Monday, 6 October 2014

The Option to Monetise



Nick Rowe has a very confusing post about sacrificing goats.  To be honest, I didn't really understand the post, but reading some of the comments and his replies, as well as following his link, made it a little clearer.  So hopefully, I've got I right what he is trying to say.

The point relates to the possibility of funding government deficits with newly created money, rather than bonds.  Nick's point (I believe) is that, given certain assumptions about how the central bank conducts monetary policy, it doesn't make any difference how its funded.  If we assume that the central bank is targeting a certain level of NGDP and acting in the market to achieve that (including buying and selling government debt), then any change in deficit funding will be exactly offset by a change in central bank actions.

If my interpretation of his point is correct, then I'd agree with it.  However, I wanted to look at a slightly different point (but related, I think).

It is sometimes suggested that funding deficits with newly created money is a way of addressing rising levels of public debt.  The concern is that debt must eventually be refinanced, and if there is an ever increasing amount, this refinancing may eventually become impossible at an acceptable price.  At this point, the government will be forced into raising taxes.  This then leads to Ricardian Equivalence concerns.  If debt is inevitable going to lead to higher taxes in the future, then people may feel they need to start saving for it now.

Regardless of the question of how realistic this is, monetisation of debt seems to avoid it.  Newly created money never has to be repaid, so there will never come a day when taxes have to be levied to pay for it.  So maybe monetary financing of deficits is the way to avoid the problem of rising public debt.

The point I would like to make here, is that if this is correct (and I'd say it is), then it is not actually necessary for the government to carry out the monetary financing.  All that is required is the knowledge that they are prepared to do so at some point in the future, if necessary.  In other words, once you have admitted the option to monetise if appropriate, you have already removed any constraint that a rising debt level imposes.

If we assume that public debt carries a higher rate of interest than public money, then the debt / money mix will impact on net current transfers.  But otherwise, what really matter is whether debt monetisation is an option at all, whether it is actually used is less important.

18 comments:

  1. One of the "holes" in Ricardian Equivalence is seigniorage revenue - the discounted value of the savings having government liabilities in the form of money instead of debt. Some treatments skip over it completely. But in cases where the discount rate is close to the growth rate of the economy, it means that the "need" for future primary surpluses disappears. Monetisation is just cranking that effect up to 11.

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    1. Yes, I guess that's right. I'm also aware that what I'm saying here is closely aligned with the point that MMT likes to stress - that a government with a sovereign currency cannot face a borrowing constraint.

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  2. Nick. Oh dear. I tried to be clear, but obviously I failed! Sorry about that.

    But I think our points are closely related.

    My point: if the government wants an increase in G to be money-financed, this will only happen if the central bank permanently increases the NGDP target when the government increases G.

    But if the government increased G, and this caused the central bank to increase the NGDP level target **at some point in the future**, then the increase in G would also be (at least in part) money-financed.

    Which (I think) is your point?

    If an increase in G increases *the likelihood* of exercising in future the monetisation option, by raising the NGDP target, then the effect on AD now is much the same.

    Yes.

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    1. I think it was the goats that confused me.

      "If an increase in G increases *the likelihood* of exercising in future the monetisation option, by raising the NGDP target, then the effect on AD now is much the same."

      I agree with this, but I don't think this is just about NGDP targetting as I think there's a more general point about targets here. Ideas like Ricardian Equivalence require some sort of rule that it is binding for ever more, like a no-money-financed-deficits-rule. The conclusion often depends on the rule. In reality, we don't have such rules (although there are obviously constraints). Things change. Policy is endogenous.

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    2. Yes, it doesn't have to be an NGDP target. It could be a price level target, or something else.

      (I brought goats into the picture to try to explain more clearly that it was the increased NGDP target that was doing all the work, and that the rise in G and M were secondary consequences. A failed literary device.)

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    3. "...Ricardian Equivalence require[s] some sort of rule that it is binding for ever more, like a no-money-financed-deficits-rule."

      That is correct. I have seen a few other economists say this (Willem Buiter?), but not many. If you have all the other assumptions for Ricardian Equivalence, but allow that a bond-financed tax cut may eventually lead to an increased money supply, it will increase aggregate demand.

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  3. Hi Nick

    I'm glad you found Nick Rowe's post confusing. I was left very confused, even after reading the link to Gali's post as well as Nick R's subsequent post in which qualifies his position.

    Taking all these posts, as well as Nick R's response above, together I think I'd summarise his point as follows.

    Nick Rowe agrees that Jordi Gali's proposal would work.

    He equates what Gali calls monetised fiscal policy (a temporary increase in government purchases, financed entirely through money creation.) with what he considers ordinary monetary policy (CB buying assets of any kind, aka sacrificing goats). Both agree that there is some constraint on the accumulation of governement debt.

    In his words:

    I see that Jordi Gali has a proposal (HT Mark Thoma) that is very similar to mine. He too wants goat sacrifices to be money-financed. The only difference is that Gali wants the government to sacrifice real goats, and to pay the going market price for goats.

    Whith that last sentence, he goes one step further to say that no actual CB asset purchases are necessary. It is enough for the CB to announce future asset purchases (to sacrifice symbolic goats) for the NGDP path to adjust to the desired level.

    I may not have portrayed this last point to the total satisfaction of a market monetarist, but my personal beef is actually with the first point.

    Imho, Gali's proposal and what Nick Rowe is saying are two very different things.

    Nick Rowe considers G to be an exogenous variable.

    In his words:

    My point: if the government wants an increase in G to be money-financed, this will only happen if the central bank permanently increases the NGDP target when the government increases G.

    What determines nominal demand = supply = NGDP is the amount of that exogenous G that is money financed, i.e. not offset by monetary policy (asset purchases).

    What I think Gali is trying to say OTOH, is that G itself is what determines demand, whereas the financing mix determines whether such demand in surplus of non-government spending is feasible in future in terms of developing unsustainable debt dynamics (the Ricardian thing).

    Nick R thinks that when government buys goats from goat farmers it has the same effect as if the CB buys shares in goat farms which I personally think is ridiculous.

    Asset purchases are not government purchases! The latter are defined as government spending on goods and services. Which creates income / output. In contrast, asset purchases create neither income nor output. Using newly printed money to do so will have an effect on overall asset prices but none (directly) on NGDP.

    In fact, NGDP / NI targeting, in the way that it is being put forward by the M&Ms, involves just about every possible excuse for NOT targeting P(product) or I (income) directly. The label is misleading!

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    1. I'm a bit wary of analyzing Nick's post too much here, as I'm still not sure I know what point exactly he is making.

      However, I would agree that there are important differences between the different ways additional money might enter the economy, in terms of the effects they might have. Even if it were possible to hit an NGDP target using either route, they are not equivalent.

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  4. Correction: Confused endogenous and exogenous. Should read:

    Nick thinks that G is an endogenous variable etc...

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  5. Beneficial Government debt spending creates its own source of repayment by virtue of it benefiting the economy and thus growing the tax base. Ricardian equivalence concerns aside. And so on the face of it there is no benefit to the concept of monetary financing as the only reason to desire that government spending be financed by monetary financing would be to allow the opposite case ie to enable it to spend on projects that were not beneficial to the economy - or were even harmful to the economy, which is of course an unwanted scenario

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    1. Well, I agree that increased government spending should increase tax revenues, although whether that will fully finance depends on various things. Either way, the fact is that deficits do exist, so it is a legitimate question to ask whether, and under what assumptions, the way they are funded matters.

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  6. What about the following article: "Can taxes and bonds finance government spending?", Stephanie Bell, working paper 244, june 1998, Levy Ec. Institute.

    Het conclusion: "[...] that the proceeds from taxation and bond sales are technically incapable of government spending and that modern governments actually finance all of their spending through the direct creation of high-powered money".

    Anton

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    1. MMT likes to present a view of government finance that says that all spending is financed by issuance of high powered money (HPM) and that taxation and debt issuance is just a way of reducing private holdings of HPM. I think this way of looking at things can sometimes be useful, but it is just one perspective. The fact is that the state faces a budget constraint that says (roughly) that spending equals taxation plus debt issuance plus money issaunce, so for given spending the state has to decide how to split things between the last three. It's then just a matter of terminology to say whether one thing is really "funding" another thing or not.

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  7. Like you and others, I found Nick Rowe's post confusing. As I continue to puzzle about the post and read follow-up commentary, I realize that at least part of my confusion was a result of Nick's line "This is how an increase in G (money-financed goat sacrifices) would increase aggregate demand:". The problem here is the use of the term G without a definition.

    My assumed definition was "he was going lazy and meaning GDP". When I carried that definition through the rest of the paper, confusion was the result. MUCH later, I realized that probably he was using the term G to mean government spending in the form of fiscal spending increase. With that reference, he was comparing the sources of money that government could use to accomplish fiscal spending.

    This conclusion of Nick's meaning was confirmed (or maybe was the genesis) with the comment from Nick to me " Roger: if I lend you $100 forever, at 0% interest, you are $100 richer. If I lend you $100 for one year, at 0% interest, when other interest rates are 10%, you are $10 richer."

    Now I conclude that Nick was thinking that by issuing money, government makes a permanent loan. By issuing debt (thus borrowing money to spend), government makes a temporary loan (to the economy).

    Nick continues his post to discuss the monetary base and currency as if they were mostly the same, and relates NGDP.

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    1. When the government issues money, the private sector is making a permenant loan to the government, not the other way round. And when the government issues debt, the private sector is making a temporary loan to the government. I'm sure this is what Nick meant.

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  8. Wouldn't it be more correct to say that:
    - when the government issues money (spends newly created money in the private sector), it is getting goods and services from the private sector for free,
    - when the government issues debt, it is borrowing goods and services from the private sector, in the sense that it has to return the monetary value of these goods and services in a later stage.

    Anton

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    1. You might say that. But the distinction depends on the assumption that repayment of debt will always be financed by taxes. My main point in this post is that we cannot assume this is generally the case - once you recognise that repayment of debt may itself be financed by issuing new money, you realise it's not very different from issuing money in the first place.

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