The Eventual Krugman/Modern Monetary Theory Convergence

Paul Krugman has a write-up on VoxEU about a new paper with Gauti Eggertsson, “Debt, Deleveraging, and the Liquidity Trap.” This paper is vintage Krugman (I say that having known about the man for 4 whole years)- he comes up with a simple and elegant model, and derives salient insights. I think he moves his arrow closer to Modern Monetary Theory here, in that he begins to probe the distribution of debt. In particular, he writes,

Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person’s liability is another person’s asset.

I wrote about attending part of the MMT teach-in back in March. Randy Wray brought up this asset/liability idea as a way to express MMT to skeptical parties, particularly non-economists. Rather than thinking of our economy as a household, he said, realize that every asset is a liability. If one wants the non-government sector be net savers, the government sector must be a net borrower.

Now, recall that back in July, Krugman and Jamie Galbraith had a friendly skirmish over whether deficits ever matter. Krugman wrote,

And there are limits to all three. Even a country with its own fiat currency can go bankrupt, if it tries hard enough…

Since the price level is, by assumption, proportional to M, this tells us that the higher the debt burden, the higher the required rate of inflation — and, crucially, that as D-S heads toward a critical level, this implied inflation heads off to infinity…

So there is a maximum level of debt you can handle.

Then, Galbraith argued that by talking about future inflation, Krugman assumed the consequent, etc. I’m not here to rehash that. I do want to point out that in this paper, Krugman seems more concerned about the distribution of debt.

It follows that the level of debt matters only because the distribution of that debt matters, because highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past. This becomes very clear in our analysis. In the model, deficit-financed government spending can, at least in principle, allow the economy to avoid unemployment and deflation while highly indebted private-sector agents repair their balance sheets, and the government can pay down its debts once the deleveraging crisis is past.

I believe MMTers would argue that this need for non-government deleveraging is necessary in cases other than a liquidity trap. I think this point is where we see the divergence, and Krugman’s eventual caution against high levels of government debt (it’s the inflation at full employment, stupid, he would say). While I side with MMT on this front, I think Krugman can move the discussion in a positive direction by encouraging folks to think clearly about debt distribution. When calling for the government sector to dissave, do conservatives and neoclassical economists really want the private sector to be saving more? In a vacuum of aggregate demand? I’m sure they will reject his model out of hand, which isn’t surprising, because much of center and right economics seems politically and not intellectually motivated. Boo on them.

As for Krugman, I’d love to see his insights on what happens when we’re not in a liquidity trap, but household debt remains a crippling burden. Remember, much of his discussion of depression economics is around this idea of a liquidity trap, Nipponization, etc. If the liquidity trap ends, and unemployment remains high and resources underutilized, does Krugman have a model for that? Because I know MMT does. Somehow I think that Krugman will sound a lot more like Galbraith in 2 or 3 years.

Read Full Post »

Krugman v. Galbraith, Mainstream v. Heterodox- a Healthy Debate

Mark Thoma has the goods on the debate between Jamie Galbraith and Paul Krugman over whether deficits are always ok. Go read his block quoting, and then return here for my thoughts…

OK, in case you don’t want to go over there, here’s the gist of the argument. Krugman is worried that at some point, governments will run into the problem of inflation as a result of the deficits. He makes a small model, and then writes,

To spend, the government must persuade the private sector to release real resources. It can do this by collecting taxes, borrowing, or collecting seignorage by printing money. And there are limits to all three. Even a country with its own fiat currency can go bankrupt, if it tries hard enough…

Since the price level is, by assumption, proportional to M, this tells us that the higher the debt burden, the higher the required rate of inflation — and, crucially, that as D-S heads toward a critical level, this implied inflation heads off to infinity…

So there is a maximum level of debt you can handle.

Galbraith says that Krugman makes a false assumption:

Paul’s logical error here is that of assuming-the-consequent. He assumes the inflation which causes dumping of money. But if there is no dumping of money, the inflation will not generally occur.

Yes, again, it’s technically possible that the banks and others would start dumping dollars and buying up oil, wheat, rubber, and so forth (and leasing storage facilities for the stuff) thereby driving up the price level.

Then Krugman says that at some point, there will be supply-side constraints, as the private sector will step in adequately. Given the last 20 years of economic history, I find this assumption dubious:

Someday the private sector will see enough opportunities to want to invest its savings in plant and equipment, not leave them sitting idle, and the economy will return to more or less full employment without needing deficit spending to keep it there.

The MMTers (at least at the teach-in I went to) believe that we’re nowhere near this constraint- private sector money is in the side lines, and they desire the saving opportunities that only government deficits can provide. Galbraith doesn’t say as much in his second response, but instead challenges Krugman to lay off on the long-term budget issues.

Paul, I challenge you to drop the long-term deficit argument entirely– it will be used in a few months, in a dishonest way by unscrupulous people, to support cuts in Social Security and Medicare that cannot be justified by economic logic. These are cuts which, I am sure, you will oppose when they are proposed.

This debate is a healthy thing for our economic discourse. Krugman (without calling it by name) recognizes the MMT argument in Galbraith for what it is. Galbraith and Krugman ultimately divide on their trust of the private sector’s viability. I side with Galbraith on this one, certainly. While I agree with Krugman when he argues that the current conjecture means that he and Galbraith have no substantive short-term policy differences, I also believe that Galbraith is being more practical in the long-term. I’m simply unconvinced by the debt service arguments, given over a decade of stagnant job growth.

Krugman seems to be limited here by his place in the mainstream, which ultimately believes the capitalist class will apportion money in a way that benefits society, even if it needs a Keynesian nudge. Galbraith, on the other hand, is able to take a more realistic approach because he sits outside the mainstream. Let’s hope this debate catches fire in the discipline at large.

Also, see Galbraith’s testimony for a lengthy argument on the wrong-headedness of the deficit commission.

Read Full Post »

Deficit Dovery is so Not Mainstream…

But is should be. That’s my conclusion after seeing liberal blogger Ezra Klein’s tweet about his interview with James Galbraith:

James Galbraith weighs in with a very uncommon take on the deficit.

The headline he puts on the story:

Galbraith: The danger posed by the deficit ‘is zero’

Here’s are some excerpts from Galbraith in their exchange:

At this point, the whole thing is completely incoherent. You cannot write checks to 20 percent to anybody without that money entering the economy and increasing employment and inflation. And if it does that, then debt-to-GDP has to be lower, because inflation figures into how much debt we have. These numbers need to come together in a coherent story, and the CBO’s forecast does not give us a coherent story. So everything that is said that is based on the CBO’s baseline is, strictly speaking, nonsense…

What people worry about is that the federal government won’t be able to buy bonds. But there can never be a problem for the federal government selling bonds. It goes the other way. The government’s spending creates the bank’s demand for bonds, because they want a higher return on the money that the government is putting into the economy. My father said this process is so simple that the mind recoils from it…

Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector.

Nothing groundbreaking here, at least for this blog’s commenters and folks who read billyblog. The reason Ezra brands this take “uncommon” is because among “respected voices” (pardon my use of scare quotes), it really is uncommon. It’s very difficult to be a respected liberal or progressive if you don’t cow at least a little to deficit hawkery. The good news is that Ezra has a lot of readers in the mainstream, and Galbraith did an excellent job making digestable the sensible view on deficits.

Read Full Post »