Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 6 January 2016

Confidence as a political device

Some technical references but the key point does not need them

This is a contribution to the discussion about models started by Krugman, DeLong and Summers, and in particular to the use of confidence. (Martin Sandbu has an excellent summary, although as you will see I think he is missing something.) The idea that confidence can on occasion be important, and that it can be modelled, is not (in my view) in dispute. For example the very existence of banks depends on confidence (that depositors can withdraw their money when they wish), and when that confidence disappears you get a bank run.

But the leap from the statement that ‘in some circumstances confidence matters’ to ‘we should worry about bond market confidence in an economy with its own central bank in the middle of a depression’ is a huge one, and I think Tony Yates and others are in danger of making that leap without justification. Yes, there are circumstances when it may be optimal for a country with its own central bank to default, and Corsetti and Dedola (in a paper I discussed here) show how that can lead to multiple equilibria.

But just as Krugman wanted to emulate Woody Allen, I want to as well but this time pull Dani Rodrik from behind the sign. In his excellent new book (which I have almost finished reading) Rodrik talks about the fact that in economics there are usually many models, and the key question is their applicability. So you have to ask, for the US and UK in 2009, was there the slightest chance that either government wanted to default? The question is not would they be forced to default, because with their own central bank they would not be, but would they choose to default. And the answer has to be a categorical no. Why would they, with interest rates so low and debt easy to sell.

The argument goes that if the market suddenly gets spooked and stops buying debt, printing money will cause inflation, and in those circumstances the government might choose to default. But we were in the midst of the biggest recession since the 1930s. Any money creation would have had no immediate impact on inflation. Of course their central banks had just begun printing lots of money as part of Quantitative Easing, and even 5 years later where is the inflation! So once again there would be no chance that the government would choose to default: the Corsetti and Dedola paper is not applicable. (Robert makes a similar point about the Blanchard paper. I will not deal with the exchange rate collapse idea because Paul already has. A technical aside: Martin raises a point about UK banks overseas currency activity, which I will try to get back to in a later post.)

Ah, but what if the market remains spooked for so long that eventually inflation rises. The markets stop buying US or UK debt because they think that the government will choose to default, and even after 5 or 10 years and still no default the markets continue to think that, even though they are desperate for safe assets!? In Corsetti and Dedola agents are rational, so we have left that paper way behind. We have entered, I’m afraid, the land of pure make believe.

So there is no applicable model that could justify the confidence effects that might have made us cautious in 2009 about issuing more debt. There are models about an acute shortage of safe assets on the other hand, which seem to be ignored by those arguing against fiscal stimulus. Nor is there the slightest bit of evidence that the markets were ever even thinking about being spooked in this way.

Martin makes the point that just because something has not yet been formally modelled does not mean it does not happen. Of course, and indeed if he means by model a fully microfounded DSGE model I have made this point many times myself. But you can also use the term model in a much more general sense, as a set of mutually consistent arguments. It is in that sense that I mean no applicable model.

Now to the additional point I really wanted to make. When people invoke the idea of confidence, other people (particularly economists) should be automatically suspicious. The reason is that it frequently allows those who represent the group whose confidence is being invoked to further their own self interest. The financial markets are represented by City or Wall Street economists, and you invariably see market confidence being invoked to support a policy position they have some economic or political interest in. Bond market economists never saw a fiscal consolidation they did not like, so the saying goes, so of course market confidence is used to argue against fiscal expansion. Employers drum up the importance of maintaining their confidence whenever taxes on profits (or high incomes) are involved. As I argue in this paper, there is a generic reason why financial market economists play up the importance of market confidence, so they can act as high priests. (Did these same economists go on about the dangers of rising leverage when confidence really mattered, before the global financial crisis?)

The general lesson I would draw is this. If the economics point towards a conclusion, and people argue against it based on ‘confidence’, you should be very, very suspicious. You should ask where is the model (or at least a mutually consistent set of arguments), and where is the evidence that this model or set of arguments is applicable to this case? Policy makers who go with confidence based arguments that fail these tests because it accords with their instincts are, perhaps knowingly, following the political agenda of someone else.     


  1. On the LRB blog, 'In Moscow' by Peter Pomerantsev 22 July 2014, on Putin's use of propaganda:

    "I met Mark Galeotti, an NYU professor who has been teaching in Moscow, in a Pain Quotidien inside a business centre. ‘The Soviet Union used to reinvent reality too but they still kept to a single version of the truth. Pravda would telegraph the party line so everyone knew what to say,’ he told me. Now, instead of a single truth, the TV spits out contradictory conspiracy theories. The effect is to leave the viewer so confused and he is demoralised that he gives up on trying to find a ‘real’ version. This is effective in keeping people both paranoid and passive, but it means, Galeotti said, that ‘everyone has to improvise their own version of the truth.’"

    The application of 'confidence' since the 1970s in economics has had a similar political usage.

  2. You say “You should ask where is the model”. For non-economists this is irrelevant – they wont understand – for economists they should already know the answer.
    Everybody knows that an economist speaking on behalf of a financial institution is acting in a PR role and maybe using the confidence thing is lazy, but try and get technical and they'll gawp like goldfish.
    Regards – clinging to the wreckage.

  3. For those of us with long memories, the classic example of economics outweighing confidence was the UK exit from the European Exchange Rate Mechanism (ERM) in September 1992. This was followed by a large sterling depreciation.

    The economics of this was clear (and supported by models) - it was a positive stimulus to the UK economy that had been in recession (both directly, by improving competitiveness, and by allowing monetary policy to be eased.) But very few forecasts reflected this at the time, as confidence fell, and talk was about a massive policy failure.

    In the end, economics outweighed confidence and growth resumed during 1993!

    1. I would go further. Entering the ERM at the overvalued rate we did was in direct contradiction to what nearly all models were telling us at the time.

    2. Interesting, did these models tells us what the 'correct rate' was?

      An important historical explanation was that it was a problem of timing: German reunification was pushing up interest rates in Germany making the peg difficult to maintain.


    3. For the UK only part of the answer. The models suggested we entered at a rate overvalued by around 10%.

  4. "Bond market economists never saw a fiscal consolidation they did not like, so the saying goes, so of course market confidence is used to argue against fiscal expansion."
    I'm not entirely clear on why this should be. It seems to me that sovereign debt these days serves as safe collateral in repo operations, so that interested parties actually need a plentiful supply of it, with assurances that it is as risk-free as an asset can get. I get this impression from investor complaints in the late 90's that U.S. budget surpluses endangered the supply of Treasuries. So I'm skeptical of the claim that the investor class as a whole has a vested interest in fiscal consolidation. Rather they have an interest in governments continued provision of their debt, while running primary surpluses to assure that this debt is "sustainable" and therefore "safe" in the long-run. I'm still with you that financial participants get to push their interests through by evoking the confidence fairy, but that doesn't mean those interests are always for fiscal consolidation.

    1. Indeed - I noted the safe asset shortage point in the post. Which is why I think it is more complex than thinking about the 'markets interests'. So why, in the UK and the US, are those economists that have media access who work for financial market firms much more pro-austerity than other economists? Would be interested in your or others thoughts.

  5. Of course it's possible that the UK might default on it's debts in some circumstances. Maybe the North Koreans could nuke London or there could be a War of the Worlds style alien invasion or some exotic set of political or economic circumstances that the textbooks couldn't possibly predict. Nevertheless that doesn't change fundamental fact that if you're managing a very large sum of money, either for yourself or some other entity, you can't very well put it in a sock under the bed. You have to invest it in something, and from that perspective Government bonds backed by an independent central bank are as safe as it's possible to get in terms of getting your money back.

  6. I think there might be similar points to be made about invoking uncertainty. I have always been a bit suspicious of Bloom's work for that reason, in so far as there are lots of things to be uncertain about and "meddling politicians with their fiscal policy" is a dubious choice (although I am being unfair to him there).

  7. "The argument goes that if the market suddenly gets spooked and stops buying debt, printing money will cause inflation, and in those circumstances the government might choose to default."

    The entire conclusion you put forward follows from the premise that the bond markets can decide things.

    However if it is clear to the markets that the government believes it ultimately controls the Bank of England and the understanding is that the Bank of England will prevent yields from rising, then they will not rise.

    Any bond that drops below par can be purchased by the Bank of England and cancelled. That means that the private sector gets less back than it paid out for the bond.

    And that is a tax. Show me a financial person that will voluntarily queue up to pay a tax and I'll show you a unicorn.

    So it matters not what the bond market thinks. It matters whether the government decides to voluntarily tie its hands.

    What you put forward is a slippery slope logical fallacy.

    And it won't cause inflation. Inflation is due to the *flow* of spending. Any spending public or private can cause inflation.

    1. Can't you see you are saying very similar things to what I am saying: that there can be no forced default, so what matters is the government choosing to default (does MMT talk about this), and that creating money right now will not cause inflation.

    2. Agreed. Which is why it pains me so much.

      "so what matters is the government choosing to default (does MMT talk about this)"

      "which is one big reason why governments issues bonds rather than just create money: it gives them another option to inflation if it gets into budget difficulties."

      Please lay out the other reasons.

      They can do this anytime nutjobs are in power (e.g Republican teabaggers.) It is never necessary.

      Why should a government pay 'interest' (in reality welfare payments) to non-specified foreigners for years and years on end, when a 'windfall tax' achieves the same savings confiscation as a 'voluntary default' .

      If you don't pay interest then you reduce the savings of wealthy people month on month, which reduces the need for a 'windfall tax' in the first place. Savings and interest can then be better structured towards specific domestic individuals via National Savings instruments (e.g. granny bonds).

      The MMT approach is functional finance and it does not involve confiscation of saving and never will. Saving aka government 'debt' does not lead to inflation. Functional Finance focuses on the real circuit and maintaining appropriate level of *flow* around the economy. No need to 'default' or confiscate savings.

      And fixing the *distribution* so people do not unfairly amass wealth.

      What you need to understand is saving effectively acts as a voluntary tax:

      Government can't get into 'budget difficulties.' The government will get all its money back if there is no financial saving for any positive tax rate.

      So government 'borrowing' is like your bank 'borrowing' your salary - a function of non-government

      In a monetary economy there has to be enough money in circulation to ensure that all real output that can be created is created.

      If there is any unemployment, then you are leaving real output on the table and operating inefficiently.

      The primary cause of this is the paradox of thrift - savings are not spent. That means there is no effective demand signal, and things don't get made. Hence unemployment.

      There are three ways to deal with that. You confiscate excess savings via taxation (i.e. money expires if not spent). You allow the economy to boom and bust so that the excess savings are destroyed in a depression - along with lots of sound capital. Or you accommodate those financial savings because they act as a voluntary tax anyway.

      No other mechanism can balance the flows. You need an oil pump in the engine of the monetary economy or the oil drops to the sump and the engine seizes up.

      MMT takes the third way via the functional finance approach - following from the insights of Post Keynesianism.

    3. Also sorry if I am a little grouchy. With all this human misery around I don't have a lot of sympathy for idiot politicians and their economist lackeys coming out with nonsense statements.

      Let us take an example - the floods :(

      Both sides are as bad. The Tories for failing to invest in flood defences and pretending climate change isn't happening, and the Labour lot for either suggesting foreign aid should be cut, or trotting out their usual 'tax the rich' line as though either of those approaches will cause flood defence engineers to rise fully formed from the primordial soup.

      They need to take a Modern Money approach.

      What Modern Money tells us is that the state can command any resources available for sale in its own currency. And it tells us that the only constraint on what resources it can command is the inflation constraint - in other words multiple bids for the same item that causes the price to rise.

      So the correct approach is to forget about the numbers. They just happen automatically as a consequence of taking action. And they always add up as a matter of accounting. What you need to concentrate on is the engineering resources required. Where are they and what else are they doing at this point in time?

      If what they are currently doing is less important than fixing flood defences, then you suspend what they are currently doing and reallocate them to fixing flood defences.

      Within construction that is fairly easy because everything needs the State's permission to proceed anyway - via planning and building control. That means you can delay any project currently proposed or operating via advanced policy tools rather than using the primitive price mechanism to bid away resources.

      So the State can set a price for a job, and if it doesn't get enough bids from free resources it can suspend activity around the area to free up capacity until it does get enough bids for the job. Projects are then reordered in time with the state's requirements coming first. Since the mechanism used eliminates other offers there can be no multiple bids. Therefore no change in prices and no inflation.

      The real costs are then borne by the businesses whose projects are delayed and by the banks whose lending volume will drop as projects are prevented from starting due to lack of available resources. Which would always be the case however you get there.

      So, with a correct Modern Money understanding, you end up with a much more precise and direct approach to resource allocation. The correct people and stuff are found, surgically extracted and reallocated in a way that the carpet bombing approaches of 'tax the rich', 'cut foreign aid', or 'expansionary fiscal austerity' could never achieve.

    4. (cont)

      Very simply you cannot make a silk purse out of a sows ear. You can't fix things by putting on a few training courses. People don't work like that.

      There are strict limits to fungibility. Ignore them at the higher skill levels as happened with 1970s style Keynesian injections and you will get supply side INFLATION. Noted?

      The people you need to start with on any project are the designers, architects and project managers. Plus the initial civil engineers.

      It's called the Onion structure of team building. You need a set of core competence to get anything done. The labourers are on the outside of the onion.

      Now at the moment we have a construction boom running, and pretty much anybody that can be a labourer is working as a labourer. Construction people are constantly dealing with poaching issues. There are supply side issues, and that's with all the Poles and East Europeans they can eat. But hey what do I know over the great brain of Simon Wren Lewis.

      The core competency people have a large pipeline of work ahead of them. Lead times of three to six months are not uncommon at the moment.

      You have to get core competency people onto the public projects in a manner that will actually work. Rather than taxing people, which then tries to price people out of the market - and therefore doesn't and will not work.

      The point is to show that you don't need to raise taxation to get public works done. In fact it is likely counter productive because of the dynamics of construction.

      The other issue on the supply side, which is rarely mentioned, is that rich people have a lot of work done and therefore they get the priority. a one off public sector job isn't enough to get people to abandon their rich patrons. Construction work is project based and you always need to have a view to your pipeline. "They give me a lot of work."

      That's why you need to make sure that public investment spending is CONSTANT. Construction people need to know that the public pipeline is secure. Otherwise they'll go work for rich property magnates instead.

      In addition, by concentrating on finding the available actual resources at your disposal, you end up realising that the engineering talent within the armed forces exists and is much better deployed repairing riversides in Rochdale than rearranging the rubble in some distant land.

      It's all very straightforward once you think about it properly in terms of actually getting stuff done.

    5. Simon
      I believe that the MMT position is that the government will never have to choose between default and inflation because bond issuance is not inherently any less inflationary than money creation. See for example this post by Bill Mitchell:

      what do you think of this?
      what do you think of this?

  8. When the CB credits a non-government account at the direction of the Treasury, banks account as the CB are credited with reserves balances (aka settlement balances). The reserve balances are liabilities of the CB and assets of the banks. The banks then credit customer accounts as directed. Notice that two sets of books are involved, that of the CB, the only place where reserves balances exist, and the banks. When the appropriate entires are made the books are in balance and government has increased its liabilities while non-government has increased its assets.

    Taxes and other obligations to government must be paid using settlement balances. That drains some of the settlement balances created by spending. When government spending is in excess of payment of obligations to the government, excess reserves remain in the hands of nongovernment, increasing nongovernment net financial assets in aggregate.

    When governments issue government securities in the amount of the fiscal deficit, then the reserve add in excess of withdrawals is drained into government securities, since government securities are purchased with reserve balances. The amount that the reserve balances increased from Treasury spending in excess of withdrawals is drained into government securities through this operation.

    Since the government securities purchased are assets of non-government, non-government net financial assets have increased in that amount, which corresponds to the Treasury spending in excess of taxes.

    Of course, if government didn't issue securities corresponding to the deficit, then the increase in nongovernment net financial assets in aggregate would remains in the form of reserves balances.

    The degree that the CB expands its balance sheet by purchasing government securities from nongovernment the amount of nongovernment net financial assets remains the same but the composition changes. This goes both ways in the course of monetary operations conducted by a CB. The Cb can also shrink its balance sheet by selling securities to nongovernment, which decreases the amount of reserve balance held as bank assets and increases the amount of government securities held by nongovernment.

    Where most people get confused is in not understanding nongovernment net financial assets in aggregate and also reversing causality based on the so-called money multiplier, which is actually an accounting residual, ex post instead of ex ante.

    People also fail to understand that obligations to government and purchase of government securities only takes place through the central bank through exchange of CB liabilities. That means that government must supply those liabilities for those transactions to take place. Thus, the MMT dictum that a reserve drain into government securities requires a prior add of government liabilities, either as cash or reserve balances.

    The other difficulty comes from failure to realize that there are two sets of books involved, those of the consolidated government and those of consolidated nongovernment, or else mixing them up. This is the reason it is necessary to follow the accounting trail in thinking about this.

    Nobody has the authorisation to bounce a government cheque.

    The DMO already has cross facilities in place with the banks in the interbank market to ensure that everything clears to where it should be at the close of the day if they have a particularly heavy day in the spending department.

    The Treasury plays the same game as the banks. They run massive overdrafts *intraday* and then clear in the interbank market at the end of the day. MMT just says dispense with the BS and run an official overdraft.

    It's a very important point that there is never any serialisation restriction on government finances. Serialisation is the loanable funds myth.

    The monetary system expands as is required and then everybody saves with everybody else to clear at the end of the day and maintain the pretense.

  9. Why do you macro guys ignore the massive demand for long bonds in the derivatives clearing houses, for use as collateral? There isn't enough debt, under this upside down system where debt has become gold:

    1. I noted the safe asset shortage point in the post. Which is why I think it is more complex than thinking about the 'markets interests'. So why, in the UK and the US, are those economists that have media access who work for financial market firms much more pro-austerity than other economists? Would be interested in your or others thoughts.

    2. Thanks for replying Simon. Yes, I note that you did speak about safe asset shortages. Sorry. You are one of the few. The MM boys, Sumner, etc., don't talk about it at all and they won't listen to me so they may listen to a real economist, like you. As far as the economists, they all listen to Larry Summers who says you either have secular stagnation or bubbles, and no in between. That is a dreadful choice. I suppose they feel secular stagnation is a better choice than bubbles. Mostly I think that as well, but, when they start talking about a cashless society and massively negative interest rates, I long for easy money while they call cash a barbarous relic. But then I remember, easy money toxic loans hurt a lot of people in the last decade. So, is there no other way to sustain growth than to give folks a small stipend? One MM guy, Benjamin Cole said the Fed could buy treasuries and load them into the Social Security trust fund but I told him I thought there were not enough treasuries as is. So, solutions seem elusive, but surely speculation must be stopped for any solution to work.

  10. Do we all understand that a sovereign FIAT currency ISSUING economy and its consolidated central bank, can't go broke / default, in its own currency; it has a bottomless pit of the stuff. There is never a bill, presented in its own currency, that it can’t pay. There is no good or service, for sale in its own currency, that it can’t afford to buy.

    We came off the Gold Standard decades back! Government bond markets since then are secondary and parasitic for sovereign currency issuing government Treasuries. They are trade-able savings certificates for risk free punters. Sovereign currency governments do not have to issue debt instruments because they don't have to borrow their own currency from anybody. (But they do if they are a USER of a foreign currency, the Euro for instance, like Eurozone members).

    The central bank can't create new "money", that is, net increase the quantity of “fiscal assets”, in the non-government sector, only the Treasury, the currency ISSUER can do that. It can (a) swap government debt back into the "reserves" (previous government spending), that bought the debt, from the Treasury in the first instance (now called QE when done in large lumps). (b) It can lend against collateral, like any other bank. Like all commercial bank lending these (horizontal) transactions always sum to zero. For every asset there is an equal and opposite liability.

    The above is nothing to do with, increasingly irrelevant, NK macroeconomics; it is basic fiat currency accounting. Can I recommend you have a read of the Whole of Government Accounts (WGA)

    If the UK was a currency USING corporate entity, you will see from the WGA that in IFRS terms, it is insolvent. It has over £400 billion negative working capital and its liabilities are about twice its assets.

    Alas, not a problem. The beauty of being a sovereign FIAT currency issuing economy is that the UK Treasury can use its own credit card to pay off its own, same, credit card.

    1. Can I suggest you stop saying the same thing over and over and read the post. It is all about voluntary default - which is one big reason why governments issues bonds rather than just create money: it gives them another option to inflation if it gets into budget difficulties.

    2. "one big reason why governments issues bonds rather than just create money: it gives them another option to inflation if it gets into budget difficulties"

      Do you really believe that? Sounds highly implausible to me that governments think like that. Surely governments issue bonds because: they always have done, investors like safe assets and the taboo against 'printing money'?

      Also, as MMT-ers and (I think) Corseti Dedola point out, if the government (via the CB) pays interest at the CB target rate on the bank reserves created by its spending, it would have no need to issue bonds and the default or inflation question goes away.

    3. NK economists make two mistakes. They assume FX has infinite liquidity when it doesn’t (because there are no market makers in FX as such) and they assume Bonds have finite liquidity when they don’t (since the market makers have to offer a price and are inevitably backed by the state).

  11. "You should ask where is the model (or at least a mutually consistent set of arguments), and where is the evidence that this model or set of arguments is applicable to this case?"

    At last someone is talking sense here. Whether you are arguing algebraically or verbally this is all we want. Nobody can reasonably disagree with that. If we can take this approach we can start ending the tribalism that exists between disciplines and schools of thought, start engaging more with the real world, and really start to get answers - like why US dollar assets actually increase in demand during crises and times of uncertainty and why the financial sector has been pushing for fiscal consolidation.


  12. Do models of safe asset shortages suggest that the government increasing the amount of safe assets in an economy through issue bonds will increase overall welfare? If so, through which mechanism? It seems a strange rationale for the government to borrow more.

    1. I think they really argue for the creation of gross assets, and yes it would increase welfare, or at least make the system safer. Argument is partly that attempts to manufacture safe assets before the crash were a disastrous failure.

  13. Seems to me that the real argument here is between 'My gut tells me something I can't express in a model' and 'okay, give me a model or at least a mechanism'. Between those two, I know which side I'm on.

  14. Excellent post. This is Michal Kalecki territory.

    The Political Aspects of Full Employment:

  15. Not directly relevant to this post but wanted to get it out there. Mostly because of the despair I feel at the ability of our government to successfully misinform:

    What the Chancellor said today:
    "I worry about a creeping complacency in the national debate about our economy. A sense that the hard work at home is complete and that we’re immune from the risks abroad."

    What the chancellor meant:
    "My complete mismanagement of the economy over the past 5 years has left us particularly vulnerable to shocks from home and abroad. I aim here to do two things: 1) Get the blame out early so you all don't realize the real cause of the problems and 2) Make the case that whilst my economic policies in reality are the heart of the problem I will scare you in to thinking there is no alternative. It's what is technically called a win-win situation.

    Or to put it another way; we've bled the patient. He's much weaker. So we'll bleed him again.


  16. "For example the very existence of banks depends on confidence (that depositors can withdraw their money when they wish), and when that confidence disappears you get a bank run."

    Have you ever heard of deposit insurance?

    Why can't the state offer services via a post office bank?

    The lending banks we need are the ones that can lend development capital effectively and stick to doing just that. If we are to have private lending banks, then they need to be able to make a decent profit doing development capital lending.

    The way I would narrow banks is to offer them an incentive - an unlimited cost free overdraft at the Bank of England. 0% funding costs. In return they must drop all the side businesses and just do capital development lending on an uncollateralised basis - probably in the form of simple overdrafts. In other words they become an agency businesses delivering state money to those that require it.

    I'm not even sure a capital buffer is required here. Losing your lending licence if your underwriting isn't that good should be sufficient incentive to run a tight ship. Backing off the entire thing to the central bank reduces the barriers to entry in lending - making self-employed, highly dispersed and, importantly, locally focussed underwriters a possibility (the 'Provi Model').

  17. "... I want to as well but this time pull Dani Rodrik from behind the sign. In his excellent new book..."

    I hope we do not get a whole of chummy back-patting and hubris from this (although not accusing you in particular of this). We would like an honest review about whether you think the 'filing system of models' (when we have what looks like X pull out model X) is the way forward or does it distract from engagement with other disciplines, things that abstraction does not handle well, and the real world. Lars Syll has done a series of critiques on Rodrik and the "smorgasbord of models" which agree with him or not, I think articulates well a lot of the scepticism critics have.


  18. Excellent post. Anyone interested in the 'confidence' point should read Kalecki, 1943:
    "Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of 'sound finance' is to make the level of employment dependent on the state of confidence."
    The full paper is at

  19. It is true that confindece is crucial.
    But confidence can come only from one source; selling all you produce.
    If consumers demand more of what is being produced (which means consumers have confidence and spend all they earn which comes only from not fearing unemployment) that itself holds up the confidence of investors. Investor's confidence can not be established by any other way then by buying all they produce, which means increasing purchasing power of public at large.

    Increase employment and wages and that will solve all other "probems" automaticaly. "Problems" like business confidence, deficit, or public debt.

  20. To answer the question on why financial economists demand consolidation even tough it is contrary to their demand for more safe assets.
    It is all about QE. QE reduces available safe assets while seamingly increasing government debts (if CB balance sheet is viewed as government debt).

    Even tough you complain about MMTers keep repeating the same thing over and over, the answer is there. But since you never studied government finances and banking so you can not connect the dots.
    QE is taking safe assets out of the banking sistem and leaving them with excess reserves. Reserves can not be loaned to nonbanking or to nongovernment sector. Banking reserves can be loaned only to government or other banks. If CB is taking out safe assets and leaving excess reerves that itself is showing lack of safe assets.

    And as Random explained that deficit spending is creating extra reserves, compartmentalized nature of banking is showing how narrow focus of some financial advisers who demand consolidation and more safe assets at the same time, they want to solve only one "problem"; excess reserves.

    Another reason might be that consolidation ultimately creates more debt/ safe assets. In long term, reduced debt is the excuse to reduce taxes on wealthy which creates more government debt/ safe assets.

  21. I feel like this argument conflates several issues. I agree that a spontaneous crisis of confidence does not seem likely in the US or UK. Further, it seems clear that avoid a technical default through intentional inflation. However, any modeling that enables a country to do this at no economic cost seems to be assuming the existence of a free lunch - that while one might think that a drop in demand for government bonds would require a corresponding price reduction or cut back of supply, that a government with its own currency can do the seemingly impossible and increase demand by increasing supply. Doesn't seem plausible - and in fact the models showing how this can work seem to be considering the impact of an increase in money supply without considering the action needed to bring that increase about. Finally, if there were a triggering event such as a real drop in demand (e.g., the Chinese stop buying) then the presumptions of your starting condition would no longer apply.

    1. I realize I didn't actually ask a question. I'm specifically referring to Krugman's claim in his Mundell Fleming lecture that a country with its own currency is "invulnerable" to a Greek-style crisis, btw. I'm not an economist so I am in no way challenging the economic models he uses. In fact when he initially applies the models he gets the results one would expect. My observation is that when he seemingly reverses conventional wisdom and obtains a result he agrees is "counter-intuitive," that he's doing so by making some false assumptions, and he's not actually modeling the scenario correctly (he assumes static input conditions when they are in fact dynamic). Further, his "historical proof" regarding post-WWI France is merely an anecdote, and does not include the specific data needed to form a robust conclusion one way or the other.

      To me, he seems to be making a very strong assertion ("invulnerable") that is based on a premise that seems to violate Econ 101 (you can increase demand by increasing supply). For these reasons I would expect academic audiences to be very skeptical, and yet while this paper has been discussed by very prominent economists recently no one has challenged it - so I have to suspect that I'm the one making the mistake.

      Nevertheless, the assertion that interest rates wouldn't go up because they're set by the central bank which would have no reason to raise them seems.... wrong.

      My question, then, is what am I missing? Does the argument actually follow, even on its own terms?


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