mind, someone who accepts the liquidity preference theory. That does not imply that the rate of interest affects desired savings and desired investment. On the contrary, if you believe that desired savings and investment do not depend on the rate of interest at all, it is much easier to advance a pure liquidity preference theory of the rate of interest. That is one of the things my post was supposed to be showing.

"They reject loanable funds theory as a relic of the gold standard."

They reject the loanable funds theory as a theory of the rate of interest, sure. Rather, instead of S and I determining r, S and I determine Y. (My calling that a "loanable funds theory of the level of income" was a bit of wordplay).

"They believe aggregate demand is a function of income..."

Desired consumption is a function of income. That relationship is already built into the standard textbook IS curve. It's the old Keynesian multiplier.

"Their concept of a “zero natural rate of interest” accords with institutional evidence..."

I know that Warren has talked about the natural rate of interest being zero. I read his paper. I think that terminology just confuses things. Instead he could either say:

'There is no natural rate of interest, and so the central bank can set any rate it wants permanently, and I think it should set it at 0%.'

Or he could say:

'The natural rate of interest depends on fiscal policy, and fiscal policy should be set to keep the natural rate at zero, so the central bank can also set the actual rate at zero.'

[Ramanan]

I agree with pcle | April 16, 2011 at 01:29 AM

I also think that the fixed exchange rate anti-analogy is counterproductive. Post Keynesians have described those regimes in detail and their description is nowhere close to the IS/LM/BP description.

Nick .. you should make an attempt to distinguish between MMTers and Post-Keynesians in general. You won't then (hence) have the doubts which Andy has raised.

[paine]

this strikes me as off target
why is a model the basis of a functional finance mechanism ??

well because not all methods are equally efficient or costly

right ??
but the mmt thesis is really about a zero real cost to cedit creation ...no ??

elaborating systems of equations
ie hicks and after
are irrelevent in a clinical science like
macro management

its an empirical question an observational question that keynesian policy raised no ??

and we hve our answer and have had it since the question was raied and the obsrvations "noticed"

by increasing the fiscal deficit you can raise real ouput and job hours
eqally by pinning the policy rate in conjunction with a full employment fiscal budget
and spontaneous firm produced inflation
you can adjust the real rate of interest
the method becomes not an a priori model
but trial and error
do it and if after we do it we see it works grea keep doing it
fine it
sure see how well various combos work
obviously the real output performance is what counts
that and the number of job hours purchased by firms

the various nominal rates and levels ..well to hell with em
if they're veils or if the problem is sub optimal sticky
blow off the stickiness
or if mltipliers aren't as potent as one had anticipated
without fear of peak debt you plow on right ??

so why not fear peak debt ??

nick
has your stick model answered that question ???

mmt is far more bold then GT
because it essentially sez
the long run debt number is of no deep matter

like any nominal levels the real value is subject to macro adjustments
that can be made costlessly in terms of real output
that is
if the macro system has no concern about price levels and why should it ??
price level targets are fetishize the veils

peak debt ?? some b/p * ????
well so long as the macronauts can fiddle up the p level
why worry

interest rate ?? again only the change in p makes that real
and the monetary authority can set any nominal rate it chooses to set
and again since macro can raise the price level u can set the debt to NI ratio
where ever you want right ?? tis just y/p with both nominal and ths policy controlable
as with
m/p

b/p

err but its not the level its the rate of change that can go out of control short of real ouput effects no ??

the point
mmt lacks one big tool
control over the rate of change in p level

well that's where economy wide mark up markets enter
just as they should have in the late 70's

we need another instrument besides a policy rate a fed borrowing rate

we need a price level control mechanism
if we had only one ouputie no relative prices ..no big whoop
but we do have lots of different ouputs different q's
jumping a few obvious steps
so how do we remove the firms disregard of the effect of their own absolute prices
on ther firms absolute prices ???
restated:

what can be done
when only relative prices matter to the allocation system and
execessive or inadequate price level change is a macro hazard
under the present free range firm level price setting regime
and
imposition of frankenstein like price controls has no long run viability

obviously we need a way for firms to trade required mark up warrants

and why the need for such a mechanism to regulate the price level's movements doesn't
fall directly out of front line macro policy discussions
is the biggest failing of our post 70's era
instead of lerner we got volcker

and that is a crime against the bulk of toiling humanity
that is unless you are so comfortable with using the spontaneously emergent
reserve army mechanism to regulate wages and prices
you'd never bgive it up no matter what

yes now we have self concious reaerve army macro management no ??
rationalized nairu guided credit and budget policy
that can induce the equivalent wage "moderation"
of the spontaneous system with less fuss and fury and loss of output

or of your pro profit class or pro rentier class
and you don't want to entertain any sublationary moves to a higher system
that might crimp these bulwarks of free enterprise

ttttttttttttttttttttttttt

[Nick Rowe]

Ramanan: "Post Keynesian" can mean a lot of things. There are only so many models that can be distinguished with 2 curves. To me, Abba Lerner's viewpoint on the financing of government deficits is one of the key distinguishing features of MMT. And my very simple model shows how that Functional Finance perspective fits within the MMT model.

Probably one of the things I should have said, right up front in this post, is that I'm not just trying to build an MMT model. I'm trying to show how it differs from the textbook and New Keynesian models. (My "New Keynesian" model above is also a stick figure, that leaves a lot of stuff out.)

If you start by doing what I have done above, you have a basis from which to begin comparing MMT and other approaches. Otherwise, everyone just keeps talking at cross purposes and nobody gets anywhere.

[Frances Woolley]

Nick, I enjoyed this post, this is macro I can understand. Congratulations on all those facebook likes - according to Steve Gordon, last month 9% of WCI traffic came to the site via facebook.

[Nick Rowe]

Thanks Frances! I can't understand all those Facebook likes. (Not that I really understand Facebook and "likes" in any case.) I have never got anywhere near that number before, and this isn't an especially good post. My only guess is that this post is very accessible to undergrads, and undergrads use Facebook??

[paine]

the key to lerner
and i'm glad to see randy and you see abba as a rushmore figure in this area
is the state capturing the demi urge role away from private "own bottom" firms

whether merely budget constrained or more refined and rational
profit guided outfits
firms can't run a smooth output max operation on anything like a steady macro basis
even as a closed system
but ....the state can ...even in an open system

with their part whole co ordination firms
their reliance on voluntary transactions
their poorly mediated meta-less
system of interacting but incomplete markets etc etc
yes this can be seen also as problems created by firms r lack of universal default insurance
and the deeply interconnected payment system based on an equally unco ordinated
rationed based ie constrained credit availibility system
well to shut up and sum up

the notion of a sudden agent arrival with the ability to run an indefinite ponzi
nicely caputures the game changer gubmint is
in this market mediated set of producing and exchanging outfits

something tells me
the fact i refuse to play baby graphics leads to a by pass

well i submit you basically swallowed the is/ ml by the end of your stick figure run

in effect once all is either vertical or horizontal
the chosen relations are useless
its as if you were trying to rake off possible clogs to functional finance flo9wing without blockages and leaks
i say so what the substance flowing is pure opportunity cost
and once it is looked back at as a past set of flow vectors
its systemically sunk costs that one regrets and real value on going
of these nominal obligations
is so elastic forget about it
it is only as household wealththese assets become signifigant

---btw households are irrelevent really
whatever provides final demand will be what it needs to be given the gubmints unconstrained transfer and spending capacity

households only exist in models to motivate a welfare function different from the income total
and constrain demand to factor earnings plus the credit flows factor earnings can attract
at any rate
after all macro is about getting somewhere
not defining where somewhere ought to be ...but that's for another thread ---

[anon]

"The liquidity preference theory of the rate of interest says that the rate of interest is determined by, and adjust to equalise the demand and supply of money. Anyone who says that the central bank (as supplier of money) can set the rate of interest where it chooses is, to my mind, someone who accepts the liquidity preference theory. That does not imply that the rate of interest affects desired savings and desired investment. On the contrary, if you believe that desired savings and investment do not depend on the rate of interest at all, it is much easier to advance a pure liquidity preference theory of the rate of interest."

There is a terminology problem here, in that folks mean all sorts of things by "rate of interest". Money has a convenience yield over other assets, and this yield is obviously affected at the margin by changes in the money supply: in this sense, the central bank can "set the rate of interest". OTOH, one can still posit that the yield of assets more generally is set by equilibrium between desired saving and desired investment, i.e. the market for loanable funds.

[paine]

the credit system is a rationing system like the job system
markets hardly clear

the rate of interest no more can "...equalise the demand and supply of money"
then the wage can equalise applicants and opennings

the point of both is to set a rate subject to filter and viewed as a reward

this hicks nonsense
is well...
talk about faulty micro foundations

the market system requires a chronic shortage of demand

the soviet system proves what happens when supply chronically eceeds demand

in fact one problem with a working mark up market is the re emergence of
structural chronic shortages

much here to harvest ..maybe too much

[paine]

hicks himself
long recognized the limits of his tight litttle system of functionalizing k's
largely diffuse verbal GT

why this became the macro model of choice for college courses post war
i suspect had a gret deal to do with this introduction of this r to become a second variable to y
that well brought back much of the old school nonsense about the rate of interest as a price
just like the doak price for the days catch of fish
to clear the market for loanable funds
andprovide a way to variablize investment I(r) without introducing y as in I(y)
ie the accelerator

but that's superficial
a deep narrative of the causal pttern
behind our wave of post war college text books and their choice of models
exists somewhere i'm sure but not in my head

[paine]

i doubt history will look back on macro as taught 1948 thru 1978 with much more favor then
as taught from 1978 to 2008

[William peterson]

I found this attempt to fit MMT into a standard framework very helpful. It also reminded me very strongly of the sort of macroeconomics that I was taught as a Cambridge undergraduate in the late 1960's, so there is a clear link with at least one version of the 'Cambridge Keynesian' oral tradition. In particular, the assumption that private expenditure depends purely on income, and not on either the interest rate or the stock of private sector assets, is consistent with the way in which some of my teachers (for example, Joan Robinson) dismissed the IS-LM model as a misguided attempt to reconcile Keynes with classical macroeconomics(they also rejected the two-equation IS-LM model in favour of one in which goods and money markets were essentially separate, with causality going from effective demand to income to money).

In this framework the IS curve was vertical (though we were not actually taught about it in these terms). Any influence of interest rates on expenditure was rejected on the basis of Keynes's arguments in the General Theory (for the consumption-savings decision) and the pre-war Oxford surveys (for investment). Any effect of asset stocks on expenditure was also rejected (partly because to accept the existence of such effects would open the door to Pigou/Patinkin real balance effects, and thus endanger what was seen as the key message of the General Theory).

One additional feature of MMT which seems baffling to me is the argument that the level of Government debt does not matter because Governments have the monopoly of money creation. Even if the Governmemt can borrow at an interest rate less than the growth rate, and thus run a stable Ponzi scheme, this does not imply that deficits do not matter. To see why, assume that the growth rate and interest rate are equal. Then the Government can finance its interest payments on outstanding debt by further debt issue, and still maintain a constant debt to GDP ratio (whatever the initial level of debt). But if it also runs a primary deficit the debt/GDP ratio will continue to rise: the beneficiary of the stable Ponzi scheme (who should perhaps be called the Madoff) cannot take an unlimited amount out of the scheme for consumption without endangering the stability of the scheme. The only circumstances in which deficits would truly not matter would be those where the private sector was willing to hold an infinite amount of Government debt, and where additionally the size of their holdings did not affect private sector expenditure in any way. But it is very hard to justify this assumption. Incidentally, MMTers cannot justify it by adopting the quasi-Ricardian line that private holdings of public debt are not net wealth because of the expected future tax liability, since (because this is Ponzi finance) there is no such liability.

A further (historical) point. After World War II the UK attempted to follow what in some ways looks like an MMT-inspired policy - nominal interest rates were pegged at very low values, so that the real interest rate was close to zero. One motive for doing this was the high debt/GDP ratio (the result of war expenditure) and the wish to minimise interest costs. But it was also an attempt to place the economy on the horizontal section of the LM curve: since the low interest rate on bonds balanced out the prospective capital loss if interest rates rose, the speculative demand for money would be large, and deficits could be financed without danger of inflation. Investment and consumption were subject to physical controls, and set at levels which would ensure full employment. Since capital movements were also controlled, there was no need (even given a fixed exchange rate) to maintain interest parity with other countries. Most historians do not think that this experiment was a resounding success.

[dilletaunted]

@ peterson. not ponzi scheme because gov't does not have to borrow

http://www.nakedcapitalism.com/2011/03/scott-fulwiler-paul-krugman%E2%80%94the-conscience-of-a-neo-liberal.html

[F]

This post is great, but does anyone have a link to a purpose-built MMT model with equations and graphs - one that expresses the concepts using those traditional tools in addition to a bunch of text and a few pictures showing accounting relationships?

[Ramanan]

Nick,

(@ April 16, 2011 at 10:16 AM)

Yes its true "Post Keynesian" is a very general word and even Paul Samuelson called himself a Post Keynesian! I am referring to the Horizontalists who describe the monetary policy and also describe how New Keynesians view it.

The "Descriptive/Prescriptive" language was used recently by John Taylor on his blog on his rule.

For the case in hand, MMT Prescriptive - zero CB rate looks sophomorish to me.

[tjfxh]

Nick, MMT'ers seem to reject the idea that MMT can adequately expressed through IS-LM, along with most other Post Keynesians, so I dount that inquiry along these lines will illumine understanding of MMT.

"Post Keynesian economics has no need for, and rejects, the IS-LM model of Hicks, the Phillips curve, and the empirically unsupported notion of the liquidity trap (Davidson 2002: 95)."
http://socialdemocracy21stcentury.blogspot.com/2011/01/overview-of-major-schools-of-economics.html

See Randy Wray, "The Endogenous Money Approach"
http://www.cfeps.org/pubs/wp-pdf/WP17-Wray.pdf

___________, "Keynes's Approach to Money: What can be recovered?"
http://tinyurl.com/3g9hsds

If you are looking for a diagram, MMT'ers are more encouraged by the Krugman cross as a simple diagram of sectoral balances.

Robert Parenteau, "Employing Krugman's Cross. Farewell, Mr. Hicks?"
http://neweconomicperspectives.blogspot.com/2009/07/employing-krugmans-cross-farewell-mr.html

Bill Mitchell, "Nobel prize winner sounding a trifle modern moneyish"
http://bilbo.economicoutlook.net/blog/?p=3574

Scott Fullwiler, "The Sector Financial Balances Model of Aggregate Demand"
http://wallstreetpit.com/8568-the-sector-financial-balances-model-of-aggregate-demand

[Scott Sumner]

Nick, I'm fine with the assumption of sticky prices, but that doesn't tell me what determines the price level. I want to know what in the model explains why the price level isn't 100 times higher, or 100 times lower. Are prices proportional to total government debt, or something analogous?

I believe the term is "nominal anchor". What's the nominal anchor in the model?

[MamMoTh]

According to Warren Mosler:

the price level is necessarily a function of prices paid by govt when it spends and/or collateral demanded when it lends.

[tjfxh]

Warren Mosler:

A Note on Pricing
The State is effectively the sole issuer of its currency. As Lerner and Colander put it, “if anything is a natural monopoly, the money supply is” (1980, p. 84). This means that the State is also the price setter for its currency when it issues and exchanges it for goods and services. It is also price setter of the interest (own) rate for its currency (Keynes, 1936, ch. 17) The latter is accomplished by managing the clearing balances and securities offered for sale....

http://moslereconomics.com/mandatory-readings/a-general-analytical-framework-for-the-analysis-of-currencies-and-other-commodities/

[tjfxh]

see also:

"Monopoly Money: The State as a Price Setter" by Pavlina R. Tcherneva
http://www.epicoalition.org/docs/Pavlina_2007.pdf

BTW, MMT suggests using the ELR as the nominal price anchor.

Bill Mitchell: Moreover, central banks use the pool of underutilised workers as a price anchor. But given that the effectiveness of this strategy depends on the “condition” of the unemployment pool, we argue that a more effective buffer stock option lies in a public employment program, which we term the Job Guarantee (JG). 2 We show that the JG not only anchors the price level to the price of the buffer stock labour but also produces useful output with positive supply side effects.

We thus contrast the current NAIRU orthodoxy (unemployment buffer stock) with the JG alternative. The JG approach represents a break in paradigm from the NAIRU-buffer stock approach but also traditional Keynesian analyis. The difference is a shift from what can be categorised as spending on a quantity rule to spending on a price rule. Under current policy (and generalised Keynesian expansion), government generally budgets a quantity of dollars to be spent at prevailing market prices whereas under the JG, the government offers a fixed wage to anyone willing to work and lets market forces determine total government spending.

"Why public sector job creation should be fashionable"
http://tinyurl.com/3ger92b

[Luis Enrique]

Nick,

thanks. this is what confuses me - the thing about how net financial assets are created/destroyed seems to me, when I translate it into terms I understand, as a perfectly unremarkable restatement of text book macro. But (some) MMTers portray it as an insight (we know how the monetary system really works!) so I must be missing something.

[paine]

the jg
is a erious error
in time
a gulag
and in further time
the next "we must end welfare as we know it" type target
a wpa forever has a certain dynamic to it in a system
founded on
corporate voluntary hires
the pub sec job gulag will become just that an onerous punitive corvee

hence the need for a control mechanism for th corporate pricing system itself
a cap and floor warrant trading ystem
for aggregate price movements both up and down

that this topic gets so reified summner has to demand in the model an anchor

only demonstrates the reactionary pro free range corporate roots of most academic model building
go un noticed for what they are
an implicit demand for nominal wage control

[paine]

wp

perhaps won't read this

but u needed to change a couple things
its not a pri sec willing to hold infinite pub debt
its unlimited pub debt ie no peak nominal deby load

as to real debt
the price level for current ouput can be used to regulated the real value of existing debt no ??

the old cambridge school of robinson et al wasin essence a thermostat model as meade and lerner saw right away and went toward automatic stablization mechanisms
ie allgorithms of the transfer systems textraction and pay out mechanisms in meade's case
and a more general declaration by lerner of gubmint full employment maintenance empowerment

the problem of the interaction between price evel of ouput and real value of existing public obligations in an open system
does require additional instruments
but they have been drafted
by weintraub colander and many others
we simply would need to have a manhattan project to
begin constructed and prolly a value added tax system to
ease the institutionalization whether of atax or cap and trade system here

the externality of a price move by a firm has its obvious parallels to other
instances and forms of social micro decisions and their unintended cnsequences
in macro behaviour

letus consider moving from the anchor spontaneously emergent historically
from our ever nore dominant credit driven production system
ie
the business cycle with its variable purgatory of the reserve army of theunemployed

[Nick Rowe]

paine: I agree that market economies look like they are in excess supply in most (output and labour) markets nearly all the time. (And command economies like Cuba are the exact opposite). I think that observation is very important. I think that puzzle is resolved by replacing perfect competition with something like monopolistic competition. I see that as one of the biggest strengths of New Keynesian macro, because it did just that. I have done half a dozen posts on that subject. Search on "excess supply" in WCI to find them.

But I would get more out of your comments if I didn't have to reverse-engineer them. That's why I usually by-pass them.

[Nick Rowe]

William Peterson: I generally agree with your comment. It reminds me too of the British (especially Cambridge) Keynesianism that I remember being taught and influencing policy in my UK youth. (And how close is the Radcliffe Report to MMT? My memory of RR is too hazy to answer that.) Also, I detect hints of the ex post-ex ante savings investment confusion. Some British Keynesians: "The rate of interest cannot adjust to equalise savings and investment, because they must be equal by definition". They might have added "to the penny!". They misunderstood the role of accounting.

A couple of comments on your paragraph beginning: "One additional feature of MMT which seems baffling to me is the argument that the level of Government debt does not matter because Governments have the monopoly of money creation."

1. Since money (currency anyway) does not pay interest, there is no government budget constraint on money-financed deficits. The only limit is too much aggregate demand and inflation. And, if you accept the MMT framework, so that the central bank can set r less than g, it's the same for bond-financed deficits too. True, there is the limit you describe -- if the stock of bonds gets too big people will want to spend too much. But all this means is that AD is too big relative to LRAS. And the MMTers (Abba Lerner) do allow that inflation is the (they say only) constraint on deficits. So they don't disagree with your point there.

[Nick Rowe]

tjfxh: OK. Listen up guys, this is important:

Read Robert Parenteau's post for example, that tjfxh links to:
http://neweconomicperspectives.blogspot.com/2009/07/employing-krugmans-cross-farewell-mr.html

1. Robert Parenteau, if I understand him correctly, is saying that the "Krugman Cross" is a good way of representing MMT thought.

2. The Krugman Cross is formally identical to the Keynesian Cross model.

3. The Keynesian Cross model is formally identical to a vertical IS curve.

I conclude from that:

1. My stick figure model with a vertical IS curve is a good way of representing MMT thought, and is acknowledged as such by MMTers.

2. MMT is a special case of ISLM.

3. When MMTers reject the ISLM, I really begin to wonder if they understand their own model and understand ISLM.

[Nick Rowe]

Scott: there is no "nominal anchor" in the model. Just as there is no nominal anchor in the Wicksellian framework. Think of the price level as being a heavy ball on a flat surface. If the surface is perfectly level, the ball will either stay wherever it is, or keep rolling wherever it is already rolling. The monetary (in Wicksellian models) or fiscal (in MMT models) authority must keep tilting the table up or down to try to stop the ball rolling off.

The current price level is determined solely by its own history, and its direction of change is determined by history plus current policy.

[Nick Rowe]

tjfxh:

There are two ways you can interpret the MMT Jobs Guarantee policy. And MMTers consider both.

1. As an automatic stabiliser that replaces standard fiscal stabilisation policy. This is theoretically very interesting. In principle, it can provide a nominal anchor to the system. It's just like the old Gold Standard, theoretically, except that government purchases of labour at a fixed nominal price replace government purchases of gold at a fixed price. There are practical difficulties I won't go into here, but labour is not homogenous like gold.

2. As a voluntary(?) workfare system that does not replace standard fiscal stabilisation policy. Much less interesting theoretically. No different from any other policy to recommend workfare. Maybe good, maybe not.

[Ramanan]

Nick,

Yes, the resemblance to Cambridge Keynesianism (of "New Cambridge") is tight.

And the reason is straightforward - the late Wynne Godley (who was the head of the Cambridge Economic Policy Group (CEPG) and a close associate of Nicholas Kaldor) moved to the US in the 90s to the Levy Institute. He was the champion of the sectoral balances approach, and an accounting framework with emphasis on maintaining stock flow consistency at every stage of the analysis - and has had a strong influence.

Hence the connection to Radcliffe Committee also. Kaldor was associated with it (mentioned in his book The Scourge Of Monetarism in 1982). He was the first person to call the money supply horizontal and authors who were fans of Kaldor (Basil Moore / Marc Lavoie) were strong vocal advocates of Horizontalism.

The New Cambridge however pinpointed to the balance of payments constraint economies face and hence wouldn't argue that government debt don't matter. In fact they had a special attachment to stock/flow norms (ratios). Thus even though they perfectly understood demand management, they were arguing that demand management options in free market determined open economies have limitations.

[Nick Rowe]

luis: "thanks. this is what confuses me - the thing about how net financial assets are created/destroyed seems to me, when I translate it into terms I understand, as a perfectly unremarkable restatement of text book macro. But (some) MMTers portray it as an insight (we know how the monetary system really works!) so I must be missing something."

Same here. Apples bought must equal apples sold. Financial assets bought must equal financial assets sold.

[Nick Rowe]

Ramanan: that makes sense. And I well remember the recurring "balance of payments crises" in the UK of my youth. With a fixed exchange rate system, an excess of AD tends to create a loss of foreign exchange reserves, as opposed to the inflation it creates under flexible exchange rates or in a closed economy.

[paine]

nr
i appreciate your replies
to unknowns
it shows a true pedagues spirit of universal intruction

as to reverse engineering my prose

i agree pretty tedious affair mostly

but a few iterations usually removes the typos mis spells etc
and leaves only the residue of undigested mentation

the key point oi plug in these waters is the mark up marketnotion
invented by colander ad adopted by lerner and my mentor wild bill vickrey
--also colander's mentor btw --a few years earlier---

the mmt fad out of kc (m) strikes me as an un finished bucket
not much better then none at all
if not provided with the missing bottom
the price level
and when you go open system
the other instruments required
like balancing the trade product sectors
which may -- i submit must --
require an overt industrial policy
with border price adjustments emergency quoota auctions etc etc
besides simply the universal daisy cutter
of a currency exchange ratio adjustment
that is if a ntional production system
desires to avoid the de facto de industrialization process
open throttle inter border arbitrage encourages

[Nick Rowe]

paine: "the key point oi plug in these waters is the mark up marketnotion
invented by colander ad adopted by lerner and my mentor wild bill vickrey
--also colander's mentor btw --a few years earlier---"

Didn't Joan Robinson beat the lot? (She and Chamberlain). That's the model underlying New Keynesian macro.

[paine]

nr
"I think that puzzle is resolved by replacing perfect competition with something like monopolistic competition"

that knocks several balls into called pockets eh ??
example
stigilitz talks about the wrong micro foundations
in main stream post lucas /barro /sargent macro models

and yet the key to functioning market systems
once credit flows freely seems to emerge
from mmt demands colliding with firm level fully autonomous
pricing systems
ie
precisely where as you suggest lras < ad
---that is where lras is the nairu line
ie not really physical bottle neck points ---

but free range firm pricing then requires credit rationing

nd credit rationing de links interest rates from credit flow rates
as the admissions system so to speak shifts
from tight to losse and visa versa

the I(r) function becomes meaningless

where as I(Y) retains the relation between default rate and income level and thus some traction as an "inductive " policy instrument

[Andy Harless]

Nick:

Some British Keynesians: "The rate of interest cannot adjust to equalise savings and investment, because they must be equal by definition". They might have added "to the penny!". They misunderstood the role of accounting.

I don't see why they're wrong. In fact I don't see how there is any coherent concept of savings (except as another name for investment) in a monetary economy. In a barter economy, any act of saving would itself be an act of investment. In a monetary economy, there is no such thing as an "act of saving" in the sense of an act where the intent to save results directly in savings being created. Rather savings are created (necessarily and sufficiently) by acts of investment. If the interest rate adjusts, it does so not to equalize savings and investment but to change the level of savings and investment -- both in the same direction. When there are slack resources, it is desirable that there be more output produced, so that there can be either more savings or more consumption. Ideally, the interest rate will fall, which will result in either more savings (i.e., more investment) or more consumption. In the former case, the fall in the interest rate results in more savings, not less; in the latter case, it has no effect on the level of savings or investment.

The concept of "loanable funds" is an incoherent attempt to conflate real variables with financial ones. It is a failed metaphor. "Funds" in the literal sense are "loanable" only before they have been loaned. The loanable funds model creates the fiction that all funds get loaned instantaneously as soon as they become loanable. But it's impossible to tell a coherent story where such simultaneous saving and lending takes place. Funds, in the literal sense, are a stock, and we are concerned with flows into and out of that stock. In order for the loanable funds model to work, there needs to be a constraint that forces inflows to equal outflows, but there is no reason to assume that such a constraint exists.

[Paine]

The hairless on strikes at a fluxy spot with this line
About investment and savings moving in the same direction with rate changes
That pretty nicely demolishes the usual marshal cross applications eh
AS and AI rising together and falling together

Andy also raises the what in he'll is money besides medium of exchange measure of exchange value and store of wealth

Well as means of payment ie the basis of a credit system the disjunction between recipt of product and recipt of money
And of course the simpler lending of money ie injection of medium of exchange into the transaction system

None of this gets us very far by itself
Except it points out clearly the only real saving is storage
And the storage of a pure medium of exchange is a peculiar form of storage
That in a closed system is hardly providing a future real consumable product for exchange
Like laid up corn ala Joseph and the pharaoh

The building of production machines revolutionizes this world
Now u can make provision for future production not just future products

[Nick Rowe]

Andy: Let's clear the decks. Closed economy, no government, and no investment either. The only produced good is backscratches. The only other good is a bond, which promises to pay (1+r) backscratches next period.

Actual savings is always zero, since backscratches cannot be stored. But desired savings are not equal to zero, except in equilibrium.

If this is a barter economy ("you scratch my back and I'll scratch yours", there cannot be unemployed backscratchers. Two unemployed backscratchers will scratch each others' backs. But, if desired savings depends on the rate of interest, there might be an excess demand for bonds if r is above the natural rate of interest. Each agent wants to give a backscratch and get a bond in return. That's an excess supply of "loanable funds" corresponding to an excess demand for bonds and desired savings being positive. Equivalently, desired consumption is less than full-employment output. So, if r is stuck too high, we get all these things.

But if this is really a barter economy, the unemployed backscratchers, who want to sell backscratches for bonds but can't (because everyone wants to do the same), will revise their optimal plans subject to this quantity constraint. And they will swap backscratches as a second-best. So there's no unemployment in a barter economy, even though desired savings is positive (with r stuck too high for some reason).

Now switch to a monetary exchange economy. You can only sell backscratches for money, because I can't reach your back while you are scratching mine, so we need a Wicksellian triangle. Now an excess desire to save (in the form of money) will cause unemployment.

[Paine]

The harness man
Hits lots of points

The system uses credit to connect producers with available capacity
And it works gropingly well
When the source of credit is un spent money
A kind of rough and ready crimp on AD is set by the money stock if it has no elasticity thru
Fract.tonal storage mechanisms etc

It do get complex t.oo fast to get much mileage out of these
just so tales
of ally oop o comics

[anon]

why do you respond to Harless, whose point is about macro saving and investment, with that tired old backscratch example, where there is no macro investment?

[Paine]

Nr

I think we may be on different wave lengths

Jr indeed explored less then perfect market systems b4 she was swallowed whole by Keynes

But here I'm talking about map
The learner colander
Market anti inflation plan
That involves warrants to increase prices
I think some one may have referenced their pamphlet of 1980 on same
And tootled. Same
Ie MAP

It really is av memory holed affair
Colander himself rarely speaks of it

The roaring price levels of the 70's led to several plans to deal with rogue price levels
In ways that would go beyond the simplex of controls and freezes
Used since commodity exchange wore short pants

Abba learner had been on this kick since the post war period
Only he in his usual astute way focused only on wage control
Politically less then acceptable

In the 70's weintraub had come up with an inflation pigou tax
Lerner no fan of weintraud jumped on colanders alternative
A cap and trade
One can review the pollution control debate to se the features of each approach
I come down strongly on the colander side here
Because certainty about the price level is the whole game here
Unlike say carbon emission
Where cost is a serious counter factor one might rather make certain then amount

At any rate
I m like a child crying in the wilderness since the era of price level tameness
In product prices
Of course assets like equities and lot values were hardly moderate
At any rate
The fear of inflation
as say made into concrete shoes for an economy with stuff like the Nairu bugaboo

[anon]

PS

Your example is one of saving at the level of sector financial balances – where each of the backscratchers is effectively a sector with a financial balance. But there is zero investment. That’s not what the (appropriately discredited) loanable funds theory is about.

[Josh]

"Let's clear the decks. Closed economy, no government, and no investment either. The only produced good is backscratches."

Wouldn't an enterprising entrepreneur just invent a backscratcher that could be used by each individual thereby implying autarky as the natural evolution of the economy? (By the way Nick, I am not being serious, just antagonistic.)

[Paine]

Nr
There you go with your hyper abstractions
I love em
But I think they are badly off course
The notion that intertemporal exchange is corn only type economy explicable is dangerous

In fact all these just so stories only serve to confuse
Then you get into a pure service system and from there

Why not read some paleo ethnology here
Yes lock might have needed to create a primeval fantasy society but not you anymore
Then Rousseau

Now I love these gadget systems more then most
But I think you can't get at the system by simplification only by abstraction
And with a healthy dose of anti reification pills
Which is what I think the harmless guy is after
The false concreteness of most notions of a loan market where suppliers of loans are savers themselves and demanders of loans are machine builders and storage speculators

[Nick Rowe]

anon: I used the "tired old backscratch example" for simplicity, obviously. If we can't get this straight when I=G=T=X=iM=0, we don't have a hope in hell of getting it straight in a more complex example. Why do you resist simplicity so? Are you just trying to run off and hide in anonymous thickets of words, institutional detail, and accounting identities?

[Nick Rowe]

Paine: yes, I figured you might be talking about MAP, or TIP. You and I may be the last people alive who remember it. In principle, MAP would work in NK macro models. And Abba Lerner was right too to say the same thing about the labour market. But yes, politically unacceptable (from both ends of the spectrum). Also, totally impractical too? See my old post http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/02/we-are-all-paid-too-much.html

On LRAS vs bottlenecks, see the two LRAS curves in my: http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/01/macroeconomics-with-monopolistic-competition-in-pictures.html

[Scott Sumner]

Nick, That's what I thought, but I could never understand the attraction of that sort of model. The QTM can explain why Japanese prices are roughly 100 time higher than US prices. The various interest rate-oriented models cannot. That's a deal breaker for me. The are two main goals of monetary economics--explaining the price level and explaining the business cycle. If you try to explain changes in the price level without being able to explain the level of the price level, the model will be highly susceptible to the Lucas Critique.

For instance, it will be almost impossible to explain why Britain had a much higher trend rate of inflation over the past 50 years than Germany. When I return I'll do a post on what determines the price level.

[paine]

totally impractical too?

we have room here for debate

i read the link to your ad flatline micro neg slope post
and it certainly underlines the key
part whole fallacy and the system co ordination problem
when you have many pricers "free to choose " their prices

i'll duck the TU bashing
its obiously all in good quixotic fun

but i'd certainly would appreciate some one posting on map
somewhere at the intersetion of econ con alley and people's avenue

why not u ???

[anon]

I agree with Andy Harless that the notion of "saving" perse is somewhat incoherent, and that the "loanable funds" model has problems. Nevertheless, most economists would agree that the interest rate is dependent on supply and demand for future goods and services. Liquidity effects can affect market interest rates only in so far as folks are willing to accept a compensating differential for holding certain kinds of assets.

[Nick Rowe]

[email protected] (who is different from the earlier anon, confusingly!):

I agree too that "saving" is a horribly confusing concept. It is defined negatively -- as that part of income (net of taxes) you *don't* desire to spend on newly-produced consumer goods. OK, so what *do* you desire to do with it? There are many things you can desire to do with it: desired investment (buy newly produced capital goods; desired purchases of land, used furniture, old paintings, whatever and other old stuff; desired purchases of bonds (i.e. lend it to someone else); and desired additions to your stock of medium of exchange. In my view, it is only when excess desired savings takes the form of desired excess additions to your stock of medium of exchange that it causes a recession. (But that's getting off-topic, and into my quasi-monetarist peculiarities. I'm trying to pretend I'm a good mainstream Keynesian for this post).

[tjfxh]

@ Luis,

The paper that started MMT and laid out the basics of the MMT approach to the nonconvertible floating rate system is Warren Mosler's "Soft Currency Economics."
http://moslereconomics.com/mandatory-readings/soft-currency-economics/

[Andy Harless]

The interest rate can adjust to make desired savings equal actual savings, by causing either the desired or actual to change. But it's misleading to say that it equalizes savings and investment. Investment is whatever people decide to invest. Actual savings is determined directly by investment.

[Nick Rowe]

Andy: "Investment is whatever people decide to invest."

No it isn't. Two counterexamples:

1. An economy in excess demand for newly-produced goods. People might desire to buy investment goods but can't find a willing seller.

2. Undesired inventory accumulation. If goods are durable, and you produce in advance of output, and you can't adjust output instantly, desired savings determines actual investment in the very short run.

The underlying truth to the idea that I is determined by Id is that, in an economy in excess supply, the short-side of the market determines quantity traded. Q=min{Qs;Qd}. The Keynesian model assumes goods are always in excess supply, so we are always on the IS curve. So if newly-produced goods are in excess supply Cd determines C, and Id determines I, because Cd+Id is less than Ys.

In economies like Cuba, where goods are in excess demand, and the short side is the supply side, Cd and Id are less than C and I. S determines I. If people decide to save more (consume less) that leaves more goods available for investment. (Though it depends on who gets first call on the goods).

We really would find life easier of we stopped talking about S, and just said that Yd(Y,r)=C(Y,r)+I(r) and Y=min{Yd,Ys)

[Nick Rowe]

And the loanable funds theory says that r adjusts so that Yd(Y,r*)=Ys=Y where r* is the natural rate of interest. And the problem with the loanable funds theory is that (as was understood by Hicks) it only works when Y is pinned down by LRAS (or a vertical LM curve).

And this is formally equivalent to Sd(r,Y)=Y-Cd(r,Y)=I(r) which is the normal way of writing the loanable funds equilibrium condition.

[tjfxh]

@ NIck" "When MMTers reject the ISLM, I really begin to wonder if they understand their own model and understand ISLM."

MMT'ers reject ISLM because they see it as monetarist, whereas MMT'ers are fiscalists.

pcle | April 16, 2011 at 01:29 AM, I thought MMT was a subset of Minsky post-Keynesianism. In which case this exposition is nothing to do with the theory. It suffers from the over-aggregation problem. One of Minsky's critiques of Keynesian macro was its failure to take account of the complex inter-relationships of balance sheets across myriad entities. Casting it into Hicksian framework is "bastard post-Keynesianism" to echo Joan Robinson. Surely you've got to exposit the theory in a stock-flow consistent framework as laid down by for example Godley-Lavoie or its not worth doing at all.

See also JKH | April 16, 2011 at 08:16 AM. I believe he has the MMT position right. He concludes: You can reverse engineer this to ISLM, but you’re reverse engineering something that is implicitly and fundamentally a rejection of that engineering framework.

Warren Mosler | April 15, 2011 at 04:17 PM, "And let me also add that the islm model is a fixed exchange rate model."

This is essentially what Parenteau, MItchell, and Fullwiler are saying in the posts I cited, which is fiscal., whereas ISLM is monetary.

Check out Parentau's graph of the three sector financial balances.

http://www.nakedcapitalism.com/wp-content/uploads/2010/03/Picture-51.png

[paine]

ss

" If you try to explain changes in the price level without being able to explain the level of the price level, the model will be highly susceptible to the Lucas Critique"

these ahistorical models swallow their own tale models are a quick shuffle fraud

the lucas critique boldly claims
the economic systems demiurge role
for real ouput levels
can not be moved from the partitioned babel like complexity of many firms
independently setting prices and ouput
to the meta level of the state
simply regulating ouput by changing the states intake and ouflow rates

my guess
ss wants
to preserve free range private corporatism's" profiteering liberties "
and
for the obvious reasons

even as these reasons delight in going around disguised as
long run social welfare considerations
of course sincere belief by the wearer of the disguise
ie when he/she/they look in the mirror
and see not a special pleader and casuist
but a universal altruist
wht that sure ccn
make the disguise all the more convincing to others

[Nick Rowe]

tjfxh: I had a look at Parenteau's graph you linked to. It is not a model. It is an accounting identity in graphical form. And it is exactly the same accounting identity that is assumed in the standard (open economy) IS curve. Namely (I-S)+(G-T)+(X-iM)=0.

That's not economics. It's accounting. What the ISLM model does is take that exact same accounting identity, adds some behavioural assumptions, converts it into a semi-equilibrium condition, so you can use it to (try to) explain the world.

If you take an ISLM model, and make the IS curve vertical, it becomes a pure fiscalist model. Monetary policy does nothing to affect aggregate demand.

[William peterson]

My memory of the Radcliffe Report is also hazy (I still have my copy, but I'm away from my office). But my memory was that it argued strongly against 'monetarism' on the basis that there is a spectrum of assets of different degrees of liquidity, and that many of these assets are created by private agents (banks etc) and therefore endogenous. Hence Kaldor's horizontal LM curve: M is determined by demand, but Governments can stiil fix the interest rate. Where MMT seems to go further is the argument that this rate can be whatever the Givernment likes, and in particular can be zero.

On the argument that Government debt doesn't matter, since Governments can issue debt (money) at a zero interest rate and there is therefore no tax liability. I don't see how this can work in an open economy (agents can buy foreign bonds) or in an economy where agents can hold real assets (? houses). It might be worth pointing out that what I have argued was an early attempt at an MMT policy (the UK post WWII) was an economy with well-enforced exchange controls, planning-based controls over investment (particularly private housebuilding), controls on the access of private firms to the capital market, and a small private housing sector.

Finally, on the role in MMT of Wynne Godley. Under the pre-72 fixed exchange rate regime a high level of AD led to a current balance of payments deficit, hence to a balance of payments deficit. 'New Cambridge' was an attempt to establish a direct link between Government and BoP deficits under these conditions. In this sense it was a purely 'fiscalist' theory. But this does not imply that the stock of debt does not matter, even if some MMTers argue that this approach allows the exchange rate to be used as a nominal anchor, and ignore the role of debt. Governments cannot force foreigners to hold money, or other assets which yield zero interest, and therefore (given the preferences of the domestic private sector) they cannot run continuous deficits. So under fixed exchange rates there is a binding BoP constraint (as those who remember the UK in the 1960's know very well).

[tjfxh]

If I understand MMT'ers correctly, the BoP constraint vis-a vis the fiscal condition occurs as the ROW's desire to save in a county's currency diminishes. MMT'ers view the floating rate system as an effective automatic stabilizer.

[Ramanan]

William @ April 17, 2011 at 02:13 PM

Not only fixed exchange rate regimes, they - the New Cambridge economists - carried it to the present market-determined economies (which is not just flexible exchange rates, but the whole set of Laissez-Faire arrangements to promote free trade) and argued that in addition to constraints from the supply side, the balance of payments constraint is a supreme constraint.

Perhaps they were misunderstood by everyone including inside Cambridge itself (Richard Kahn and Michael Posner) and they thought they were advocating IMF's Jacques Polak's stand (purely 'fiscalist'). That was I believe because even though were putting forth behavioural models, everyone thought, they were simply stating an accounting identity! But, nobody stopped listening because they got all the problems the British economy was heading to, completely right.

On RR:

The RR was an attempt to figure out how the monetary system works. The Radcliffe Report according to Nicholas Kaldor got it right, but didn't manage to explain it to everyone.

Here is a Google Books link where Kaldor explains the connections. http://books.google.com/books?id=CyDb8HK_fN4C&lpg=PP1&dq=scourge%20of%20monetarism&pg=PA23#v=onepage&q&f=false

Even draws IS/LM diagrams.

[Ramanan]

Btw William,

The Neo-Chartalists (MMTers) argue that flexible exchange rate regimes allows nations to get rid of the BoP constraint and Keynesian demand management works.

If you see me in their blogs (commenting), you will find me debunking such claims ;-)

[tjfxh]

Nick: That's not economics. It's accounting. What the ISLM model does is take that exact same accounting identity, adds some behavioural assumptions, converts it into a semi-equilibrium condition, so you can use it to (try to) explain the world.

If I understand them correctly, MMT'ers (and other PKE'ers in this line) don't think that such an explanation works. Tried and failed. See Thomas Palley, "Endogenous Money: What it is and Why it Matters," Abstract:

Endogenous money is widespread in economic theory. The Post Keynesian contribution is identification of a causal link between bank lending and the money supply. Though driven by macroeconomic concerns, the Post Keynesian debate has reduced to a microeconomic debate over the role of financial intermediaries in the accommodation process. In the ISLM model endogenous money flattens the LM. This misses its substantive significance which is discrediting of monetarist money supply policy rules and monetarist critiques of central banking, its identification of the key role of credit, and its provision of a credit driven theory of the business cycle.

MMT'ers are in the line of Lerner, Kalecki, Kaldor, Minsky and Godley. As JKH says, you can model MMT on ISLM but that misses what MMT is actually about, which is revealed in the understanding of monetary operatons, SFC approach to sectoral balances, and the functional finance response options. Godley and Lavoie lay out the SFC macro modeling in Monetary Economics (Elgar 2007).

I think that Warren's response sums up your reverse-engineering: Interesting! I would interpret this as saying, you can look at this way if you like, but that is not actually what we are doing — which is clear from their writings.

[Ramanan]

.. A boom developed in the years 1954-6 which the authorities were quite powerless to control. These troubles were ascribed, however not to the ineffectiveness of monetary policy but only to the ineffective manner in which the policy was operated (whether on account of ignorance or the lack of suitable instruments or institutions.) This was to be remedied by a grand inquiry into the workings of the monetary system - the Radcliffe Committee - whose report is the subject-matter of the lectures reproduced in the first part of the volume.

The unanimous Report of the Radcliffe Commmittee, issued in the summer of 1959, represented a serious set-back to monetarism. For the Report, much to everyone's surprise and in clear contrast to all previous grand Committees of Inquiry on the subject (such as Cunliffe's or Macmillan's), declined to accord any importance to the money supply or its changes, and asserted that 'in ordinary times' monetary policy cannot play more than a 'subordinate part' in guiding the economy. All this represented a clear break with the classical monetarist tradition of Britain, a total rejection of the ideas of the Friedmanites (who at that time were making a lot of noise and spreading out fanwise from Chicago), and the reaffirmation of Keynesian principles of economic management which continued to dominate the British scene...

-page xxii - The Scourge Of Monetarism, Nicholas Kaldor.

[RSJ]

Nick,

"2. Undesired inventory accumulation. If goods are durable, and you produce in advance of output, and you can't adjust output instantly, desired savings determines actual investment in the very short run."

In your production-in-advance-of-sale model, investment occurs when the firm produces the good, because at that point it has paid the factors of production but not yet received payment for the sale of the good, so that the rest of the economy has saved.

If there are many firms all placing goods into inventory and selling (previously produced) goods from inventory, and if people decrease their purchases of goods, then the (stock) of inventory does increase, but inventory investment, which is the inflow into this stock, does not increase. Another way you can think about it is that goods not sold but carried over to the next period are not newly produced goods and so are not counted in measures of Y.

Therefore you cannot have unwanted inventory investment in such a model. To have unwanted inventory investment requires the firm to have the option of producing and selling the good in the current period _or_ placing goods into inventory in the current period. And that doesn't seem plausible, particularly if your model is in continuous time, or the periods of your model are very short. I am big fan of the production-in-advance-of-sale models.

But with regard to your point #1, that has nothing to do with savings demands.

The argument is that there is no "market" in which savings and investment curves cross, determining r. There are obviously money markets in which money is lent out at a rate, but borrowing and lending of money is not the same as saving and investing final output, obviously. The corresponding markets in which "real" capital is bought and sold would be the output market, say the hardware store, and you can apply the short side rule to those markets.

But you cannot apply the short-side rule to money markets. First, these markets have no price-rigidity and they always clear. Think of what happens when the central bank sets a very low rate. If the short-side rule held, then there would be very little lending. But we know that there is a lot of lending when the CB sets a very low rate, so that tells you that the demand curve will determine the amount of lending, rather than the short-side rule.

[Nick Rowe]

RSJ: "There are obviously money markets in which money is lent out at a rate, but borrowing and lending of money is not the same as saving and investing final output, obviously."

A terminological point would really help here. Even though it sounds picky, I *really hate* the phrase "money market". In a monetary exchange economy, *all* markets are "money markets", in that the medium of exchange is one of the two goods traded. So "money market" is a .... (what's the opposite of an oxymoron?) a redundancy?

You presumably mean "bond market", or market for non-monetary financial assets like bonds and shares, etc. Call them all "bonds".

Now, there is a market for bonds. And you *can* apply the short side rule to the market for bonds. If (for whatever reason), the rate of interest does not adjust, the quantity of bonds traded will be the lesser of demand and supply.

Where you *can't* apply the short side rule is in the market for money. precisely because there is no such market. Or, rather, every market is a money market. There are 2 ways to get more money: selling more other goods; and buying less other goods. And nobody can ever stop you buying less other goods. Which is why we get recessions.

That's the point at which I've been hammering away at for the last couple of years on this blog. The medium of exchange really is special. A monetary exchange economy really is different from a barter economy.

But, ultimately, I sort of agree with you. New Keynesians (for example) say that the rate of interest must adjust to equalise demand and supply of newly-produced goods. Which is another way of saying that the rate of interest adjusts to equalise desired savings and desired investment. And ultimately, I think it's the real stock of medium of exchange that must adjust to equalise desired savings and desired investment, not the rate of interest on bonds.

Think back to my post on the Pro-Usury party meets the Neo-Wicksellians.

My biggest disappointment with the MMTers is that I see no sign that they take the medium of exchange role seriously. They lump money+bonds together. They say it's the flow of money+bonds that needs to adjust to ensure AD=AS. And they have what is essentially the fiscal theory of the price level (to the extent that they have a theory of the price level).

But now I have wandered waaaay off-topic. Into my quasi-monetarism.

Reverting to New-Keynesian mode, the central bank must adjust the rate of interest so that AD(r)=AS. Which is to say it needs to adjust r until desired S(r,Y) equals desired I(r) at full-employment Y. Which is to say it needs to set r equal to the natural rate. That reconciles the liquidity-preference theory of the *actual* rate of interest set by the central bank with the loanable funds theory of the *natural* rate of interest that the bank needs to set to ensure full-employment.

I'm getting tired. That wasn't as clear as I wanted it to be.

[Andy Harless]

Scott,

Isn't the QTM itself an example (perhaps the clearest example) of a theory that fails via the Lucas Critique? Some economist observes that experience seems to confirm the QTM: nominal income goes up and down in parallel with monetary aggregates. So all we have to do, he reasons, is control the money supply, and we've solved the business cycle. So the central bank goes ahead and tries to control the money supply, and, lo and behold, the old correlation between monetary aggregates and nominal income breaks down. And the Lucas people are like, "Dude, what'd you expect? Your money demand function isn't robust to large changes in the interest rate."

[Nick Rowe]

RSJ: and on inventory investment: if people don't buy the apples and eat them, the stock of uneaten apples increases. That is an increase in the capital stock, and is (undesired) investment, that results from an increase in desired savings.

[David Beckworth]

Nick:

Your MMT model and description of it seems to indicate that if there were an increase in expected productivity or a change in intertemporal preferences these changes would have no bearing on the "equilibrium" interest rate in the MMT model. If this assessment is correct, then MMT is lot harder for me to swallow than I previously thought.

[paine]

wp
again i suspect u no read this

but beating fixed exchange to death
fails to notice mmt
is for flex exchange systems
by definition
after all fixed rates can bind like a gold fetish binds
notice the poor piigs caught in the german disinflation vice
if macro managers at the nation statte level
obey some exchange rate fixity hocus pocus for whatever reason
its a swindle...like now

the job rationing credit rationing combo

is pure artifact of arbitrary constraints
ie taboo lines
like nairu
itself a nice no go zone
substitute for the hard barriers of exchange fixity
with its BOP jolt
that can pole axe
any tightening job market real wage surge

"I don't see how this can work in an open economy (agents can buy foreign bonds) or in an economy where agents can hold real assets (? houses). "

you forget
the full system here has no concern about paper capital flight
the credit system can provide all the funds necessary
there is nolonger any dependence on a private asset holding class

as to houses and house lots
show me your point
bubbles are bubbles they require regulation
but nominal prices have no anchor
in a full sysem that has a price level control mechanism
can move these levels around at differnt and off setting ates as needed

are you afraid this is some sort of perpetual motion hoax ??

it isn't

the deep secret is this
such a full system could drive private capital to the wall

not only a zero credit but a zero sum profit system
but that's anoher tier of sublation

this ill add
the instinct to oppose mmt is well founded
if you happen to be into free range private corporate capitalism
a full system neuters the capitalist class
---------------

r:
"you will find me debunking such claims "

show me how my friend
provide a link to you struttin' yer stuff

[paine]

nick tries to link saving to storage
i like that attempt
it shows the perverse nature of that link

new storing new production plants or them forcing perfetly useful but older plants into moth balls
is hardly the same as a warehouse full of rotten apples
locke consider money a social contrivance that allowed big men to hold onto value
and avoid the social imperative to pas out perishable products
a right to save but no right to spoil

[paine]

beckworth is running scared

"no bearing on the "equilibrium" interest rate ... then MMT is lot harder for me to swallow than I previously thought"

what
no role for interests rates in regulating investment ??
gad zooks
but becky what if that is already the case ???
outside your model generated wonderland
what if credit markets aren't like markets for apples or fish or ...oil and gold even

i submit the micro of th years 1970 to 1990
pretty much demolished this fisherian simnplicity
about inter tempora preference
and clarkian nonsense about marginal productivity of "capital"

[RSJ]

Nick, I think that was pretty clear!

But I don't think you are being a bit unfair to the MMTers vis-a-vis money, and are not hitting them hard enough for thinking they can set rates to zero :P No need to hide your quasi-monetarism.

OK, let me bounce this off you.

Suppose rumors spread that over the next hill, there is a gold mine.

Budding entrepeneurs write IOUs for delivery of gold next period, and they go to stores to purchase shovels, labor, etc, with these IOUs. Will the storekeeper accept the IOUs as payment? Of course! Even if the storekeeper does not wish to save for a year. He will charge a liquidity premium, or discount, that will be the _minimum_ of
{risk that the IOU will decline in price when he re-sells it for present consumption, premium that he would need in order to defer consumption for one year}.

And it's quite possible -- say if the bond is a government bond -- that the minimum will be the first term and not the second.

We have examples of this -- in the early days merchants had discount desks that discounted Bills of Exchange. The Bills circulated as money, and of course Bills issued by the Bank of England became money, but this does not mean that the privately issued bills stopped circulating as money.

When you accuse the MMTers of viewing bonds as money, just ask, "to what degree are bonds money", and think of the interest rate as an upper bound on the difference between the bond and money.

Now if there are large fluctuations in the quantities of bonds issued then this will be as if there are large fluctuations in the stock of money. The conversion factor is not 1-1, but nevertheless, the volume of bonds is so much larger than the volume of high powered money that it becomes more important.

Back to our hopeful village, if the storekeeper would charge a 10% discount in order to keep the bond himself, but he plans to consume in one hour, and believes that there is a 2% risk that the bond will decline in price when he tries to sell it in hour, then he will charge a 2% discount and re-sell the bond in one hour for present consumption. If no one wants to save the quantity of IOUs, then they keep exchanging the IOUs for present consumption and the price level rises up until the price of the IOUs divided by the price level is equal to the savings demanded at the 2% rate.

[Nick Rowe]

David: I agree.

[RSJ]

Nick: re: apples.

Instead of apples, let's think of something more storable, such as wheat. It's easier to swallow wheat as capital rather than apples.

The firm has a wheat buffer -- storage. It takes 1 year to grow wheat, so wheat produced in period n can only be sold in period n+1. It cannot be sold in period n. But in period n+1, it is no longer newly produced output, it is previously produced output, so it is not counted in period n+1's measurement of production. This is true whether it is consumed or kept in storage.

Now if in a given period, people eat very little wheat, due to an increased desire to save, then this does not mean that in the same period there is an increase in investment. In every period, investment is the amount of wheat grown.

This means that the capital stock is not the running total of investment, it is the running total of investment - consumption of capital, or of net investment. An increase in savings demands causes an increase in net investment, not gross investment. Gross investment is constant.

All of this only holds under the assumption that it takes one period to produce goods. But you can make your period as short as you want.

[RSJ]

Paine,

Just because investment responds in non-linear ways to the short rate does not mean that it is independent of the short rate. Take a look at China to see what happens when you set interest rates too low. You get ponzi investment, in which people expand capacity in order to expand more capacity, all while the consumption share of GDP keeps plunging. I think consumption there is only 1/3 of GDP now. It's a huge waste of real resources.

[Nick Rowe]

RSJ: Forget wheat. Switch to Scotch. 10 year old malt. There's a constant flow of new scotch distilled. Value is added throughout the 10 years it is maturing in oak casks. Normally its is bottled and immediately sold and drunk at 10 years. But then people save more and stop buying and drinking it. So for the next 10 years the existing stock maturing in casks gets bottled and invested.

This is getting Austrian!

[Andrew]

Nick, you have been very fair-minded and kind. How about a post now explaining where and why you disagree with the MMT view? Would be very interested in seeing it because you seem to be one of the rare MMT dissenters that have actually put some thought into the debate. Thanks!

[Nick Rowe]

Andrew: thanks. I disagree with the idea that desired saving and desired investment are (even roughly) independent of the real rate of interest. I believe that there is a non-trivial substitution effect of interest rates on both intertemporal consumption and production plans. But I'm just echoing the mainstream there.

I still don't feel I understand MMT well enough to give a full critique. Plus, there's MMT, and MMTers. If an individual MMTer gets something wrong (for example gets accounting mixed with economics, as they so often do) it doesn't mean MMT itself is wrong.

Decades ago I read Abba Lerner's Functional Finance. It is far from an obviously wrong thesis. It's a coherent view of the world.

In many ways, (aside from the vertical IS question) MMT is closer to the Neo-Wicksellian orthodoxy than I am to either. I'm the guy out on left (or right) field. So if I were critiquing MMT I would also be critiquing the orthodoxy. I think both miss the essential role of the medium of exchange. For example, in comments on Steve's blog, Scott Fullwiler said (as a simplification) we could think of money+bonds as being kept in one big chequable savings account on which the central bank sets the rate of interest. That vision is very much in line with the orthodox Woodfordian vision.

[RSJ]

LOL

I like the scotch analogy. You are right! Not buying the scotch *is* investment. But I prefer Rye.

[Scott Fullwiler]

"Scott Fullwiler said (as a simplification) we could think of money+bonds as being kept in one big chequable savings account on which the central bank sets the rate of interest"

I think you've misinterpreted somewhere. And I never use the word "money," at least when I'm trying to actually describe something. Money is always someone's liability, and I'm always clear about whose liability I'm referring to.

Also, regarding "medium of exchange":

http://www.levyinstitute.org/publications/?docid=1344
http://www.levyinstitute.org/publications/?docid=1357

Finally, while, as Warren noted, the attempt to reverse engineer is interesting, as JKH suggested it conceals far too much of what is important to MMT--namely, the interaction of the Tsy, central bank, and financial system. We may or may not have a complete theory worked out depending on whom you ask (we are, after all, only about 10 economists; forgive us if our output doesn't rival the 1000s working out other approaches, even as some MMTers are quite prolific), but what we would say is that if anyone's preferred model isn't consistent with how the Tsy, central bank, and financial system actually interact, it is not relevant to the real world.

[JKH]

Nick,

Rob Parenteau (from reference above) on Krugman - and maybe this point reflects why MMTers don’t like ISLM:

“If Paul recalls his reading of Keynes’ General Theory (and he is to be applauded for being one of the few New Keynesians to actually read Keynes in the original), this is one of the reasons Keynes argues incomes adjust to close gaps between intended investment and planned saving. Interest rates do not equilibrate investment and saving - incomes do, in Keynes’ General Theory. Paul has taken a very large step in this direction with his financial balance diagram, which hopefully he will find more powerful than his IS/LM analytics which he employed in the case of the Japanese balance sheet recession.”

Note, he says: “interest rates do not equilibrate investment and saving”

I suppose you could interpret that as a vertical IS curve - or an outright rejection of the ISLM model.

(which reminds me of Mosler’s earlier comment above on ISLM – i.e. that it applies to a fixed exchange rate model)

You cast MMT as the case of a vertical IS curve within ISLM. I believe you’ve explained that a vertical IS curve means monetary policy is without effect. That seems to be the precise logical translation of vertical. But I don’t think that’s precisely what MMT is saying. It’s saying that monetary policy may have effect, but that it’s effect is unreliable - in at least one important sense in that its potential impact may be directionally ambiguous – a point I made earlier above and a point that Mosler made in his comment. MMT does claim I believe that fiscal policy is more effective than monetary policy in closing the employment gap, because it is unambiguous in its income creation effect, without the necessary complication of (ambiguous) interest rate manipulation. This ambiguity is a fairly important point to MMTers. So one might intuit that the IS curve according to MMT may not be vertical – instead it may be some unreliable squiggle, with different compound effects in two different directions in different circumstances. That’s uncertainty more than verticality. And they dislike that uncertainty and ambiguity.

See also Mosler’s comment at http://www.interfluidity.com/v2/1357.html#comment-15730

And Scott Fullwiler: http://www.interfluidity.com/v2/1357.html#comment-15809:

“As Warren explained in his response to Nick, it’s not necessarily the case that MMT sees aggregate spending as completely interest inelastic. That’s one example of why we cringe at such simple models–there are several channels, including the Minskyan links Warren didn’t even mention. That is, the rationale for not manipulating interest rates doesn’t rest on an assumption of (to use Nick’s framework) a vertical IS curve–instead, the rationale is that the effects of manipulating (short-term) interest rates are highly uncertain given multiple channels, and given our Minskyan background, frequently destabilizing. As I said, it’s very hard to put that into a simple IS-LM or similar framework.”

And: http://www.interfluidity.com/v2/1357.html#comment-15810:

“Note that Mosler often describes interest rate effects on aggregates spending that would be more in line with an upward sloping IS curve (e.g., one can find in several places on his site where he suggests that Japan’s zero rate policy might be deflationary). So, again, the idea of a vertical IS as being a representative description of the MMT view of the world is a gross oversimplification.”

Nick, you’ve reverse engineered MMT to a vertical IS curve within the framework of ISLM. That may reduce MMT to an ISLM case, but in doing so it may also oversimplify and possibly distort the reason for MMT’s fiscal preference - as revealed through its distaste for ISLM rather than some assigned niche within ISLM.

[Scott Fullwiler]

OK, looks like you're talking about this:

"1. bonds vs. money doesn’t matter in terms of inflationary impact, aside from interest differentials."

If we "miss the essential role of the medium of exchange," perhaps that just means we don't accept that holding more deposits as a % of total assets is necessarily going to lead to more spending than otherwise. Treasuries don't restrict aggregate spending--as just one example--in a world in which there are 20 or more primary dealers with an open bid and the ability to repo out their existing inventory to create the funds to buy more bonds (that is, Tsy's actually enable greater "money" creation). But none of this has anything to do with whether or not we have integrated the "medium of exchange" role of "money." We have integrated it as it actually works.

[Nick Rowe]

Just a quick response. Because my students write an exam this morning and I have little time over the next few days.

Keynes GT said that Y adjusts to equilibrate desired S and I. But that wasn't really internally consistent, because he forgot the feedback loop from Y to the demand for money (he recognises that the demand for money does depend on Y) and so to interest rates and S and I. The textbook ISLM says that *both* Y and r equilibrate S and I. The New Keynesian ISLM says that for given r set by the Bank, Y adjusts to equilibrate S and I. But, in the long run, the Bank must set r equal to the natural rate, and only the natural rate of r equilibrates S and I at the long run equilibrium level of Y.

I repeat my point about Robert Parentau though. The "Krugman Cross" he praises *is* formally identical to the Keynesian Cross and the vertical IS curve. This is not in any way "Modern".

(Sure, I understand that nobody believes the IS is literally vertical under all circumstances, and that this is just a simple representation of "it might slope up or down it depends".)

[Nick Rowe]

Let me put it another way. The orthodox New Keynesian view is that Y equilibrates S and I in the short run, given the r set by the Bank. But in the long run, when Y is set at "full employment" Y cannot adjust to equilibrate S and I, so the r set by the Bank must be adjusted to equilibrate S and I.

And the big difference between MMT and orthodox NK, if my simple model here is correct, is that with a vertical IS curve the central bank *cannot* set an r to equilibrate S and I at full employment Y. Instead, fiscal policy must be used to equilibrate S and I at full employment Y. That's because there is no natural rate of interest.

If MMTers did believe what my crude model says they believe, then the MMT policy prescriptions make sense. In that sense, my reverse engineering gets the right answers.

[paine]

". I disagree with the idea that desired saving and desired investment are (even roughly) independent of the real rate of interest. I believe that there is a non-trivial substitution effect of interest rates on both intertemporal consumption and production plans. But I'm just echoing the mainstream there"
nr
have you really come to terms with credit rationing
our sstem always leaves borrowers desired funds at the going rate
in excess of funds provided

once you add the unliited elasticity of credit
what's left ???

i know the entire edifice of certain models comes crashing down when
there is no spontaneous unique equilibrium the system drives itself toward ..eventually

but hey there isn't with granular systems under newtonian law either

lots of "ideal " physical models lack unique points of balance

thank god or we'd have no history only periodic orbits
which is not to say we just get one damn thing after another
in fact i prefer totally determined models

stochastics is heroin

[Nick Rowe]

Scott: thanks for the links. I will try to read them later. But don't pay too much attention to me when I start going on about medium of exchange stuff. This is my private fight with 95% of the profession. And, from my perspective, "all you horizontalists, orthodox, or unorthodox, look alike to me". (As the bishop said to the actress).