Another year older, another year useless, that’s all I really have to say.
And a belated birthday present from Saul Eslake – check the comments.
So, out of (genuine) interest, what didn’t you like about my article about GST and the taxation of trusts?
Dear Saul Eslake,
I’m just a fledgling post-keynesian neo-chartalist more commonly known as MMT or Modern Monetary Theory. I have no formal finance or economics training. I must say I am in a little awe at your presence.
I do not disagree with you at all on Trusts but I do have an academic disagreement with you regarding the GST. The GST, given the way it is collected, is an unnecessary redistributive vehicle for any sovereign nation that issues its own currency and freely floats it on the exchange.
What the GST achieves can just as easily be achieved with targeted fiscal deficits spent by the federal government, however I recognise the political reality that would make it quite difficult to achieve this.
Dear Sennex, I have to confess to lacking familiarity with ‘Modern Monetary Theory’ as you describe it – perhaps because I completed my economics degree in the 1970s (when modern monetary theory referred to something different). Hence I am not sure what the relevance of a country having its own currency (as almost all countries do) and a freely floating exchange rate (as some, though by no means all, countries do) is to the appropriateness or otherwise of a GST. But it’s never too late (and one is never too old) to learn.
I’d note that most countries with a GST or something similar (including all the members of the EU, Canada, Australia, NZ and Japan) have ‘freely floating’ exchange rates.
I acknowledge (as I did in my original Age article on this topic) that the GST can have regressive distributional consequences, and that these should be countered by appropriate changes to other taxes and/or transfer payments. Although I’m also aware of some research suggesting that the rich actually spend more on food and other items, so that including food in the GST base, or increasing its rate, might not be as regressive as widely believed.
On the GST given my limited knowledge of how it is collected and redistributed I could easily be mistaken. I am under the impression that the GST (though effectively a state tax) is collected and redistributed by the federal government. The federal government is a currency issuer, where a state government is a currency user. Federal governments do not have to obtain revenue to spend money (as I will try to show) but State governments do.
I would note that the members of the EU that are part of the European Monetary Union are not sovereign in their own currency and are subject to the Eurodollar via the ECB. So members of the EU are more like States in the Australian sense than their own nation.
I am glad that you are interested in MMT. It is largely based on G.F. Knapp’s State Theory of Money, Abba P. Lerner’s Functional Finance, Hyman Minsky’s Financial Instability Hypothesis, Wynne Godley’s Stock-Flow consistency, and extends Keynes work (hence Post-Keynesian). The ultimate goal of MMT is full employment. MMTers define full employment as 0% underemployment and only frictional unemployment (changing jobs, etc). It is my understanding this was the definition of full employment prior to the NAIRU gaining dominance and the type of employment Australia had from 1945 to approximately 1974.
MMT is a description of the way in which a modern government creates, destroys and utilizes its monetary unit (after the collapse of gold and bretton woods systems) within a fiat currency system where the issuer of this currency has monopoly supply of currency in a floating exchange rate system. The name MMT is a bit of a misnomer as it is really just a way of describing how modern monetary systems work and is not necessarily a theory. The theory is all in its application. Some believe government should be highly involved in the economy and others believe it should be involved to a lesser extent.
The short version of what gives fiat money worth is the governments ability to tax it. Pay your tax in $AUD or go to gaol. However to get that money, the government has to spend it first. So the very act of obtaining the unit of account ($AUD) is deficit spending.
It uses stock-flow consistency with national accounting. You would be familiar with the following identities:
C + S + T = GDP = C + I + G + (X – M)
So after rearranging this equation we get the sectoral balances view of the national accounts:
(I – S) + (G – T) + (X – M) = 0
That is the three balances have to sum to zero. The sectoral balances derived are:
The private domestic balance (I – S) – positive if in deficit, negative if in surplus.
The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
The Current Account balance (X – M) – positive if in surplus, negative if in deficit.
The point of a floating exchange rate which was discussed earlier is it frees monetary policy from the need to defend foreign exchange reserves (including gold). I should probably mention that this fiat currency is non-convertible (into say gold) and thus is only convertible to itself.
This makes the fiat currency revenue independent and it does not need to finance spending by issuing debt (“borrowing”).
So government borrowing doesn’t fund its spending. It merely stops interbank competition which allows the central bank to defend its target interest rate.
The flexible exchange rate system means that monetary policy is freed from defending some fixed parity and thus fiscal policy can solely target the spending gap to maintain high levels of employment. The foreign adjustment is then accomplished by the daily variations in the exchange rate.
Wikipedia now gives a good layman’s rundown of MMT
Pragmatic Capitalist also has a good crack at MMT
YouTube even has a go at explaining MMT
The three seminal works on MMT would be L. Randall Wray’s Understanding Modern Money & Warren Mosler’s 7 Deadly Innocent Frauds which can be seen in draft form for free here (pdf), as well as Scott Fulwiller’s Primer on the Operational Realities of the Monetary System
Bill Mitchell is Australia’s leading proponent of it & research director for the Centre of Full Employment and Equity (CofFEE) at the University of Newcastle
That’s my rather crass version of MMT (I probably missed a thing or two but was trying to keep this short). I know you’re a busy man with the Grattan Institute and all but I encourage you to read the original literature as some like Paul Krugman have been critiquing the critiques of MMT as if it was the original rather than the source material.
P.S. Please keep blogging at Club Troppo.
Sennex … thanks for that explanation. I’m familiar with some of Minsky’s work (particularly since the global financial crisis focussed renewed attention on some of his insights into the way credit cycles work), and with Wynne Godley. Some of the other references were unfamiliar to me, but if I get time (not likely in the weeks either side of a federal budget!) I might try to chase some of them down.
Prior to the mid-70s, ‘full employment’ was usually regarded as consistent with an unemployment rate below 2%, that number being thought sufficient to cover frictional and seasonal unemployment. Remember though, this was a time when a much smaller proportion of the population wanted to work (ie, men and single women) so the number of jobs needed to ensure ‘full employment’ wasn’t as large (relative to the size of the population) as it is today.
You’re right that with a floating exchange rate, a central bank can pursue an independent monetary policy and doesn’t need to hold a relatively large stock of reserves (the People’s Bank of China is a hugely relevant contemporary counter-example). That’s a standard result of all monetary theories that i am aware of.
Likewise the national accounting identity that you present and re-arrange is well known as the basis for the (now somewhat discredited) ‘twin deficits’ theory linking the budget and current account deficits. However I am not sure how that identity “makes the fiat currency revenue independent and it does not need to finance spending by issuing debt (“borrowing”)” or how it leads to the conclusion that “government borrowing doesn’t fund its spending [but] merely stops interbank competition which allows the central bank to defend its target interest rate”.
Governments do sometimes borrow for reasons other than to fund spending (most recently in Australia in the years immediately prior to the GFC when the government was running budget surpluses but nonetheless continued to issue bonds in order to maintain liquidity in the bond market); but it would be hard to argue that the budget deficits which have been incurred since 2008-09 have been for any purpose other than to fund government spending.
The Reserve Bank keeps the cash rate (very) close to its announced target by buying and selling government and (more recently) other securities in sufficient volumes to ensure that it remains there; the cash market (strictly speaking, the market in the exchange settlement funds that banks maintain in their accounts at the RBA) is very small and thus pretty easy for the Bank to deal in).
I’m not sure whether it’s a conclusion of MMT, although it’s widely recognized in other monetary theories that fiat money systems are much more prone to inflation than systems anchored by (most commonly) gold – although even gold-based monetary systems experience inflation when the supply of gold increases rapidly (as in Victoria in the second half of the 19th century, for example). That’s why other monetary theories emphasize the importance of having a ‘nominal anchor’ on which inflationary expectations can be founded – either an exchange rate peg (but it has to be credible, as in Hong Kong, or Denmark’s peg to the euro), or (in most advanced economies including Australia) a credible inflation target backed up by a prohibition on central bank financing of budget deficits.
Anyway it’s an interesting subject so thank you for drawing my attention to it.
If you’re still around, this is a new piece by L. Randall Wray on Wynne Godley and Hyman Minsky that I recommend reading http://www.levyinstitute.org/conferences/godley2011/Wray.pdf (PDF)
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