Tag Archives: ZIRP

Is Public Debt a Real Issue?

OK I just couldn’t help myself. I have to take issue with one of my favourite Australian economists yet again. A terribly nice guy.

This is a repost of a comment philosopher Tom Hickey wrote at the Economist in 2012.

First some abbreviations that are in use in the comment

NGDP = nominal GDP
MBS = Mortgage Backed Securities
QE = Quantitative Easing
ZIRP = Zero Interest Rate Policy

MMT proponents argue is that there is a difference between money created by fiscal deficits and money created by bank lending. When the government issues currency into non-government it does so through the Treasury directing its bank, the Fed, to credit non-government deposit accounts, e. g., to pay for fighter planes or to pay grannie’s social security. The transmission from reserves to bank deposits is direct and does not depend on bank lending. Moreover, since there is no liability corresponding to the assets created in non-government in crediting these bank accounts, deficit disbursements inject net financial assets into non-government. Conversely, bank lending nets to zero since each asset has a corresponding liability, so non-government net financial assets remain unchanged no matter how much banks lend.

The reason that NGDP targeting will not work is the flawed notion of the transmission mechanism from reserves to spendable bank deposits. When the Fed buys financial assets of whatever type, it simply increases bank reserves. The erroneous presumption about transmission is that that banks lend against reserves or lend out reserves. Neither is the case, as MMT points out. Rather, bank lend against capital based on demand from creditworthy borrowers willing to pay a rate that is profitable enough for the bank to risk it’s capital against. Increasing bank reserves does not spur banking lending and it does not affect the factors banks take into consideration in lending.

From this is simple to see why NGDP through increasing bank reserves, e.g., via QE, will not increase effective demand and spur increased investment to meet it. The transmission mechanism is bank lending, which is in abeyance, and increasing reserves will not increase it as the failure of QE has shown. Unless the Fed would buy real assets like houses instead of financial assets like MBS, it cannot not inject net financial assets into non-government, and there is no reason to expect an increase in effective demand due to increased bank reserves.The US is already at ZIRP and has been for some time. That has done nothing either. MMT predicted the failure of monetary policy — QE1 and QE2, as well as ZIRP, and QE3 will also fail unless the Fed would purchase real assets, which it is not permitted to do under current statute even under emergency powers, at least as I understand it. Time for fiscal policy to step up to the plate.

Now, John Quiggin calls himself an Old Keynesian but I find he is closer to a left-wing New Keynesian

As he said on RT:

…the only difference between the market monetarists and ordinary old keynesians as I see it is that they precisely treat nominal GDP as if it is a policy instrument when of course it is the target.

As we can see there is an immediate contradiction between Hickey’s second paragraph and Quiggin’s view. Perhaps that’s not the transmission mechanism he had in mind. So I asked:

Whilst we could agree with fiscal policy as indicated by Hickey above, how exactly would the monetary policy part work?

Remember the goal of monetary policy is to get you to change your behaviour with existing income contra fiscal policy which does it with additional income.

What we end up with is that monetary policy as conventionally defined cannot do nGDP targeting but fiscal policy can. That raises the question of why you would target nGDP when there are many better targets to use.

Or we could invoke the colloquial version of Goodhart’s Law:

When a measure becomes a target, it ceases to be a good measure

We could continue to discuss how government debt is functionally the net money supply and how debt management is the mechanism by which we adjust rates and more but I feel that avoids the most provocative and productive question.

Would it not be better to target real outcomes & real supports with fiscal policy? Some examples could be any of the Australian Real Progressives goals.