Ep. 136 MMT Follow-up: A Framework for Money, Inflation, and Debt
As a follow-up to his discussion on MMT with Rohan Grey (in ep. 130), Bob goes solo to explain the basic cash balance framework for thinking about money, inflation, and debt. Specifically, Bob will explain why he thinks it’s far more important to know how the government finances a deficit rather than knowing what it spends the money on.
Mentioned in the Episode and Other Links of Interest:
- BMS ep. 130 with Rohan Grey.
- Bob’s infamous inflation bet: response to Krugman/DeLong and his explanation years later for reason.com.
- Rothbard’s critique of the “equation of exchange,” MV=PQ.
- Bob’s QJAE article on the economics of fractional reserve banking.
- Help support the Bob Murphy Show.
The audio production for this episode was provided by Podsworth Media.
The baby added cuteness to this episode.
I definitely derived marginal utility from the baby too.
A gentle but firm rebuttal to Thaddeus Russell … demonstrating who has a better grip on the concept of why we have “male” and “female” and the … errr … deeper meaning behind these social constructs.
Upon re-listening to your discussion with Rohan Grey, I came to the conclusion that the misunderstanding between you and him is based on whether or not you assume that the Fed monetizes any and all (new) government debt issuance. Rohan seems to make this assumption without being explicit about it and – more importantly – without acknowledging that this was not the case historically.
I am by no means an expert on the technical implementation of monetary policy, but if I get this right, the mechanism by which the Fed maintains control of the FFR has changed:
Pre-QE it used to do so using open market operations, i.e. adjusting the amount of reserves in the system by buying and selling USTs until the FFR (which is an Interbank rate the Fed can never directly control) was inside its target range. Above and beyond those purchases necessary in order to control the FFR, the Fed DID NOT buy any more USTs (importantly not in order facilitate government borrowing either). So clearly, in the pre-QE-regime, it would have mattered a whole lot whether the government issued debt (subsequently NOT monetized as just explained) or a trillion dollar platinum coin that would immediately be monetized by the Fed.
Now, post-QE, if I understand this correctly, the Fed cannot use OMOs anymore to set the FFR as the amount of existing reserves is so gargantuan that no commercial bank is even close to not meeting the reserve requirement. Instead, it has decoupled the implementation of its interest setting function from the amount of debt it holds (and employs IOER instead). Hence, the Fed is now free to monetize whichever amount of government debt it wants without foiling its efforts to keep the FFR on target.
Now if in this new regime, the Fed decided to monetize 100% of new UST issuance (a situation we are getting close to post-Covid), then indeed it wouldn’t matter whether the trillion dollar coin or regular debt instruments were used to finance government deficits. Otherwise, however, I believe you are absolutely right in that it does matter to the price inflationary effect of government spending whether or not the funds are sucked out of the private sector first.
Rohan may be right that this money that the private sector is now lacking would not have been spent on milk anyways (hence also the relatively muted CPI-inflation despite massive amounts of monetary inflation in the recent decade) but it certainly isn’t there any longer to compete for other financial or real assets such as stocks, bonds, real estate and the like whose prices should – all else equal – fall.
One thing I’d like to hear your thoughts on is the point made by some Austrian aligned analysts like Mike Shedlock and EB Tucker, and Mike Maloney that debt monetization, while clearly distorting the market and inflating asset prices can and has had a deflationary effect on consumer prices by artificially inflating the supply of certain consumer goods and services by keeping zombie companies afloat and the like. Where the deflation is not as much directly a monetary phenomenon but indirectly one by subsidizing near term supply. Such that the more the Fed keeps failing firms afloat the near term effect is actually consumer price deflation and the ultimate effect is long term consumer price inflation.
I think to some extent you’ve talked about this as well but I’m wondering what your thoughts are in the context of the MMT discussion.
I really like these fundamental episodes. With MMT’s ascendance and the whole money printing for Corona Virus, this topic is more important than ever. The idea of “we can’t afford it” just really seems out of the window, and both major political parties are now in “but they spent money we didn’t have as well, so we’ll do it too!” mode.
In a very “explain it to me like I’m 5 years old” way, I think it’s quite obvious that we can’t create wealth with an accounting trick, no matter how neat it is.
It’s very easy to explain even to a non-economically interested person or a child that if you borrow money you will have to pay it back.
The polemic advantage of printing money is that it’s very much NOT obvious where the money “comes from.” It seems to “come from nothing.”
Price inflation is the place enemies of the printing press have traditionally pointed towards, but a) price inflation is laggy, b) the measures are being gamed, c) and is unevenly distributed.
Yet clearly, we can’t have something for nothing.
It seems to me we need an ELI5 (explain like I’m 5) way of explaining who actually pays for those expenses – it’s not rich people, they’re in stocks and other non-nominal investments. It really comes out of the pocket of current and future holders/earners of nominal dollars, and that’s mostly seniors with fixed nominal income, wage-earners, and so on.
I think one important factor, too, is that we don’t focus too much on consumer prices in this narrative. As you mention in this episode, nobody’s mad his house and stocks got “inflated” in price.
In my opinion, wealth inequality is a huge symptom of this. The money printing takes money from financially less savvy people and re-distributes it to the financially more savvy ones. Everything becomes financialized, you can’t make any money by just “saving,” you now need to engage in a perpetual cycle of yield-chasing to outrun the other yield-chasers.
Public imagination somehow finds it easy to imagine that the additional money just “came out of nowhere” if it’s not immediately obvious where it is missing from, unlike taxes or borrowing.
Somehow we need to find a way to explain that money is always coming from somewhere, and that it is actually not in the interest of many people to take away the nominal value of the dollar and hand it to the already-rich.
I don’t know if this rant makes sense to you, but I’d be interested in an exploratory episode or interview about this less-technical and more “what actually happens to Joe Schmoe” side of the dynamic.
Late comment and review on the Rohan epic … approx 1:00:00 to 1:06:00 there’s a key discussion in the interview (ep 130) about Bonds vs Cash in terms of what is “real money” and what is some other type of asset. I’m going to summarize a bit:
Bob: You can have debt as money, provided the debt shows up on the Fed balance sheet and the money is the type of money that can be spent at the grocery store.
Rohan: The Fed can always rebalance any type of debt against any other type of debt, and since interest rates are effectively zero that makes no difference either … here’s an example scheme to illustrate the way the Fed can create a scenario where private actors end up holding Treasury Bonds in order to get the balance that the Fed desires.
Now, here’s what I noticed (after sitting and thinking for a while) … Rohan’s scheme involved what he called “Sweetheart Deals” and “a few extra basis points” in order to nudge, nudge those private actors who didn’t really want to hold illiquid assets but could be offered a little incentive to hold the Treasury Bonds where necessary. I thought about it … hmmmm … offering someone an incentive to hold illiquid assets … there used to be a name for that … oh yeah, now I remember, it’s called “Yield Curve”.
In a nutshell, Bob’s argument is that if the Fed wants private actors to hold illiquid assets over a decent length of time, interest rates must go up … and Rohan’s response is, “Hey we just pay them to hold those assets.” Ohhhh, that’s kind of the same thing, ain’t it?
On even deeper reflection, I started thinking along the lines of “Nothing Is As It Seems, Nor Is It Otherwise” and I figure that perhaps the published yield curve rates are not really the rates.
Recently I purchased a bunch of stocks (the safest ones I could think of) when the market dipped hard, around March thanks to the recent virus scare. I figured that there’s a lot of business (e.g. mining) that isn’t significantly effected and when some of their shares have dropped by half this might mean that the short term profits could be down a bit but there’s no way the whole business is devalued by half in the space of a few weeks. What’s this got to do with rates? Good question, allow me to continue … clearly when Treasury Bonds are down at fractions of a percent that means government can borrow money cheaply, but no one thinks this is a genuine market … you and I can’t borrow cheaply like that. The only way the Fed can manipulate rates so strongly is by locking a lot of normal people out of that market and leaving a lot of other interest rates (e.g. credit card rates) that normal people pay much higher. No they say there’s a risk factor … government bonds are super safe … actually no bonds are not safe, consider this scenario: you buy your 10 year Treasury Bond while rates are 0.7% and you hold it for a while, knowing you can sell it again if you need the liquidity … but something happens and the 10Y Treasury rate goes up to 2% and now you cannot sell it, unless you are willing to take a loss … oh dear, not so safe after all.
Getting back to what normal people do, suppose there’s people holding equities making a market return with typical dividends around the 3% P/A level (depending on the sector) and then gosh something happens and you need to sell the stocks and get liquidity … but hey correlation is here, everyone else wants to sell, the market as a whole doesn’t have the liquidity, so prices fall. What is this doing? It’s offering a better value to anyone sitting on the sidelines with money who wants to buy into those falling prices. Indeed, it’s paying people to hold illiquid assets (with a bit of risk, and there’s risk in EVERY illiquid asset including Treasury bonds, there’s also risk in fiat money and different risk in gold and everything else) but that’s what interest rates do!
What happens when the central bank pulls shenanigans with interest rates? Things move to other places, but the basic concepts don’t change. The stock market can also be a money market, and I put it forward that is what is happening right now, because central banks cannot manipulate everything all the time. Any illiquid asset that’s tradeable can also be collateral for a loan … and any market will take on these properties if that’s what people need at the time. The details of the contract might look a bit different, but don’t get fooled by the illusion.
I feel like this was made particularly because I noted my confusion last time. At the very least, I’m glad I wasn’t the only one who thought that Rohan was jumping around harder than Mario in an Italian Restaurant at Peach’s birthday party.
I feel like the key part of this for me was 46:20 onwards.