By Stuart Medina Miltimore. Extract from a long interview with Warren Mosler held in Mallorca on October 14, 2021. Originally published by Red MMT in both English and Spanish
Inflation
Stuart Medina Miltimore (SMM): A good starting point is your inflation and interest rates story. Let’s start with inflation. You frequently argue that inflation is not always driven by demand. Indeed, you could argue that [demand driven inflation] is a rare event. After that, we can talk about interest rates.
Warren Mosler (WM): Inflation academically is defined as the continuous increase in prices that is faced by agents today looking to purchase things for delivery in the future, whether it’s next week, next month, next year or five years forward. But they want to purchase it now for those dates. And they’re facing what I like to call a term structure of prices. The continuous increase of that term structure of prices is academically the rate of inflation. And, with floating exchange rates, it’s also a direct function of the central bank policy rate.
So, if you have a permanent zero-rate policy, something like Japan has now, where [the Central Bank] controls up to ten years at zero, the term structure of prices is flat. And so the inflation rate under the academic definition — the way I read it — is zero, because agents are looking at flat prices relative to spot prices. So, if I’m a gold manufacturer, I can buy gold today for jewellery manufacturing at $1,800 an oz. But I have other choices: I could buy it a year from now for $ 1,800 or ten years from now for $ 1,800 plus some storage, insurance and other sundry charges. But effectively it’s the same thing.
Now, if the central bank raised rates, say to 1% from zero, the term structure of rates would now be locked at 1% instead of zero. Then the price of gold for every year forward I want to buy would go up. Prices would continuously go up at a 1% compounded rate, so the rate of inflation would be 1%. By the academic definition of inflation — as I read it — the central bank sets the policy rate, which is the rate of inflation, the structure of the policy rate.
The Fed only sets overnight rates, as in the European Union, and allows the term structure to adjust to what market participants anticipate that the Fed is going to do. That’s their policy choice. So today, with a one and a half per cent ten-year note, you could say the forward structure of prices is increasing linearly at an average of one and a half per cent a year for ten years. For people looking today to purchase things for delivery next year or the year after —and this could be somebody who wants to buy a house which is going to take a year to build, or who wants to build a factory which is going to take three years to build — they have to look at the forward prices of those things. The term structure of prices, which is set by the policy rate, is the rate of inflation.
According to that definition, you would not see a headline today saying inflation is at 4%, right? Because that’s what the CPI did versus a year ago, which is a very different thing. What we have today is what’s called a price level. And if the rate of inflation is zero, as it is in Japanese yen, that’s not to say that the price level won’t change, go up, go down, go sideways for the next ten years. It is to say that, right now, if I want to buy something for one-year delivery, the forward price is the same as the spot price.
The next question is, what does determine the structure of prices? And one of the questions it brings up is why the central banks won’t even consider this, or put any time or effort into trying to see what the relationship is between the term structure of prices and their policy rate. Because central banks think they’re in control by using the reference rate.
Well, they’re looking at changing the price level, not realizing that when they raise rates, which presumably causes the price level to go down, they’re establishing a higher inflation rate. They haven’t looked at it from this point of view, nor done the research on it. So, it’s not that they’re right or wrong, it’s just that it doesn’t even occur to them to look at this.
Let’s look at the price level. Why are prices where they are? Why does this thing cost $10 or €9? Where does this price come from? The mainstream [economists] do not have a theory of the price level or a way of determining it independently from what it was yesterday. So they just say it’s historic, because they don’t have anything better and their math doesn’t work to determine the price level as they claim.
SMM: It’s an infinite regress story such as the Marxist labour theory value. Prices are determined by the amount of [socially useful productive] work that you need to get that gold out of a mine, yes, but how much was that hour of work worth in your first place?
The currency is a simple public monopoly.
WM: They don’t understand the source of the price level. What I recognized with MMT, since inception, is that the currency is a simple public monopoly. The economy needs the government’s funds to pay taxes and the government is dictating the terms of exchange when it spends, — whether it knows it or not. So, what markets can do, and that is what the mainstream recognizes, is set relative value. And all their models do is try to determine relative value. They can tell you why peaches cost twice as much as apples or 1 hour of labour earns enough for three pizzas or one pizza per hour of labour. Markets can determine relative value, but markets can’t determine absolute value. They can’t determine whether the hour of labour should be $10 or eleven and a half euros per hour.
SMM: It’s like saying I can tell that this distance is twice this other distance, but somebody has to define a measuring rod.
WM: That’s what I call absolute value. The only information the markets get on absolute value comes from the government through its institutional structure.
SMM: What we’re seeing with the electricity market in Europe right now, is that an institutional structure is determining the pricing in the market. It has nothing to do with production cost.
WM: Exactly. And the institutional structure has a large effect on relative value.
If the government needs to pay for soldiers and nobody else wants them, then it’s setting their value. They get what we pay for them. These soldiers can say, “We need the money to pay the tax”, and we say, “This is what we will pay”. They’re kind of stuck with those terms right now. The government, of course, is setting some price in terms of currency supply and demand.
The demand comes from the tax liability, which then causes the private sector to need the government’s money. So, nothing happens without the tax liability. The story begins there. The mainstream money story begins with the government collecting taxes and what they don’t collect, they have to borrow.
But we see it the other way around, the actual way it works, where the government spends first and then taxes are paid. But they can’t spend first without creating the tax liability. Once the tax liability is established, then the government is in a position to dictate terms of exchange. So, the price level is necessarily a function of prices paid by government when it spends. And, I used to add, also the collateral demanded when it lends, because, if the government lent, open-ended, with no collateral, anybody could borrow all the money they wanted and become the agent for government spending. If you’re getting it in exchange for nothing, it has no value and you would just get hyperinflation. Money would be worth nothing. You could borrow the money, pay the taxes, and nobody would care about it anymore.
However, if you look carefully, when a bank lends, the debtor signs a note and they give you a balance in their account. They give you a cheque; they’re buying a note. It’s a purchase of a signed note. So lending is a [financial] asset purchase by a bank. And any purchase by a bank is paid for by increasing the balance in someone’s account. That creates a new deposit or addition to an existing deposit. This is new money, so to speak, if you define bank balances as money, which everybody does.
Banks in the commercial banking system are agents for the state because they are chartered members. They have an account at the central bank. They’re fully regulated. Regulation includes who they can lend to, what collateral they have to provide, their management, how much they can pay their management, whether they can pay a dividend on their profits… everything. The Regulators have an acronym, CAMELS[1], which explains what they regulate, which is everything. If the banks are agents of the state, I can now say that bank lending is a subset of government spending in the purchase of financial assets.
Then we can just stick with the simple statement. The price level is a function of prices paid by the government when it spends. We don’t have to qualify further with regard to lending. That’s the only source of absolute value. So, the price level doesn’t change without some change in the absolute value information coming from the state.
SMM: How do you put into the equation the fact that the government buys an assortment of goods and not a single uniform homogeneous commodity?
WM: So it’s determined by what needs to be offered at the margin: what the population has to do to get that next dollar from the Government. But it’s not the same offer for everyone. For someone, it could be one hour of labour and for someone else an additional mile of highway.
The government is not only influencing the absolute price level. It could also be influencing the relative price level. If they decide they want apples for everybody in the army, then the price of apples goes up. If they want everybody in the Army to wear a Rolex watch, the price of Rolex watches goes up.
The government creates a notional demand but there isn’t any aggregate demand until the government spends first. It is the source of aggregate demand. I call it the ‘demand filter’. How do the dollars get from the government to the taxpayer? If they just hired everybody —let’s say they tax everybody’s house — then everybody would work for the government and it would give you a job. In this case, the demand filter just has one layer. But if they took the whole $5 trillion [budget], or whatever it is, and gave it to one contractor and said: “here you go; run the economy”, then you would get very different results. He might keep a bunch for himself and you get a whole different distribution.
SMM: Then this person would be the price setter instead of the Government.
WM: Exactly. Especially if he wasn’t given any instructions. Now, if you give him money without instructions, then he becomes an agent of government spending in terms of price level. If the Government pays you a Social Security cheque, you can go out and tell people what they have to do to get this money. But if they say, “here’s money to buy a car”, or “here’s money for food only”, then that’s a different story.
SMM: When you talked about banks, you said they are buying those promissory notes from their borrowers. Presumably, those borrowers will pay back their loans and the promissory note will be cancelled, as well as the deposits that were created when the promissory note was first given out to them. What happens when a borrower goes bankrupt and is not able to pay back?
WM: So that deposit is still outstanding. The bank capital has been reduced and that’s a loss for the shareholders. So it all balances out in the end.
SMM: Recently the European Central Bank redefined their inflation target. They used to say, less than, but close to, 2%. And now they say that they will allow inflation to overshoot that target a bit. However, do you expect the Fed or the European Central Bank will be raising interest rates [in response to the recent price increases]?
WM: They’ve got the interest rate thing backwards. So the answer to that question is, if they believe that inflation, the way they define or report — the CPI, the core, all these things — is somehow ahead of their targets, whatever that means, then their response will be to raise rates because they believe that the cause-and-effect sequence is “we raise rates; inflation comes down”. They don’t have any hard evidence nor supporting theory for that anymore, but they believe it. That’s their story and they’re sticking to it.
We can give them all the theory and evidence to the opposite. [However] they fear that if they’ve got their money and interest rate stories backwards, then the logical conclusion is that central banks really cannot do that much about inflation in the first place. They never have, indeed. That’s why they will never believe this story because they know they will be out of work.
In the meantime, MMT has pointed out several things that the economics profession totally got backwards to the detriment of the economy and the standard of living for a long time. One of them is the sequence of spending. They think that they have to take money in at the federal level to be able to spend. We pointed out that’s backwards. It’s the economy that needs the government’s money. Every mainstream economics model gets that backwards. And that’s a lot of models for many years that have won a lot of Nobel Prizes for having it backwards.
SMM: Their models were designed under the assumption of a gold standard [monetary system].
WM: Now they’re coming around on the realization that government at least prints the money or creates the money when it spends. They haven’t taken the next step: which means accepting that all their models are wrong, but they do know that all their models are broken. And that includes their interest rate models because, when you look at all their forecasts which are based on their models, they’ve all been wrong. So, they recognize their models are broken. So that’s a good start.
Interest rates
WM: The second major thing that we’re saying is they’ve got the interest rate thing backwards. They haven’t gotten anywhere near as close to seeing that our way — at least in public — as they have on the fiscal side. They’re no longer worried about default, but they’re worried about inflation. And of course, the reason they worry about inflation is because it’ll cause the central banks to raise rates to fight it, which is backwards. So now it’s in their best interest to be able to do the countercyclical spending without concern that central banks are going to raise rates, because that’s only going to make matters worse.
Once they know it’s in their best interest to leave interest rates at zero, they should just leave them there forever, which is what we’ve been saying for 35 years now and Japan has proven for 30 years.
SM: There’s also a twisted logic in thinking that by raising interest rates and causing the economy to slow down, they’re actually decreasing capacity and increasing productivity. They’re actually making things worse by slowing down the economy.
WM: Let’s look at their thinking. Remember the situation with Greece. They were not right about the Greeks being lazy and not wanting to work. It was shown that Greeks actually work harder than anybody else. But let’s just concede that they were right. So here you have a population that’s lazy and doesn’t want to work. How do you punish them? Well, you impose austerity and put them out of work. What sense does that make? So even on their own terms, which are completely wrong, their whole internal logic has always been completely flawed since the beginning. But it’s always worked politically and only things that work politically actually happen. If it doesn’t work politically it doesn’t happen.
Unfortunately, they’re not anywhere near as close to the idea that they’ve got the rate thing backwards.
Export-led growth model
SMM: What do you think about this obsession with the export-led growth model, which a lot of countries pursue?
WM: The old textbooks show that it is absurd. Imports are a real benefit; exports are a real cost. It couldn’t be more obvious.
SMM: Yes, even Paul Krugman or Milton Friedman or any classical economist would have said that some years ago.
WM: But not anymore.
SMM: They are just thinking in terms of export-led growth models.
WM: That’s just rhetoric demanded by fixed exchange rates to build reserves so that you can maintain that fixed exchange rate. That is what the IMF was created for: to help countries in the fixed exchange rate system to maintain reserves. So they would recommend these export-led growth models. Not because it served your population or standard of living or terms of trade or anything like that, but because, under the Bretton Woods system, that’s what had to be done to sustain that system for better or for worse.
The system is long gone, but they’re still doing it and the whole understanding is still there. People are doing that unilaterally without even being pressured by the IMF.
SMM: I’m hoping some of the readers of this interview will be Latin Americans, where there’s a long tradition, or obsession you may call it, with fixing the exchange rate or pegging it to the US dollar or managing it some way or another to stabilize the exchange rate. What would you tell them? What’s the point of doing that?
WM: The place to start is to look at the real wealth of the nation. And then you can look at the distribution of that real wealth. So the real wealth is what I call your pile of stuff [for consumption] and everything you produce domestically makes your pile of stuff bigger. All the goods and services you produce, and the more people working, the bigger your pile of stuff that you have to allocate somehow, through market forces or whatever, to everyone.
So, if you want anything less than full employment, you’re sacrificing your pile of stuff. So why would you ever do that? Why don’t you just get as large a pile of stuff as possible? Whatever you’re producing, you don’t want to give that up to adjust your prices, which is an allocation. You probably want to deal with your allocation problem separately. Don’t sacrifice your workers and your production of real output. Domestic real output, is yours, right? And that’s your wealth. Real wealth, plus anything you import from China, or Japan, or Korea, makes your pile bigger.
Your imports minus your exports, which make your pile smaller, are your real terms of trade. Just making your pile larger or smaller. Now, once you understand that, then you can go on to ask if fixing the exchange rate will help make my pile larger or smaller. And what happens if you use fixed exchange rates to maintain your foreign exchange reserves, that requires periodic episodes, sometimes extended periods, even forever, of unemployment to stay competitive. It requires you to keep your people working for fewer calories and you can’t afford to eat your own meat, so that you can maintain your exchange rate. When your target is your exchange rate and your reserves, you’re at less than full employment. So your domestic pile of stuff is smaller than otherwise; you’re giving up that much real wealth.
Employment
WM: With a World unemployment rate that is probably 15%, the losses of real output in one year are probably much larger than all the destruction of real goods and services done by all the wars in the history of the world. It’s unbelievably staggering!
SMM: Some of the economists who argue for these sorts of exchange management policies would say that, given that your output capacity is limited and that employment or unemployment is determined by your productive capacity, we need to manage exchange rates so we can afford the capital goods that we need to increase the productive capacity of our economy [in the future].
WM: Two hundred years ago, when we were a totally agricultural society and 99% of people worked in the fields or they would starve, what was the unemployment rate?
SMM: Zero.
WM: Then we started inventing tractors and everything else, creating unemployment in the process. So those people didn’t need to do [that work any longer]. And then manufacturing came along so we went from 99% in agriculture to 1% today. But unemployment is not 99%. Then people went to manufacturing but now manufacturing in the US is 7% of the employment. So at 8% in Agriculture and Manufacturing, unemployment is not at 92%, it’s 3%.
SMM: There is a twisted logic in the idea that, since we can’t create more employment, we have to create unemployment.
WM: The point is there’s always more to do than people to do it. Every day we start off with too many things to do and not enough time to do it with everybody working. So there is never a shortage of jobs. There’s only a shortage of funding.
SMM: I was reading a paper by the Reserve Bank of New Zealand, which was published some years ago when they decided to float their currency. One of the arguments they gave for free float is that managing the exchange rate creates more abrupt changes in the exchange rate, and hence more disruption to the economy and the financial system. Whereas the floating system makes for smoother adjustments in the exchange rate to changes in response to the trade imbalances.
WM: You can always use countercyclical fiscal policy and a Job Guarantee to support full employment. But you can’t do that with fixed exchange without losing your reserves from time to time, which means you have to float.
SMM: The argument these economists retort with is that’s not real employment. You are not creating real jobs nor creating real output.
WM: Well, no, but it’s only short term, because if you have a job guarantee or a transition job guarantee, you then either hire them in regular public service out of the pool, or you relax fiscal policy and the private sector will hire them, which they will. Yes, on day one, it’s not full employment, but on day two and day three it is and those people immediately transition out of there. And it’s a process where you’re keeping the number of people in the job guarantee somewhere between 2% or 5%, something like that, on a continuous basis. So, in that sense, over time you’re at full employment-
SMM: What is your view on the proposals to use the job guarantee as part of the Green New Deal and employ those who are going to be rendered unemployed by shutting down coal mines or oil rigs in the ocean and employ them, presumably in a job guarantee program? Do you think that makes sense?
WM: I consider myself a progressive, okay. To me, that’s not a progressive way to provision the public sector with labour. If you want to hire these people, just hire them! Hire the coal miners to do whatever you want them to do. Don’t put them in a job guarantee at ten Euro an hour. If the regular public service job is €30, just hire them at €30. The whole point is not to undercut the base scale of the public sector. Once you fully provision the public sector with the green new jobs wherever you want, then the rest of those people you want to transition into the private sector, they’re the ones in the job guarantee.
And then you conduct a fiscal policy, you give government grants, loans or whatever you want to do to get the private sector to hire them. If you don’t want them in the private sector, if you want them in the public sector, just hire them.
SMM: The size of the public sector is a political choice that depends on the preferences of the electorate or the elected representative.
WM: I met with a guy from the Pentagon in 1999 or so and, in about three minutes, everything that’s wrong with hiring in the public sector came out. He said, “We really need to build the military up so we’re going to do that.” And I said, “Well, look, unemployment is at 3% right now. We’re at full capacity. You can do it, but you’re going to be taking those people away from the private sector right now. It’s going to be transfer of real resources and you’re going to be competing with them for those. You should have done that seven or eight years ago when we had high unemployment because of the recession. That would have been the time to do it if you’re going to build up the military.” He said “Well we could not do that then because we were running a budget deficit. We didn’t have the money. Today, with a surplus, we can get this done.”
So, that little story tells you everything wrong with how the public sector operates right now. The monetary system gives them no information as to what they should be doing. What gives the public sector information is the real economy. How many people do we want in the military? If we have too many then there’s nobody to grow the food and build cars. If we don’t have enough, we’re going to lose the war. That’s how you make your decisions.
What’s our budget and what balance do we have has nothing to do with it. The thing that gives them no information is where they get 100% of their information.
SMM: I think it was Keynes who understood this in his famous treatise How to Pay for this War. He understood that it is the real resources that matter. He just wanted people to spend less and make sure that they were either taxed or put their money away in patriotic bonds or whatever
WM: Which is true, but at the same time he has the government spend by getting money through taxes or borrowing to be able to spend, right? You could argue that under the fixed exchange rate those policies were true, and, although he wasn’t a supporter of those, he still was operating under that context.
The trillion-dollar platinum coin and the debt ceiling
SMM: Speaking of government deficits and debt, let’s talk about the trillion-dollar platinum coin. What’s your take on that?
WM: Well, as you know, it came off a discussion by blogger Carlos Mucha (Beowulf), which was a very good comment and led to a discussion that I had with him at the time. He pointed out that under the Constitution, or whatever, the Treasury could mint a platinum coin, which would be an asset at face value and the Fed would be obliged to buy to it. That would put those funds in the Treasury’s account. My response to that was “that’s nice, but they really don’t need it. The treasury can sell three month bills and that is what it always has done.” But it’s certainly valid and it’s something they could do if they wanted to. And I don’t have any objection to it or anything like that. I thought it was a good find on his part. It was very perceptive on his part to pick that up as an option.
Not much happened since then, except that it was seen as some sort of a cool thing. Then now we ran into the debt ceiling and we said the Treasury can sell all the three month bills at once. But Congress is saying; “No, we don’t want you to sell three month bills. We don’t want you to pay your bills.” So the will of Congress is for the Treasury to not make its payments. Yes, we approve the spending, but we’re not approving you the means to get the money, presumably because we don’t want you to actually spend the money we appropriated.
So now the question is, what does the Treasury have to do: do they abide by the will of Congress immediately? Do they look at the Constitution, which says the government has to honour all its obligations? And President Obama said: “It’s the will of Congress”. I think President Biden is saying the same thing: “It’s the will of Congress”, and we are going to let Congress figure this out and then tell us what to do. We’re not going to try and undercut the will of Congress.
In the meantime, he could have said “We have a constitutional requirement to pay our bills. So, we’re going to mint the coin.” But the political decision was made to go by the will of Congress. And Congress came back kicking the can down the road until December. You can argue which is right or wrong or what they should or shouldn’t do, but their position is a legitimate position.
My issue with this is they’re not well informed as to what happens if we do hit the debt ceiling limit. They’re saying that we would default on our bills or the Treasury bills won’t mature, or that we won’t make payments on the bonds and our credit would be bad and so we wouldn’t be able to borrow.
That’s not the problem though. None of that actually matters. They just start trading arrears like they did in Russia in 1989 and we get through that and they say, well, the government shut down.
We’ve had government shutdowns before. Nothing particularly bad happens. The national parks are closed, etc. The reason nothing bad happens is because, although workers don’t get paid – not because of the debt ceiling, but because the government is closed and there’s no budget – other things get paid and it causes spending to go on. A lot of automatic spending goes on, such as Social Security cheques. And the deficit goes up.
SMM: Yes, automatic stabilizers kick in because there’s more unemployment.
WM: Yes. So the automatic stabilizers kick in and the deficit is allowed to go up. But when you hit the debt ceiling, you suspend all the stabilizers. A better way to explain it is that, when the government stops spending, tax revenues fall off. Before, that was okay, but this now means that you’ve got to cut more. Which means within about three days, you’ve watched 25% of GDP wiped out. It’s unimaginable how pro-cyclical deficit spending is. And also, a lot of spending comes from bank lending. The banks can’t lend when the government shuts down and people are losing their jobs, because their lending is pro-cyclical. So now the automatic stabilizers required to get through are much higher and they’re accelerating. What you get is this accelerating race to the bottom.
I’ve never seen it described in any [analysis] of the consequences of hitting the debt ceiling. They assume the consequences are the same when the government shuts down, so they kind of slough over them. But they’re much, much more severe. If those consequences were understood, I think they wouldn’t think of going anywhere near it, because it’s seriously catastrophic; much worse than they think. It’s like nuclear weapons. One of the dangers is that we might hit it because they don’t understand the consequences.
SMM: One of the implications of MMT and political theory is that really Parliament, or Congress, or whatever your legislator is called, is the creator of money.
WM: It’s the source of money. It’s the government that levies a tax liability and then it establishes what the tax credit is, the dollar or the Euro, that can be used to pay it.
SMM: In fact, in the Spanish [Government] budget, the items in the budget, the Appropriations for the government are called ‘budget credits’. I don’t know if it’s the same in the US. So that means the government has credit to spend and it’s authorized to spend to whatever limit is set in the budget.
WM: Very good.
Taxation
SMM: So there’s political theory implications that derive from MMT, which I think are profound and transcend economics.
WM: The whole system is based on coercive taxation. That’s not well understood, because that taxation creates a not well understood anxiety in the population. It creates greed and people being money-hungry who then can’t sleep and start taking all kinds of medications and everything else. That’s the anxiety created by ongoing tax liabilities. It’s like you’re in a bathtub with the water continuously going out and you’ve got to work to keep water coming in. And it literally drives people crazy and mad. And it’s a very powerful force to provision government, and it wins the war and creates this largest standard of living but it creates massive psychological consequences for the population. I’ve never seen it discussed.
SMM: You wouldn’t see that sort of behaviour in the premonetary sort of tribal society. They would have other problems like finding food, but that wouldn’t have those psychological effects that you described.
WM: That’s not to say that there isn’t a better way to do it, whatever better means, or a different way to do it. There are probably alternative ways and the results are going to be very different. Maybe this is the desired way, but that doesn’t mean you don’t recognize it, understand it, and look into it to see what you’re doing and how you can modify some of these effects.
Monetary sovereignty
SMM: I mentioned the words monetary sovereignty previously, and you reacted by asking “what do you mean by monetary sovereignty?” What is your position regarding the notion of monetary sovereignty?
WM: Before MMT, the meaning of monetary sovereignty was a sovereign government that issues its own currency. But right now, the meaning has been extended to include other meanings such as non-convertible currency, or no foreign debt, or food independence, or something else. So now I have no idea what they mean anymore.
SMM: I would understand it as a government that issues its own non-convertible IOU.
WM: Right. But let’s say you are the Franklin University, and you’re issuing the Franklin franc, which is your tax credit of which you are the sole issuer and which the students need to pay a tax. Do you have monetary sovereignty?
SMM: Well, no. They are only the sole issuer of that currency.
WM: When you said ‘sole issuer of the currency’ I wouldn’t have questioned you when you say that they have monetary sovereignty. But you don’t need to be a sovereign to be the sole issuer.
So, what are you trying to say when you use the word monetary sovereign? Well, you could be just referring to countries that do this or that. And some of the proponents have a list of eight things you need to have, or you don’t have monetary sovereignty.
SMM: It muddles the issue.
WM: Yes, it muddles the issue, and it opens you up to criticism that sidetracks the issue for no reason. It’s hard enough to have enough time to focus on the actual points, without having to put out all these fires all around the edges which using that word creates.
So, it’s like using the word money. I don’t ever use the word money unless it is in a casual conversation.
SMM: What do you use?
WM: If you go back, you will remember that I said bank loans create bank deposits. It’s the same thing. The definition of ‘money’ is so casual that it is not constructive.
SMM: It’s more a taxonomy sort of issue, or rather about being precise about the definition of what we’re talking about.
WM: You want to get your point across. And this concept makes it more difficult to get a point across, not less difficult. It works against you getting the point across. So when I say bank purchases create bank deposits, I’ve got my point across. If I say bank purchases create money, you might raise all kinds of questions and start discussing those, maybe even arguing about them.
The European Union
SMM: Now that you’ve been in Europe for a few weeks, what would you recommend the European Commission, the European Council or the ECB do regarding the end of the pandemic and the gradual return to normal? Employment rates have bounced back, not completely to their pre-epidemic levels, but they have recovered; activity is almost back to normal. Would you recommend them to continue with the €1.5 trillion program that Christine Lagarde announced a year and a half ago?
WM: Let’s just review the last thirty years quickly. Twenty-five years ago, we were sitting in a Bretton Woods conference on the European Monetary Union, recognizing what was going to happen this whole time, discussing what the end game would be. The Endgame would be a permanent zero rate policy. There would be a central bank guarantee of all national debt, and they would have to use the deficit as a policy tool, rather than as a constant deficit limit. So now here we are. And we also discussed that they were going to need a credible central bank guarantee which is necessary for deposit insurance. Without that, the banking system is going to collapse. They are forced to have one because there’s no other way to do it. This is a point of logic.
So here we are 25 years later. I would say it’s time to declare victory and move on. They’ve got a 0% rate. Just make it permanent! They’ve got the central bank guarantee of all member nations. They’ve got the credible deposit insurance. Just put it in writing. Don’t make it a Mario Draghi policy that we are continuing.
And, as of last year, the Commission decided to change the 3% limit.
SMM: Yeah. The escape clause.
WM: Make it a policy tool!
SMM: But you know that this is temporary.
WM: But temporary and crisis means it’s a policy tool, right? It’s a policy for a crisis. It’s a policy, temporary or permanent. So what they’ve decided is that it’s not fixed at 3%. It’s a tool to use to obtain a result: to get out of the crisis. To solve the energy crisis, the natural gas price crisis, whatever, they’ve recognized that you have to do this. Before that, there was no discussion about this. We went through a lot of crises and they never changed it. They tried to enforce penalties, and then the central bank enforced the rules by letting people up from under the umbrella to let your spreads widen if you didn’t comply with what was always a hard limit. Now it’s a policy tool.
Now, they can move it back if they think that’s beneficial. If they think it isn’t beneficial, they don’t have to move it back. And that’s what they’re trying to decide. Is it a trillion and a half, or isn’t it? It’s a policy tool now. Otherwise, there’s no discussion like before. Three per cent, there is no discussion! Where did we get that?
Now they’ve got the correct policy tool.
What’s left is to recognize that raising rates causes inflation, in which case they will leave interest rates permanently at zero. Because why would you raise rates if you don’t want to cause inflation? Use the other policy tool. Let everybody have lower taxes or higher public services. Raising rates is a totally regressive way to regulate the economy: basic income for people who already have money. There’s nobody in favour of that! Right? Even the basic income people are against that kind of basic income.
So, their economists now have data that show what this deficit limit of 11% or 6% or 3% or 20 % or whatever does. They can give the Commission a spectrum as to what their forecasts are when they put the policy tool at those levels, and they can also get forecasts from private-sector economists, like they already do.
Where do we want it to be next? Should we be back to 3% or not? Well, what do our forecasters say is going to happen at these various levels?
We know that with the central bank guarantee, even Greek debts are at zero %. There’s no credit risk anymore. They used to have credit risk but now that’s all behind them. It’s not there for the banking sector. It’s not there for the government. The debt to GDP ratio is what it is. And with permanent zero rates, why should they sell long term securities at all? They should all just sell three months securities at zero per cent. Now they have no debt service.
The tool of fiscal policy is where all the impact comes from. Use your technocrats to determine what it should be. And then the Commission would decide which one is the most appropriate for the European Union.
SMM: Well, this would still be a rules-based determination of what the deficits should be. The reasonable alternative might be that we want a rule that requires as low an unemployment rate as possible and let the deficit be whatever it needs to be.
WM: The technocrats can tell them that, so they have to make the decision. They’ll tell them what the corresponding inflation rate will be. They’ll tell them what the currency will do. They’ll tell them everything.
SMM: Unfortunately, my impression is that next year they’ll start tightening the belts again.
WM: They might. If they recognize it as a policy tool and that they’re not bound by historical limits, but by future outcomes, then the European Union could do enormously well. It could be the most prosperous Union of all time. They can figure that out. And they’re right there. They’ve already got the things in place now, which they didn’t have two years ago. I say they’re on the edge of greatness. Right?
SMM: Except some people are closer to that edge than others. Not all the technocrats have the same understanding. They have the guarantee from the central bank. They’ve suspended the deficit limits. But they’re still anxious about the consequences of that.
WM: But they have data on what the consequences are, right? They have data on what happens with 11%. They didn’t have that before. They might have been afraid that the currency would collapse, hyperinflation, etc. Well, now they know it doesn’t happen.
The Biden administration’s proposals for tax increases
SMM: What’s the deal with the Biden administration’s proposals for tax increases and wealth taxes and so forth? Do you think it’s necessary?
WM: Trump was the price that the voters were willing to pay to keep the Clintons out of office. Now, with Biden, the price voters are willing to pay to keep Trump out of office [laughs]. There isn’t anything positive about the last couple of US elections, it has all been about the lesser of two evils.
So, Biden is in there in the middle of the road, finding ways to pay for things, looking for legislative compromises.
SMM: Do you think it’s just tweaking the tax rates a bit to satisfy part of his progressive electorate, rather than an actual policy?
WM: Satisfy the headline progressives; not the real progressives, the MMTers. It satisfies people like Robert Reich who say that you could tax the rich and get enough money to feed everybody. That’s what a lot of voters want to hear.
SMM: Are you concerned about the hike in oil and gas prices having consequences in terms of prices and demand?
WM: Isn’t that what triggered the 2008 debacle? Oil just went straight up.
SMM: That year was the maximum for oil prices. I was looking at a time series of natural gas and oil prices. And the last peak was around 2007-2008. I have been hearing comments of people saying, oh, prices of natural gas are an all-time high. No, they’re not! They are higher than they were a year ago, but not at an all-time high.
WM: Yes, but that can drain demand and money goes to places that don’t spend it.
Trade
SMM: Before we began recording, you mentioned something which I thought was interesting about the European official trade surplus perhaps not being as high as recorded in the official figures. You said one proof that the official statistics are not picking up the real imports could be that the Euro is not appreciating.
WM: Yes, because you never see a case where trade surpluses keep going on and on without the currency appreciating. According to purchasing power parity, the rate should increase; although there are other things that determine the value of the currency.
There are several articles about how trade figures from different customs offices don’t add up.
SMM: Well, if you add the trade surplus or deficits of all the nations in the world, there’s always a huge gap. Those missing exports must be going somewhere. It’s not going to another planet, for sure. But the statistical discrepancy is very large indeed.
The future of MMT
SMM: What is your opinion on where MMT is headed?
WM: It’s just nice to see the proliferation of MMT discussions. Anybody who gets involved in the discussion can go right to the source material. My Seven Deadly Innocent Frauds book was written for readers with a third grade level. All the knowledge is there.
The interesting thing is that MMT has become a grassroots movement. We might have created our own celebrity with Stephanie Kelton, but we certainly didn’t have a celebrity promoting it in the beginning. Nor did we have any central banks promoting it.
Somehow, people like yourself just sprung up all over the world. For what? It wasn’t for say animal rights, or women’s rights, or the green movement. Who would have heard of a movement to get central banks and governments to understand that they have fiscal policy backwards, that they spend first and then tax? How is that the stuff of a grassroots movement that not only spread to millions of people but also filtered up? And none of them were senior economists, even junior economists. There were zero mainstream economists participating.
But now — there might be one or two reluctant ones — they’ve all started changing their models because they could see that they weren’t right. And MMT is now mentioned and studied at every central bank of the world and discussed in every legislature. How improbable was that!
SMM: And there have even been some attempts to declare MMT a pernicious and dangerous idea.
WM: Yes. The US Congress has a resolution condemning a theory describing monetary operations.
When I talk to senior people at the Fed they go: “Well, yeah, of course. That’s how it works. Everybody knows that!” Then why don’t you say anything? “Well, it’s not our job”.
So, it’s nothing except monetary operations. So how do you get a grassroots movement to instruct the central banks and the legislatures on monetary operations and how it’s done? How improbable is that? It is quite improbable in this channel.
SMM: You didn’t expect this when you started writing about this, did you?
WM: This started purely as an exercise of logic.
SMM: Well, I think it has to do with the pain that standard neoclassical economics has caused to a lot of people, especially in countries like in Southern Europe, where you have high rates of unemployment, which wasn’t necessary.
WM: Yes, but that is not how it started. It wasn’t the unemployed who started this. It came in kind of out of nowhere, off on a tangent somewhere, and filtered its way in through regular working people. It wasn’t like we started addressing the unemployed and getting them all whipped up. People we talked to were already working. And it was just me at first and my partners in ‘92 or ‘93 and then some people in the financial sector followed. I tried to introduce these ideas to the academic community in ‘96 without much success. Later, Bill Mitchell, Randy Wray got involved and then we met Stephanie Kelton.
SMM: What is the issue with the academic community? Why are they so reluctant to embrace MMT? Because the logic is impeccable. It’s hard to contest it. But you get these, sometimes, visceral reactions from some of the academic economists. It is true that some post-Keynesians seem to be more sympathetic to these ideas. But in general, a lot of the neoclassical economists are just plain hostile. They will claim that MMT is nothing new, nothing that we didn’t know already, and if it’s new, then it’s false. I don’t know if you’ve ever reflected on why there’s so much hostility on their side.
WM: I take it personally (chuckles). I worked in the financial sector for 20 years, been out of it for 30, but that doesn’t seem to matter.
SMM: They don’t like an outsider telling them how it actually works, right? Ivory tower complex, I guess.
WM: Yes. Maybe they just resent having been wrong, but they won’t even agree to realize that they were wrong. Maybe that is just what the type of people that go into that field are like, and it has less to do with anything that I or anybody else did to them. They are like that towards life in general.
SMM: They’re just bitter with life (laughs). It took them a long time to realize they didn’t understand anything about how the currency and the system work.
WM: That’s going to come around eventually. I’m not going to be around to see it, but history is not going to be kind to them.
SMM: That is what happened with Darwin’s theory. There was a lot of hostility towards it initially. Nowadays few people would reject the theory of evolution or even Einstein’s theory of relativity, which was probably not well understood initially.
[1] CAMELS is an international rating system used by regulatory banking authorities to rate financial institutions according to the six factors represented by its acronym. The CAMELS acronym stands for “Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity.”