Bill Mitchell responds. Alright, so I’m aware these kinds of internet disagreements inevitably reach a point of diminishing returns and we’re both really busy – so I’ll keep this short and positive. A commenter at Mitchell’s site chastises us for being a bit rude to one another and that’s probably right. I apologise in particular for calling Mitchell ‘eccentric’ – though he should note that it’s not entirely meant in a bad way, since eccentricity is historically a prerequisite for making a real contribution to economics. And no doubt my own views are eccentric too. I think it’s great that organisations like CofFEE exist and focus on taking the issues out of academia and policy circles and out to the public.
So I’ll start with where we agree. I have agreed all along that the government is not ‘operationally constrained’ by its budget, because it can ultimately issue currency. There are issues here with the independence of the central bank, which Mitchell is well aware of, but I agree that it is politically possible to end that independence.
Neither is my point that the government should not run deficits, especially in a recession. I think much of the media discourse on budget deficits at the moment is ludicrous, as I wrote a couple of weeks ago. Many perfectly orthodox, neoclassical-Keynesian economists would agree here also. Back in February I wrote another piece about how for many years technocratic economists who understood the budget as a cyclical stabiliser exploited conservative pseudo-economic predudices about balanced budgets to win political support for surpluses, but now find themselves beseiged by the conservatives when deficits are called for.
(For this reason Mitchell’s chart of the Australian-US dollar exchange rate vs. the government deficit misses my point, because throughout the period, deficits were funded conventionally through bond-issuing and not simply through creating new currency.)
The limits to government expenditure are macroeconomic. They concern the value of the currency, both in terms of goods and services (the price level) and in terms of other currencies (the exchange rate). Governments have the power to print as much money as they like, and print whatever numbers they like on the bills, but they have no control over the quantities of goods, services and financial assets they exchange for. (Mitchell objects to the money-printing metaphor, and I’m not suggesting most money is created with the printing press, but it’s the standard metaphor.)
The rational reason for governments to ‘fund’ deficits by borrowing, i.e., issuing bonds, rather than just issuing new currency, is to take money out of the private sector to ‘make way’ for their own spending. This is why I say (federal) government finance is a macroeconomic issue, and not an accounting issue. In fact, decisions about interest rates and the quantities of government debt and currency out there ought to be made on quite different principles than principles of budgeting. And in reality they have been ever since monetary policy emerged as a practice, because much of monetary policy is the art of providing to the private sector the ‘right’ amount and/or price of liquidity, so that the amount of government debt and currency in private sector hands is not a function of fiscal policy alone.
But does this mean government budgets are entirely independent, such that the consequences of any fiscal decision on the value of money can be neutralised by monetary policy if desired? I don’t think so, because the central bank is far from all-powerful. It is a powerful actor in the money market, i.e., the market for short-term debt, but it does not control it, and its power diminishes further up the interest rate spectrum, in debt markets which are highly internationalised. It certainly doesn’t control what private sector agents choose to do with their money, and while the Reserve Bank of Australia is a Leviathan in the domestic financial system, it’s a minnow in world markets. Because monetary policy cannot necessarily neutralise its effects on the supply of domestic currency, fiscal policy faces limits. Not tight, well-defined limits, but limits nonetheless.
So as I see it, the essence of my disagreement with Mitchell concerns the effects of changing quantities of currency from ‘unfunded’ deficits (i.e. not matched by bond issues) on the value of currency. Some of the points we have been discussing revolve around the question of the private sector demand for currency. Mitchell relies on an argument that the domestic private sector needs domestic currency to pay tax, which somehow underpins its value. My response is that this is an element of the demand for domestic currency, but it is limited, and far from the dominant factor.
He also repeats an argument about how central banks always accommodate private banks’ needs for reserves. This is an argument I am familiar with from Basil Moore (see his 1988 book Horizontalists and Verticalists), which has been controversial in post-Keynesian circles since it came out. If it were true, it supports my argument rather than Mitchell’s, because it is an extreme form of what I have been saying about the lack of power of the central bank to control the supply of currency! Mitchell does make a different point in his latest post, that private banks are unlikely to hoard spare reserves but will deposit them with the central bank. But in his own framework, this is only an issue if non-banks’ demand for bank credit is low enough to leave such spare reserves. The fact remains that if additional currency has entered the system from ‘unfunded’ deficits, this currency is available to fuel non-bank private sector borrowing for whatever purpose, including asset-price or currency speculation.
The core of the debate here is about the passivity or otherwise of private and central banks in the mediation between the supply of currency and the supply of credit and bank credit-money. This is a well-worn debate in the post-Keynesian literature, and if people are interested, I would recommend starting with Robert Pollin’s 1991 paper in the Journal of Post Keynesian Economics, “Two theories of money supply endogeneity: some empirical evidence”, or with the 2005 book edited by Arestis and Sawyer, A Handbook of Alternative Monetary Economics. In this debate Mitchell’s position is ‘accommodationist’ while my own view is ‘structuralist’. At least that’s my interpretation – I can’t speak for him of course.
Finally, the question of Minsky. Mitchell says he is going to get Randall Wray to “clearly tell us that Mike just is talking nonsense here” about Minsky not being on his side. I can only say I look forward to it, and I’ll hold off on the Minsky quotes until then. I know Minsky’s work very well and Wray’s pretty well also. Wray’s 1990 book Money and Credit in Capitalist Economies is really good. But when I told Wray how much I liked it at a conference dinner a few years ago, he told me his views had changed quite a bit since he wrote it. So I look forward to hearing how.