by From David Richardson Krugman has decided to take on the MMT supporters and based his New York opinion piece on criticising the views of influential Stephanie Kelton. In particular it seems Krugman does not like the idea that, as he puts it, “expansionary fiscal policy is automatically expansionary monetary policy”. Earlier I argued (Richardson 2015) that fiscal magnitudes need to be examined in a stock-flow consistent analysis. I pointed out that when government spending increases, that spending is received as additional income. Corresponding to that flow is a stock adjustment through which the government issues more liabilities and more liabilities are taken up by the rest of the economy. The latter point is critical as it means the spending is virtually self-financing. The
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from David Richardson
Krugman has decided to take on the MMT supporters and based his New York opinion piece on criticising the views of influential Stephanie Kelton. In particular it seems Krugman does not like the idea that, as he puts it, “expansionary fiscal policy is automatically expansionary monetary policy”. Earlier I argued (Richardson 2015) that fiscal magnitudes need to be examined in a stock-flow consistent analysis. I pointed out that when government spending increases, that spending is received as additional income. Corresponding to that flow is a stock adjustment through which the government issues more liabilities and more liabilities are taken up by the rest of the economy. The latter point is critical as it means the spending is virtually self-financing. The recipients of the additional government spending accept the additional government liabilities and so increase their holdings of financial assets, at least in the first instance—they may then spend them. But here we need to slow down a bit.
Suppose I go into a bar, order a drink and ask the bar staff to put it on my tab. If we compare the stock of financial magnitudes before and after we see that the bar has an additional asset in the form of my IOU. I have an additional debt in the form of that IOU. So my purchase, the flow, has the effect of increasing the stock of assets/debt at the end of the transaction. If my name were well known and my credit standing good then the bar may be able to swap that IOU for cash and my IOUs would, in effect, be part of the money supply. Note that it is the purchase itself that creates the IOU and the two are simultaneous. No-one has to do any prior borrowing; you might have to establish your creditworthiness but that is a different matter.
Much the same thing happens when the government purchases an additional good or service or makes a transfer payment. However, in this case the financial status of the IOU is much clearer. Most likely your bank account will be credited with a deposit from the government.[1] Financial holdings in the private sector have thereby increased and the stock of financial holdings will increase by the value of flow of goods or services purchased. The income flow is necessarily equal to the change in the stock of financial assets. The financial transaction is likely to involve a purchase using an account with a bank but in principle there could just be a purchase using a new Treasury Bill. But most likely the transaction will involve an increase in the private sector’s holding of something we are likely to define as money. At that point the Fed (in the US) might intervene and get back the additional money by selling something in exchange for money. Of course there are an infinite variety of transactions that could lead to that result. But the main thing to note is that at the end of all that there will be additional financial assets held by the private sector equal to the value of the additional government transaction/s.
Note that so far we have not mentioned interest rates at all. None of this need have any effect on interest rates.
In Krugman’s vision the government cannot spend any more without first borrowing more and in principle interest rates have to rise to elicit more loanable funds. But what could it possibly mean if the government first borrows. Suppose the government feels the need to buy a new hospital worth $1 billion. It will then issue securities of some sort to a value of $1 billion and receives additional cash worth $1 billion. Now for the private sector there is an additional holding of $1 billion in government securities and a reduction of cash worth the same amount. No one has saved an extra cent but now the government is cashed up to buy the new hospital. A moment’s thought is enough to clarify that the government cannot elicit more savings by this or any other means prior to the purchase of the hospital. It is stock-flow inconsistent to say otherwise. Any net increase in the stock of financial assets has to have been due to some new flow of income but nothing has yet taken place. So if the government tries to borrow first it may well change the composition of the private sector’s assets but that will not change total savings and the net change in private financial wealth is zero.
When the government does get around to buying the hospital it gives the private sector additional cash worth $1 billion. At that point the private sector’s net financial wealth increases by $1 billion. If the private sector is content to sit on the cash then nothing more need change and the additional income of $1 billion is saved. However, it is likely that the recipients will spend it and so increase incomes elsewhere in the economy until eventually everyone who has received additional income is happy to just hold any remaining financial assets they have and at that time total savings will be $1 billion more than they would have otherwise been. At this point we will have experienced the full unwinding of the multiplier effects. There will also be a financial paper trail that matches the spending decisions such that in each instance purchases result in a depletion of net financial assets on the part of the purchasers and an increase in the financial assets of the recipients.
The above example makes it clear that it is the actual spending that increases both savings and the financial assets used to store those savings. This is the sense in which fiscal policy inevitably involves changes in the private sector’s holding of government liabilities which Krugman refers to as ‘expansionary monetary policy. We certainly do not have to rely on any loanable funds market.
This whole debate seems so unnecessary. The Keynesian revolution should have taught us that no matter what happens and over whatever period we use savings has to equal investment, government deficits and other injections. By modelling scenarios in which the demand and supply of funds can be different depending on interest rates the loanable funds theory is modelling a logical impossibility. Krugman is stock-flow inconsistent but he shares that with many other economists.
Ref
Richardson D (2015) ‘What does “too much government debt” mean in a stock-flow consistent model?’ real-world economics review, Issue no. 73, 11 December
[1] This requires that the private bank in question is happy to recognise additional debt to the customer because it is happy to hold the government debt as part of its assets. If not it would treat it like other deposits and wait until the funds are cleared.