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In Part 1 of this mini-series – When relations within government were sensible – the US-Fed Accord – Part 1 – I examined the pre-1951 agreement between the US Treasury department and the US Federal Reserve Bank, which saw the bank effectively fund the US Treasury. The nature of that relationship, which began when the central bank was formed in 1913, changed in 1935 when the legislators voluntarily chose to change the capacity of the currency issuer to buy unlimited amounts of US Treasury debt directly to one of only being able to purchase the debt in the secondary markets once issued. But the effect was the same. The central bank could control the yields at any segment of the bond maturity curve at its will. The shift in 1935 was the result of conservative forces that were intent on derailing the government’s capacity to use the consolidated central bank/treasury to efficiently advance well-being. They wanted political constraints placed on the Treasury, such that it would have to issue debt to the non-government sector before it could spend, which they knew was an arrangement (similar to formal debt ceilings) that could be used to pressure the government towards austerity. By the time the Korean War ensued, these conservative forces were winning the political debate and big changes were to come, which would limit the fiscal capacity of the US government to this very day. The result has been an inefficient fiscal process prone to capture by conservatives and certainly not one that a progressive would consider to be sensible. I analyse that shift post-1942 in this blog, which is Part 2 in the series. In Part 3, we pull the story together and reveal what was really going on.

Tensions mount – 1942-1951

The first graph shows the yield behaviour of long-term government bonds from the end of WW2 to the late 1950s. The vertical line (Treasury-Fed Accord) marks a discrete shift in policy, which we will discuss in this Part and the final Part of this mini-series.

Clearly, the pegged arrangement was effective (it was abandoned, as we will learn, in 1951).

The US Federal Reserve Bank was not necessarily a willing partner in the arrangement to peg government bond yields. All organisations have their own dynamic even if they are part of a consolidated entity (in this case, the government).

The dynamic within the central bank saw it increasingly concerned about what they constructed as being a loss of control of their balance sheet and the inflation threat they perceived as following from that.

It was a strange way to think. The more reasonable construction was that the Treasury reflected the democratic will of the American people and was subjected to the electoral cycle and that the central bank should use its constitutional capacity to serve that mandate as best it could.

The idea that pre-conceived ideas about the size of the balance sheet should become a self-serving objective in isolation of the broader public purpose was not sensible.

But the conservative forces exploited fears of inflation (as the central bank’s balance sheet increased via its on-going government bond purchases) to pressure the US Treasury into abandoning the pegged arrangement.

This is despite the obvious empirical fact that it had kept yields low.

The total money supply in the US went from 132.6 billion to 130.9 billion in 1951 and between 1945 and 1946 dropped to 118.1 billion

The following graph shows the annual US inflation rate from 1915 to 1955 (per cent).

While there was some immediate Post-WW2 inflation, as there was in almost all countries given the shortages and the transition back to peace and the abandonment of rationing systems, the situation had stabilised until the onset of the Korean War in 1951, a year in which the inflation rate rose by 7.9 per cent.

However, there was little to tie the arrangement between the Federal Reserve and the Treasury to the inflation spike.

It was believed that selling bonds to the non-government sector reduced the inflation risk of running fiscal deficits whereas ‘selling’ them to the central bank, which was effectively what was being done during the pegged arrangement increased the risk.

The reality is that neither arrangement with respect to the bond sales changed the inflation risk inherent in the government net spending. If the government competed with the non-government on price for resources in the market then price pressures would emerge, whether they matched their deficits with bonds or not.

The next graph shows the US Federal fiscal balance between 1930 and 1955 (and the gray bars show the NBER recessions). By the end of WW2, the government was contracting fiscal policy and that effort caused the recession in 1945.

The austerity continued and recession returned in 1949. But the Korean War effort saw fiscal policy return to deficit in 1950. It could hardly be said that the fiscal shift was extreme.

The growing tension between the central bank and the Treasury mounted in the early 1950s and came to a head at the Federal Open Market Committee (FOMC) meeting held on August 18, 1950.

The Minutes show that the FOMC began by considering a letter from the Secretary of the Treasury which was dated July 31, 1950.

The Treasury letter was in response to a letter from the FOMC on July 12, 1950 which stated (among other things) that:

outlined serious problems now faced by the Federal Open Market Committee in maintaining an orderly market for Treasury financing. My letter explained why, in our judgment, it was urgent that the Treasury make an early announcement that it had decided to raise funds by means of a long-term 2-1/2 per cent nonmarketable issue on a tap basis.

A tap issuance refers to the system whereby the Treasury would announce an issue of debt and issue however much was demanded at a set yield.

This is in contrast to an auction system where the volume of debt issued was fixed and the bond dealers would then set the yield as an indication of what they were prepared to pay for the debt.

Importantly, the central bank wanted it made clear that the Treasury would not call on central bank funds to participate in the tap issue.

The FOMC stated in their response to the Treasury letter:

We think it will greatly contribute to confidence in the value of the dollar and hence in Government bonds to offer such a tap issue. It would signalize the Government’s purpose to rely primarily on nonbank financing, thus avoiding as far as possible resort to the highly inflationary process of financing through the banking system. Experience has shown that it is not technically difficult for the Treasury to raise money by selling securities which are either bought directly or indirectly by banks, provided the Federal Reserve supplies banks with the necessary reserves. The market and the public are now fully educated to these technical possibilities and they know that a procedure of this sort feeds the fixes of inflation.

The FOMC was convinced that the non-government bond market would soak up all the debt that the Treasury would need to issue to match its deficit as the military expenditure associated with the Korean conflict escalated.

The FOMC then concerned itself with the question of what it was:

… going to do about making further reserve funds available to the banking system in a dangerously inflationary situation.

They discussed the need to tighten up on credit availability via higher interest rates.

Allan Sproul (the President of the New York Federal Reserve Bank and Vice-Chairman of the FOMC, sitting in as Chair because the Chairman Thomas McCabe was absent due to flight delays from Maine) said that the bank should increase rates:

This time I think we should act on the basis of our unwillingness to continue to supply reserves to the market by supporting the existing rate structure and should advise the Treasury that this is what we intend to do — not seek instructions. If we don’t act we will have failed to take the action required by the economic situation and the national program for meeting the present emergency …

The FOMC discussion reveals that, while Sproul had sought short-term interest rate increases, there was a feeling that “a much broader program was needed”, which would include increasing the “discount rate” (the rate the central bank supplied reserves to the commercial banks), increase “reserve requirements” and more.

Board member Marrinner Eccles concurred with Sproul, saying (not verbatum but minuted):

… it was time the System, if it expected to survive as an agency with any independence whatsoever, should exercise some independence, that the country today was faced with the probability of an even greater expansion in military expenditures then had been announced and therefore with an increasing deficit, that while he felt an increase in taxes to meet the additional expenditures was essential it was also essential that credit expansion be curbed …

He also noted that pushing up the short-end of the yield curve would have the beneficial effect of pushing up long-term rates as well.

After further discussion, the FOMC determined to reconvene later after Chairman McCabe had visited the Treasury at 14:00 to consider the Treasury funding position.

The reconvened meeting of the FOMC reaffirmed its intention to push rates up to slow down domestic spending, given the escalating war expenditure.

They signalled that McCabe and Sproul would meet with the Secretary of the Treasury (Mr Snyder) at 16:30 that afternoon to inform him of their leanings.

While desiring the Treasury to rely only on the non-government bond investors, the FOMC did say (in their draft press release) that they would continue to:

… purchase for the System open market account direct from the Treasury of such amounts of special short-term certificates of indebtedness as may be necessary from time to tie for the temporary accomodation of the Treasury; provided that the total amount of such certificates held in the account at any one time shall not exceed $1,000,000,000.

So, in effect, while still realising it had to stand ready to fund the Treasury should the non-government tap issue not be sufficient, the FOMC decided at that point “to challenge Treasury Secretary Snyder’s unwillingness to allow any rise in interest rates, short-term or long-term.”

But at this stage, the Federal Reserve Bank was still operating under the pegged arrangement and stood ready to absorb any shortfalls in demand for Treasury bonds.

There were two meetings of the Federal Reserve Open Market Committee (FOMC) on January 31, 1951. The first, at 10.00 The FOMC considered “its institutional arrangement with the Treasury Department” while the second, at 18:45 followed a meeting with the President (Truman) at the White House.

The documents available are:

1. Federal Open Market Committee, Minutes, 6:45 p.m..

2. Federal Open Market Committee, Minutes, 10 a.m.

The records record that this was “the first between a U.S. president and the committee”.

At the earlier meeting, it was noted in response to the latest Treasury bond issue that “demand for such bonds was not sufficient to absorb the supply, vith the result that approximately $30 million of bonds were purchased for the System account”.

They had purchased the gap to maintain “an orderly market” (that is, to stop the rates falling and maintain the peg).

The FOMC had received a telegram from Synder which read:

As fiscal agent of the United States, you are authorised and requested to purchase for account of the Postal Savings System not more than two hundred million dollars Treasury bonds December 1967-72 at par and 22/32nds, plus commission, at such times when open market purchases are not made at this price for open market account.

In other words, the FOMC was being instructed to conform with Treasury wishes to maintain the pegged yields.

McCabe and Sproul had private meetings with the Treasury during January 1951 and had expressed their inflationary fears and their belief that credit had to be constrained and the provision of bank reserves tightened (and made more expensive).

They also told the Treasury that with the term structure of interest rates rising:

… the Treasury will face a prob- lem unless it offers a higher long term rate.

In other words, exhorting the Treasury to abandon the pegged yield agreement.

McCabe reported that President Truman had called him at his home in December 1950 furious about a media report that said that there was:

… open speculation as to whether the Federal Reserve is again undercutting the (Treasury) financing …

Truman had told McCabe that “he hoped we would stick rigidly to the pegged rates on the longest bonds”.

A subsequent letter (December 4, 1950) from Truman to McCabe reaffirmed the President’s view that:

… this situation is a very dangerous one and that the Federal Reserve Board should make it perfectly plain to the open market committee and to the New York Bankers that the peg is stabilized …

if the Federal Reserve Board is going to pull the rug from under the Treasury on that, we certainly are faced with a most serious situation …

I hope the Board will realize its responsibilities and not allow the bottom to drop from under our securities. If that happens that is exactly what Mr. Stalin wants.

I found the reference to Stalin to be very interesting and it has prompted a lateral document search, which I may report on another time, when I have a better view on the developments.

But it was clear that the government was caught up in Communist scaremongering and saw it as a way to pressure the FOMC to take instructions from the Treasury.

McCabe responded in writing (December 9, 1950) expressing his “great concern” for the President’s demands but reaffirmed that the Federal Reserve’s actions in relation to Treasury bond issues makes it clear that:

… that we have faithfully followed the policy as outlined to you.

But he restated his view that the pegged yield arrangement was distorting the market and allowing inflationary forces to percolate.

McCabe sought a meeting with the President to reach an understanding about this growing tension.

That meeting took place on January 17, 1951 at the White House. The Secretary of the Treasury was in attendance.

The President restated his wish that the 2.5 per cent peg be maintained on long-term government securities. Both the President and the Secretary wanted the parties to the agreement to “let the public know that the 2-l/2 per cent rate was going to be maintained” as soon as possible.

There were subsequent interchanges over January 1951 between the parties, which all added to the tensions. It was clear McCabe was annoyed with public statements that Snyder had made, which seemed to ignore the interactions between the bank and the Treasury.

All of this was part of the core discussion at the morning meeting on January 31, 1951.

The FOMC were then informed at that meeting that the President wanted to meet with the full FOMC at 16:00 on the same day. The FOMC moved to discussing tactics in response to their speculation on what Truman might be about to say to them.

These were:

1. Confirm the FOMC would continue the pegged arrangement but issue a public statement that the FOMC “as acting in response to a specific request of the President during the emergency” – which would “leave the Federal Reserve with nothing to do in the field of general credit controls” and reduce its capacity to control inflation.

2. Publicly announce that the FOMC would abide by the peg unless “changing economic conditions” (inflation etc) required a different policy response whereby the FOMC would inform the President and the Treasury and require a conference between the parties – which would be “equally as bad” as Option 1.

3. “If the views that might be expressed by the President were diametrically opposed to those of the Committee, the members of the Committee could resign.”

In other words, Option 3 would seriously up the pressure on the President to abandon the peg and allow the Federal Reserve to run its monetary policy as it saw fit.

The subsequent discussion highlighted the FOMC’s distrust of Secretary Snyder who they believe was behind the President’s request for a meeting, which would tell the FOMC that they were there to do the President’s bidding not the other way around.

Allan Sproul considered Options 1 and 2 would not allow the central bank to “do the main Job Congress had given the System to do … to maintain public confidence in the real value of the dollar”.

Sproul thought Option 3 “would be an admission of failure or inability to carry out our statutory responsibilities”. He thus proposed Option 4 which would ask Congress:

… ask for a new set of rules to govern the Federal Reserve System because it could not continue on the present course which involved either continued open conflict with the Treasury or complete abdication of the responsibility of the members of the Federal Open Market Committee.

They didn’t reach a decision on the Options floated but did agree to place a statement on file that effectively said that if the FOMC was instructed by the Treasury to “follow a course” then the FOMC “had no alternative but to follow
that course” but would be effectively servants of the President.

The meeting with the President then resulted in further documentation from the FOMC.

The President had told the FOMC that Stalin was playing up and the US “must combat Communist influence on many fronts” and that:

… He said one way to do this is to maintain confidence in the Government’s credit and in Government securities …

if people lose confidence in Government securities all we hope to gain from our military mobilization, and war if need be, might be jeopardized.

Which I found hilarious – the ‘reds under the beds’ scaremongering to pressure the Federal Reserve to play ball with the Treasury!

But, moreover, it was interesting that the President considered public confidence was ensured if the central bank used its capacity to continuing buying government debt.

That sort of statement would not be made today in this vehement, neo-liberal era.

After the meeting, without consultation, the White House issued a statement saying that “The Federal Reserve Board has pledged its support to President Truman to maintain the stability of Government securities as long as the emergency lasts”.

The later meeting that day (January 31, 1951) of the FOMC executive members just confirmed what had happened that day and that the Federal Reserve System would continue to buy Treasury securities to stabilise the Government securities market (the peg) but would limit the contribution (as above) to $US1 billion.

The next meeting of the FOMC was on February 6, 1951. Here the mood sharpened as a result of reported leaks from the FOMC about the nature of the meeting on January 31 between the President and the FOMC.

The – Minutes of the Board of Governors of the Federal Reserve System – for February 6, 1951 reveal that the Board was concerned about “several leaks to the press concerning the FOMC’s Jan. 31 meeting with President Truman.”

An FOMC board member (Mr Vardaman) had requested another member (Powell) approve the release of a public statement recounting the meeting. Powell refused because the statement “contained the names and views of individual members of the Board” and should be approved by the full Board.

Vardaman rang Powell, saying that unless the latter “wished to assume the responsibility for throttling another member of the Board in the expression of his views” he should call a full Board meeting “to consider the matter”.

The subsequent Board meeting approved Powell’s actions because Vardaman had apparently expressed disatisfaction with McCabe’s handling of the matter with the President, specifically, Vardaman’s impression that McCabe “had given President Truman every reason to believe that the Committee and Board would support the Government financing program” and the Board’s failure to release a clear public statement to that effect”.

The inference was that the FOMC really was trying to abandon the peg and push up rates and to present itself otherwise would be not only misleading the President but also the public.

Vardaman was questioned about a media article published the day before (February 5, 1951) which seemed to have inside knowledge of the interactions with the President on January 31, 1951. He denied leaking any information to the press.

Another Board member (Evans) put it on the public record that he thought Vardaman was lying.

Vardaman just responded by saying that he disagreed with the Board and wanted “to make his position clear” in the media release.

But it is clear that at this stage things were falling apart.


In Part 3 we will reach the conclusion of this affair and examine what was really going on behind the scenes, including the role played by Wall Street bankers intent on pressuring the New York Federal Reserve Branch to do its bidding.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

At present, I am writing this from Kansas City where I will be presenting several sessions at the – First International Conference of Modern Monetary Theory.

The Conference Program details times and sessions.

I am told that there will be live streaming of the sessions. When there is a reliable link available I will make it available in one way or another.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

Travelling all day today …

Sep. 19th, 2017 10:00 pm
[syndicated profile] billyblog_feed

Posted by bill

I am travelling all of today to the US for the MMT Conference in Kansas City which begins on Thursday. I hope to see some of you at the conference which will be a major development in our program of work and advocacy. From there I am onto London for the British Labour Party Conference presentation (Monday) and the book launch of my latest book (with Thomas Fazi) Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Tuesday – see below for free ticket access). For details of all the events associated with my speaking tour in the next fortnight see below.

While I am away, the blog might be rather sketchy. The itinerary is very tight with lots of travel which is disruptive for considered research and writing.

I also won’t be able to attend to comments in the next 24 hours or so.

At the very least, while I am away, I will keep a daily diary and post audio, interviews, photos, videos etc where possible.

But for now – some music ….

Some music to listen to ..

On Thursday night I am playing guitar in Kansas City with a jazz trio (piano, bass, drums). This is the sort of stuff we will be exploring although it might go from this to some things a little more raucous as we go!

This is the title track from the 1963 Album – Midnight Blue – by American guitarist Kenny Burrell.

It is one of my favourite records of all time. A Blue Note label jazz classic.

Reclaiming the State Lecture Tour – September-October, 2017

Thursday, September 21: Kansas CityInternational Conference of Modern Monetary Theory – see program for details.

Friday, September 22: Kansas City – MMT conference, as above.

Monday, September 25: Brighton (UK) – I will be speaking at a fringe event – Economics for a Progressive Agenda – associated with the British Labour Party Annual Conference.

Location: The Brighthelm Centre, North Road, Brighton, BN1 1YD.

Time: The event will run from 14:00 to 17:00.

Entry: Free. All are welcome.

See – RSVP page.

Also – The fringe event that promises to empower Labour’s Progressives against neoliberalism – for more details and background.

Tuesday, September 26: London – Formal Book Launch of – Reclaiming the State – Newington Green Unity Church, 39a Newington Green, Stoke Newington, London, N16 9PR.

Time: The event will run from 18:30 to 20:30.

Entry: Free. All are welcome.

Please see – Ticket Page (entry free).

Wednesday, September 27: BerlinReclaiming the State launch combined with German language version of my 2015 book Eurozone Dystopia: Groupthink and Denial on a Grand Scale.


  • Professor Dr. William Mitchell, Author, University of Newcastle, Australia.
  • Professor. Dr. Heiner Flassbeck, Former State Secretary for Economic Affairs.
  • Dr. Dirk Ehnts, University of Chemnitz.
  • Thomas Fazi, Co-Author of “Reclaiming the State”, Journalist.

Location: neues deutschland, Franz-Mehring-Platz 1, 10243 Berlin.

Time: The event will start at 19:00.

Entry: Free. All are welcome.

Thursday, September 28: MadridReclaiming the State Presentation at Ecooo – http://ecooo.es/


  • Professor William Mitchell, Author Reclaiming the State.
  • Thomas Fazi, Co-author Reclaiming the State.
  • Dr Eduardo Garzón, Adviser in the economic cabinet of the Economy and Finance Area in the City of Madrid.
  • Manolo Monero, Parliamentary Deputy for United Podemos.

Location: Ecooo, Calle Escuadra 11, 28012, Madrid, Spain.

Time: The event will start at 18:30.

Entry: Free. All are welcome. A small donation will be appreciated by organisers to cover room hire.

For further details: E-Mail Stuart at redmmt.info@redmmt.es or madrid@redmmt.es

Friday, September 29: MadridReclaiming the State presentation at Universidad Autónoma de Madrid

Activities: Presentations. Meetings with student activists. Meetings with various politicians. Press engagements.


  • Professor William Mitchell, Author Reclaiming the State.
  • Thomas Fazi, Co-author Reclaiming the State.

Location: Salón de Actos, Facultad de Ciencias Económicas y Empresariales, Universidad Autónoma de Madrid, Cantoblanco.

Time: 12:30.

Entry: Free. All are welcome.

Saturday, September 30, RomeReclaiming the State presentations.

There will be two events in Rome on this day.

Event 1


  • Professor William Mitchell, Author Reclaiming the State.
  • Thomas Fazi, Co-author Reclaiming the State.
  • Nicola Genga, Director of the Centro per la Riforma dello Stato (Centre for the Reform of the State).
  • Stefano Fassina, Sinistra Italiana MP.

Location: Campidoglio – Sala del Carroccio, Piazza del Campidoglio, 1.

Time: 16:30.

Entry: Free. All are welcome.

Event 2: – Organised by the Think Tank Trinità dei Monti


  • Professor William Mitchell, Author Reclaiming the State.
  • Thomas Fazi, Co-author Reclaiming the State.

Location: Hotel Il Palazzetto, Vicolo del Bottino, 8.

Time: 20:00.

Entry: Free. All are welcome.

Sunday, October 1: FerraraReclaiming the State presentation at Festival di Internazionale.

There will be two events in Ferrara on this day.

Event 1Money and debt. The errors and horrors of financial markets:


  • Professor William Mitchell, Author Reclaiming the State
  • Thomas Fazi, Co-author Reclaiming the State.
  • GECOFE (Gruppo economia cittadini di Ferrara)

Location: Sala dell’Arengo, Piazza del Municipio, 2

Time: 11.00

Entry: Free. All are welcome.

Event 2 – will include Reclaiming the State presentations, discussion and screening of the documentary PIIGS.


  • Professor William Mitchell, Author Reclaiming the State
  • Thomas Fazi, Co-author Reclaiming the State.

Location: Ascom, via Baruffaldi 14/18 (Sala Zamorani, 1st floor)

Time: 15:00

Entry: Free. All are welcome.

More information: gruppoeconomia.fe@gmail.com.

Monday, October 2: MilanReclaiming the State presentation at Milan Culture Festival.


  • Professor William Mitchell, Author Reclaiming the State.
  • Thomas Fazi, Co-author Reclaiming the State.

Location: Palazzo Pirelli, Via F. Filzi 22 (Sala Pirelli)

Time: 18:00.

Entry: Free. All are welcome.

Tuesday, October 3: Helsinki – Meetings with activists etc.

Details coming.

Wednesday, October 4: Helsinki – Dual Book Launch – Reclaiming the State (William Mitchell and Thomas Fazi, Pluto) and Exits and Conflicts: Disintegrative Tendencies in Global Political Economy (Heikki Patomäki, Routledge).


  • Professor William Mitchell, Author Reclaiming the State.
  • Professor Heikki Patomäki, University of Helsinki, Author Exits and Conflicts: Disintegrative Tendencies in Global Political Economy.
  • Thomas Fazi, Co-author Reclaiming the State.

Location: PIII in Porthania, University of Helsinki, City Campus.

Time: 11:15 – 12:45.
Entry: Free. All are welcome.

Thursday, October 5: Helsinki – Public Lecture.


  • Professor William Mitchell, Author Reclaiming the State.

Location: University of Helsinki, Lecture Hall 5, Main Building

Time: The event will begin 16:00.

Entry: Free. All are welcome.

Friday, October 6: Paris – To be confirmed.

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

My discounted book promotion is over for the time being. I might have more stock by mid-October.

But I hope you all get to one of the events in the next few weeks.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

LFG: Donald Duck

Sep. 19th, 2017 08:29 am
dduck: (Default)
[personal profile] dduck posting in [community profile] musemostwanted
Your Muse: Donald Duck
Muse wanted: Literally any
Community: I'm specifically looking for one!
Fandom: Duckverse comics, Carl Barks/Don Rosa timeline
Canon or AU: Canon (but made human)
Medium: Comics
Contact via: Comment here or PM

I'm looking for a game to join. Actual canonmates would be fun but is in no way necessary. (I assume I'm unlikely to find any, except maybe Ducktales ones.)

Mix of slice-of-life and plot-based is cool. No games focused on horror or sex (some of either is fine, just not the focus). Has to be on Dreamwidth. Medium-paced, not crazy huge, somewhere I'd be welcome and wanted.

(Feel free to check out character journal for more info about him and stuff!)
[syndicated profile] billyblog_feed

Posted by bill

I have all that much time today to write this up and it is going to be one of those multi-part blogs given the depth of the historical literature I am digging into. So this is Part 1. The topic centres on an agreement between the US Federal Reserve System (the central bank federation in the US) and the US Treasury to peg the interest rate on government bonds in 1942. What the agreement demonstrated is that a central bank can always control yields on government bonds, which includes keeping them at zero (or even negative in the current case of Japan). What it demonstrates is that private bonds markets, no matter how much they might huff and puff about their own importance or at least the conservatives who are ‘fan boys’ of the bond markets), the government always rules because of its currency monopoly

There is a rich set of documents now available, which help us understand what the 1942 agreement was all about.

There was also a special edition of the – Economic Quarterly, a quarterly publication put out by the US Federal Reserve Bank Richmond branch in the Winter of 2001, which “commemorated the 50th anniversary of the Accord”.

It is very interesting to read through the historical documents and the more recent (2001) interpretation of them.

On December 7th, 1941, the Japanese bombed Pearl Harbour, which provoked the US to formally enter the World War 2 conflict in an allied alliance with the United Kingdom and the Soviet Union.

On December 11, 1941, war was declared between Germany and Italy and the US.

In April 1942, as the US ramped up the prosecution of its War effort, the Treasury Department requested that the US Federal Reserve Bank use its monetary policy operations to maintain:

… a low interest-rate peg of 3/8 percent on short-term Treasury bills. The Fed also implicitly capped the rate on long-term Treasury bonds at 2.5 percent.

That is, control yields on government debt across a broad maturity range. By controlling the short-end of the yield curve (the structure of interest rates by maturity of the debt), the central bank would condition the longer term rates.

And they could directly control the longer rates, which would then influence the cost of investment type borrowing by the private sector.

All in a day’s work for a central bank that works in harmony with the fiscal authority.

The aim of the US Treasury was:

… to stabilize the securities market and allow the federal government to engage in cheaper debt financing of World War II …

Fairly simple.

The President, Harry Truman and the Secretary of the Treasury John Snyder were both, not only motivated by a desire to keep the ‘cost’ of borrowing down for the Government, but also, importantly, “to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war”.

What did they mean by that?

To fully understand that, we need to briefly understand how bond markets operate.

Ignoring specific nuances of a particular country, governments match their deficits by issuing public debt. For Eurozone Member States this is a funding operation, for other fiat currency issuing states it is a reserve draining operation.

What needs to be understood that in this fiat currency era where nations can float their exchange rates at will (if they issue their own currency), the act of issuing debt is a totally voluntary act for a sovereign government.

The only purpose debt-issuance serves is when it is used as part of a monetary operation (to maintain central bank control over target interest rates). And even then, it is unnecessary because the central bank can just pay a competitive return on excess reserves.

It does not have to drain them via open market operations (selling debt in return for extinguishing reserves).

But what we clearly know is that for a currency-issuing government, the debt issuance is entirely unnecessary for its spending decisions.

The practice of debt-issuance gives the impression that the borrowing is funding the spending but that is a chimera. The arrangements that motivate that perception are ephemeral and can be altered by the government should it have the will to do so.

Which is what happened in 1942 in the US.

To understand bond market auctions etc, we distinguish between a primary market and a secondary market.

Governments (more or less) use auction systems to issue debt. The auction model merely supplies the required volume of government paper at whatever price was bid in the market. Typically the value of the bids exceeds by multiples the value of the overall tender.

The primary market is the institutional machinery via which the government sells debt to a select group of nominated banks and financial institutions, who ‘make the market’.

The secondary market is where existing financial assets (that were previously issued in the primary market) are traded by interested parties. This is where the speculators live.

So the financial assets enter the monetary system via the primary market and are then available for trading in the secondary.

Clearly secondary market trading has no impact at all on the volume of financial assets in the system – it just shuffles the wealth between wealth-holders. In the context of public debt issuance – the transactions in the primary market are vertical (net financial assets are created or destroyed) and the secondary market transactions are all horizontal (no new financial assets are created).

Please read the following introductory suite of blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts.

The way the auction process works is simple. The government determines when a tender will open and the type of debt instrument to be issued. They thus determine the maturity (how long the bond would exist for), the coupon rate (the interest return on the bond) and the volume (how many bonds).

The issue is then put out for tender and demand relative to the fixed supply in the market determines the final price of the bonds issued. Imagine a $1000 bond had a coupon of 5 per cent, meaning that you would get $50 dollar per annum until the bond matured at which time you would get $1000 back.

Imagine that the market wanted a yield of 6 per cent to accommodate risk expectations. In this case, the bond is unattractive and so they would put in a purchase bid lower than the $1000 to ensure they get the 6 per cent return they sought.

The general rule for fixed-income bonds is that when the prices rise, the yield falls and vice versa. Thus, the price of a bond can change in the market place according to interest rate fluctuations.

When interest rates rise, the price of previously issued bonds fall because they are less attractive in comparison to the newly issued bonds, which are offering a higher coupon rates (reflecting current interest rates).

When interest rates fall, the price of older bonds increase, becoming more attractive as newly issued bonds offer a lower coupon rate than the older higher coupon rated bonds.

So for new bond issues the government receives the tenders from the bond market traders which are ranked in terms of price (and implied yields desired) and a quantity requested in $ millions. The government then issues the bonds in highest price bid order until it raises the revenue it seeks. So the first bidder with the highest price (lowest yield) gets what they want (as long as it doesn’t exhaust the whole tender, which is not likely). Then the second bidder (higher yield) and so on.

In this way, if demand for the tender is low, the final yields will be higher and vice versa. There are a lot of myths peddled in the financial press about this. Rising yields may indicate a rising sense of risk (mostly from future inflation although sovereign credit ratings will influence this).

But rising yields on government bonds do not necessarily indicate that the bond markets are sick of government debt levels. In sovereign nations (not the EMU) it typically either means that the economy is growing strongly and investors are willing to diversify their portfolios into riskier assets. It is also usually a time that the central bank pushes up rates and bond yields more or less follow.

The point is that if the central bank pushes up the demand for extant government bonds in the secondary market, it will, other things being equal, push up the price and the yields will fall (even though the coupon is fixed).

So it was a simple monetary operation by the central bank to control yields at whatever level they desired. In doing so, there were allegations raised (by conservatives and central bankers) that the central bank was being politicised.

This came to a head during the Korean War and conflict between the Treasury and the Federal Reserve saw the 1942 peg scrapped. More about that in Part 2.

But the whole ‘politicisation’ ruse is interesting because the original legislation establishing the Federal Reserve Bank system in the US (the Federal Reserve Act 1913) clearly allowed the the Federal Reserve Banks to buy unlimited amounts of Treasury bonds directly from the Treasury.

In 1935, the Federal Reserve Board was “renamed and restructured”.

Prior to 1935, that power to by unlimited amounts of US Treasury bonds directly from the Treasury was used regularly. The first time this was used was in 1917.

There was an article in the New York Times (March 28, 1917) – Reserve Banks Lend M’Adoo $50,000,000 – which said that:

To maintain the working level of the general fund of the Treasury, Secretary McAdoo has borrowed on Treasury certificates from the Federal Reserve Banks $50,000,000 at 2 per cent per annum … The Federal Reserve Banks subscribed with such promptness that at 3 P.M. today the entire amount had been taken.

The Secretary of the Treasury Mr McAdoo said that the “twelve Federal Reserve Banks … are fiscal agents of the Government”.

Part of the funds went to pay the sale price of the Danish West Indies, now the US Virgin Islands.

The other interesting aspect of the ‘loan’ was that the private bond markets were not interested in the deal and a spokesperson said that “other institutions would not care to invest their funds in these securities at the very unattractive rate”.

The prevailing market rate at the time on short-term Treasury certificates was 3 per cent.

So the principle was clear. At a time when competitive market rates were deemed higher than the government wanted to pay on any debt it issued, the solution was simple – get the central bank to buy the debt.

In 2014, Kenneth D. Garbade published a Federal Reserve Bank of New York Staff Report – Direct Purchases of U.S. Treasury Securities by Federal Reserve Banks – which recounts the way the central bank in the US could purchase unlimited amounts of treasury debt by creating funds out of thin air and how that capacity was eventually constrained.

Garbade documents how the Federal Reserve Board has some reluctance to purchase directly and considered “that the normal services of the Bank as fiscal agent will best be rendered by assisting in distributing Government securities rather than by acting as a purchaser of them.”

That is, buying government bonds in the secondary markets (once they had been issued via tender) from non-government bond holders.

Eventually, the growing central bank consternation about direct purchases led to a legislative change.

In 1935, the 1913 Federal Reserve Act was qualified by the the Banking Act of August 23, 1935, which meant that the Federal Reserve Banks could only purchase government bonds “in the open market” – that is, the secondary market.

The upshot of this new legislation was that the “proviso explicitly prohibited direct purchases of Treasury securities by Federal Reserve Banks.”

So a voluntary financial constraint was imposed on the relationship between the central bank and the US treasury despite history telling us that the central bank direct debt purchases from the Treasury between 1913 and 1935 had gone “without incident”.

It was conservative antagonism that led to the 1935 constraints. So we understand them to be purely ideological and political.

The debates at the time made it clear that the legislators knew there was smoke and mirrors at work here.

It was observed by the US House of Representatives Committee on Banking and Currency, which was overseeing the legislation that:

There is no logic in discriminating against obligations which, being in effect obligations of the United States Government, differ from other such obligations only in that they are not issued directly by the Government.

In other words, it was flim flam to prohibit the central bank from purchasing debt from the Treasury directly when it could simply signal to the private bond markets that upon issue, it would buy unlimited quantities of bonds from them (indirectly).

These sort of accounting ruses dominate government fiscal operations today and place a smokescreen over what is really the intrinsic nature of the monetary system.

It is also the way that the ECB is getting around the Treaty of Lisbon constraints, which prevent bailouts of governments.

If the central bank is creating demand for financial assets (bonds) in the secondary market then people can be tricked into believing that it is the private sector that ‘funds’ government, despite the reality being that it is the same government that issues the currency in the first place and has to spend it first before it can borrow it back.

Of course, the effect of pointless exercises like that are that they provide the neo-liberals with ammunition by linking government deficits with public debt buildup and then all the rest of the nonsense about ‘mortgaging the grandchildrens’ futures’ and the like are wheeled out on a largely ignorant public to engender political support for austerity-type fiscal stances.

It is all a total ruse and the US House Committee in 1935 clearly knew that.

But their colleagues in the US Senate changed the legislation to prohibit “direct purchases of Treasury securities by Federal Reserve Banks” although the Senate Banking Committee “did not explain the reason for the prohibition”.

Kenneth Harbade cannot find a clear answer to why they introduced this prohibition against the wishes of the Treasury at the time, which considered it essential to have that direct capacity in times of emergency.

The obvious reasons are entertained in the Report.

First, “direct purchases may have been prohibited to prevent excessive government expenditures”.

Second, to prevent “chronic deficits” and force the government to the “test of the market”. As if the private bond markets have the interests of the entire nation at their hearts.

In relation to these motivations, it is clear that the neo-liberal expression of this over the last three decades has overwhelmingly imposed massive political restrictions on the ability of the government to use its fiscal policy powers under a fiat monetary system to ensure we have full employment.

In Europe they took the constraints to one higher level of idiocy by banning any ECB bailout (since violated) and imposing the Stability and Growth Pact. But in other monetary systems where the national government still issues the currency, the voluntary constraints are also oppressive.

We now accept very high unemployment and underemployment rates as a more or less permanent feature of our economic lives because of the ideological constraints imposed on government.

The collapse of the Bretton Woods system in 1971, which freed currency-issuing governments of any financial constraints, did not prevent the logic that applied in the fixed exchange rate-convertibility days from being imposed despite the economic fact that it does not apply in the fiat currency era.

As a result, governments impose voluntary constraints on themselves to satisfy the dominant ideological demands of the elites.

However, the 1935 shifts were not to last very long. The 1935 prohibition of direct central bank purchases of US Treasury debt were relaxed in 1942, which is where I began.

From 1942, the Treasury borrowed “huge sums of money” from the central bank as part of its war effort.

In this blog – Time for fiscal policy as we learn more about monetary policy ineffectiveness – I considered some of the views of the Federal Reserve Bank Chairman Marriner Eccles in 1935.

Mariner Eccles wrote at the time that by allowing direct purchase of debt by the central bank the nation could:

… avoid the necessity of having the Treasury offer Government obligations for sale on the open market at a time when the market is demoralized and an additional public offering might add to the confusion and demoralization of the market and do incalculable harm to the Government’s credit and to the holders of outstanding Government obligations.”

Eccles went further though and believed that the Treasury should never be at the behest of the private bond markets. He said:

If the market situation happens to be unfavorable on any given day when a financing operation is up … the Federal Reserve System should be in a position where it can take care of it by a direct purchase from the Treasury of an issue of securities.

Whether a government buys debt directly from the Treasury or indirectly makes little difference in this respect. The former avenue is always preferable from a Modern Monetary Theory (MMT) perspective because it cuts out the corporate welfare element inherent in exclusive primary issuance to non-government dealers.

The 1942 amendment allowed the central bank to buy debt directly from the Treasury but only up to a certain limit ($US5 billion).


In Part 2, we will examine the breakdown of the pegged arrangement as central bank politics overcame the pragmatism of the US Federal Treasury.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

I have run out of stock of the discounted book offer. I might have some more in mid-October. But you can still purchase the book at various bookshops including Amazon, Pluto Books, Barnes and Noble, Dymocks, Readings etc.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

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Last week (September 13, 2017), the President of the European Commission, Jean-Claude Juncker, presented his State of the Union Address 2017 in Strasbourg before the European Parliament. My only query arising from the speech was which Member State has left, given that the President began his speech by thanking “the 27 leaders of our Member States” (joke). He opened by saying how unity among the Member States had “showed that Europe can deliver for its citizens when and where it matters”. I wonder which Planet he was referring to. I thought Europe was on the Mother Earth and it certainly hasn’t been delivering for its citizens, if the usual measures are considered. Juncker’s speech just continues what I considered to be ‘Groupthink and Denial on a Grand Scale’, which was the subtitle of my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale. It is amazing that the denial continues after 10 years and that guys like Juncker can still command an audience and a salary.

In heaping praise on his own regime, the EU President said:

We are now in the fifth year of an economic recovery that finally reaches every single Member State.

Growth in the European Union has outstripped that of the United States over the last two years. It now stands above 2% for the Union as a whole and at 2.2% for the euro area.

That statement is true. But the US reached the pre-GFC peak after only 15 quarters whereas it took 27 quarters (3 more years) before the EU28 reached the pre-GFC level and 30 quarters for the Eurozone Member States (taken together).

So the lost output due to the crisis was much higher for the European Union (especially the Eurozone) than it was for the US.

Other nations such as Australia never had a recession because it introduced a large discretionary fiscal stimulus early on in the crisis and held it for long enough to maintain overall growth.

The next graph shows the path of real GDP in the Euro19 Member States from March 1995 to December 2016 (indexed to 100 at the March-quarter 2008 – the peak before the GFC).

The simulated line is based on extrapolating out the actual growth path from 1995 to the December-quarter 2007 using the average quarterly growth rate over the period.

Despite the President’s claims, actual real GDP is only 4.1 per cent higher than it was in the March-quarter 2008 for the Eurozone as a whole.

A comparable figure for the US is 12.7 per cent; for the UK, 9.1 per cent; Norway 11.4 per cent; and Australia 23.7 per cent.

That makes the Eurozone’s growth look shocking – and it has been.

The average growth rate since the September-quarter 2015 (when the Eurozone finally passed the level of GDP attained before the crisis) has been 0.51 per cent per quarter compared to the average rate of 0.64 per cent per quarter between March 1995 to December 2007.

So the rate of growth is still well below the pre-crisis level and the output gap is massive. I qualify that statement by noting that the red line is probably not the current sustainable trend rate of growth given the massive collapse of capital formation in the Eurozone since the crisis.

In fact, potential GDP has probably fallen significantly.

The next graph provides some relative information by comparing post-GFC real output performance for the US, the UK, Australia, the Eurozone 19 and the EU28.

The series for each nation is indexed to 100 at their respective peak. So for Australia the peak came three quarters later than it did say for the Eurozone 19 (hence the shorter series for the former).

The European performance has been vastly inferior to that of the three Anglo-speaking nations.

If we consider the lost output since the peak, the following data is relevant:

  • EU28 – at trough 94.4 (June 2009) – 27 quarters to return to pre-GFC peak. Index at June 2017 = 106.2
  • Euro19 – at trough 94.3 (June 2009) – 30 quarters to return to pre-GFC peak. Index at June 2017 = 104.1
  • Greece – at trough 72.9 (December 2016) – still 26.4 percentage points below pre-GFC peak. Index at June 2017 = 73.6
  • Spain – at trough 90.4 (September 2013) – 37 quarters to return to pre-GFC peak. Index at June 2017 = 100.4 (after major fiscal stimulus which violated all Stability and Growth Pact rules)
  • Italy – at trough 90.5 (March 2013) – still 6.4 percentage points below pre-GFC peak. Index at June 2017 = 93.6
  • USA – at trough 95.8 (June 2009) – 15 quarters to return to pre-GFC peak. Index at June 2017 = 113.6
  • UK – at trough 93.7 (June 2009) – 23 quarters to return to pre-GFC peak. Index at June 2017 = 109.0
  • Norway – at trough 95.8 (September 2010) – 18 quarters to return to pre-GFC peak. Index at June 2017 = 110.0
  • Australia – at trough 99.3 (December 2008) – 2 quarters to return to pre-GFC peak. Index at June 2017 = 123.7

Juncker then decided to seek solace in the labour market data. He said:

Unemployment is at a nine year low. Almost 8 million jobs have been created during this mandate so far. With 235 million people at work, more people are in employment in the EU than ever before.

The European Commission cannot take the credit for this alone. Though I am sure that had 8 million jobs been lost, we would have taken the blame.

I just love it when politicians claim there “are more people working than ever before”.

Which always seems to echo (in my mind) – sure and there are more people than ever before – so what!

The overall European Union population has expanded by 11.5 million since the March-quarter 2008, while total employment has risen by 4.5 million, a slight fall in the ratio of employment to total population.

So the employment rate is lower.

It is about rates you see.

The following graph shows the evolution of the official unemployment rate for the EU28 (blue) and the Euro19 (green) from the March-quarter 2008 to the June-quarter 2017. The dotted grey line is the March-quarter 2008 EU28 level

The rates are still at elevated levels more than 9 years after the crisis began.

Further, while there are more people in employment there are also 3.4 million more workers unemployment in the EU28 than there was in the March-quarter 2008 and 3.9 million more in the Eurozone.

But consider the fact that the European Commission was entrusted with creating conditions that would allow convergent (rather than divergent) outcomes to be achieved.

That clearly hasn’t happened.

The next graph shows the change in the official unemployment rate between the March-quarter 2008 and the March-quarter 2017 in percentage points.

So the Greek unemployment rate has risen from 8 per cent to 22.6 per cent (a change of 14.6 percentage points). Similar Spain’s unemployment rate is 8.9 percentage points higher than what is was in the March-quarter 2008 (nearly double).

Italy’s unemployment rate has risen from 6.5 per cent to 11.6 per cent over the same period.

But in contrast, some nations have reduced their official unemployment rate (noting that only the UK operates a fiat currency).

Clearly divergent outcomes are the norm in terms of this most important indicator.

Another way of viewing the failure of the European Union and the Eurozone, in particular, is to exclude the impact of the German economy.

The next graph shows the official unemployment rate for the EU28 and the Euro19 Member States with (solid line) and without Germany (dotted line) from the March-quarter 2005 to the March-quarter 2017.

The dotted lines just take the German unemployment and labour force out of the respective totals for the EU28 and the Euro19 aggregations.

Once again you witness divergence. Germany’s success has come at the expense of rather significant losses elsewhere in the Eurozone, particularly in the Southern States (Italy, Spain, Portugal, Greece, Cyprus).

The Eurozone unemployment rate excluding Germany is a full 2 percentage points higher (at 11.7 per cent) than the official rate. It has been above 10 per cent since the June-quarter 2009 and peaked at 14.7 per cent.

That is not a system that I would be crowing about.

Juncker praised the European Investment Plan which he said had “triggered €225 billion worth of investment so far”.

I last wrote about thta plan in this blog – Hype aside – the Juncker Plan – a failure from day one.

The so-called ‘Juncker Plan” was announced on November 24, 2014 as a EU launches € 315 billion Investment Offensive to boost jobs and growth.

There were three components to the ‘Juncker Plan’:

1. the “creation of a new European Fund for Strategic Investments, guaranteed with public money, to mobilise at least € 315 billion of additional investment over the next three years (2015 – 2017)”.

2. “establishment of a credible project pipeline … to channel investments where they are most needed.”

3. “an ambitious roadmap to make Europe more attractive for investment …”

It was claimed the Juncker Plan would “add €330 – €410 billion to EU GDP over the next three years and create up to 1.3 million new jobs”.

So for the President, 3 years into the plan to admit that it had “triggered €225 billion worth of investment so far”, when the aim was to add € 315 billion, signals failure.

And that is not to mention that the Juncker infrastructure plan was a drop in the ocean of what was needed, given the collapse in investment during the crisis.

Further, the ‘Juncker Plan’ was not an addition to the net financial assets of the Member States (that is, a ‘federal’ spending injection funded by the ECB) but, rather, was just redistributed Member State spending.

To put that assessment in context, the following graphs shows the evolution of investment ratios (as a percent of GDP) in the European Union (28) and the Eurozone (19) from the first-quarter 1995 to the June-quarter 2017.

The investment ratio is the share of capital formation (buildings, equipment etc) in total national output and is a strong measure of sentiment and growth potential in the economy.

At the onset of the GFC (March-quarter 2008), the investment ratios were 23.7 per cent for the EU28 and 24.1 per cent for the Euro19.

They reached a trough during the GFC of 19.2 per cent in the EU28 (March 2013) and 19.4 in the Eurozone in the same quarter.

By the June-quarter 2017, the EU28 investment ratio was only 20.3 per cent (and below the December-quarter 2016 value) and the ratio for the Eurozone was 20.5 per cent, also below the December-quarter 2016 value of 20.7 per cent.

Both ratios are still well below the pre-GFC levels and are now falling.

Juncker told the Brussels gathering that:

We can take credit for the fact that, thanks to determined action

How can Jean-Claude Juncker claim that sort of data to be evidence of a successful policy intervention? Answer: Groupthink and Denial.

Juncker was obviously reaching a delusional state as he moved through his Speech. Towards the end he claimed that he wanted “a stronger Economic and Monetary Union” and a “More United Union”.

At that point, he claimed that:

If we want the euro to unite rather than divide our continent, then it should be more than the currency of a select group of countries. The euro is meant to be the single currency of the European Union as a whole. All but two of our Member States are required and entitled to join the euro once they fulfil all conditions. Member States that want to join the euro must be able to do so.

Result: an immediate furore, especially in Germany.

The German press, in particular, was incensed by the implication that a whole range of “Greece-type countries” would be admitted to the common currency.

A headline in Die Welt (September 13, 2017) – Junckers Idee zum Euro ist völlig absurd (“Juncker’s idea of ​​the euro is completely absurd”) and went on to say that:

In seiner Grundsatzrede hat Jean-Claude Juncker seine Vision für Europas Zukunft vorgestellt. Doch sein zentraler Vorschlag klingt mehr nach einem Horrorszenario.

Which says that in his speech, Juncker presented his vision for the future. But his central suggestions sounds more like a horror story.

They went on to say:

Wenn Europa mitten in der tiefsten Krise steckt, braucht es dann wirklich mehr Euro für noch mehr Länder?

Man muss leider feststellen: Es wäre der beste Weg, um aus dem Traum von einem gemeinsamen Europa einen nicht enden wollenden Albtraum zu machen.

Which says that with Europe being in the midst of the deepest crisis, does it need more countries to adopt the euro. Unfortunately, one has to say that this would be the best way to turn the dream of a common Europe into a never-ending nightmare.

That is saying it!

One might reasonably conclude that the nightmare began years ago when they adopted the currency and this would just be another chapter in that sad tale.

Last Friday (September 15, 2017), the European Commission issued an emergency press release – Juncker: ‘I don’t intend to force countries to join the euro if they are not willing or not able to do so’ – to quell the outrage that emerged after Juncker got ahead of himself.

The European Commission clearly ran scared after this torrent of abuse and stated that:

All EU Member States should have the possibility – as required by the EU Treaties – to introduce the euro, but no one would be forced to do so … The strict euro-accession criteria would continue to apply … Yesterday I didn’t insist or request that everyone, by 11 o’clock in the morning, should now adopt the euro – I am amazed by much of what is written in the press, and that includes the German press. What I said was that those countries that have not yet adopted it, but that want to, must be given that possibility. And we should provide the technical – and in some cases financial – assistance to enable them to do so …

I have no intention of forcing countries to join the euro if they are not willing or not able to do so.

Phew. The thought of Romania and Bulgaria with the euro – that is a worse nightmare than Greece!


Juncker’s speech displayed the usual mixture of hubris, denial and error-prone behaviour that has defined his Presidency.

Sure enough, the Eurozone is growing again, albeit rather slowly and in a divergent way from a Member State perspective.

But the legacy of all the fiscal austerity remains with suppressed growth rates, elevated unemployment levels and inferior employment outcomes.

And that is not to mention the continuing poor investment performance, despite Junckers ‘grand’ (not) plan for revival.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

You can also find details on that site of how to purchase a copy of the book (paperback version) at discounted prices, well below the current market price from the booksellers.

The discounted price I can make the book available (while my stock lasts) is plus postage.

My stocks are limited (getting very low now) – only 12 left as I post this blog.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

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Muse wanted: Natasha Romanoff or Clint Barton. Also Steve Rogers
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Here are the answers with discussion for this Weekend’s Quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

In the past week, we observed, Monday, September 11, 1973 – the day when right-wing forces, aided by the US government, overthrew the elected government of Chile. It was a terrorist act and we should not forget that.

Question 1:

When a sovereign government issues debt to match its fiscal deficit, the debt adds to the financial wealth of the non-government sector.

The answer is False.

The fundamental principles that arise in a fiat monetary system are as follows.

  • The central bank sets the short-term interest rate based on its policy aspirations.
  • Government spending is independent of borrowing and the latter best thought of as coming after spending.
  • Government spending provides the net financial assets (bank reserves) which ultimately represent the funds used by the non-government agents to purchase the debt.
  • Fiscal deficits that are not accompanied by corresponding monetary operations (debt-issuance) put downward pressure on interest rates contrary to the myths that appear in macroeconomic textbooks about ‘crowding out’.
  • The “penalty for not borrowing” is that the interest rate will fall to the bottom of the “corridor” prevailing in the country which may be zero if the central bank does not offer a return on reserves.
  • Government debt-issuance is a “monetary policy” operation rather than being intrinsic to fiscal policy, although in a modern monetary paradigm the distinctions between monetary and fiscal policy as traditionally defined are moot.

National governments have cash operating accounts with their central bank. The specific arrangements vary by country but the principle remains the same. When the government spends it debits these accounts and credits various bank accounts within the commercial banking system. Deposits thus show up in a number of commercial banks as a reflection of the spending. It may issue a cheque and post it to someone in the private sector whereupon that person will deposit the cheque at their bank. It is the same effect as if it had have all been done electronically.

All federal spending happens like this. You will note that:

  • Governments do not spend by “printing money”. They spend by creating deposits in the private banking system. Clearly, some currency is in circulation which is “printed” but that is a separate process from the daily spending and taxing flows.
  • There has been no mention of where they get the credits and debits come from! The short answer is that the spending comes from no-where. Suffice to say that the Federal government, as the monopoly issuer of its own currency is not revenue-constrained. This means it does not have to “finance” its spending unlike a household, which uses the fiat currency.
  • Any coincident issuing of government debt (bonds) has nothing to do with “financing” the government spending.

From a monetary operation perspective, the central bank conducts “operations” to manage the liquidity in the banking system such that short-term interest rates match the official target – which defines the current monetary policy stance.

The central bank may: (a) Intervene into the interbank (overnight) money market to manage the daily supply of and demand for reserve funds; (b) buy certain financial assets at discounted rates from commercial banks; and (c) impose penal lending rates on banks who require urgent funds, In practice, most of the liquidity management is achieved through (a).

That being said, central bank operations function to offset operating factors in the system by altering the composition of reserves, cash, and securities, and do not alter net financial assets of the non-government sectors.

Fiscal policy impacts on bank reserves – government spending (G) adds to reserves and taxes (T) drains them. So on any particular day, if G > T (a fiscal deficit) then reserves are rising overall. Any particular bank might be short of reserves but overall the sum of the bank reserves are in excess.

It is in the commercial banks interests to try to eliminate any unneeded reserves each night given they usually earn a non-competitive return.

Surplus banks will try to loan their excess reserves on the Interbank market. Some deficit banks will clearly be interested in these loans to shore up their position and avoid going to the discount window that the central bank offeres and which is more expensive.

The upshot, however, is that the competition between the surplus banks to shed their excess reserves drives the short-term interest rate down. These transactions net to zero (a equal liability and asset are created each time) and so non-government banking system cannot by itself (conducting horizontal transactions between commercial banks – that is, borrowing and lending on the interbank market) eliminate a system-wide excess of reserves that the fiscal deficit created.

What is needed is a vertical transaction – that is, an interaction between the government and non-government sector. So bond sales can drain reserves by offering the banks an attractive interest-bearing security (government debt) which it can purchase to eliminate its excess reserves.

However, the vertical transaction just offers portfolio choice for the non-government sector rather than changing the holding of financial assets.

Even when the government issues debt in the primary market to match its deficit spending the debt is not an net addition to non-government wealth. It is just, in the first instance, a different way of storing the wealth.

Thus the fact that the government issues debt does not of itself increase the wealth of the non-government sector.

The deficit spending increases net financial wealth, whereas the accompanying monetary operation is just an asset swap.

Question 2:

Ignoring any reserve requirements that might be imposed, if the central bank pays a positive interest rate on overnight reserves held by the commercial banks then it may still have to conduct open market operations as a means of ensuring that levels of bank reserves are consistent with its policy target rate of interest.

The answer is True.

The first thing to understand is the way in which monetary policy is implemented in a modern monetary economy. You will see that this is contrary to the account of monetary policy in mainstream macroeconomics textbooks, which tries to tell students that monetary policy describes the processes by which the central bank determines “the total amount of money in existence or to alter that amount”.

In Mankiw’s Principles of Economics (Chapter 27 First Edition) he say that the central bank has “two related jobs”. The first is to “regulate the banks and ensure the health of the financial system” and the second “and more important job”:

… is to control the quantity of money that is made available to the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy (emphasis in original).

How does the mainstream see the central bank accomplishing this task? Mankiw says:

Fed’s primary tool is open-market operations – the purchase and sale of U.S government bonds … If the FOMC decides to increase the money supply, the Fed creates dollars and uses them buy government bonds from the public in the nation’s bond markets. After the purchase, these dollars are in the hands of the public. Thus an open market purchase of bonds by the Fed increases the money supply. Conversely, if the FOMC decides to decrease the money supply, the Fed sells government bonds from its portfolio to the public in the nation’s bond markets. After the sale, the dollars it receives for the bonds are out of the hands of the public. Thus an open market sale of bonds by the Fed decreases the money supply.

This description of the way the central bank interacts with the banking system and the wider economy is totally false. The reality is that monetary policy is focused on determining the value of a short-term interest rate. Central banks cannot control the money supply. To some extent these ideas were a residual of the commodity money systems where the central bank could clearly control the stock of gold, for example. But in a credit money system, this ability to control the stock of “money” is undermined by the demand for credit.

The theory of endogenous money is central to the horizontal analysis in Modern Monetary Theory (MMT). When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).

The essential idea is that the “money supply” in an “entrepreneurial economy” is demand-determined – as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 (Currency plus bank current deposits of the private non-bank sector plus all other bank deposits from the private non-bank sector) is just an arbitrary reflection of the credit circuit.

So the supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept.

Central banks clearly do not determine the volume of deposits held each day. These arise from decisions by commercial banks to make loans. The central bank can determine the price of “money” by setting the interest rate on bank reserves. Further expanding the monetary base (bank reserves) as we have argued in recent blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – does not lead to an expansion of credit.

With this background in mind, the question is specifically about the dynamics of bank reserves which are used to satisfy any imposed reserve requirements and facilitate the payments system. These dynamics have a direct bearing on monetary policy settings. Given that the dynamics of the reserves can undermine the desired monetary policy stance (as summarised by the policy interest rate setting), the central banks have to engage in liquidity management operations.

What are these liquidity management operations?

Well you first need to appreciate what reserve balances are.

The New York Federal Reserve Bank’s paper – Divorcing Money from Monetary Policy said that:

… reserve balances are used to make interbank payments; thus, they serve as the final form of settlement for a vast array of transactions. The quantity of reserves needed for payment purposes typically far exceeds the quantity consistent with the central bank’s desired interest rate. As a result, central banks must perform a balancing act, drastically increasing the supply of reserves during the day for payment purposes through the provision of daylight reserves (also called daylight credit) and then shrinking the supply back at the end of the day to be consistent with the desired market interest rate.

So the central bank must ensure that all private cheques (that are funded) clear and other interbank transactions occur smoothly as part of its role of maintaining financial stability. But, equally, it must also maintain the bank reserves in aggregate at a level that is consistent with its target policy setting given the relationship between the two.

So operating factors link the level of reserves to the monetary policy setting under certain circumstances. These circumstances require that the return on “excess” reserves held by the banks is below the monetary policy target rate. In addition to setting a lending rate (discount rate), the central bank also sets a support rate which is paid on commercial bank reserves held by the central bank.

Many countries (such as Australia and Canada) maintain a default return on surplus reserve accounts (for example, the Reserve Bank of Australia pays a default return equal to 25 basis points less than the overnight rate on surplus Exchange Settlement accounts). Other countries like the US and Japan have historically offered a zero return on reserves which means persistent excess liquidity would drive the short-term interest rate to zero.

The support rate effectively becomes the interest-rate floor for the economy. If the short-run or operational target interest rate, which represents the current monetary policy stance, is set by the central bank between the discount and support rate. This effectively creates a corridor or a spread within which the short-term interest rates can fluctuate with liquidity variability. It is this spread that the central bank manages in its daily operations.

So the issue then becomes – at what level should the support rate be set? To answer that question, I reproduce a version of teh diagram from the FRBNY paper which outlined a simple model of the way in which reserves are manipulated by the central bank as part of its liquidity management operations designed to implement a specific monetary policy target (policy interest rate setting).

I describe the FRBNY model in detail in the blog – Understanding central bank operations so I won’t repeat that explanation.

The penalty rate is the rate the central bank charges for loans to banks to cover shortages of reserves. If the interbank rate is at the penalty rate then the banks will be indifferent as to where they access reserves from so the demand curve is horizontal (shown in red).

Once the price of reserves falls below the penalty rate, banks will then demand reserves according to their requirments (the legal and the perceived). The higher the market rate of interest, the higher is the opportunity cost of holding reserves and hence the lower will be the demand. As rates fall, the opportunity costs fall and the demand for reserves increases. But in all cases, banks will only seek to hold (in aggregate) the levels consistent with their requirements.

At low interest rates (say zero) banks will hold the legally-required reserves plus a buffer that ensures there is no risk of falling short during the operation of the payments system.

Commercial banks choose to hold reserves to ensure they can meet all their obligations with respect to the clearing house (payments) system. Because there is considerable uncertainty (for example, late-day payment flows after the interbank market has closed), a bank may find itself short of reserves. Depending on the circumstances, it may choose to keep a buffer stock of reserves just to meet these contingencies.

So central bank reserves are intrinsic to the payments system where a mass of interbank claims are resolved by manipulating the reserve balances that the banks hold at the central bank. This process has some expectational regularity on a day-to-day basis but stochastic (uncertain) demands for payments also occur which means that banks will hold surplus reserves to avoid paying any penalty arising from having reserve deficiencies at the end of the day (or accounting period).

To understand what is going on not that the diagram is representing the system-wide demand for bank reserves where the horizontal axis measures the total quantity of reserve balances held by banks while the vertical axis measures the market interest rate for overnight loans of these balances

In this diagram there are no required reserves (to simplify matters). We also initially, abstract from the deposit rate for the time being to understand what role it plays if we introduce it.

Without the deposit rate, the central bank has to ensure that it supplies enough reserves to meet demand while still maintaining its policy rate (the monetary policy setting.

So the model can demonstrate that the market rate of interest will be determined by the central bank supply of reserves. So the level of reserves supplied by the central bank supply brings the market rate of interest into line with the policy target rate.

At the supply level shown as Point A, the central bank can hit its monetary policy target rate of interest given the banks’ demand for aggregate reserves. So the central bank announces its target rate then undertakes monetary operations (liquidity management operations) to set the supply of reserves to this target level.

So contrary to what Mankiw’s textbook tells students the reality is that monetary policy is about changing the supply of reserves in such a way that the market rate is equal to the policy rate.

The central bank uses open market operations to manipulate the reserve level and so must be buying and selling government debt to add or drain reserves from the banking system in line with its policy target.

If there are excess reserves in the system and the central bank didn’t intervene then the market rate would drop towards zero and the central bank would lose control over its target rate (that is, monetary policy would be compromised).

As explained in the blog – Understanding central bank operations – the introduction of a support rate payment (deposit rate) whereby the central bank pays the member banks a return on reserves held overnight changes things considerably.

It clearly can – under certain circumstances – eliminate the need for any open-market operations to manage the volume of bank reserves.

In terms of the diagram, the major impact of the deposit rate is to lift the rate at which the demand curve becomes horizontal (as depicted by the new horizontal red segment moving up via the arrow).

This policy change allows the banks to earn overnight interest on their excess reserve holdings and becomes the minimum market interest rate and defines the lower bound of the corridor within which the market rate can fluctuate without central bank intervention.

So in this diagram, the market interest rate is still set by the supply of reserves (given the demand for reserves) and so the central bank still has to manage reserves appropriately to ensure it can hit its policy target.

If there are excess reserves in the system in this case, and the central bank didn’t intervene, then the market rate will drop to the support rate (at Point B).

So if the central bank wants to maintain control over its target rate it can either set a support rate below the desired policy rate (as in Australia) and then use open market operations to ensure the reserve supply is consistent with Point A or set the support (deposit) rate equal to the target policy rate.

The answer to the question is thus True because it all depends on where the support rate is set. Only if it set equal to the policy rate will there be no need for the central bank to manage liquidity via open market operations.

The following blogs may be of further interest to you:

Question 3:

If participation rates are constant, percentage unemployment will not change as long as employment growth matches the pace of growth in the working age population (people above 15 years of age).

The answer is True.

The Civilian Population is shorthand for the working age population and can be defined as all people between 15 and 65 years of age or persons above 15 years of age, depending on rules governing retirement. The working age population is then decomposed within the Labour Force Framework (used to collect and disseminate labour force data) into two categories: (a) the Labour Force; and (b) Not in the Labour Force. This demarcation is based on activity principles (willingness, availability and seeking work or being in work).

The participation rate is defined as the proportion of the working age population that is in the labour force. So if the working age population was 1000 and the participation rate was 65 per cent, then the labour force would be 650 persons. So the labour force can vary for two reasons: (a) growth in the working age population – demographic trends; and (b) changes in the participation rate.

The labour force is decomposed into employment and unemployment. To be employed you typically only have to work one hour in the survey week. To be unemployed you have to affirm that you are available, willing and seeking employment if you are not working one hour or more in the survey week. Otherwise, you will be classified as not being in the labour force.

So the hidden unemployed are those who give up looking for work (they become discouraged) yet are willing and available to work. They are classified by the statistician as being not in the labour force. But if they were offered a job today they would immediately accept it and so are in no functional way different from the unemployed.

When economic growth wanes, participation rates typically fall as the hidden unemployed exit the labour force. This cyclical phenomenon acts to reduce the official unemployment rate.

So clearly, the working age population is a much larger aggregate than the labour force and, in turn, employment. Clearly if the participation rate is constant then the labour force will grow at the same rate as the civilian population. And if employment grows at that rate too then while the gap between the labour force and employment will increase in absolute terms (which means that unemployment will be rising), that gap in percentage terms will be constant (that is the unemployment rate will be constant).

The following Table simulates a simple labour market for 8 periods. You can see for the first 4 periods, that unemployment rises steadily over time but the unemployment rate is constant. During this time span employment growth is equal to the growth in the underlying working age population and the participation rate doesn’t change. So the unemployment rate will be constant although more people will be unemployed.

In Period 5, the participation rate rises so that even though there is constant growth (2 per cent) in the working age population, the labour force growth rate rises to 3.6 per cent. Now unemployment jumps disproportionately because employment growth (2 per cent) is not keeping pace with the growth in new entrants to the labour force and as a consequence the unemployent rate rises to 11 per cent.

In Period 6, employment growth equals labour force growth (because the participation rate settles at the new level – 66 per cent) and the unemployment rate is constant.

In Period 7, the participation rate plunges to 64 per cent and the labour force contracts (as the higher proportion of the working age population are inactive – that is, not participating). As a consequence, unemployment falls dramatically as does the unemployment rate. But this is hardly a cause for celebration – the unemployed are now hidden by the statistician “outside the labour force”.

Understanding these aggregates is very important because as we often see when Labour Force data is released by national statisticians the public debate becomes distorted by the incorrect way in which employment growth is represented in the media.

In situations where employment growth keeps pace with the underlying population but the participation rate falls then the unemployment rate will also fall. By focusing on the link between the positive employment growth and the declining unemployment there is a tendency for the uninformed reader to conclude that the economy is in good shape. The reality, of-course, is very different.

The following blog may be of further interest to you:

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

You can also find details on that site of how to purchase a copy of the book (paperback version) at discounted prices, well below the current market price from the booksellers.

The discounted price I can make the book available (while my stock lasts) is plus postage.

My stocks are limited.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

Pumpkin Doughnut Muffins

Sep. 15th, 2017 10:33 am
underused: an illustration of a collared trogon,  a type of tropical bird (Default)
[personal profile] underused posting in [community profile] thecookbook
pumpkin doughnut muffins

Yeah, I said it.

Let's not pretend you don't want to know. )
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Welcome to The Weekend Quiz. The quiz tests whether you have been paying attention or not to the blogs I post. See how you go with the following questions. Your results are only known to you and no records are retained.

1. When a sovereign government issues debt to match its fiscal deficit the debt adds to the financial wealth of the non-government sector.

2. Ignoring any reserve requirements that might be imposed, if the central bank pays a positive interest rate on overnight reserves held by the commercial banks then it may still have to conduct open market operations as a means of ensuring that levels of bank reserves are consistent with its policy target rate of interest.

3. If participation rates are constant, percentage unemployment will not change as long as employment growth matches the pace of growth in the working age population (people above 15 years of age).

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The latest labour force data released today by the Australian Bureau of Statistics – Labour Force data – for August 2017 shows that total employment growth was relatively robust (up 54,200) with full-time employment growth accounting for much of that increase. Unlike recent months, where if full-time growth was positive, part-time growth was negative (and vice versa), both components of employment rose. Further, the participation rate rose by 0.2 points as job opportunities expanded. Labour underutilisation overall (underemployment and unemployment) was at 14.1 per cent summing to 1,842.8 thousand persons. The teenage labour market showed further improvement but remains in a poor state. Overall, my assessment of the Australian labour market is that it still to early to conclude that the uncertainty of the last few years is giving way to sustained growth.

The summary ABS Labour Force (seasonally adjusted) estimates for August 2017 are:

  • Employment increased by 54,200 (0.5 per cent) – full-time employment increased 40,100 and part-time employment increased 14,100.
  • Unemployment decreased 1,100 to 727,500.
  • The official unemployment rate remained steady at 5.6 per cent.
  • The participation rate increased by 0.2 pts to 65.3 per cent. It still remains below its December 2010 peak (recent) of 65.8 per cent.
  • Aggregate monthly hours worked increased 6.1 million hours (0.4 per cent).
  • Using the seasonally-unadjusted quarterly data, the total labour underutilisation rate (unemployment plus underemployment) was 14.1 per cent (1,812.6 thousand workers). Underemployment was 8.5 per cent and there were 1,101.3 thousand persons underemployed.

Employment growth – stronger in August

Employment increased by 54,200 (0.5 per cent) – full-time employment increased 40,100 and part-time employment increased 14,100.

This is a relatively strong result.

We have observed a zig-zag pattern in total employment growth over the last 36 months or so – where the employment estimates have been switching back and forth regularly between negative employment growth and positive growth with the occasional spikes.

This month, the pattern where full-time or part-time would alternative with negative and positive growth changed with both recording positive movements.

The following graph shows the month by month growth in full-time (blue columns), part-time (grey columns) and total employment (green line) for the 24 months to August 2017 using seasonally adjusted data.

It gives you a good impression of just how flat employment growth has been over the last 2 years. The positive note is that there has been four stronger full-time employment outcomes in the last eight months.

The following table provides an accounting summary of the labour market performance over the last six months. The monthly data is highly variable so this Table provides a longer view which allows for a better assessment of the trends.

Full-time employment has risen risen by 211.9 thousand jobs (net) over the last 6 months, while part-time employment has risen by 38.9 thousand jobs.

The conclusion – overall there have been 250.8 thousand jobs (net) added in Australia over the last six months while the labour force has increased by 230.1 thousand. The result has been that unemployment has fallen by 20.7 thousand.

Overall – an improving labour market performance, especially given the growth of the labour force as a result of two successive increases in the participation rate.

Given the variation in the labour force estimates, it is sometimes useful to examine the Employment-to-Population ratio (%) because the underlying population estimates (denominator) are less cyclical and subject to variation than the labour force estimates. This is an alternative measure of the robustness of activity to the unemployment rate, which is sensitive to those labour force swings.

The following graph shows the Employment-to-Population ratio, since February 2008 (the low-point unemployment rate of the last cycle).

It dived with the onset of the GFC, recovered under the boost provided by the fiscal stimulus packages but then went backwards again as the last Federal government imposed fiscal austerity in a hare-brained attempt at achieving a fiscal surplus.

The ratio began rising in December 2014 which suggested to some that the labour market had bottomed out and would improve slowly as long as there are no major policy contractions or cuts in private capital formation.

The series turned again as overall economic activity weakened. Over the last few months it has improved again.

The series rose by 0.2 points in August 2017 to 61.6 per cent and remains a 1.3 percentage points below the April 2008 peak of 62.9 per cent.

In recent months, the ratio has risen quite quickly which is a good sign.

Teenage labour market – further improvement in August 2017

The stronger overall labour market position has not really filtered down to the teenage segment.

Despite the stronger full-time employment growth overall, full-time teenage employment fell by 0.2 thousand jobs in August 2017, while part-time employment rose by 7.1 thousand.

As a result, total employment rose by 7 thousand (net) in August 2017.

The following graph shows the distribution of net employment creation in the last month by full-time/part-time status and age/gender category (15-19 year olds and the rest)

Over the last 12 months, teenagers have lost 0.2 thousand (net) jobs overall while the rest of the labour force have gained 325.8 thousand net jobs.

Full-time employment for teenagers over the last 12 months has risen by 8.8 thousand while part-time employment employment has fallen by 9 thousand.

The following graph shows the change in aggregates over the last 12 months.

In terms of the current cycle, which began after the last low-point unemployment rate month (February 2008), the following results are relevant:

1. Since February 2008, there have been only 1,621.4 thousand (net) jobs added to the Australian economy but teenagers have lost a staggering 93.3 thousand over the same period.

2. Since February 2008, teenagers have lost 117.5 thousand full-time jobs (net).

3. Even in the traditionally, concentrated teenage segment – part-time employment, teenagers have gained only 24.2 thousand jobs (net) even though 870.2 thousand part-time jobs have been added overall.

To put the teenage employment situation in a scale context (relative to their size in the population) the following graph shows the Employment-Population ratios for males, females and total 15-19 year olds since February 2008.

You can interpret this graph as depicting the loss of employment relative to the underlying population of each cohort. We would expect (at least) that this ratio should be constant if not rising somewhat (depending on school participation rates).

The facts are that the absolute loss of jobs reported above is depicting a very difficult situation for our teenagers. Males, in particular, have lost out severely as a result of the economy being deliberately stifled by austerity policy positions.

In the latter months of 2015, with the part-time employment situation improving, there was some reversal in the downward trends in these ratios.

However, in recent months the ratios have fallen again, with a slight pickup in July.

The male ratio has fallen by 11.6 percentage points since February 2008, the female ratio has fallen by 4.7 percentage points and the overall teenage employment-population ratio has fallen by 8.2 percentage points.

That is a substantial decline in the employment market for Australian teenagers.

The other staggering statistic relating to the teenage labour market is the decline in the participation rate since the beginning of 2008 when it peaked in January at 61.4 per cent. In August 2017, the participation rate rose 0.7 points to 53.8 per cent.

That amounts to an additional 114.8 thousand teenagers who have dropped out of the labour force as a result of the weak conditions since the crisis.

If we added them back into the labour force the teenage unemployment rate would be 28.2 per cent rather than the official estimate for August 2017 of 18 per cent.

Some may have decided to return to full-time education and abandoned their plans to work. But the data suggests the official unemployment rate is significantly understating the actual situation that teenagers face in the Australian labour market.

Overall, the performance of the teenage labour market remains extremely poor. It doesn’t rate much priority in the policy debate, which is surprising given that this is our future workforce in an ageing population. Future productivity growth will determine whether the ageing population enjoys a higher standard of living than now or goes backwards.

I continue to recommend that the Australian government immediately announce a major public sector job creation program aimed at employing all the unemployed 15-19 year olds, who are not in full-time education or a credible apprenticeship program.

Unemployment decreased 1,100 to 727,500

The official unemployment rate remained steady at 5.6 per cent in August 2017.

The labour market still has significant excess capacity available.

The following graph shows the national unemployment rate from February 1978 to August 2017. The longer time-series helps frame some perspective to what is happening at present.

After falling steadily as the fiscal stimulus pushed growth along, the unemployment rate slowly trended up for some months.

It is now still 0.6 points above the level it fell to as a result of the fiscal stimulus and 1.6 points above the level reached before the GFC began.

Broad labour underutilisation – at 14.1 per cent

The ABS publishes monthly and quarterly labour underutilisation data. The quarterly data was updated this month (for the August-quarter 2017):

1. Underemployment was estimated to be 8.6 per cent of the labour force (slightly down on the May-quarter).

2. The total labour underutilisation rate (unemployment plus underemployment) was 14.1 per cent.

3. There were 1,115.3 thousand persons underemployed and a total of 1,842.8 thousand workers either unemployed or underemployed.

The following graph plots the history of quarterly (seasonally-adjusted) underemployment in Australia since February 1978 to the May-quarter 2017.

The next graph shows the evolution of the broad underutilisation rate over the same period. You can see the three cyclical peaks corresponding to the 1982, 1991 recessions and the more recent downturn.

Unemployment was a higher proportion of the two earlier peaks but underemployment now dominates the current cycle (just).

The other difference between now and the two earlier cycles is that the recovery triggered by the fiscal stimulus in 2008-09 did not persist and as soon as the ‘fiscal surplus’ fetish kicked in in 2012, things went backwards very quickly.

The two earlier peaks were sharp but steadily declined. The last peak fell away on the back of the stimulus but turned again when the stimulus was withdrawn.

If hidden unemployment (given the depressed participation rate) is added to the broad ABS figure the best-case (conservative) scenario would see a underutilisation rate well above 16 per cent at present. Please read my blog – Australian labour underutilisation rate is at least 13.4 per cent – for more discussion on this point.

The next update will be for the November-quarter 2017 and will be published published in the December 2017 Labour Force release. In between those releases, the monthly estimates guide our thinking.

Aggregate participation rate – rises by 0.2 points to 65.3 per cent

While the participation rate edged up again in August 2017, it remains below the most recent peak in November 2010 of 65.8 per cent when the labour market was still recovering courtesy of the fiscal stimulus.

What would the unemployment rate be if the participation rate was at the last November 2010 peak level value?

The following graph tells us what would have happened if the participation rate had been constant over the period November 2010 to August 2017. The blue line is the official unemployment rate since its most recent low-point of 4 per cent in February 2008.

The red line starts at November 2010 (the peak participation month). It is computed by adding the workers that left the labour force as employment growth faltered (and the participation rate fell) back into the labour force and assuming they would have been unemployed. At present, this cohort is likely to comprise a component of the hidden unemployed (or discouraged workers).

With the rise in participation in recent months, the red line is dropping quite sharply, which is a good sign.

1. Total official unemployment in August 2017 was estimated to be 727.5 thousand.

2. Unemployment would be 831.7 thousand if participation rate was at its November 2010 peak.

3. The unemployment rate would now be 6.3 per cent rather than the official August 2017 estimate of 5.6 per cent.

The difference between the two numbers mostly reflects, the change in hidden unemployment (discouraged workers) since November 2010. These workers would take a job immediately if offered one but have given up looking because there are not enough jobs and as a consequence the ABS classifies them as being Not in the Labour Force.

There has been some change in the age composition of the labour force (older workers with low participation rates becoming a higher proportion) but this only accounts for less than 1/3 of the shift. The rest is undoubtedly accounted for by the rise in hidden unemployment.

Note, the gap between the blue and red lines doesn’t sum to total hidden unemployment unless November 2010 was a full employment peak, which it clearly was not. The interpretation of the gap is that it shows the extra hidden unemployed since that time.

This gap shrinks as participation rises relative to the November 2010 peak.

Hours worked – increased 6.1 million hours (0.4 per cent)

Over the last three months we have seen swings in both directions.

The following graph shows the monthly growth (in per cent) over the last 24 months. The dark linear line is a simple regression trend of the monthly change – which depicts an upward trend – driven mostly by the outlier in May 2017.

You can see the pattern of the change in working hours is also portrayed in the employment graph – zig-zagging across the zero growth line.


My standard monthly warning: we always have to be careful interpreting month to month movements given the way the Labour Force Survey is constructed and implemented.

Today’s figures show that the Australian labour market improved again in August 2017, if we consider positive overall employment growth to be the benchmark.

The net result was relatively strong and was accompanied by a rise in full-time work (reversing last month’s result).

Unemployment fell even though the participation rose. That suggests that employment growth was robust.

There was a slight improvement in the teenage labour market in August 2017, but it remains in a poor state.

Overall, the state of the Australian labour market still remains uncertain although the positive employment growth is a good sign.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

For sale – Just released book at discount price

I have stock of the book (paperback version) available for sale at discounted prices, well below the current market price from the booksellers.

If you would like a copy signed by yours truly then you should send me an E-mail me (Bill.Mitchell – @ – newcastle.edu.au deleting the – and space before and after the @ sign) with your location and I will send you PayPal details plus postage costs.

The discounted price I can make the book available (while my stock lasts) is plus postage.

My stocks are limited.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

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Next Friday (September 22, 2017), I will be presenting at a panel on developments associated with the proposed MMT University and our new MMT Macroeconomics textbook, which will be published by Macmillan in April 2018. The panel will present during the First International MMT Conference, to be held in Kansas City. In part, my contribution will be to discuss the general pedagogical concerns that we (Randy Wray, Martin Watts and myself) had as we wrote the textbook over what turned out to be several years. We were confronted with the situation that we want our textbook to be used as widely as possible in the first and second years of a typical undergraduate program, but also didn’t want to fall into the trap of compromising what we considered to be a unified body of theory based upon Modern Monetary Theory (MMMT) for what other colleagues (particularly, mainstream academics) would claim to be necessary material to prepare a student for the labour market. We now have what we believe is a very strong two-year sequence in macroeconomics, firmly founded on MMT principles, with a good balance between discursive narrative, historical context, empirical challenge, and formal (mathematical) reasoning. When one compares it to other post-GFC developments in the pedagogy of macroeconomics, some of which have received the headlines in the past week, I think the curriculum embodied in our text is progressive, consistent, and doesn’t fall into the typical neoliberal default regarding governments and the monetary system.

A few years ago, I was invited to speak at a iNET (Institute for New Economic Thinking) in Toronto, Canada. iNET was a George Soros-funded initiative aimed at stimulating changes in the economic debate following the GFC, which left no reasonable person in doubt that the mainstream macroeconomic theory and practice was defunct (putting it mildly).

At the conference, one of the sessions focused on a new project designed to revise the introductory economics curriculum to incorporate new insights (allegedly) that were missing in the standard first-year programs at universities all around the world.

The Project, entitled CORE Econ, has just released an on-line version of their proposed curriculum which they claim addresses the limitations of the extant mainstream approach and responds to “what are our students asking, what are they curious about?” (Source).

The Times article (September 12, 2017) – The financial crisis demands a new type of economics – writes that:

CORE promises to be the biggest shake-up since Paul Samuelson’s Economics became the standard bearer for introductory texts in 1948 …

I bet to differ (see below).

The principal authors (Samuel Bowles and Wendy Carlin) recently published a promotional Op-ed article (September 7, 2017) – A new paradigm for the introductory course in economics – where they claim that the proposed CORE curriculum represents a paradigms shift in the way economics is taught and “provides a very different vision of the economy.”

The press has been fawning over the project.

The New Yorker carried a glowing review of the CORE book (September 11, 2017) – A New Way to Learn Economics.

It said that the release of the CORE on-line “introductory economics curriculum” was “good news for incoming students of economics”.

I beg to differ.

The book is replete with the standard neo-liberal monetary myths and is just dressed up to appear to be a progressive development. I question whether any student will gain any valid macroeconomics knowledge by pursuing the curriculum that is set out by the CORE group.

Cassidy also noted something that I think is telling:

Students looking for expositions of Marxian economics or Modern Monetary Theory will have to look elsewhere.

Which means that the CORE curriculum fails to incorporate the inherent labour-capital conflict that marks Capitalism from previous historical epochs (despite its claims to historical context) and also fails to situate the role of government as the monopoly currency-issuer in any meaningful way.

As I note below, the macroeconomics presented in the CORE curriculum begins with the usual neo-liberal myths and so students are mislead from the start.

The CORE authors go out of their way to claim they are responding to what students want to know. They say:

During the past four years we have asked, in classrooms around the world: “what is the most pressing problem that economists should address?” …

we indicate some of the most important problems that students and others have told us that “economists should address” …

This is, in part, a sop to the latest trends in university teaching – ‘student-centred learning’ – which is an anomaly if there ever was one.

Apparently, despite years of education and research, academics are only meant to be ‘facilitators’ as the students beaver away building their own knowledge base, following their interests and curiosities.

The ‘student-centred’ developments were in response, partly, to the perceived disadvantages of a teacher-centred classroom, where the lecturer would turn up, present the material and require the student to go away and read up to achieve an understanding.

Of course, the traditional system was not exactly that, was it? Tutorials and smaller workshops were designed to bring out the student’s individual learning through interaction in a peer-group environment.

But the teacher was the teacher – because after all they had PhDs and were ‘qualified’ in the disciplines they worked within.

The old expression – ‘students do not know what they do not know’ – is an overwhelming problem in the modern approach.

A PhD is meant to narrow the things that the lecturer doesn’t know. Which means the teacher is really meant to be an authority and the student is called a student for a good reason – they don’t know things that are deemed important to know and they do not know what is important and what is not.

So to design a curriculum in economics based upon what the students are curious about gives too much away to the obvious ignorance that the students have – which is not a perjorative observation in any way. Education is meant to be about developing knowledge not appealing to popular (media-driven) interests.

I have always encouraged students to be daring and read widely and question every statement their teachers make. But there also has to be respect for the fact the teachers have studied for years and the students are the novices, there to learn, listen and challenge.

So if students have only been exposed to mainstream macroeconomics ideas – in the media, school, from their parents etc – then how are they going to be in a position to demand their teachers discuss currency sovereignty, for example?

The CORE curriculum does not represent a paradigm shift. Thomas Kuhn introduced this concept in 1962 in his marvellous book – The Structure of Scientific Revolutions.

Kuhn considered a ‘paradigm shift’ (revised “disciplinary matrix”) had to, at least, expunge the most obvious anomalies and be able to present ‘solutions’ to important “unsolved puzzles”.

So if you had studied macroeconomics in a mainstream university program and tried to explain the dynamics of the Japanese fiscal and central banking system you would fail.

Only Modern Monetary Theory (MMT) provides a body of ideas that are consistent with understanding Japan, for example.

A teaching program that assumes governments have to borrow in order to spend will not address the most obvious anomalies.

John Cassidy (New Yorker article) also claims that the

CORE material isn’t just for incoming students. It will also reward the attention of general readers and people who think they are already reasonably conversant with economics.

I would actually recommend the general public read The Mandibles instead. At least the neo-liberalism is more upfront in that (-:

The CORE curriculum covers both microeconomics and macroeconomics. I am only concerned here about the macroeconomics. I could critique the former but I have no interest in doing so. For a start its treatment of power is rather orthodox and fails to address inherent class conflict. But that is all another story.

It is not until Chapter 14 – Unemployment and fiscal policy that we meet the currency issuer. Prior to that there are chapters on Money and financial assets but students will not understand from that the essential, and primary relationship between the government (as the currency-issuer) and the non-government (as the currency-user).

Where does the currency come from? A basic question but one obscured in the CORE approach.

We just get the standard (mainstream) discussion that “Money is a medium of exchange” and refines the exchange possibilities relative to “barter exchange” – the standard argument talks about eliminating the ‘double coincidence of wants’ problem inherent in barter.

That is, to get a plumber to do some plumbing you have to have some service that he or she desires simultaneously. That is not often likely.

As the CORE book says:

Money makes more exchanges possible because it’s not hard to find someone who will be happy to have your money (in exchange for something), whereas unloading a large quantity of apples could be a problem.

Money is thus seen as the means of lubricating the exchange of goods and services. There is no other reason why a person would wish to hold it under this limited conception of money.

In our MMT textbook, we note that money is much more than just a means of exchange.

Money matters because:

1. We need money to spend … Money buys goods and goods buy money but goods do not buy goods.

2. We measure success in terms of money. Marx argues that capitalist production takes the form of Money -> Commodities -. (hopefully) more Money.

3. We can hold money against an uncertain future.

But we go further than this, in the MMT approach.

MMT adds the link between money and sovereign power, which is largely lacking in other heterodox approaches to money, as well as in orthodoxy.

The state too, needs to finance its spending and plays an important role in organising the monetary system to move resources to the public sphere.

Money cannot be neutral for the state either, since currency sovereignty is critically important to ensure that the state is not financially constrained.

The neoclassical notion of Ricardian Equivalence cannot hold in the case of a sovereign currency. If a government spends more or taxes less, it would be irrational for the private sector to cut its own spending in anticipation of future tax hikes.

Sovereign governments do not need to raise taxes in the future to pay for spending (or tax cuts) today.

And indeed, they do not do so in the real world. We observe that the normal situation for most sovereign governments is to run nearly continuous deficits and rarely, if ever pay down a significant portion of debt.

What matters, in any case, is to run the economy near to continuous full employment of its resources. Any labour resources not used this year cannot be stockpiled for future use, nor can those labour resources used this year be somehow paid for by taxes later. Any resources mobilised this year for use in the public sector are paid for now immediately, by cutting cheques or by marking up bank accounts.

It would be irrational for the private sector to react to greater receipts from government spending by cutting back household and business spending. Rather, it is far more rational to increase private spending alongside the rising public spending.

These ideas underpin the concept of the Keynesian multiplier, although if you read the CORE approach to the multiplier, this understanding is missing.

Further, while orthodoxy (and even some heterodox approaches) imagine that money was invented by private markets in order to reduce the inconvenience of barter based trade, MMT argues that the macroeconomic analysis of government policy must take account of the difference between a sovereign currency and a non sovereign currency, where the latter applies, for example, to members of the Eurozone.

The sovereign government chooses the money of account, issues its’ own sovereign currency, spends its’ currency, and enforces most legal contracts in that currency. It also accepts its’ currency in payment for various obligations, notably taxes, fees, and fines.

Thus, there is an important relationship between the government and its’ monetary system, that any student should be familiar with and, which is missing in the CORE approach.

The CORE approach also claims that “money requires trust to function” becauses “the fundamental characteristic of money … is a medium of exchange.”

There is no mention that fiat currency is worthless unless the government imposes a tax obligation that can only be lawfully dispensed using that fiat currency.

All the talk about “trust” as the driving force towards currency acceptance misses the basic point – that we have to get hold of the currency (as a non-government sector) to pay our taxes and therefore we have to be prepared to supply goods and services to the government sector (that is, accept government spending) before the currency is spent into existence by the government.

That is basic macroeconomics. It is missing from the CORE approach which is as mainstream as they come in this area.

Chapter 14, Section 8 is about The government’s finances.

We read:

When there is a budget deficit, this means the government must borrow to cover the gap between its revenue and its expenditure. The government borrows by selling bonds …

Because of the existence of global financial markets, foreigners can also buy home country bonds. Government bonds are attractive to investors because they pay a fixed interest rate and because they are generally considered a safe investment: the default risk on government bonds is usually low. Investors are likely to want to hold a mixture of safe and risky assets, and government bonds are normally at the safe end of the spectrum.

‘paradigm shift’? Hardly. Mainstream as it comes. And wrong to boot!

First, the statement that “the government must borrow to cover the gap between its revenue and its expenditure” as an assertion of some law (“must”) is false. It is fake knowledge.

It immediately imposes a structure in the mind of the student that the government is financially comstrained, like a household, and needs to fund its spending either through taxation or borrowing.

That is false.

Currency-issuing governments may choose to match the gap between ‘revenue’ and expenditure with debt-issuance but that is a voluntary imposition on their intrinsic capacity in a fiat-monetary system, which is not financially constrained.

Even the illusion that the non-government sector provides funds that permit the government to spend denies the way in which the non-government accumulates the net financial assets that it then swaps for bonds in the bond issuance process.

In MMT, students learn that past deficits accumulate as net financial assets (in one form or another across the non-government wealth portfolio).

The CORE curriculum says nothing in this regard. A major deficiency.

Second, bond markets consider government bonds from currency-issuing governments to be risk-free rather than low risk. A student should learn that a currency-issuing government can always honour its financial obligations (liabilities) at all times.

So in the rare times that such a government has defaulted, the reasons are not financial but political.

The mainstream literature often accumulates instances of government debt default but fails to discriminate between situations where the debt is denominated in a foreign currency, the government uses a foreign currency (for example, a Member State of the Eurozone), or where the government has simply, for political purposes chosen not to pay its debts (for example, Japan during World War II).

The CORE text also files in this regard.

It’s discussion of sovereign debt crises is mixed in with the discussion on government finances. There is no distinction made between a currency-issuing government and a government that, for example, uses a foreign currency.

So students are reading about accounting relationships (“primary budget deficits”) and then suddenly confronted with a discussion about the 2010 Eurozone crisis where the “Irish, Greek, Spanish, and Portuguese governments” were considered to be at risk of default.

The CORE text then says:

Governments of countries experiencing a sovereign debt crisis may have no alternative to austerity policies if they can no longer borrow, because in this case they cannot spend more than the tax revenue they receive.

Which is as mainstream as you will get and fundamentally wrong.

For example, the currency-issuing governments did not experience a sovereign debt crisis during the GFC. Only the Eurozone Member States were deemed to be at risk of default, because the bond markets understood, intrinsically, the difference between a currency issuing government and a Member State of the Eurozone.

In the latter case, the Eurozone Member States that were facing default because their tax revenue had been demolished by the magnitude of the recession, had a clear alternative option to that suggested by the CORE textbook (as TINA).

They could have simply left the Eurozone and reinstated their currency sovereignty and redonominated the external debt in the new currency.

Why does the CORE team think that TINA is an appropriate assertion for students. It gives them no understanding of what actually happened or what the alternatives were.

Further, a government which is facing stress in the bond markets (low demand for their assets and thus higher yields) can keep spending, despite the inference from the CORE curriculum that they are financially constrained by the preferences of the bond markets.

They are not. A currency-issuing government could simply instruct its central bank to credit bank accounts at will to facilitate its spending plans.

The CORE team are marketing themselves as offering a new paradigm.

They are misleading their audience. Their treatment of the government sector is a disgrace and students will continue to be taught fake knowledge interspersed with some new more reasonable analysis.

But the most basic thing that a student needs to start with in macroeconomics is the importance of the currency-issuer and what capabilities the government has.

The CORE curriculum goes further into the morass of fake knowledge.

We read:

A large stock of debt relative to GDP can be a problem because, like a household, the government has to pay interest on its debt and it has to raise revenue to pay the interest, which may require raising tax rates. However, governments are not like households in that there is no point at which they need to have paid off all their stock of debt—as one set of bonds matures, governments will typically issue more bonds, maintaining a stock of debt (this is called rolling over debt, which firms also typically do to finance their operations).

The household does have to pay back debt and service the outstanding liabilities. True. It has to finance those commitments before they can be fulfilled.

A currency-issuing government also has to service its liabilities and pay back its debts. But the fundamental difference is that the government does not have to do “raise revenue to pay the interest” nor increase “tax rates” to pay the interest or repay the outstanding liability upon maturity.

Further, the basic difference between a government and a household is not that the government can continually rollover their debt, but, rather, that the government issues the currency whereas the household uses the currency.

Thus a most basic element missing from the CORE treatment is that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.

Finally, the CORE curriculum introduces the intergenerational problem within the chapter on fiscal policy, in the most standard way. We read that “governments and voters are facing a difficult choice: do they limit benefits, or put up taxes?”

Which is as mainstream as you will get an fundamentally wrong.

The problem of the ageing society and the increased dependency ratios that are implied is nothing to do with the financial capacity of the currency issuing government to meet the rising demands for public services.

The problem is ensuring that there will be sufficient real resources available to ensure that first-class hospital services can be supplied and that pensioners can continue to enjoy a reasonable material standard of living.

If those real resources are available, any currency-issuing government will be able to purchase them and make them available to advance public purpose.

The challenge is productivity not finance.

The CORE student will learn nothing of these matters from studying the curriculum as it is.


I will write more about our pedagogical approach in the MMT textbook soon.

The manuscript is completed and the publisher is currently working through it to prepare it for release in April 2018.

In terms of ‘paradigms shifts’, our approach can justifiably be seen to satisfy the requirements.

The CORE project, despite its claims to the contrary, is a major disappointment and a waste of the significant funds that have been spent to develop the textbook.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

For sale – Just released book at discount price

I have stock of the book (paperback version) available for sale at discounted prices, well below the current market price from the booksellers.

If you would like a copy signed by yours truly then you should send me an E-mail me (Bill.Mitchell – @ – newcastle.edu.au deleting the – and space before and after the @ sign) with your location and I will send you PayPal details plus postage costs.

The discounted price I can make the book available (while my stock lasts) is plus postage.

My stocks are limited.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

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In The role of literary fiction in perpetuating neo-liberal economic myths – Part 1, I noted introduced the idea that fictional literature plays a significant role in framing false economic concepts and, thus, can promotes neo-liberal biases among the readership, even when the plot of the narrative is ostensibly about something other than economics. In other words, what parades as fiction becomes a powerful tool for spreading ideological propaganda, often in a very subliminal or subtle way. In Part 2, I demonstrate that further and provide correct Modern Monetary Theory (MMT) interpretations of popularised economic statements that the characters in the book in focus (The Mandibles) weave into their conversation as if they are accepted facts. The lesson is clear. To further advance Modern Monetary Theory (MMT) ideas, novelists who are sympathetic to the cause should construct their narratives consistent with the MMT principles, where economic matters are touched upon in their work. This will help to counter the misconceptions that arise in literary fiction when authors engage with flawed neo-liberal arguments about the monetary system. It might also help educate book reviewers who often, knowingly or unknowingly, reinforce the myths in the main text.

To start, consider the way book reviewers fail to correct the record. In the case of Lionel Shriver’s work – The Mandibles: A Family, 2029-2047 (published May 2016) – which is our demonstration novel, the press reception of the book tended to reinforce its claim to reality.

In Part 1, I noted that Shriver has made it plain in many interviews that the motivation for the book was to present “a cautionary tale about today” (Source).

The Australian Fairfax press review of the book (June 3, 2016) – The Mandibles review: Lionel Shriver’s family saga of the world going bung – claimed that Shriver’s “trick … is to take what might be a schematic parable of a plotline and then fill it with all the circumstantial realistic air in the world so that we will feel we inhabit this endangered dumpster of a universe as if it were our own.”

It also reinforces Shriver’s claim that the book is not some dystopian fantasy by saying that Shriver:

… is so well-informed about the eloquence of risk that lies beneath the American economy. She is intimately aware of how much trust has to underwrite the greenback as well as God-given American democracy …

So the reader, who might be perusing reviews before purchasing and reading the novel, will be already trained to accept that Shriver has a strong command of economic matters and and firm understanding of the inner workings of the monetary system.

This just reinforces the gullibility of the readership and perpetuates false ideas.

As another example, the Irish Times review (May 14, 2016) – The Mandibles review: future shock family – told the readership that the book is “laced with Shriver’s spicy intellect, her unapologetic eye for detail” and:

… is a not-too-distant epoch in which children are no longer able to write with a pen and paper, but instead understand perfectly the specifics of monetising national debt.

All adding ‘credibility’ to the fiscal discussion that is woven throughout the book.

We left yesterday’s discussion with Douglas Mandible (in 2029) discussing the financial collapse with his son, Carter.

His first parry was the standard Austrian School, gold bug claim that the US dollar has lost 95.8 per cent of value since 1913. We demonstrated how misleading that particular claim is.

Even a mainstream, neo-classical economist (which I generally refer to as the dominant neo-liberal group in the profession) would reject the gold bug claim.

But Shriver is apparently not fussed by consistency. She presents a pot-pourri of fiscal scaremongering drawn from disparate camps as if they belong to a unified and accepted body of theory and praxis.

After the gold bug discussion between Douglas and Carer, Shriver then launches into doomsday scenarios that the mainstream economists typically use to attack government.

Shriver writes that:

Douglas now immersed himself in the more recently minted genre of apocalyptic economics, rehearsing debt-to-GDP ratios … America in particular has been getting away with murder—playing on the heartbreaking international belief in Treasury bonds as the ultimate ‘safe haven.’ Really, the blind trust bears all the irrational hallmarks of theology. What else, financially, is there to believe in besides the full faith and credit of the United States? So we’ve borrowed for basically nothing on the basis of a childlike credulity for thirty years. You know the Fed’s been steadily trying to monetize the debt … buying American bonds was a sign of worldwide gullibility.

This is a statement of the repetitive theme in the book that foreign purchases of US government treasury debt have been propping up American government spending and, without it, the US government has no financial viability.

A corollary of this theme, is that the power lies in the hands of those foreigners who hold the US government debt rather than the issuer, the US government.

Of course, the Chinese could liquidate their holdings of US government debt. But in doing so they would devastate their own fortunes. As we will see such a liquidation would have no bearing on the US government’s capacity to buy goods and services for sale in US dollars but would seriously undermine the trading capacity of China. None of this is recognised in Shriver’s narrative.

The importance of who purchases US government debt is close to zero when assessing the capacity of the US government to run its fiscal policy program.

The US government is the only government that issues US currency so it is impossible for the Chinese to ‘fund’ US government spending.

Modern Monetary Theory (MMT) demonstrates that the external deficit countries ‘finance’ the desire of the external surplus nations to accumulate financial assets denominated in the currencies of the deficit countries. If the deficit countries stopped purchasing that desire would be unfulfilled.

The propensity to foreign-held US public debt is a direct result of the trade patterns between the countries involved (and cross trade positions).

For example, China will automatically accumulate US-dollar denominated claims as a result of it running a current account surplus against the US.

These claims are initially held somewhere within the US banking system and can manifest as US-dollar deposits or interest-bearing bonds. The difference is really immaterial to US government spending and in an accounting sense just involves adjustments within the banking system.

The accumulation of these US-dollar denominated assets (bits of paper and electronic bank balances) is the ‘reward’ that the Chinese (or other foreigners) get for shipping real goods and services to the US (principally) in exchange for less real goods and services being shipped from the US.

Given real living standards are based on access to real goods and services, you can work out, from a macroeconomic perspective, who is on top.

Please read my blog – Modern monetary theory in an open economy – for more discussion on this point.

Note, I used the qualifier ‘from a macroeconomic perspective’. A US worker in Detroit who has endured unemployment as a result of cheaper imports coming from nations with lower labour standards (pay and conditions) than the US is unlikely to be among those who benefit.

The US thus benefits from China’s willingness to deprive its citizens of material wealth (use of its own real resources) and net ship its ‘labour’ and other real resources embodied in the exports to other nations.

This is not to deny that when an economy experiences a depletion of foreign exchange reserves or finds the exchange terms of its own currency against foreign currencies it requires to purchase essential imports it has to take some hard decisions in relation to its external sector.

This is especially so if it is reliant on imported fuel and food products. In these situations, a burgeoning external deficit will threaten the dwindling international currency reserves.

In some cases, given the particular composition of exports and imports, currency depreciation is unlikely to resolve the CAD without additional measures.

The depreciation, in turn, raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, depreciation leads to expectations of further depreciation and fuels the run out of the currency. There may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default.

The reality is that a nation facing a lack of ability to purchase imports, for whatever reason, has to either increase its exports or reduce its imports.

For less developed countries faced with currency crises, there is probably no short-run alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default.

For an advanced nation, similar constraints might apply and a sudden shift in international sentiment against the nation or other financial assets denominated in that currency are no longer deemed as desirable, then adjustments in the flow of real goods and services sourced from foreigners are required.

And, as I explain in this blog – Ultimately, real resource availability constrains prosperity – the limits for a nation are clear – if it cannot command access to real resources owned by foreigners the it must rely on the resource wealth it has for sale in its own currency.

But none of that reduces the financial capacity of the currency-issuing government to purchase whatever is for sale in that currency.

It might also be the case that certain accounting procedures are rehearsed by the US Treasury and the Federal Reserve bank before the former spends US dollars.

These voluntary constraints – shunting cash from bond sales into a particular account that is then debited when government spending occurs – are just a chimera.

The intrinsic financial capacity of the US government is clear – it issues the currency.

The stupidity of these voluntary constraints would become more obvious if the US Congress passed a law that required all Treasury officials to run a lap of the President’s Park each day, which is near the Treasury Building on 15th Street North West in the District of Columbia, before it could formalise each government spending transaction.

Such a rule would have as much logic as the sort of accounting gymnastics that are operating in practice.

Ultimately, the US government is not dependent on the financial markets. The latter are dependent on the government spending! And China would have to find other assets to hold if it did not invest the US dollar earnings it makes from its trade surpluses against the US in US treasury bonds.

Please read my blog – Who is in charge? February – for more discussion on this point.

Debt monetisation

Shriver also linked the ‘foreign funding of US government deficits’ myth with the related claim that as the private bond markets were losing confidence in the dollar, the Federal Reserve was “steadily trying to monetize the debt”.

This is another one of those mainstream deceptions and is introduced to logically point to the next causal argument in the neo-liberal chain against government deficits – that the central banks will cause hyperinflation as the currency collapses and it spews ‘money’ into an economy already saturated with the increasingly worthless money.

The popular image of citizens pushing wheelbarrows full of $US100 bills to buy a loaf of bread, while crazed-central bankers in basements are running printing presses at breakneck speed, is then conjured up.


In this context, Shriver has Douglas Mandible’s saying to Carter that “monetizing the debt” amounted to:

You loan me ten bucks. I photocopy the bill four times, give you back one of the copies, and announce that we’re square. That’s monetizing the debt: I owe you nothing, and you’re stuck with a scrap of litter.

This is not remotely what the orthodox concept of debt monetisation refers to. It is really just a restatement of the argument that the more of a currency that is issued, the lower its value.

Shriver wants her readers to believe the false claim that continually expanding the money supply will inevitably be inflationary.

To monetise means to convert to money. Gold used to be monetised when the government issued new gold certificates to purchase gold.

In a broad sense, a federal (fiat currency issuing) government’s debt is money, and deficit spending is the process of monetising whatever the government purchases.

All government spending in a flexible exchange rate system, is operationalised by the government crediting bank accounts (directly or indirectly by issuing cheques). This process adds to bank reserves. Alternatively, taxation payments to government result in bank accounts being debited and reserves being reduced.

So among other impacts, a fiscal deficit is a net reserve add or a net credit to commercial bank accounts.

If we understand the banking operations that accompany these transactions further, we will learn that those who receive the net payments from the government are in possession of bank liabilities which are matched by the banks’ reserve positions which are central bank liabilities. Some of the deposits are held in the form of cash but this is a nuance.

Note that irrespective of what else the government (via the treasury or the central bank) does in relations to the operational management of the cash system (bond sales) and/or aggregate demand management (taxation changes), government spending is the same process.

So the alleged three sources of finance (taxes, debt-issuance, or ‘money printing’) noted in the mainstream textbook literature are misnomers and mislead you into thinking that the process of government spending differs depending on how it is ‘financed’.

But in terms of debt monetisation, students are taught to believe that:

… with the central bank’s cooperation, the government can in effect finance itself by money creation. It can issue bonds and ask the central bank to buy them. The central bank then pays the government with money it creates, and the government in turn uses that money to finance the deficit. This process is called debt monetization. (excerpt from Blanchard’s 1997 macroeconomics textbook, page 429).

Following Blanchard’s conception, debt monetisation is usually referred to as a process whereby the central bank buys government bonds directly from the treasury.

In other words, the federal government borrows money from the central bank rather than the public. Debt monetisation is the process usually implied when a government is said to be ‘printing money’, although MMT proponents will never use that terminology, because government spending is done by crediting bank accounts (as above). No printers are involved!

Debt monetisation, all else equal, is said to increase the money supply and, ultimately, lead to severe inflation.

The mainstream macroeconomics text book argument that increasing the money supply will cause inflation is based on the Quantity Theory of Money.

The Quantity Theory of Money, a leftover from the Classical era, is expressed in symbols as MV = PQ. In English, this says that the money stock (M) times the turnover per period (V) is equal to the price level (P) times real output (Q).

The mainstream argument linking increasing M to P makes two major assumptions:

1. V is fixed (despite empirically it moving all over the place).

2. Q is always at full employment as a result of market adjustments – so the economy is assummed to be unable to physically produce more output in response to rising spending (MV).

In applying this theory the mainstream thus deny the existence of unemployment or idle capacity. The more reasonable mainstream economists admit that short-run deviations in the predictions of the Quantity Theory of Money can occur but in the long-run all the frictions causing unemployment will disappear and the theory will apply.

In general, the Monetarists (the most recent group to revive the Quantity Theory of Money) claim that with V and Q fixed, then changes in M cause changes in P – which is the basic Monetarist claim that expanding the money supply is inflationary.

They say that excess monetary growth creates a situation where too much money is chasing too few goods and the only adjustment that is possible is nominal (that is, inflation).

One of the contributions of Keynes was to show the Quantity Theory of Money could not be correct. He observed price level changes independent of monetary supply movements (and vice versa) which changed his own perception of the way the monetary system operated.

Further, with high rates of capacity and labour underutilisation at various times (including now) one can hardly seriously maintain the view that Q is fixed. There is always scope for real adjustments (that is, increasing output) to match nominal growth in aggregate demand.

So if increased credit became available and borrowers used the deposits that were created by the loans to purchase goods and services, it is likely that firms with excess capacity will react to the increased nominal demand by increasing output.

Even at full employment, productivity growth and investment means that the level of real output commensurate with all productive resources being fully utilised is always expanding.

So as long as the volume of spending (MV) keeps pace with the real capacity of the economy, there is unlikely to any price response from firms keen to preserve market share.

Thus, even if the money supply is increasing, the economy may still adjust to that via output and income increases up to full capacity. Over time, as investment expands the productive capacity of the economy, aggregate demand growth can support the utilisation of that increased capacity without there being inflation.

Moreover, Modern Monetary Theory (MMT) demonstrates that the orthodox concept of central bank monetising the deficit is largely inapplicable to a fiat currency monetary system with flexible exchange rates.

It stems from the fallacious idea that the national government faces a fiscal constraint in the same way that a household operates.

Students are taught that deficits are inflationary if financed by so-called ‘debt monetisation’ or squeeze private sector spending if financed by debt issue because they soak up what is claimed to be a finite pool of savings and thus push up interest rates, choking off private borrowing.

The latter claim categorically fails to understand that private banks do not loan out reserves and create deposits (and liquidity) whenever they issue a loan to a credit-worthy borrower. It also fails to understand that when deficits promote income growth, saving increases, and so cannot be considered a finite pool.

Once you understand that and that the monetary operations surrounding government spending do not alter the inflation risk inherent in any spending, government or non-government then we can move on to put the concept of debt monetisation into a real world perspective.

The reality is that the fear of debt monetisation is unfounded, not only because the government doesn’t need money in order to spend but also because the central bank does not have the option to monetise any of the outstanding government debt or newly issued government debt.

Why is the central bank so constrained?

As long as the central bank has a mandate to maintain a positive target short-term interest rate, the size of its purchases and sales of government debt are not discretionary.

The central bank’s lack of control over the quantity of reserves underscores the impossibility of debt monetisation in typical times.

The central bank is unable to monetise the government debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to any support rate that it might have in place for excess reserves.

Why is that?

I discuss it in detail in the introductory suite of blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts.

In summary, central bank operations aim to manage the liquidity in the banking system such that short-term interest rates match the official targets which define the current monetary policy stance.

The main instrument of this liquidity management is through open market operations, that is, buying and selling government debt.

When the competitive pressures in the overnight funds market drives the interbank rate below the desired target rate, the central bank drains liquidity by selling government debt.

This open market intervention therefore will result in a higher value for the overnight rate. Importantly, we characterise the debt-issuance as a monetary policy operation designed to provide interest-rate maintenance.

What might drive these competitive pressures in the overnight funds market?

When the government runs a fiscal deficit, it is adding more reserves to the banking system (via the spending) than it is draining reserves (via the taxation).

So on any particular day, a fiscal deficit means the reserves are rising overall. Any particular bank might be short of reserves but overall the sum of the bank reserves are in excess. It is in the commercial banks interests to try to eliminate any unneeded reserves each night. Surplus banks will try to loan their excess reserves on the Interbank market. Some deficit banks will clearly be interested in these loans to shore up their position and avoid borrowing from the lender of last resort (the central bank) which is typically more expensive.

The upshot, however, is that the competition between the surplus banks to shed their excess reserves drives the short-term interest rate down.

But, all these transactions net to zero and so the non-government banking system cannot by itself eliminate a system-wide excess of reserves that the fiscal deficit created.

The excess is drained by central bank open market operations. That is, the bond sales (debt issuance) allows the RBA to drain any excess reserves in the cash-system and therefore curtail the downward pressure on the interest rate. In doing so it maintains control of monetary policy.

Accordingly, the concept of debt monetisation is a non sequitur. Once the overnight rate target is set the central bank should only trade government securities if liquidity changes are required to support this target.

Given the central bank cannot control the reserves then debt monetisation is strictly impossible.

Imagine that the central bank traded government securities with the treasury, which then increased government spending. The excess reserves would force the central bank to sell the same amount of government securities to the private market or allow the overnight rate to fall to the support level.

This is not monetisation but rather the central bank simply acting as broker in the context of the logic of the interest rate setting monetary policy.

The alternative to an open market operation, is for the central bank to pay a competitive rate on excess reserves. You will appreciate that this will eliminate the motive of the banks with surplus reserves to seek a competitive return in the interbank market and thus allow the central bank to maintain a positive target interest rate.

But, in substance, this is equivalent to selling an interest-bearing bond to the private banks. The name of the account where the funds are recorded might be different (bonds in the first case, interest-earning reserves in the second) but the effect is the same. The non-government sector receives a flow of income from the government sector (either a bond interest payment or an excess reserve interest payment) and holds a financial asset it can cash in any time.

So it is only when the central bank is prepared to allow the interest rate to drop to zero can it ‘monetise’ government debt without any other liquidity management intervention.

Why is the zero interest rate situation different? Then the central bank does not have to drain the excess reserves by selling government bonds to the markets even if there is an on-going fiscal deficit adding to those excess reserves on a daily basis.

The competitive processes within the interbank market will ensure there is a zero interest rate.

In fact, this is the preferred MMT position – no government debt issued, overt monetary financing (that is, the equivalent of debt monetisation) and zero interest rates.

In Chapter 4 of The Mandibles we are introduced to the POTUS, who it turns out is of Hispanic ethnicity, again an illusion to alleged demographic shifts in the US between now and 2029.

President Alvarado, presents all his speeches in Spanish before providing an English version.

Another part of the family, Willing, a 12 year old is watching the President address the nation but his mother Florence, who is the daughter of Carter, decides to catch it later.

Alvarado announces that the speculative attacks on the US dollar have been:

… designed to raise the cost of financing our national debt, which would translate into you the American taxpayer keeping less of your hard-earned income.

Of course, this is the standard neo-liberal line. That taxpayers, ultimately are the source of funds that the government spends.

But for the non-government sector to get the funds that they remit to relinquish their tax obligations, the government has had to spend them into existence. Spending has to pre-date tax payments, which means, as a matter of elementary logic that the taxes cannot cause the spending!

Please read my blog – Taxpayers do not fund anything – for more discussion on this point.

The President continued and claimed that the introduction of the bancor was an international conspiracy where the “rogue IMF” had decreed that:

American bonds held by foreign investors must henceforth be redeemed in bancors, at an unfavorable exchange rate … American bonds sold to foreign investors must henceforth be denominated in bancors—which is a challenge to our very sovereignty as a nation.

Which if it ever occurred would mean nothing in relation to the US governments ability to spend US dollars. They could simply determine that the bond auctions were off limits to non-US citizens, or, instruct the central bank to buy the debt not sold to US citizens (up to the volume necessary to match the fiscal deficit), or, better still, stop issuing debt altogether.

So even if a ‘rogue IMF’ intervened in this way, the only losers would be the foreigners running external surpluses against the US who would have dollars in bank accounts earning nothing and no access to a ‘safe’ interest-earning bond.

The POTUS then bans US citizens from holding these bancors, which would, in effect, stop imports.

He also confiscates all private gold reserves, which according the Shriver’s narrative, is to “mobilize our resources to defend our liberty” – that is, provide the government with funds. Gold exports are also prohibited.

First, the US government does not need ‘funds’ in order to spend US dollars.

Second, think about it logically, if there is to be no trading of gold, not private holdings of gold and no exports of gold, how would the confiscation help the government spend – which is an act of providing net financial assets to the non-government sector in exchange of the real resources owned by the latter sector?

Finally, the POTUS announces that the government will default on all outstanding debt because:

In the interest of preserving the very nation that would meet its obligations of the future, we are compelled to put aside the obligations of the past. All Treasury bills, notes, and bonds are forthwith declared null and void. Many a debtor has wept in gratitude for the mercy of a wiped slate, the right to a second chance, which for individuals and corporations alike all fair-minded judicial systems like our own have enshrined in law. So also must government be able to draw a line and say: here we begin afresh.

The point is that outstanding debt obligations do not hinder a currency-issuing government’s capacity to run deficits (or surpluses) in the future.

A past deficit (surplus) does not mean the government has less (more) spending capacity tomorrow.

The only way a large interest bill on public debt might limit the capacity of the government to spend today is that the income flow to the non-government sector would reduce the real resource space necessary for non-inflationary government spending.

But history tells us that that sort of problem is unlikely to ever be binding.

And if it was looking to become a problem, the central bank always has the capacity to control yields, down to zero and hence interest payments.

So it is a nonsensical claim by Shriver’s POTUS that they have to default to free up fiscal space. Another neo-liberal myth.


The rest of the book continues in this vein. But in Parts 1 and 2 I have dealt with most of the key neo-liberal myths that are woven into the story as if they are facts or have some relevance to reality.

I urge all prospective authors who want to discuss economics in their next book to base the narrative on Modern Monetary Theory (MMT) principles. That will help our cause immeasurably, presuming the books have wide sales.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

For sale – Just released book at discount price

I have stock of the book (paperback version) available for sale at discounted prices, well below the current market price from the booksellers.

If you would like a copy signed by yours truly then you should send me an E-mail me (Bill.Mitchell – @ – newcastle.edu.au deleting the – and space before and after the @ sign) with your location and I will send you PayPal details plus postage costs.

The discounted price I can make the book available (while my stock lasts) is $AUD28 plus postage.

My stocks are limited.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

Goddess' Island: Multi Fandom Game

Sep. 11th, 2017 01:40 pm
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Goddess' Island

The last hope for the Goddess.

Toto, this doesn't quite seem like Kansas anymore. The island is far from the world you remember. This isn't your home, this isn't even Earth from as far as you can tell. But why? How did you get here? It seems the whims of an unknown and forgotten goddess has decided that she needed your help, dragging you from your world and timeline and placing you on an island that is about to die. Welcome to Goddess’ Island, where the world is ending and you are its savior.

The island is clouded mostly in darkness but there is a spot, a beautiful valley, that is still flourishing. That is where you find yourself when you wake up. But you’re not alone. There are others stuck on the island just like you and if you’re lucky the goddess didn't just steal you away, but friends and family you know as well. Let's also not forget the creature that you bond for life with. Best idea though? Make friends, powerful friends. Make sure there are people to watch your back because when the God attacks, you're going to need every little bit of help you can get.

Will you survive, or will you give up and break under the pressure? Apply and become one of the saviors that the Goddess is depending to keep her alive. Canon and original characters are welcomed. The game starts on September 16th, 2017. Go check out the Wanted Characters or Holds page and get your application in!

Game starts on September 16th. APPLY.

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Posted by bill

A few weeks ago I wrote a blog – Reflections on a visit to New Zealand – which began by summarising some research I am working on which will be presented (with Dr Louisa Connors) at the upcoming MMT conference in Kansas City. This specific paper will be examining the role that fictional literature plays in framing false economic concepts and, thus, promoting neo-liberal biases among the readership, even when the plot of the narrative is ostensibly about something other than economics. We show that fiction is a powerful tool for spreading ideological propaganda, often in a very subliminal or subtle way. The lesson we draw from this work is that to further advance Modern Monetary Theory (MMT) ideas, authors, who introduce economic concepts into their writing, should construct their narratives consistent with the MMT principles. This will help to counter the misconceptions that arise in literary fiction when authors engage with flawed neo-liberal arguments about the monetary system. This blog is in two parts and today is Part 1. Part 2 will come another day (soon).

One book we are working with at present to demonstrate our argument is the recent work by influential American author Lionel Shriver entitled The Mandibles: A Family, 2029-2047 (published May 2016), which traces a family through 18 years of economic chaos after the US government is forced to default on its national debt because it has run out of money and the US dollar has been rendered ‘worthless’ in international currency markets.

Shriver has made it plain in many interviews that the motivation for the book was to present “a cautionary tale about today” (Source).

She told the BBC Radio 4 show Front Row (see previous link) that:

I have to admit that it was kicked off by the crisis of 2008 … This is not an unrealistic book it is not a science fiction book.

In other words, Shriver places her work firmly in the realm of critical realism, which means that she is suggesting her narrative has something to do with reality as it is rather than as she would like it to be.

But the reality is that the book presents a series of linked economic myths woven through the narrative about the dynamics of the Mandible Family – without any scrutiny or validation – just stated.

These include:

1. The ‘government will run out of money’ myth.

2. The ‘government deficits will leave a burden for the kids and the grandkids’ myth.

3. The ‘nation will go broke’ myth.

4. The ‘profligate state then turns on its people’ myth and as in ‘socialism, becomes oppressive’ myth.

5. The ‘healthcare and pensions are unaffordable’ myth.

And all of that is “realistic” and non-fiction, by the author’s own words.

It might be that Shriver believes all this economics rubbish and is just weaving it into her book as a narrative construct. But even so, her literary influence means that the people who read the book will be nodding in agreement and having all their ignorance and prejudices reinforced, not by any economic analysis and empirical validation, but by the bare-faced assertions and repetition of these economic myths.

This is a different problem for progressives to that presented, for example, by the famous tome by Ayn Rand, Atlas Shrugged.

Ayn Rand characterised her work as being a work of romantic realism, in that described, in her view, a world “as it could be and should be” (Rand, 1995: 243).

[Reference: Rand, A. (1995) Letters of Ayn Rand, edited by Berliner, M.S, New York: Dutton.]

Thus, Rayn’s Atlas Shrugged was a cry to the ideologues to crush the welfare state and eliminate the regulative structures that had given the working class a reasonable stake in the spoils of capitalist production.

It was clearly seen as a theoretical template to politically activate the right-wing elements that were increasingly, through the 1970s and beyond, coordinating attacks on the Welfare State and government defence of the poor.

Rand sought to impose a perverted sense of justice (later called ‘trickle down’) onto the policy debate to shift power away from workers towards capital.

But Shriver’s work is in a different category to that. The narrative is not ostensibly about economics. But the dynamics of the family, the central focus of the book, is intrinsically linked to their economic fortunes, which Shriver casts as being undermined by governments.

She verbals the characters by having them recite, in normal conversation between themselves, various neo-liberal economic myths, without scrutiny. They are just presented as background facts as if they have some bearing on what is likely to confront American families in the next 20 years.

This is a much more insidious problem for progressives to confront. Rand can be dismissed as a strange and rather crude ideologue.

Shriver is much more subtle and attempts to push economic myths under the radar – but all the time, suggesting they are factual realities. They are not!

Our paper (to be presented in Kansas) will have five main parts (outside an introduction that will state the problem and scope of our study) and a conclusion that will draw the argument together):

1. A discussion of the ways in which literature can reinforce flawed ideology.

2. A brief introduction to the book’s plot.

3. Why the Mandibles is pure fiction – application of Modern Monetary Theory (MMT) principles to the main monetary precepts presented by Shriver. That is, the book is a fantasy without application to the real world now or in the future.

4. What might befall the Mandibles in a world where MMT is broadly understood – we rewrite the book – in a few short pages using a consistent MMT understanding. We will come up with a much different future for the family.

5. Implications for progressive writers (non-economists) – we discuss how fictional authors with a progressive bent can help deepen the penetration of MMT understandings within the general population.

Why the Mandibles is pure fiction?

Despite Shriver claiming her story about the Mandible Family is “not a science fiction book”, by which she means it falls within the genre of critical realism, the economic concepts woven into her narrative are pure fiction and have no applicability to the real monetary system and the likely evolution of the US nor the World economy.

In this section, we test the narrative against our understanding of Modern Monetary Theory (MMT) and find that the main monetary precepts woven by Shriver into the narrative are a hybrid of gold bug hysteria and mainstream, neo-liberal myths.

It is interesting that Shriver melds together a range of criticisms from disparate sources, not appreciating that they do not comprise a coherent paradigmic position. More about which later.

The obvious conclusion that the book is a fantasy without application to the real world now or in the future.

We argue that it is representative of a number of fictional works that bias readers towards implicitly taking on neo-liberal economic fallacies as if they were verities.

Shriver takes us to 2029 where a new financial crisis is unfolding in the US. A 13-year old boy, Willing Mandible ask his mother as he watches the TV news:

Mom! … What’s a reserve currency?

That is the first hint of what is to come.

The TV news reported that “The dollar now having dropped below 40 percent of the world’s …” as the mother answered:

I’ve no idea what a reserve currency is … I don’t follow all that economics drear. When I graduated from college, it was all people talked about: derivatives, interest rates, something called LIBOR. I got sick of it, and I wasn’t interested to begin with.

The boy responded “Isn’t it important?”

Shriver writes that between the GFC and 2029, when the novel begins, the US endured massive economic change and challenges.

All the elements are there – the robots taking jobs, a hacking crisis that temporarily disabled “vital internet infrastructure” and all the utilities and related home devices that depended on it; the rise of China as the largest economy; the collapse of mastheads such as the New York Times as hackers rendered digital platforms commercially unviable; and the increasingly unreliable New York water supply.

But as the TV news was foreshadowing a major financial meltdown and worse, the Mandible family was more occupied with the everyday micro matters such as who would sweep up the “bits of cabbage from the kitchen floor”. Referencing, obviously, our capacity to bury our heads in the sand from a combination of indifference and ignorance.

We are soon introduced to other members of the family. Lowell Stackhouse, an economics academic at a US university, returns from work and relates the day’s US Treasury bond auction results to his wife Avery (nee Mandible).

He tells her the volume of bids for the bonds (bid-to-cover ratio) was equal to the volumes available and yields doubled.

Lowell, is in denial, which is Shriver’s statement on the way the economics profession handled the period leading the Global Financial Crisis.

He recounts several other potentially disastrous events to his wife, which he claims are unrelated. France is observed as being “unable to completely roll over a tranche of maturing debt—but Germany and the ECB swept in right away”, although with the Eurozone dissolved (as we learn earlier), one wonders what the European Central Bank is doing in the story.

We learn that the UK government, a currency-issuing government, “can’t bail them out this time”, them being the private British bank, Barclays, which is going “to the wall”. Again, this is Shriver denying the obvious capacity that particular government has to create unlimited pounds. If the British government did fail to bail out a failing bank it would be because they didn’t see any political gain in doing so. It could never claim that intrinsic financial constraints were binding on the decision.

But Shriver wants her readers to believe that currency-issuing governments are not able to protect their financial systems and guarantee bank deposits, when in reality, they can always ensure financial stability.

Lowell tells Avery of another “unrelated” development where the “skittish hedge funds in Zurich and Brussels reduced their dollar positions to basically zero and moved into gold”.

While he notes that “foreign demand for US debt is low”, he believes that the US national debt is entirely sustainable because “At 180 percent of GDP – which Japan proved was entirely doable – the debt has been sustained”. Again, Shriver wants us to see Lowell in denial as these negative events multiply.

Clearly, she wants her readers to concur that the public debt-to-GDP ratio somehow matters, even if she doesn’t explain how it matters. She is also, implicitly suggesting that Japan will eventually crash and provide testament to the sort of nonsense that Rogoff and Reinhardt pumped out regarding dangerous thresholds for public debt ratios.

Clearly, she wants her readers to concur that the public debt-to-GDP ratio somehow matters, even if she doesn’t explain how it matters. She is also, implicitly suggesting that Japan will eventually crash and provide testament to the sort of nonsense that Rogoff and Reinhardt pumped out regarding dangerous thresholds for public debt ratios.

Lowell’s belief is epitomised in this passage:

Money is emotional … Because all value is subjective, money is worth what people feel it’s worth. They accept it in exchange for goods and services because they have faith in it. Economics is closer to religion than science. Without millions of individual citizens believing in a currency, money is colored paper. Likewise, creditors have to believe that if they extend a loan to the US government they’ll get their money back or they don’t make the loan in the first place. So confidence isn’t a side issue. It’s the only issue.

And Shriver dismisses this (through Avery) as being pontification and the type of “crap” that economics professors deal up within the academy.

This is a curious tension in the book. She clearly has disdain for the economics profession, given her representation of it through Lowell’s character, whose “quarter-inch stubble no longer looked hip but seedy, and his longish graying hair cut in once-trendy uneven lengths now made him appear disheveled.”

But at the same time, she is happy to channel the main myths perpetuated by the core of the economics profession without question. If the academics are so full of “crap” why are their theories worthy of becoming the basis for what The New York Times review called a “dystopian finance fiction” (Franklin, 2016).

[Reference: Franklin, R. (2016) ‘Lionel Shriver Imagines Imminent Economic Collapse, With Cabbage at $20 a Head’, New York Times, July 11.]

But back to Lowell. While consumer and investor confidence is important in an economy, it is a secondary aspect of the publics’ willingness to use a fiat currency that is not intrinsically valuable (compared say, to gold or silver coins).

Shriver is obviously oblivious to the fact that the state has the capacity to denote the objects that will be required to relinquish the tax obligations of the non-government sector. That capacity is what underpins the demand for the currency rather than confidence. The non-government sector has to supply goods and services to the government sector in order to acquire the state’s currency.

In Modern Monetary Theory (MMT), this tax obligation gives relevance to an otherwise worthless currency. It requires governments to spend the currency into existence. And, logically, the capacity of the non-government sector to pay taxes must comes after the government spending, not before.

As he is travelling to work next morning, Lowell looks at his mobile information device that everyone now carries (a “fleX”) and the headlines were “DOLLAR CRASHES IN EUROPE”, presaging the generalised collapse of the US currency, which Shriver sees as inevitable.

Next we encounter the grandfather of the family Douglas who is fabulously wealthy as a consequence of early industrial innovations from his father.

He is in conversation with his son Carter Mandible (father of Avery). Carter has been trying to work out “this ‘bancor’ business”, which as we learn later, refers to the new reserve currency introduced by Russia and taken up by China.

Not only are foreigners selling off the US dollar and the ECB, Bank of Japan, Bank of England and the US Federal Reserve cannot stop it, but Vladimir Putin has introduced a new reserve currency, the Bancor, a name stolen from the supranational currency proposed by John Maynard Keynes and E.F. Schumacher in the early 1940s to support an International Clearing Union they considered essential to restore stability once peace was restored.

But the conversation then shifts to an acknowledgement that:

The SEC hasn’t deigned to re-open the Exchange since the Level 3 circuit breaker kicked in on Thursday. It doesn’t take much imagination to picture what will happen to the market when they do. I’m sure the SEC has pictured it. So whatever the values at which stocks left off are academic.

Which means that Carter’s wealth had been more or less wiped out. Further, the ATM machines had reduced the amounts they were dispensing because of a fear of “bank runs”.

Paul Krugman is the Federal Reserve Bank governor in 2029 and claims the banking restrictions are temporary.

This prompts Douglas to rail against about the problem of using capital controls. He tells Carter:

The hard part is lifting capital controls, which becomes unthinkable the moment they’re instituted. Who wants to keep funds in a country that confuses a bank account with a bear trap? The moment you remove the constraints, the nation is broke. So you can be sure that at least the freeze on making monetary transfers out of the US will stay in place for some time to come. Look at Cyprus. The capital controls levied in 2013 weren’t entirely rescinded until two years later.

Perhaps Shriver could have used the example of Iceland, which has its own currency, rather than Cyprus, which surrendered its currency when it adopted the euro. But then the story wouldn’t have gone the way she wanted it to.

For Iceland has categorically demonstrated that even with the opposition of some of the largest hedge funds in the world, a small, currency-issuing government can successfully impose capital controls and defend its currency.

Please read my blog – Iceland proves the nation state is alive and well – for more discussion on this point.

She might also have updated her knowledge of the latest research on capital controls, where even the IMF, previously implacably opposed to them, has been forced to acknowledge that they can stabilise the financial sector and provide better growth opportunities for nations under speculative attack from foreign exchange markets.

Please read my blogs – Why capital controls should be part of a progressive policy and Are capital controls the answer?– for more discussion on this point.

But all that would be inconvenient to Shriver’s intent. By introducing Douglas into the narrative she sets up a repetitive theme in the book. Shriver motivates her causal chain by asserting that the American fiscal system has been underpinned for years by foreign purchases of US government treasury debt.

The US dominance of the IMF is also over, and the New IMF (NIMF) which supervises the bancor, is no longer a policy extension of the US. The NIMF aims to “restrict the money supply” in global markets and reduce the reliance on the worthless US dollar.

But as they rue the current developments on international foreign exchange markets, Douglas informs Carter that the US dollar “is worthless now because it was worthless before“.

Shriver then, through Douglas, rehearses the standard Austrian School argument that:

In the hundred years following the establishment of the Federal Reserve in 1913, the dollar lost 95 percent of its value — when one of the purposes of the Fed was to safeguard the integrity of the currency. Great job, boys! … And the majority of that currency decay is historically recent. Why, the dollar lost half its value in the mere four years between 1977 and 1981.

American politician Ron Paul and the Tea Party supporters all mount this argument to attack the Federal Reserve Bank and the use of fiscal deficits.

The problem with the argument is that it is intrinsically misleading.

The claim is often by made in terms of the relative shifts in gold prices in US dollars. They say that in 1913, it took $US20.67 to purchase an ounce of gold (that is, each US dollar purchased 0.0484 of an ounce). By the time The Mandibles came out (2016), the gold price had risen to $US1250.74 per troy ounce (or each US dollar purchased 0.0008 of an ounce).

Simple arithmetic then tells us that there has been a 98.3 per cent decline in each US dollar’s capacity to purchase gold.

Of course, this calculation, though the result is relentlessly shouted by gold bugs and other government haters really has no relevance in calculating the real value (purchasing power) of the US currency.

Even during the ‘gold standard’ periods (which includes the Post Second World War Bretton Woods system of fixed exchange rates), using the gold price as the standard reference for the value of the US dollar, was problematic because gold itself was not in fixed supply and was also used as a speculative vehicle. The Bretton Woods system was a spectacular failure and was abandoned in 1971.

Economists also respond by saying that the real value of the dollar is best expressed in terms of how much a standard basket of goods and services costs. They use a Consumer Price Index (CPI), which converts such a basket into index number points.

If we take the All Items CPI, which the US Bureau of Labor Statistics publishes back to January 1913, we see that its average value in 1913 was 9.9 index points (base-year value of 100 in 1982-84). The average value in 2016 was 240. A simple calculation means that the CPI has increased by 2328.4 per cent over the entire span of the data.

So converting that into a dollar purchasing power expression gives us a 95.8 per cent decline in ‘purchasing power’ per dollar between 2013 and 2016.

Which would appear to validate the claim that the US dollar has declined in value by that amount.

But in repeating this Tea Party logic, Douglas Mandible was grossly misleading his son, Carter and by, inference, Shriver was grossly misleading her readers by leaving them with the impression that the US dollar was worthless now as a result of central bank policies and deficit spending by the Treasury.

The reason this Tea Party logic is grossly misleading, is that it would only make sense if the wages received by workers, for example, had not changed at all over 103 years (1913 to 2016).

But, of course, that far from true.

Official data shows that the average hourly earnings of production and nonsupervisory employees in the US Manufacturing industry in 1913 were $0.22 (US Census Bureau, 1975). By 2016, the average hourly earnings had risen to $US20.44, a rise of 9,190.5 per cent since 1913 (Bureau of Labor Statistics, Series CES3000000008).

[Reference: US Census Bureau (1975) Historical Statistics of the United States, Colonial Times to 1970, series D802 – LINK]

$0.22 per hour in 2016 dollars would have been worth $US5.34 per hour. So the real hourly earnings have risen by 282 per cent between 1913 and 2016, an incredible increase in the purchasing power of the dollar in the hands of workers.

A comparison of any occupational group would reveal a similar result.

Further, annual per capita national income was $US407 in 1913 (US Census Bureau, 1975) or $US9,883 in 2016 dollars.

By 2016 it had risen to $US57,590, an increase of 14,049 per cent in nominal terms and (which in real terms translates to a 482 per cent increase).

In other words, the average American household now has a much greater command over real goods and services in 2016 than they had in 1913.

Consider the average Manufacturing worker of 1913 who was earning 22 per cents per hour, being time-shifted into 2016. They would only be able to buy goods and services worth $US5.34 for each hours of work, whereas the actual average Manufacturing worker in 2016 was able to purchase $US20.43 worth of goods and services. A massive improvement in the command over material goods and services.

And this comparison does not take into account the huge improvements in quality of the goods and services available, particularly in areas of health, technology and housing.

Nor does it take into account the compound interest that could have been earned on the 22 cents had it been saved. A separate comparison would reveal that the compounded real $ value would now be much higher than it was in 1913.

There is a valid argument to be made that the average blurs the underlying distribution given the rise in income inequality over the last 30 years in the US. But that is not the claim underpinning the diatribe from Douglas Mandible to his son.

Overall, the inference that a recipient of the US dollar had a better material life in 1913 when compared to 2016 is plainly false.

Here we see that Shriver has brought together a sort of grab bag of criticisms from disparate sources about central banks and government deficits, without acknowledging (and perhaps, not appreciating) that they do not comprise a coherent paradigmic position.

So while the loss of dollar value is typically an Austrian School argument (politicised by the gold bugs and Tea Party activists) it is rejected by any mainstream, neo-classical economist (which I generally refer to as the dominant neo-liberal group in the profession).

Most trained economists would acknowledge the arguments we have presented above.

But, not to be fussed by consistency, Shriver immediately launches into doomsday scenarios that the mainstream would use to attack government.

To be continued …


In Part 2, we consider the demise of the US economy in Shriver’s narrative, the way the US President is characterised and more.

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

There are updated details today concerning the Madrid events.

Later in the week, I will be able to offer discounted access to the book. Stay tuned.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

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Here are the answers with discussion for this Weekend’s Quiz. The information provided should help you work out why you missed a question or three! If you haven’t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.

Question 1:

The statement that lending is capital-constrained rather than reserve constrained would not apply if the banks had to maintain a reserve ratio of 100 per cent.

The answer is False.

This answer should also be read as being complementary to the answer in Question 2 below.

In a “fractional reserve” banking system of the type the US runs (which is really one of the relics that remains from the gold standard/convertible currency era that ended in 1971), the banks have to retain a certain percentage (10 per cent currently in the US) of deposits as reserves with the central bank. You can read about the fractional reserve system from the Federal Point page maintained by the FRNY.

Where confusion as to the role of reserve requirements begins is when you open a mainstream economics textbooks and “learn” that the fractional reserve requirements provide the capacity through which the private banks can create money. The whole myth about the money multiplier is embedded in this erroneous conceptualisation of banking operations.

The FRNY educational material also perpetuates this myth. They say:

If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+…=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+…=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.

This is not an accurate description of the way the banking system actually operates and the FRNY (for example) clearly knows their representation is stylised and inaccurate. Later in the same document they they qualify their depiction to the point of rendering the last paragraph irrelevant. After some minor technical points about which deposits count to the requirements, they say this:

Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.

In other words, the required reserves play no role in the credit creation process.

The actual operations of the monetary system are described in this way. Banks seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share (this is one of Minsky’s drivers).

These loans are made independent of the banks’ reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”.

At the individual bank level, certainly the “price of reserves” will play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend.

So the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. The bank expands its balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank.

The major insight is that any balance sheet expansion which leaves a bank short of the required reserves may affect the return it can expect on the loan as a consequence of the “penalty” rate the central bank might exact through the discount window. But it will never impede the bank’s capacity to effect the loan in the first place.

The money multiplier myth leads students to think that as the central bank can control the monetary base then it can control the money supply. Further, given that inflation is allegedly the result of the money supply growing too fast then the blame is sheeted home to the “government” (the central bank in this case).

The reality is that the reserve requirements that might be in place at any point in time do not provide the central bank with a capacity to control the money supply.

So would it matter if reserve requirements were 100 per cent? In this blog – 100-percent reserve banking and state banks – I discuss the concept of a 100 per cent reserve system which is favoured by many conservatives who believe that the fractional reserve credit creation process is inevitably inflationary.

There are clearly an array of configurations of a 100 per cent reserve system in terms of what might count as reserves. For example, the system might require the reserves to be kept as gold. In the old “Giro” or “100 percent reserve” banking system which operated by people depositing “specie” (gold or silver) which then gave them access to bank notes issued up to the value of the assets deposited. Bank notes were then issued in a fixed rate against the specie and so the money supply could not increase without new specie being discovered.

Another option might be that all reserves should be in the form of government bonds, which would be virtually identical (in the sense of “fiat creations”) to the present system of central bank reserves.

While all these issues are interesting to explore in their own right, the question does not relate to these system requirements of this type. It was obvious that the question maintained a role for central bank (which would be unnecessary in a 100-per cent reserve system based on gold, for example.

It is also assumed that the reserves are of the form of current current central bank reserves with the only change being they should equal 100 per cent of deposits.

We also avoid complications like what deposits have to be backed by reserves and assume all deposits have to so backed.

In the current system, the the central bank ensures there are enough reserves to meet the needs generated by commercial bank deposit growth (that is, lending). As noted above, the required reserve ratio has no direct influence on credit growth. So it wouldn’t matter if the required reserves were 10 per cent, 0 per cent or 100 per cent.

In a fiat currency system, commercial banks require no reserves to expand credit. Even if the required reserves were 100 per cent, then with no other change in institutional structure or regulations, the central bank would still have to supply the reserves in line with deposit growth.

Now I noted that the central bank might be able to influence the behaviour of banks by imposing a penalty on the provision of reserves. It certainly can do that. As a monopolist, the central bank can set the price and supply whatever volume is required to the commercial banks.

But the price it sets will have implications for its ability to maintain the current policy interest rate which we consider in Question 2.

The central bank maintains its policy rate via open market operations. What really happens when an open market purchase (for example) is made is that the central bank adds reserves to the banking system. This will drive the interest rate down if the new reserve position is above the minimum desired by the banks. If the central bank wants to maintain control of the interest rate then it has to eliminate any efforts by the commercial banks in the overnight interbank market to eliminate excess reserves.

One way it can do this is by selling bonds back to the banks. The same would work in reverse if it was to try to contract the money supply (a la money multiplier logic) by selling government bonds.

The point is that the central bank cannot control the money supply in this way (or any other way) except to price the reserves at a level that might temper bank lending.

So if it set a price of reserves above the current policy rate (as a penalty) then the policy rate would lose traction for reasons explained in the answer to Question 3.

The fact is that it is endogenous changes in the money supply (driven by bank credit creation) that lead to changes in the monetary base (as the central bank adds or subtracts reserves to ensure the “price” of reserves is maintained at its policy-desired level). Exactly the opposite to that depicted in the mainstream money multiplier model.

The other fact is that the money supply is endogenously generated by the horizontal credit (leveraging) activities conducted by banks, firms, investors etc – the central bank is not involved at this level of activity.

You might like to read these blogs for further information:

Question 2:

A central bank can control bank lending by charging an increasing price for providing its reserves to the commercial banks while maintaining its target monetary policy rate.

The answer is False.

This question is related to Question 1 and the answers are complementary.

The facts are as follows. First, central banks will always provided enough reserve balances to the commercial banks at a price it sets using a combination of overdraft/discounting facilities and open market operations.

Second, if the central bank didn’t provide the reserves necessary to match the growth in deposits in the commercial banking system then the payments system would grind to a halt and there would be significant hikes in the interbank rate of interest and a wedge between it and the policy (target) rate – meaning the central bank’s policy stance becomes compromised.

Third, Any reserve requirements within this context while legally enforceable (via fines etc) do not constrain the commercial bank credit creation capacity. Central bank reserves (the accounts the commercial banks keep with the central bank) are not used to make loans. They only function to facilitate the payments system (apart from satisfying any reserve requirements).

Fourth, banks make loans to credit-worthy borrowers and these loans create deposits. If the commercial bank in question is unable to get the reserves necessary to meet the requirements from other sources (other banks) then the central bank has to provide them. But the process of gaining the necessary reserves is a separate and subsequent bank operation to the deposit creation (via the loan).

Fifth, if there were too many reserves in the system (relative to the banks’ desired levels to facilitate the payments system and the required reserves then competition in the interbank (overnight) market would drive the interest rate down. This competition would be driven by banks holding surplus reserves (to their requirements) trying to lend them overnight. The opposite would happen if there were too few reserves supplied by the central bank. Then the chase for overnight funds would drive rates up.

In both cases the central bank would lose control of its current policy rate as the divergence between it and the interbank rate widened. This divergence can snake between the rate that the central bank pays on excess reserves (this rate varies between countries and overtime but before the crisis was zero in Japan and the US) and the penalty rate that the central bank seeks for providing the commercial banks access to the overdraft/discount facility.

So the aim of the central bank is to issue just as many reserves that are required for the law and the banks’ own desires.

Now the question seeks to link the penalty rate that the central bank charges for providing reserves to the banks and the central bank’s target rate. The wider the spread between these rates the more difficult does it become for the central bank to ensure the quantity of reserves is appropriate for maintaining its target (policy) rate.

Where this spread is narrow, central banks “hit” their target rate each day more precisely than when the spread is wider.

So if the central bank really wanted to put the screws on commercial bank lending via increasing the penalty rate, it would have to be prepared to lift its target rate in close correspondence. In other words, its monetary policy stance becomes beholden to the discount window settings.

The best answer was false because the central bank cannot operate with wide divergences between the penalty rate and the target rate and it is likely that the former would have to rise significantly to choke private bank credit creation.

You might like to read these blogs for further information:

Question 3:

If policy makers use the NAIRU to compute the decomposition between structural and cyclical fiscal balances, then if the estimated NAIRU is above the true full employment unemployment rate, the estimated impact of the automatic stabilisers will always be biased downwards.

The answer is True.

The following graph plots the actual unemployment rate for Australia (blue line) from 1959 to June 2009 and the Australian Treasury estimate of the NAIRU (red line). The data is available from the RBA.

You can see how ridiculous the estimated NAIRU is. Suddenly it jumps up just as actual unemployment rises although for such a jump to occur (according to the logic of the concept) there has to be major structural changes occurring. Historically, there is nothing that might convincingly explain that jump. Other estimation techniques give even more nonsensical estimates (they tend to just track the movement in the official unemployment rate).

This graph show how little correspondence there is between the inflation rate and the NAIRU gap (measured as the difference between the estimated NAIRU and the actual unemployment rate). The left-panel is the actual inflation rate (vertical axis) whereas the right-panel is the change in the actual inflation rate (vertical axis). There has always been some dispute in the literature as to whether the Phillips curve (the relationship between the NAIRU gap and inflation) should be specified in terms of the actual level of inflation or the acceleration in the level.

I also tried various lags in the inflation measures (to allow for frictions) and you get the same general picture. If the mainstream economic theory was correct, then the NAIRU gap should be negatively related to inflation (whichever measure you like). That is, when the unemployment rate is above the NAIRU inflation should be falling and vice versa. The conclusion from the data is that no such relationship exists. There is no surprise in that – the NAIRU is one of the most discredited concepts in the mainstream toolkit. The problem is that governments have been significantly influenced by it to the detriment of all of us.

To see why this is the case, the next graph plots three different measures of labour market tightness:

  • The gap between the actual unemployment rate and the NAIRU (blue line), which is interpreted as estimating full employment when the gap is zero (cutting the horizontal axis.
  • The gap between the actual unemployment rate and our 2 per cent full employment rate (red line), again would indicate full employment if the line cut the horizontal axis.
  • The gap between the broad labour underutilisation rate published by the ABS (available HERE), which takes into account underemployment and our 2 per cent full employment rate (green line).

The NAIRU estimates not only inflate the true full employment unemployment rate but also completely ignore the underemployment, which has risen sharply over the last 20 years.

In the June quarter 2006 the NAIRU gap was zero whereas the actual unemployment rate was still 2.78 per cent above the full employment unemployment rate. The thick red vertical line depicts this distance.

However, if we considered the labour market slack in terms of the broad labour underutilisation rate published by the ABS then the gap would be considerably larger – a staggering 9.4 per cent. Thus you have to sum the red and green vertical lines shown at June 2008 for illustrative purposes.

This means that the Australian Treasury are providing advice to the Federal government claiming that in June 2008 the Australian economy was at full employment when it is highly likely that there was upwards of 9 per cent of willing labour resources being wasted. That is how bad the NAIRU period has been for policy advice.

But in relation to this question, in June 2008, the Australian Treasury would have classified all of the federal fiscal balance in that quarter as being structural given that the cycle was considered to be at the peak (what they term full employment).

However, if we define the true full employment level was at 2 per cent unemployment and zero underemployment, then you can see that, in fact, the Australian economy would have been operating well below the full employment level and so there would have been a significant cyclical component being reflected in the fiscal balance.

Given the federal fiscal situation in June 2008 was in surplus the Treasury would have classified this as mildly contractionary whereas in fact the Commonwealth government was running a highly contractionary fiscal position which was preventing the economy from generating a greater number of jobs.

The following blogs may be of further interest to you:

Reclaiming the State Lecture Tour – September-October, 2017

For up to date details of my upcoming book promotion and lecture tour in Late September and early October through Europe go to – The Reclaim the State Project Home Page.

There are updated details today concerning the Madrid events.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.


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