Modern Theory Lecture 3 Campinas Aug 2018 Professor L.Randall Wray

Reaction to MMT

• Federal government spends through keystrokes that credit bank accounts so it can afford anything for sale in dollars. • The reaction typically goes through four stages: • 1. Incredulity: That’s Crazy! • 2. Fear: Zimbabwe! Weimar! • 3. Moral Indignation: You’d destroy our economy! • 4. Anger: You’re a Dirty Pinko Commie Fascist! Ingham: Money is an institution; record of a social relation • Money is social in 3 ways: -produced outside mkt; no ind is free to produce own M; must be legitimately sanctioned; counted by those who count -monetary exch consists in social relation; unlike ; involves an IOU -today, money-stuff consists in symbol of state’s or bank’s promise to pay Alternative: Modern Money

• Use of and value of M are based on the power of the issuing authority, not on intrinsic value. • State played central role in evolution of M. • From beginning monetary system mobilized resources • One Nation, One Currency Rule • Separate not a coincidence. Tied up with sovereign power, political independence, fiscal authority. • TAXES DRIVE MONEY: • State chooses money of account, imposes obligation denominated in that unit, issues currency denominated in that unit, and accepts its own currency in payment of the obligations Fiscal Constraints

• Economists: Unsustainable debt path! • 70% of Americans say progress on Deficit needed • Chinese might stop lending to us! • Zimbabwe and Weimar hyperinflation! • Burden our grandkids! • Look at Euroland! • Sovereign debt crisis • Default risk • Bond vigilantes Thomas Smith 1832

• Paper money has no intrinsic value; it is only an imputed one; and therefore, when issued, it is with a redeeming clause, that it shall be taken back, or otherwise withdrawn, at a future period. (Smith 1832, p. 49) • Value maintained by Redemption • Sin of Debt and Saintliness of Redemption Drive Money Govt Spends First, Then Collects Taxes

• The BofE issues its notes to merchants upon bills of exchange… The advances to government are conducted in the same manner, the amount to be advanced is placed to the credit of the treasury, or of the particular department for which it is destined, and the officers in that department draw for it, from time to time, as may be required. When the bills discounted, or the taxes on which the advances have been made, become due, then the notes which have been advanced are returned in payment. (Smith 1832)

The BofE issues the notes that will be used to pay taxes in Redemption Banks Advance Notes, Then Collect Them, TOO

• This mode of issuing notes is not peculiar to the • bank of England, it is followed by every respectable Banks issue the and well regulated bank…A bank discounts a bill of notes that exchange…and gives its own notes, which are returned when the bill becomes due; but if, in the debtors will use interim, these notes are presented, and gold to make demanded and received for them when the bill comes due, there will be no notes to retire it with…. payments to the [B]anks always hold securities for a larger amount banks in than they have notes out. As they are not bound to take any thing except their own notes or specie; if Redemption they do not, or cannot, get the first, they must the last; and thus, not only the specie they have issued must revert to them, but, should they stop making fresh issues, a great deal more. We Cannot Run Out of Money

Uncle Sam’s Money Tree The possible consequences are: • Over-Full Employment of Resources

• Inflation Why Don’t Economists Get This?

• It was more transparent when Treasury “raised a Tally”

• Operational constraints on modern Central Banks

• Economists don’t understand banks!

• And don’t want to let the cat out of the bag Let That Cat Out of the Bag!

• Lord Adair Turner: within limits financing government spending by printing money “absolutely, definitively” does not lead to inflation.

• “I accept entirely that this is a very dangerous thing to let out of the bag, that this is a medicine in small quantities but a poison in large quantities but that there exist some circumstances, in which it is appropriate to take that risk.” But Is that True?

• “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Mark Twain

• Is there evidence of run-away, Weimar/Zimbabwe Deficit Spending? • Is debt at historic high? • Is govt spending out of control? • Have we hocked ourselves to China? • Does debt burden our grandkids? • Will Entitlements (ie Social Security) bankrupt our grandkids? Modern Money: Fiscal Policy

• Modern govt spends by crediting bank accounts, and reserves of those banks • Fed and special banks help facilitate process • Sovereign govt can “afford” to buy anything for sale in its currency • Taxes by debiting bank accts • Net creditsdeficitsnet financial assets • Govt does not, cannot “borrow” its own currency Modern Money: monetary policy summary

• sets overnight rate • Accommodates demand for reserves • Coordinates with Treas to supply/drain reserves The Central Bank • The Government’s bank: Makes and receives all payments for Treasury • Empowered to set target overnight (interbank) interest rate • While most claim to be targeting inflation, little evidence they control inflation • Fed dual mandate (high employment, price stability, and growth) prevents it from specifically targeting inflation • Usually has some bank regulation responsibility • Lender of Last Resort • Fed is “Creature of Congress” • Claims that Fed is “independent” or controlled by banks are overstated • While banks “own shares”, cannot buy/sell them, and receive no voting rights • Always subject to regulation by elected representatives • In war or crisis, subjected to closer regulation • Its operations are largely accommodating so as to hit rate target (explained below) Payments system, Reserves, Interbank market

• Interbank/fed funds rate: main policy target—a “market” rate • Discount rate: rate central bank charges at Discount Window • Interest rate paid on reserves (historically zero in US, now positive) • Maintains narrow band between discount rate and rate paid on balances— to hit fed funds rate target • Banks DO NOT lend out reserves to customers; they can only lend to one another. Used to meet req’d reserve ratio (if it exists) and for interbank payments • Central bank ACCOMMODATES demand. Otherwise it has trouble hitting target, and ultimately, maintaining stability in payments system The Treasury

• Fiscal agent of govt; charged to make budgeted payments, and receive taxes imposed by representatives • Authorized to issue currency and other debt (bills, bonds) • (including platinum!) • Historically, issued paper notes; now only Fed does so • Congress and President determine how much to spend and set tax law; Treasury is only the agent that spends budgeted amount • Deficit is known only ex post: total spending (including transfers and interest) less taxes (and other revenues) • Generally, new bond issues approximately equal deficit (ex post) • Government’s deficit = nongovernment’s surplus (Sectoral Balances) • Nongovernment net financial assets accumulated = government debt issued • Sovereign govt cannot run out of money Myths Surrounding CB Independence

• Main argument: Fed is, and should be, independent to fight inflation: • Perceived threat: financing Treasury deficits  inflation; insolvency • But operational realities ensure Fed cooperates

• Limited independence: selects overnight rate target  accommodates reserve demand. • In times of stress, voluntarily cooperates, or Congress mandates cooperation • Chairman Mariner Eccles: independence is pragmatic, not universal law Place of Fed in Government

• Currie 1935: “The Federal Reserve is a creation of Congress and not of the Constitution, and its duty is to carry out the will of Congress. It is necessary, therefore, that Congress retain some degree of control over the money issuing authority.” • US Congress 1952:“The Board of Governors, like all other parts of Government, must play as part of a team, not as an outside umpire, and must ultimately abide by the decisions that are made by Congress” …“This formal independence of the Board of Governors from the president is inevitably limited by the hard fact that fiscal and monetary policy must be coordinated with each other and with the other policies and objectives of the Government” • Bruce K. MacLaury “First, let's be clear on what independence does not mean. It does not mean decisions and actions made without accountability. By law and by established procedures, the System is clearly accountable to congress—not only for its monetary policy actions, but also for its regulatory responsibilities and for services to banks and to the public… • Nor does it mean that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public-interest.” It has a degree of independence within the government—which is quite different from being independent of government.

• Thus, the Federal Reserve System is more appropriately thought of as being “insulated” from, rather than independent of, political—government and banking—special interest pressures.” How Government Spends its Own Currency Today: Keystrokes • Spending  credits • Government credits bank’s reserves; bank credits account of recipient

• Taxes  debits • Government debits bank’s reserves; bank debits account of taxpayer

• Deficits  net credits • Government net credits bank’s reserves; bank net credits account of recipient Simple Model: Sovereign Currency Issuer

Spends

Sovereign Subject

Taxes Sovereign Currency w/CB and Banks

Treasury

CB Taxpayer Bank Bank Contractor 1 2 Money as Scorekeeping Budget “constraint” or Accounting Identity?

• Orthodox believe government “chooses” bond-finance or money-finance • Govt Budget Constraint, similar to that of household or firm

• G + iB - T ≡ ΔB + ΔMh • iB is interest on bonds, T is taxes, ΔB is bond issues, high powered money issued is ΔMh • This is just an accounting identity, ex post. A budget deficit increases nongovt sector net financial assets, held in the form of bonds or cash plus reserves • There is always a demand for treasury bonds; indeed 21 primary dealers in the US must place bids The Role of Taxes • Beardsley Ruml, Chair NYFed: Taxes for Revenue are Obsolete • “National states no longer need taxes to get the wherewithal to meet their expenses.” (with abandonment of gold standard) • Why, then, does the national government need taxes? He provides four reasons: • As an instrument of fiscal policy to help stabilise the purchasing power of the dollar; • To express public policy in the distribution of wealth and of income as in the case of the progressive income and estate taxes; • To express public policy in subsidising or in penalising various industries and economic groups; and • To isolate and assess directly the costs of certain national benefits, such as highways and social security. • Conclusion: Briefly the idea behind our tax policy should be this: that our taxes should be high enough to protect the stability of our currency, and no higher…. Now it follows from this principle that our tax rates can and should be lowered to the point where the federal budget will be balanced at what we would consider a satisfactory level of high employment. Currency sovereignty and policy independence

• With a floating exchange rate and a domestic currency, government’s ability to make payments is not revenue constrained • Logically, the sovereign currency must be issued before it can be collected in taxes • Households and firms are currency users; must obtain it first through income or borrowing. • Govt is currency issuer. It can spend currency into existence • Bond sales are really an interest rate maintenance operation: otherwise Treas spending by crediting bank reserves would cause excess reserves and downward pressure on rates • Modern self-imposed procedures do not impose constraints • Central bank and private bank operations ensure Treasury can spend up to budgeted amounts • Central bank focus on payments system and interest rate target ensure smooth operations • Treasury checks never bounce due to insufficient funds Sovereign Fiscal Policy and inflation

• Won’t MMT policy hyperinflation? Weimar! Zimbabwe! A) MMT analysis of fiscal and monetary policy coordination is description not policy B) MMT policy, such as JG is less inflationary than orthodox Keynesian policy A) It is targeted spending B) It provides a high quality buffer stock C) It is automatically countercyclical D) It is not helicopter money Hyperinflation

• Cagan definition: hyperinflation is inflation > 50% per month • He finds that in hyperinflation, money growth is very high, but not as high as inflation; V also rises. Explanation: money becomes like a hot potato • Usual explanation: “money printing”; Govt runs the printing presses at full speed. Pushes up inflation, increasing govt spending faster than tax revenues—causing deficits that are financed by printing even more money • Ironic: Quantitative Easing really does increase “government money” and it was feared by many that it would cause inflation or hyperinflation MMT explanation of hyperinflation

• Govt always spends by keystrokes; if “money printing” causes hyperinflation, then it would be very common • If high deficits cause high inflation, then Japan would have high inflation rather than deflation • But hyperinflation is actually rare • Limited to countries that have fixed exchange rates, gold standards, and/or debts in foreign currencies • These countries are exposed to exchange rate crises • In addition, hyperinflation is related to severe political and social crisis Real World Hyperinflations • Weimar: Germany lost WWI; was subjected to unbearable reparations payments that had to be paid in gold. (Keynes Economic Consequences of the Peace) Had to export, but had lost its industrial areas. Productive capacity was not sufficient even for domestic demand; govt couldn’t raise taxes to meet its reparations payments. So govt competed with private demand, creating price pressures. Germany’s producers had to borrow in foreign currency to import; currency depreciated raising costs of imports and reparations. Hyperinflation resulted; only ended with creation of a new tax driven currency. • Zimbabwe: Whites were 1% of population, owned 70% of productive land. After 2000, land reform led to collapse of food production (45% reduction), Unemp rose to 80%, exports declined 57%, manufacturing declined, etc. Collapse of supply was main cause of hyperinflation. • While it is true that tighter fiscal policy might have helped in both cases, the problem was not fundamentally related to “money printing to finance deficits”. Real World: Self-imposed constraints

• Budgeting, debt limits • Operational constraints: • Treasury writes checks on accts at CB • CB prohibited from buying Treasury Debt new issues • Use of Special Depositories • Use of Tax and Loan accts Coordination of Monetary and Fiscal Operations • We will allow more realistic assumption that CB cannot buy bonds in primary mkt • So Treas sells bonds to banks before spending • CB debits bank reserves and credits Treas deposits (at CB) • But banks must get those reserves from CB so that they can be debited; they can sell bonds to CB • After govt spends, bank reserves riseexcess reserves • So CB sells enough bonds back to banks to drain XR • Typical case: CB does a repo: buys Bg from banks to give them the Res to buy Bg from Treas; After Treas spends, CB reverses the repo, selling the Bg

• NOTE: at the final step, the balance sheet looks the same as simply crediting res accts or spending currency. In other words, the procedure followed to deal with the self-imposed constraint makes no difference! (check for yourself--appendix) Consolidated Govt: simple case

• 1A. The government’s spending credits bank accounts with reserve balances (HPM). • • 2A. Banks credit the accounts of the spending recipients. Result: Bank reserves increase, bank deposits increase, private sector net financial wealth increases. The change to the government’s financial position is necessarily the opposite—its net financial wealth has been reduced (i.e., the equity on the liability/equity side of the government/central bank balance sheet has been reduced). • • 3A. Finally, absent interest on reserve balances, the government/central bank issues bonds or offers time deposits to drain or otherwise replace the reserve balances (HPM) created by the deficit if they are not consistent with banks’ demand for reserve balances at the targeted interest rate. This is the Horizontalist recognition that if actual reserves deviate from desired balances, the central bank must drain reserves to hit its interest rate target. Implications of Govt Deficit: simple case

• (i) the government is not constrained in its spending by its ability to acquire HPM since the spending creates HPM as in 1A and 2A. Spending does not require previous tax revenues and indeed it is previous spending or loans to the private sector that provide the funds to pay taxes or purchase bonds. • (ii) the issuance of bonds in 3A is not for financing purposes but for monetary policy purposes so that the targeted interest rate can be achieved. Alternatively, government can simply pay interest on reserves (which then serve the same purpose as bonds that pay interest). • (iii) the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth as in 2A. The “market” does not set interest rates on the debt, or at the very least the government has the option of always setting the rate on its own debt. USA Case with Self-imposed constraints

• 1B. The Fed undertakes repurchase agreement operations with primary dealers (in which the Fed purchases Treasury securities from primary dealers with a promise to buy them back on a specific date) to ensure sufficient reserve balances exist for settlement of the Treasury’s auction (which will debit reserve balances in bank accounts as the Treasury’s account is credited) while also achieving the Fed’s target rate. (Note that the point here is not that the Fed necessarily engages in operations that are equal to or greater than the auction, but that the operations ensure that sufficient balances circulate such that the auction settles without the effective federal funds rate for the day moving above the target rate. This requires that the balances already in circulation plus those added via operations are sufficient to settle the auction and enable banks to end the day with their desired positions at the target rate equal to actual positions.) • 2B. The Treasury’s auction settles as Treasury securities are exchanged for reserve balances, so bank reserve accounts are debited to credit the Treasury’s account, and dealer accounts at banks are debited. Treasury auctions can only settle via reserve balances using the Fedwire and settlement system. • 3B. The Treasury adds balances credited to its account from the auction settlement to tax and loan accounts. This credits the reserve accounts of the banks holding the credited tax and loan accounts. Self-imposed constraints, con’t

• 4B. (Transactions 4D and 4E are interchangeable; that is, in practice, transaction E might occur before transaction D.) The Fed’s repurchase agreement is reversed, as the second leg of the repurchase agreement occurs in which a primary dealer purchases Treasury securities back from the Fed. Transactions in A above are reversed. • 5B. Prior to spending, the Treasury calls in balances from its tax and loan accounts at banks. This reverses the transactions in C. • 6B. The Treasury deficit spends by debiting its account at the Fed, resulting in a credit to bank reserve accounts at the Fed and the bank accounts of spending recipients. This increases the net financial wealth of the private sector. • As with the general—simple--case above, the analysis is much the same in the case of a deficit created by a tax cut instead of an increase in spending. That is, with a tax cut the Treasury’s spending is greater than revenues just as it is with pro-active deficit spending.) • What MMT stresses is that regarding (i), (ii), and (iii) above, the end result is exactly as stated in the general case, even though with the procedures adopted due to the self-imposed constraint the transactions are now more complex and the sequencing is different. Policy Implications

• Govt cannot go bankrupt in its own currency • Govt can always “afford” to buy anything for sale in its own currency • If there is unemp labor, govt can always hire it to put it to work—existence of unemp is ALWAYS a failure of policy • The only economic constraints govt faces are: full emp of resources, and inflation • Other constraints are political Modern Money: What I did and did NOT say

• I did say: Sovereign govt faces no financial constraints; cannot become insolvent in its own currency • But it can only buy what is for sale • I did NOT say that govt ought to buy everything for sale • Size of govt is a political decision with economic effects • I did NOT say that deficits cannot be inflationary: • Deficits that are too big can cause inflation • I did NOT say that deficits cannot affect exchange rates: • Sovereign govts let currency float; float means currency can go up and down Sovereign Currency: Summary

• Deficit spending creates private financial wealth • Note that CB operations do not; it buys government bonds or lends against collateral (helicopter drop is fiscal policy) • CB Lends; Treasury Spends

• Doesn’t matter whether bonds must be sold first—so long as CB accommodates reserve demand

• Doesn’t matter whether CB prohibited from buying new issues—roundabout through banks

• Doesn’t matter whether Treasury must have “money” in its acct at CB to spend—CB and banks cooperate Domestic Currency • Most nations adopt a domestic currency—IOU denominated in state money of account and issued by Government. • Alternatives: i) pegged (convertible): least policy space ii) managed: more policy space iii) floating (nonconvertible): most policy space Goodhart: Two Views Domestic Money • Dominant View: Metalist, M-theory • M originates and evolves due to private sector attempts to reduce costs of exchange. • Orig choose a commodity with value of M det’d by intrinsic value. Discovered they could lower transactions costs by using paper notes, redeemed on demand for gold. • So long as paper notes backed by 100% gold, retains value. If too much M issued, it falls in value (inflation). Orthodox Approach to Money and Exchange Rates * Role of Relative Prices: Signals • Role of Money: Lubrication; determines only Nom P • Seigniorage • Fixed Exchange rates and Specie-flow Mechanism • Flexible Exchange rates and Trade • Mundell’s OCA: 1 mkt, 1 money • Mobile labor and capital with W/P flexibilityOCA Alternative: , Cartalism, C-theory, Sovereignty

• Use of currency and value of M are based on the power of the issuing authority, not on intrinsic value.

• M is tied up with sovereign power, political independence, and fiscal authority. There have always been links among fiscal authority, M creation, the , the Central Bank.

• C-theory begins with govt and the need for govt to provide the infrastructure and institutions necessary for a mkt economy.

• Breaking link between state and currency reduces fiscal power to achieve public purpose. Fiscal Space with sovereign currency “[T]he power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony.”

~Wynne Godley, 1992 Exchange Rate Systems

• Gold Standard: fixed • Bretton Woods WWII-1973: fixed but adjustable: dollar/gold standard • Flex Exchr 1973-present; a dollar-standard but dollar floats • Future: New Bretton Woods vs Float? Davidson: Compare 3 Exchange Rate Systems

• Orthodox promise: flex exchr will allow rapid adjustment to trade balance; stabilizing force. • But “Capital flows” swamp trade in g&s; no tendency for trade imbalance to lead to currency adjustment that eliminates the imbalance. • BW has by far the best record: much faster real GDP growth in both the DCs and LDCs; faster r/g productivity; more stable P; lower unemp • Post 1973: 100 currency crises; rising international indebtedness of some countries; tendency to stagnation Why was BW better?

• Can't just be fixed exchr since gold standard had that. Must have been the way that trade imbalances are resolved. • Keynes: If you have convertible currencies, then "free mkts" will put burden of adjustment on the deficit countries; these tend to be weaker and smaller. • They adjust by austerity: slowing growth. This then leads to stagnationary bias. • So must put burden on surplus nations. This avoids stagnation. Sovereignty: Chartalism & Functional Finance: MMT alternative

In a sovereign country with its own floating currency:

A sovereign government does not need tax revenue like private units need income.

Government imposes tax liability, which generates a demand for “that which is necessary to pay taxes”—the government’s liability.

Government spends by crediting bank accounts. Cannot be revenue constrained. Should We Avoid Trade Deficit?

• Should we avoid econ growth to avoid a trade deficit? • Imports = benefit; exports = cost; => trade deficit = net benefits • Trade deficit results from ROW desire to net save $ assets • US Trade deficit “finances” ROW saving Orthodox view: Twin Deficits

• Belief that govt defhigher r • Higher rcurrency appr • Currency appreciationtrade deficit Alternative view of twin deficits

• There is a symmetry to the “twin deficits”, although not the conventional wisdom {belief that govt defhigher rcurrency apprtrade def}:

-A budget deficit occurs when the nongovt sector desires to net save in the form of sovereign debt. -A current account deficit occurs when the ROW wants to net save dollar- denominated assets.

• The common view that this net saving of the non-govt and ROW sectors, respectively, “finances” the govt and trade deficits, respectively, has confused an identity with causation. BURDEN OF THE DEBT

• Orthodox: budget and trade deficits burden future generations, who must repay. Is that true?

• We must distinguish between govt purchases and private imports. • When a US non-sovereign consumer purchases an imported Toyota, she gives up income or sells an asset or issues a liability to finance it. • The Japanese exporter holds a $ claim on a US bank that will be converted to a yen claim on a Japanese bank, which in turn will convert a $ reserve to a yen reserve at BOJ. • The American used her income, or sold an asset, or committed herself to payments on debt. • There is no free lunch—a trade deficit can be associated with rising indebtedness of consumers—a burden. Debt burden, con’t

• However, increased American purchases of domestic output have the same result, as they are financed in exactly the same way: consumer debt can rise. • By contrast, if the US govt imports a Toyota, it truly “gets something for nothing”—issuing $ that end up at BOJ. • But any Sovereign obtains “something for nothing” by imposing taxes and issuing currency used to pay tax. • The only difference in our example is that the US govt obtained output produced outside the US, by those who are not subject to its sovereign power. Is the US Unique?

• NO—other Sovereigns with floating rates obtain the same “seigniorage income”. • That ability is related to power to impose taxes in the domestic currency—only the State has this power. • While “seigniorage income” is sometimes equated to the total quantity of net imports, imports purchased by the non- sovereign population do not provide any “free lunch”. It is only the portion of a trade deficit that is due to sovereign purchases that provides a free lunch. IMPLICATIONS FOR A SMALL COUNTRY LIKE Czech Republic

• *With a floating currency, CR can exogenously set its interest rate • *CR’s national government does not need taxes or bond sales to “finance” budget deficits • *national government bond sales function to drain excess reserves from the banking system—a part of monetary policy that allows central bank to hit interest rate target • *CR can “financially afford” to buy any good or service that it is capable of producing (plus what ROW willing to sell to CR) • *CR can “afford” full employment; indeed, unemployment is a cost, employment is a benefit • *a national government budget deficit simply “finances” the non-government sectors’ desire to net hoard High Powered crowns • *a current account deficit “finances” the Rest of World’s desire to net hoard crowns US$: Hegemony or Sovereignty?

• ROW preference for $ is due, in part, to size of US economy. However, desire to hold $ reserves couldn’t be adequately satisfied if US did not run trade deficits. • US trade deficits, in turn, require that the ROW desires to sell more to the US than it is willing to buy from the US. Given ROW’s desire to accumulate $ the US is “forced” to reap “seigniorage income”. • If Japan and Euroland decided to pump up their economies to eliminate trade surpluses, they, too, would be “forced” to reap “seigniorage income”—and US “seigniorage income” would probably decline as exports rose. What about exchange rates?

• Counter argument: only US can run persistent trade deficits without causing exchr depreciation. That requires “two to tango”. So long as the ROW wants more $, it remains strong even with a trade deficit. • Under current “rules of the game”, economic success is measured by the quantity of $ reserves accumulated—just as mercantilist nations measured success by gold inflows. --consistent with fixed exchange rate regimes, and it severely constrains domestic fiscal (and monetary) policy. • However, analysis for countries on flexible exchange rates requires new paradigm: Sovereignty; Chartalism; State Money. • Further, evidence demonstrates high costs of fixed exchr—in terms of high unemployment, low economic growth, fiscal and monetary policy constraints— versus the advantages of floating rate regimes. Implications of Alternative Currency Regimes

• Government is monopoly supplier of its currency; determines conditions of supply i) floating: affordability is never an issue; consequences of too much spending include inflation, too few resources left for private sector, exchange rate depreciation ii) managed: additional constraints—maintenance of foreign currency, run on currency, currency crisis iii) pegged: additional constraint—default

NB: in all cases, there are always political constraints, operational constraints, myth, and misunderstanding Role of US in Global Economy Today

1950s: US trade surplus, capital acct deficit (lending)

1960s: Need for growing government budget deficit to allow private savings/growth of net wealth; US loses trade surplus

1970s/80s: US role as world’s —balance of trade deficit + $lending to allow ROW to accumulate dollar assets and service debts

Today: US as buyer of last resort; at full employment, budget deficit must offset current account deficit plus private sector surplus Case 1a: Government imposes tax liability and buys a bomb by crediting an account at a private bank Government Asset Liability

+ Bomb + Reserves + Tax Liability + Net Worth

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Reserves + Demand - Bomb + Tax Liability Deposits - Net Worth + Demand Deposits Taxes are paid Government Asset Liability

- Tax Liability - Reserves

Private Bank Private Nonbank Entity Asset Liability Asset Liability

- Reserves - Demand - Tax Liability Deposits - Demand Deposits Taxes are paid

Government Private Nonbank Entity Asset Liability Asset Liability

+ Bomb + Net Worth - Bomb - Net Worth Case 1b: Government deficit spends, creates private net financial assets Government Asset Liability

+ Bomb + Reserves

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Reserves + Demand - Bomb Deposits + Demand Deposits 1 b. Government sells Bond to drain reserves

Government Private Nonbank Entity Asset Liability Asset Liability

- Reserves - Reserves + Bond + Bond Final Position, Case 1b Government Asset Liability

+ Bomb + Bond

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Bond + Demand - Bomb Deposits + Demand Deposits Case 2: Government must sell bonds before it can deficit spend

Government Private bank Asset Liability Asset Liability

+ Demand + Bond + Bond + DD Deposits Government Government buys bomb, writing check on private bank

Government Asset Liability

- Demand Deposits + Bomb

Private Bank Private Nonbank Entity Asset Liability Asset Liability

- DD Government - Bomb + DD Private + Demand Deposits Final position, Case 2 Government Asset Liability

+ Bomb + Bond

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Bond + Demand Deposits - Bomb

+ Demand Deposits Case 3: Treasury can write checks only on its central bank account; first sells Bond to private bank

Treasury Private Bank Asset Liability Asset Liability

+ Bond + Bond + DD Private bank + DD Treasury Treasury moves deposit to central bank account

Treasury Central Bank Asset Liability Asset Liability

+ Loaned - DD Private bank Reserves + DD Treasury + DD CB

Private Bank Asset Liability

- DD Treasury + Borrowed Reserves Treasury buys bomb

Treasury Central Bank Asset Liability Asset Liability

- Demand - Loaned Deposits Reserves - DD Treasury + Bomb

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Demand Deposits + Demand Deposits - Borrowed Reserves - Bomb Final position case 3 Treasury Asset Liability

+ Bomb + Bond

Private Bank Private Nonbank Entity Asset Liability Asset Liability

+ Bond + Demand Deposits - Bomb

+ Demand Deposits L. Randall Wray, Levy Institute and UMKC [email protected] www.levy.org

Blogs: Great Leap Forward http://www.economonitor.com/lrwray/ NEP http://neweconomicperspectives.org/