Modern Money Theory and inflation control: look at constant tax inflation
One of the tenets of Modern Monetary Theory (MMT) is that taxes are, ceteris paribus, deflationary. When prices of gasoline increase because of green taxes, people have less money left and know that their purchasing power declines. This is not consistent with neoclassical macro, at least not in its influential ‘Ricardian equivalence’ version, but that’s not interesting. The interesting thing is that MMT states that if inflation rises, taxes should increase to cool the economy. Which means that they will have to target some kind of inflation rate. Which rate? I’m not aware of any MMT-ers writing about this (but I might have missed a paragraph here or there from Bill Mitchell). But they should. The price level doesn’t only change because of an overheated economy but also because sales taxes or VAT or other indirect taxes increase. Which means that, whenever there is a spike in indirect taxes, we might mistake ‘normal’ inflation (a possible sign of an overheated economy) with a (deflationary!) increase in the price level because of tax increases. Looking at inflation including changes in tax rates leads to the risk that you want to increase taxes because inflation is high because (indirect) taxes are increased! Fortunately, the constant tax rate inflation is calculated by Eurostat. The same holds for energy prices in an economy which has a large external energy deficit: when oil prices rise this shows up as an increase in the price level but it’s not any kind of sign of an overheated economy.
In the Eurozone, constant tax prices (as well as core prices without energy) showed a lot lower increase than the official HICP rate of inflation. In Greece in 2019 this difference was over 4% (huh!) and in the entire 2010-2012 period over 6% meaning that in these three years alone the consumer price level increased with 6% because of increases in indirect taxes. Deflation in full swing!
Alas, at the time and consistent with neoclassical macro, the European Central Bank only looked at headline inflation which led to the infamous rate increases in 2008 and 2011 and misguided austerity. The ECB changed its course. But it is good to point out that there are sound, MMT consistent, why this happened. I’m not a real MMT-er. But that’s no reason not to apply their logic to the rate of inflation.
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I dont follow. Taxes do not erase or ‘lock up’ money in a vault but only redistribute it, so if taxes go up then some people are surely left with less disposable income, therefore less purchasing power, but some other people will receive a new government contract or a grant, because taxes are inevitably spent back into the economy, and so the net change in the aggregate money supply is Zero. If the velocity of money would also remain approximately constant (as it tends to do) then no deflationary pressure is created by changes to the rates of taxation. Am I missinging something?
If taxes are used to diminish the government deficit or to prop up balance sheets of banks this is snot necessarily true. In the case of banks it might induce banks to lend more, but this isn’t a 1:1 relationship.
Yes, good point. But bailouts are extraordinary measures, not a common one. So under conditions where the banking system is stable and self-sufficient, the lever of taxation would have no effect on inflation, right?
In case of deficit reduction, bonds are bought by the Government so someone gets the money, which are thereby re-injected into the economy. Surely some of the money can be used to pay off debt to banks which would shrink the money supply, but this is not a direct effect of increased taxation; the same could happen if taxes were reduced, increasing the disposable income and allowing people to pay off loans faster.
My point is that taxes alone don’t affect inflation; it also depends how the Gov will use the associated revenue.
I do not think you understand MMT. Federal Taxes are NOT spent back into the economy although state and municipal taxes are.
1. Anyone that starts a discussion citing ceteris paribus should be ignored.
2. Anyone that thinks inflation happens in a uniform manner across all products should be ignored.
3. Inflation is related to power and control. If you have a patent or a large market share – you have power and control. This is specific to certain industries and does not happen across all sectors in a uniform way. i.e. there is not a monetary element to inflation. (barring total collapse as in Venezuela today and Germany in post WW) If there were – the QE actions by central banks where they bought tons of bad debt injecting money into the system would have created rampant inflation. US money supply went from 2 trillion to 4 trillion. – no inflation was seen.
Item three is what corporations do not want you to understand. That is why they promote “economic education” at all major universities. In thirty minutes you can learn how wrong economists have been.
QE did not increases the broad money supply but performed an asset swap, paying off debt with currency. https://www.businessinsider.com.au/the-myth-of-the-exploding-us-money-supply-2011-3
But you do have a point, supply of money does not necessarily DRIVE inflation, but demand/need for products/services may drive an increase of private/bussiness debt and thus cause the money supply to increase. De facto monopolies may certainly influence that. The banks of course still can withhold lending or make it more accessible, and so they have the last word on the money supply and therefore inflation.
A subtle point when it comes to QE. QE did ot increase the money supply when money creating banks sold government bonds and swept one kind or ‘reserve’ for another. Banks are not allowed to use that money to invest in new real estate. Pensions funds, however, also sold bonds. And these are allowed to invest this money in new real estate which means that central bank statisticians do add this money to the stock of money. QE did increase the stock of money as measured by central banks.
Good post, Mike. “That is why they [corporations] promote ‘economic education’ at all major universities.” In the more than half-century since my college years it has gotten much worse.
The point of proposed MMT policy (as distinct from its description of the money system) is to adjust the IMBALANCE between spending and taxes, so as to control the money supply.
Even in conventional thinking the ‘deficit’ varies with time. So yes you missed something: that taxes are *not* automatically spent back into the economy. In the MMT description taxed money is extinguished. If there is spending, it is with newly created money. There is no automatic equality of spending and taxing (in anyone’s description).
Yes, good point. The lag between taxing and spending would have done effect, although probably a minor one (money does not sleep).
Even if we look at this as destruction and creation of money, by destroying x amount of money the gov simply creates more demand for money and the shortfall would be compensated by an increase in private and bossiness debt, again, with little effect on inflation. At best, taxation as a means of controlling inflation is not a particularly effective tool because there are other mechanisms in the system to compensate for that.
Cultural, you do not understand MMT, even a little bit. Taxes destroy money – the instrument of debt is destroyed, when it is redeemed.
Taxes do not “redistribute” money. They remove and extinguish it. The claim that taxes are used by the creator of currency is false. Every dollar spent by the creator of currency is created on the spot for that purpose.
Except the government creates only a tiny fraction of what its expenditures are, so that theory is evidently false. We pay taxes in the debt that banks owe us, so the government just collects these debt assets as tax: tax is then what the banks owe the government.
This is nonsense.
A simple comparison of M0 expansion vs. taxation revenue could dispel your fantasy.
If increased taxation is associated with an equal increase in government spending then there will be no net effect on inflation; some people will gain purchasing power at the expense of others.
If so, yes. But the idea behind MMT is that the bond between taxes and spending should be severed.
Exactly! The government extinguishes its income. It spends only money that it has caused to be created by the FR on demand. Taxes function as a drain on the money supply. I’m not an economist, but I’ve studied MMT and the current US system. The US system is (deliberately) misrepresented as one like individuals and businesses, which must borrow if they spend more than their income. This is done to support the imposition of austerity on social spending programs.
In MMT, the federal government spends and then extracts what it spends or some portion of it from the economy by taxation.
MMT recognizes that the purpose of taxes is to create a uniformly recognized need for the sovereign currency of the realm. The effect of taxation is to decrease the available money supply. Since the sovereign creates the circulating money out of thin air at the cost of keystrokes, it needs no source of money and can never go bankrupt.
National “Debt” is a dishonest characterization of the cumulative difference between government spending and income collected and extinguished. The sole purpose of this “debt” account is to create a phony excuse for spending limits and spending choices, with austerity being unnecessarily imposed on the people while favored predators are funded.
Lobdillj. Taxes Cannot control the money supply in the present system because even if the Gov would spend less than it taxes (and thus remove some money from the economy), the increased demand for money would be satisfied by lending from banks, since banks create money as credit.
Yes, the Gov can create money out of nothing but they generally dont do so but borrow from the economy instead, at interests. This is a kind of back door subsidy to the banks.
In the Eurozone, the guys who engineered the Euro went to extreme lengths to prevent governments from creating money – at least its own money (except for coins). The ECB is the only one allowed to create notes. But not for the government. Lending to the government is off limits. Government themselfs do not have the right to create money. Remember that the Bank of Italy, part of the system of European central banks, is a private bank (they should nationalize it and sell all the gold, but that’s another discussion).
In Australia (and I believe in the UK) the central bank is wholly owned (but not nationalised0 by the government, but that makes little difference since they create only a fraction of what the banks are able to create via credit, and the Central Bank (which is really working for the banking system, even though its profits go to the Gov) prints only as much money as the banks ask for to maintain sifficient currency “reserves”. I understand that banks like to keep minim currency they deem necessary to function because currency is dead money (it doesn’t earn interest).
The main objection to the idea that Gov should print money to pay for pubic projects is that its a slippery slope that ultimately ends in hyperinflation. It is certainly possible that money printing could be abused, but even this is not necessary. All the Gov needs to do wrest some power from the banks is to mandate 100% reserve banking, to ensure a near perfect transfer of purchasing power. Then the central banks woud be creating all the money currently denominated as M1. For this to work, i believe, the Gov would need to operate at least one commercial bank, otherwise other commercial banks could still force a recession by withholding credit as a political weapon against 100% reserve banking.
Cultural – go and read J. D. Alt The Millenials’ Money, so you know what it is you’re trying to criticise.
One of the more bizarre aspects of the present system is that the government does not need to issue bonds and pay interest on them, it is a hangover from the past. The MMT people argue the bonds are now a form of savings for the private sector. It *appears* that the government is borrowing from the private sector but it does not need to.
And it is not a proposal or a choice for governments to issue money created by a few keystrokes, it is simply a description of the present system, in those polities where the government has not yielded this power (i.e. this does not apply to EMU countries nor to state and provincial governments).
Cultural – and the fact taxes do not *completely* control the money supply does not mean they do not affect the money supply. If the private banks just compensated automatically for the ‘demand’ for money then the economy would not be running well under capacity, with 5% or more unemployment. So it’s not as simple as you proclaim.
I am saying it does not matter what the government does under the present conditions because banks, not the government, control the supply of money.
As for the bonds, I did not claim that the Gov needs to borrow from the private sector, on the contrary. But they do. And the public account is reconciled on that basis. It does not matter what you think this process should be called.
culturalanal: Taxes Cannot control the money supply in the present system because even if the Gov would spend less than it taxes (and thus remove some money from the economy), the increased demand for money would be satisfied by lending from banks, since banks create money as credit.
Yes, the Gov can create money out of nothing but they generally dont do so but borrow from the economy instead, at interests. This is a kind of back door subsidy to the banks.
You are not doing the accounting correctly if you believe this. Government is in complete control of the NFA-money – it is the only one that can create or destroy it. If the government ran surpluses, the economy would eventually run out of government money= reserves or bonds. The banks can’t create government money. Eventually, nobody could pay their taxes. Government surpluses (doing the accounting correctly) are logically impossible to sustain. Deficits are indefinitely sustainable.
Mainstream craponomics focuses on meaningless, trivial, superficial distinctions like that between a Treasury bond and cash /reserves at Fed. While ignoring enormous, differences like that between bank-issued money or notes or financial assets and government-issued money or bonds “NFA”.
Cultural, you write, “If increased taxation is associated with an equal increase in government spending …”. Taxation is functionally unrelated to government spending. They are independent variables. I suggest that you study Levy Economics Institute Working Paper No. 778, “Modern Monetary Theory 101: A Reply to Critics”, by Eric Tymoigne and L. Randall Wray.
MMT economists emphasize that spending and taxation are both part of the existing automatic stabilization mechanism, with transfer payments (welfare) increasing with economic contraction and tax revenue decreasing. The opposite holds for expansion.
Since fiscal policy is not designed this way at present, the spending and offset mechanism is not functioning as well as it could to optimize performance along the cycle. Instead, fiscal policy is determined under mistaken assumptions about both spending and taxation, as MMT economists have pointed out.
This is what the debate needs to be about.
An ideal fiscal policy would incorporate this in modeling the cycle in order to optimize stabilization policy and reduce the need for ad hoc measures to correct, although that might be called for in special cases, such as the GFC and ensuing deep and persistent contraction owing to a financial cycle culminating in the stage of Ponzi finance. Incorporating heterodox knowledge could have avoided or mitigated that.
MMT economists were also pointing this out based on stock-flow consistent modeling, functional finance, and incorporation of understanding Minsky had provided prior to the crisis and they also provided a fiscal remedy that was not deployed. MMT is based on Keynes, Lerner, Godley and Minsky, for example, but integrates this knowledge and develops it further.
MMT does not agree that “automatic stabilization” of the economy exists.
MMT has money mechanics correct, and like every other heterodox theories recognizes that the system is monetarily austere. Unfortunately like every heterodox theory to one degree or another they are still hypnotized by the quantity theory of money and the velocity of its circulation. Monetary inflation occurs, but money is not its primary cause which makes it a misnomer. It actually occurs because of monetary scarcity….and there not being a better, more rational and more beneficial alternative for commercial agents existing in an austere system with a chronic and general scarcity of actually available individual income/business revenue. Thus when such agents perceive more money coming into the system they raise their prices in the hopes of garnering more revenue. The assertion that inflation will not occur if we only toss a little more money into the economy is a flimsy orthodoxy.
You have to provide the better, concrete and temporal universe alternative by looking directly at the day to day operations of the economy…not just relate to it via abstractions and near misses.
re “asset swap, paying off debt with currency” ??? Cullen Roche is an opportunist, part of the priesthood of capitalist economics. No debt was paid off. All those bad loans are now held by the federal reserve.
Cullen goes on to explain how deficit spending by the federal government increases the money supply – this is wrong as well. If the government borrows – no increase in money supply. If the government runs a deficit and uses money provided by the fed to “cover” the deficit – this increases the money supply. The fed controls the money supply. QE expanded it greatly without any interaction with the federal government. This has never been done in the history of the fed.
Classical Econ claims that debt increases money supply. This is a lie and it is told so people won’t start runs on their banks. Part of the thought control capitalist promote. M0 is money. Any of the other M’s are debt. Debt and money supply have nothing to do with each other except “capital formation” is the gathering of money in order to make a loan.
example – debt must be repaid – correct?
Money – does not need to be repaid.
Another short lesson on lies by economists about labor.
“M0 is money. Any of the other M’s are debt. Debt and money supply have nothing to do with each other except “capital formation” is the gathering of money in order to make a loan.“
The money you use every day by using your cards, the money in your banks accounts, are not M0 but M3-M0, that is, monetised debt. You can calit money or not, but you are changing the definitions. We call M3 money because it is the most important monetary aggregate for measuring aggregate inflation.
But you are right insofar as currency is different to M3-M0, that it is why it is sometimes called Hard Money vs Broad Money. What counts for money is all means of payment expressed in the unit of currency.
Also, it is a misconception that a bank needs to gather money to make a loan. Bank Debt is not a loan strictly speaking, because it does not involve a perfect transfer of purchasing power. On 4% pa mortgage loans bank make a return on capital at 35-40% pa. Bank credit is leveraged capital, not a loan of capital.
“misconception that a bank needs to gather money”…
1. A bank cannot make a loan unless it has deposits of money.
2. After a bank has loaned out is “allowed amount” given reserve requirements, it cannot make any more loans until it collects deposits or profits from previous loans. These deposits and profits are money.
3. If you have ever arranged a mortgage, there is always a closing period – during that period the bank is allocating flows from previous loans to “fund” your loan. Until the money is collected, the bank has no “M0” to pay the builder.
M0, money, is both cash, coins and “ledger amounts” on the banks balance sheet that are reflected on the accounts of the Federal Reserve bank. As an example – your paycheck is never currency, but it is a ledger entry in your employer’s bank that moves to your bank. That ledger move is mirrored at the federal reserve. That is what I would call modern money.
When a bank loans money, the banks “ledger amounts” are reduced at the Federal Reserve as that amount “moves” to the bank of the “payee”. The Federal Reserve is the only bank that can create M0. All banks can create M1 and above –
A credit card transaction is M1, as long as you pay it off in time there are no interest charges to you. The bank makes money on the 3% transaction fee it charges the merchant. Imagine 3% on a two week loan – that is an annual interest rate of +50%
Don’t be fooled by economist preaching MMT crap. They want your mind to be in their box so they can manage the confusion. M0 is money – all other M’s are credit. Or you can believe them.
Credit is a loan – M1 and above. A loan is a loan. Bank credit is a loan.
Capital is capital – either in the form of physical assets or M0.
Leverage only exists on a balance sheet. If you have $10 of assets and $90 of loans – you are highly leveraged. If you have a car worth $2000 and no loan – there is no leverage on that asset. Without a balance sheet – you have no idea about leverage
And yes – banks are highly leveraged – thus the federal reserve requirement that somewhat limits their risk. Rest assured – if everyone went to withdraw their money- the bank would close. We don’t want that behavior under any condition.
To issue credit (falsely called “loans”) the bank needs only capital (M0) and banking licence. By issuing credit the bank simply creates a liability on itself and an asset of equal value in a single operation.
The leveraging of the bank is not the ratio of liabilities to assets (these cancel out anyway) but the ratio of capital to liabilities.
All the politicians, particularly the Republican ones contend that banks know what is best for us. And banks are certain they know what is best for us. Just saying, banks rule the world. The new progressives just elected to Congress will over the next year attempt to change this. How far will the banks go to keep control? More bribery, more threats, death squads, or just shutting down the America economy till everyone agrees to play by their rules? For more than 100 years American banks have rigged the game to favor themselves. And for 50 of those 100 years American banks set the standard for all banks in the world. Now we face a dangerous and uncertain decision. How do we take back that control? For over 5,000 years one and only one entity created and controlled money, governments. Most of these were monarchies and other forms of autocratic government. That makes control of money by democratic governments more important today than ever in human history. The prospects of subjecting banks to democratic control seems unlikely today, and more unlikely the longer the current situation continues.
Ken,
You’re right the banks do “own the joint”. However, government control of the money creation process (which I also advocate) is just as problematic as private control. Was the paradigm of Debt Only changed by governmental control? Of course not. The only way to insure ethical government control of the money creation process is to firmly guide its policies with the natural philosophical concept of grace as in BENEVOLENT and UNIVERSALLY beneficial SOVEREIGN intent and then have a policy like a 50% discount/rebate at the point of retail sale that tremendously benefits all economic agents individual and commercial and also resolves the two major problems of modern economies, namely scarcity of individual incomes/business revenue and inflation….in a single policy.
I’m calling you and others out here. Why keep splashing around on the surface of the economic and monetary problems with half measures and incomplete theorizing. Visualize the new paradigm and its paradigm changing policies and philosophy…and lets get on with its acculturation.
“take back control”.. Regulation. Debt is the weapon banks use to suck out profits for their sake and leave the firm struggling to stay profitable – most go bankrupt. Any and All debt creation should be regulated.
1. No more leveraged buyouts.
2. when a firm goes under – a complete investigation and jail time for swindlers and claw back provisions to recapture bogus bonuses or golden parachutes.
3. Alternative Minimum tax for corporations. They pay congress too much money to get their “tax breaks” and fail to pay their share for the pubic commonwealth
4. No more intangible resources or goodwill that gets to be depreciated – this is bs accounting bought by corporations by bribing the accounting profession.
5. No more bribing local agencies (state or city) for tax breaks to locate a business in your city/state.
6. Tax on IPO’s so new firms “pay their way” for using existing commonwealth. 5% of issued equity goes to the public trust.
Just a few ideas…
Send a letter to your senator/representative. Call them…
Yes!
There is no better diagnosis of our (US) plight than what PCR delivers in this Interview by Rob Kall:
https://www.opednews.com/articles/Rob-Kall-Interview-with-Pa-by-Rob-Kall-AIPAC_Antisemitism_Big-Government_Globalization-190305-892.html#comment727187
The power of the banks is their dominating paradigm of Debt Only and its cowering power over government. Only a new paradigm of grace as in monetary gifting strategically implemented at the point of retail sale, and other policies, structural changes and governmental regulations aligned with and guided by the unimpeachable ethic of grace as in benevolent intention and universal consideration….can undo their dominance.
ps – get money out of politics. Bring back something like McCain/Feingold. Tell the supreme court their citizens united ruling opened the floodgates for corruption.
Yes!
Fixing this situation will require not just time and pain, but many changes to the American way of life, not just economics. Getting money out of politics means getting the plutocrats out politics. This is a delicate change. Rich persons have the right to participate in the political system in America. Just like other citizens. That means we must separate the impacts of money from the impacts of citizens’ participation. Only one solution I see for this, publicly funded politics. With the stranglehold of the rich and large corporations on the system now, this change requires a grassroots effort not seen since the 1960s. How violent this effort will become is impossible to say. Civics and civics education need to be elevated permanently above, well above economics education. Placing democracy and the protection of democracy at the center of life in America is more difficult than removing money from US politics. Since accomplishing the above requires an educated and understanding American people, both American budgets and commitment to first rate education for all Americans must be ensured. Finally, speaking as an historian, Americans must come to spend more time watching and overseeing the governments they elect. Including giving those governments feedback, positive and negative so effective changes in course can be made as needed. We also need to streamline the processes for Americans to directly face and converse with those they send to Congress and to the Presidency. This cannot be voluntary but must rather be mandatory.
Yes, well said Ken