Tag Archives: Modern Monetary Theory

A Fiscal Real-Bills Doctrine? No Such Thing As Painless Inflation Tax

14 Tuesday Jun 2022

Posted by in Fiscal policy, Inflation, Uncategorized

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A remarkable proposal made recently by Representative Ro Khanna (D -CA) would have the Biden Administration impose price controls, which would be bad enough. Khanna also would like the federal government to cover the inflation losses incurred by Americans by having it directly purchase certain goods and services and resell them “cheap” to consumers. In fairness, Khanna says the government should attempt to take advantage of dips in prices for oil, food commodities, and perhaps other necessities, which of course would limit or reverse downward price changes. When asked about Khanna’s proposal, Pete Buttigieg, Joe Biden’s Transportation Secretary, replied that there were great ideas coming out of Congress and the Administration should consider them. Anyway, the idea is so bad that it deserves a more thorough examination.

Central Planners Have No Clothes

First, such a program would represent a massive expansion in the scope of government. It would also present ample opportunities for graft and cronyism, as federal dollars filter through the administrative layers necessary to manage the purchases and distribution of goods. Furthermore, price and quantity would then be shaded by a heavy political component, often taking precedence over real demand and cost considerations. And that’s beyond the crippling “knowledge problem” that plagues all efforts at central planning.

One of the most destructive aspects of allowing government to absorb a greater share of total spending is that government is not invested with the same budgetary discipline as private buyers. Take no comfort in the notion that the government might prove expert at timing these purchases to leverage price dips. Remember that government always spends “other people’s money”, whether it comes from tax proceeds, lenders, or the printing press (and hence future consumers, who have absolutely no agency in the matter). Hence, price incentives take on less urgency, while political incentives gain prominence. The loss of price sensitivity means that government expenditures are likely to inflate more readily than private expenditures. This is all the more critical at a time when inflation is becoming embedded in expectations and pricing decisions. Khanna thus proposes an inflation “solution” that puts less price-sensitive bureaucrats in charge of actual purchases. That’s a prescription for failure.

If anyone in Biden’s White House is seriously considering a program of this kind, and let’s hope they’re not, they should at least be aware that direct subsidies for the purchase of key goods would be far more efficient. It’s also possible to hedge the risk of future price increases on commodities markets, perhaps simply distributing hedging gains to consumers when they pay off. However, having the federal government participate as a major player in commodities options and futures is probably not on the table at this point … and I shudder to think of it, but it might be more efficient than Khanna’s vision.

A Fiscal Real Bills Doctrine

Khanna’s program would almost surely cause inflation to accelerate. Inflation itself a form of taxation imposed by profligate governments, though it’s an inefficient tax since it creates greater uncertainty. Higher prices deflate the real value of most government debt (borrowed from the public), assets fixed in nominal value, and incomes. Read on, but this program would have the government pay your inflation tax for you by inflating some more. Does this sound like a vicious circle?

Khanna’s concept of inflation-relief is a fiscal reimagining of a long-discredited monetary theory called the “Real Bills Doctrine”. According to this doctrine, rising prices and costs necessitate additional money creation so that businesses have the liquidity to pay the bills associated with ongoing productive efforts. The “real” part is a reference to the link between business expenses and actual production, despite the fact that those bills are expressed in nominal terms. The result of this policy is a cycle of ever-higher inflation, as ever-more money is printed. This was the policy utilized by the Reichsbank in Weimar Germany during its hyperinflation of 1922-23. It’s really quite astonishing that anyone ever thought such a policy was helpful!

In Khanna’s version of the doctrine, the government spends to relieve cost pressure faced by consumers, so the rationale has nothing to do with productive effort.

Financing and the Central Bank Response

It’s reasonable to ask how these outlays would be financed. In all likelihood, the U.S. Treasury would borrow the funds at interest rates now at 10-15 year highs, which have risen in part to compensate investors for higher inflation.

My bet is that Khanna imagines the Fed would simply “print” money (i.e., buy the new government debt floated by the Treasury to pay for the program). This is the prescription of so-called Modern Monetary Theory, whose adherents have either forgotten or have never learned that money growth and inflation is a costly and regressive form of taxation.

Most economists would say the response of the Federal Reserve to this fiscal stimulus would bear on whether it really ignites additional inflationary pressure. Of course, rather than borrowing, Congress could always vote to levy higher taxes on the public in order to pay the public’s inflation tax burden! But then what’s the point? Well, taxing at least has the virtue of not fueling still higher inflation, and the Fed would not have a role to play.

But if the government simply borrows instead, it adds to the already bloated supply of government debt held by the public. This borrowing is likely to put more upward pressure on interest rates, and the federal government’s mounting interest expense requires more financing. What then might the Fed do?

The Fed is an independent, quasi-government entity, so it would not have to accommodate the additional spending by printing money (buying the new Treasury debt). Either way, investors are increasingly skeptical that the growing debt burden will ever be reversed via future surpluses. The fiscal theory of the price level holds that something must reduce the real value of government debt (in order to satisfy the long-term fiscal budget constraint). That “something” is a higher price level. This position is not universally accepted, and some would contend that if the Fed simply set a nominal GDP growth target and stuck to it, accelerating inflation would not have to follow from Khanna’s policy. The same if the Fed could stick to a symmetric average inflation target, but they certainly haven’t been up to that task. Hoping the Fed would fully assert its independence in a fiscal hurricane is probably wishful thinking.

Conclusion

There are no choke points in the supply chain for bad ideas on the left wing of the Democratic Party, and they are dominating party centrists in terms of messaging. The answer, it seems, is always more government. High inflation is very costly, but the best policy is to rein it in, and that requires budgetary and monetary discipline. Attempts to make high inflation “painless” are misguided in the first instance because they short-circuit consumer price responses and substitution, which help restrain prices. Second, the presumption that an inflation tax can be “painless” is an invitation to fiscal debauchery. Third, expansive government brings out hoards of rent seekers instigating corruption and waste. Finally, mounting public debt is unlikely to be offset by future surpluses, and that is the ultimate admission of Modern Monetary Theory. A fiscal real bills doctrine would be an additional expression of this lunacy. To suggest otherwise is either sheer stupidity or an exercise in gaslighting. You can’t inflate away the pain of an inflation tax.

Fiscal Inflation Is Simple With This One Weird Trick

03 Thursday Feb 2022

Posted by in Fiscal policy, Inflation

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I’ll get to the weird trick right off the bat. Then you can read on if you want. The trick really is perverse if you believe in principles of sound credit and financial stability. To levy a fiscal inflation tax, all the government need do is spend like a drunken sailor and undermine its own credibility as a trustworthy borrower. One way to do that: adopt the policy prescriptions of Modern Monetary Theory (MMT).

A Theory of Deadbeat Government

That’s right! Run budget deficits and convince investors the debt you float will never be repaid with future real surpluses. That doesn’t mean the government would literally default (though that is never outside the realm of possibility). However, given such a loss of faith, something else must give, because the real value government debt outstanding will exceed the real value of expected future surpluses from which to pay that debt. The debt might be in the form of interest-bearing government bonds or printed money: it’s all government debt. Ultimately, under these circumstances, there will be a revised expectation that the value of that debt (bonds and dollars) will be eroded by an inflation tax.

This is a sketch of “The Fiscal Theory of the Price Level” (FTPL). The link goes to a draft of a paper by John Cochrane, which he intends as an introduction and summary of the theory. He has been discussing and refining this theory for many years. In fairness to him, it’s a draft. There are a few passages that could be written more clearly, but on the whole, FTPL is a useful way of thinking about fiscal issues that may give rise to inflation.

Fiscal Helicopters

Cochrane discusses the old allegory about how an economy responds to dollar bills dropped from a helicopter — free money floating into everyone’s yard! The result is the classic “too much money chasing too few goods” problem, so dollar prices of goods must rise. We tend to think of the helicopter drop as a monetary policy experiment, but as Cochrane asserts, it is fiscal policy.

We have experienced something very much like the classic helicopter drop in the past two years. The federal government has effectively given money away in a variety of pandemic relief efforts. Our central bank, the Federal Reserve, has monetized much of the debt the Treasury issued as it “loaded the helicopter”.

In effect, this wasn’t an act of monetary policy at all, because the Fed does not have the authority to simply issue new government debt. The Fed can buy other assets (like government bonds) by issuing dollars (as bank reserves). That’s how it engineers increases in the money supply. It can also “lend” to the U.S. Treasury, crediting the Treasury’s checking account. Presto! Stimulus payments are in the mail!

This is classic monetary seigniorage, or in more familiar language, an inflation tax. Here is Cochrane description of the recent helicopter drop:

“The Fed and Treasury together sent people about $6 trillion, financed by new Treasury debt and new reserves. This cumulative expansion was about 30% of GDP ($21,481) or 38% of outstanding debt ($16,924). If people do not expect that any of that new debt will be repaid, it suggests a 38% price-level rise. If people expect Treasury debt to be repaid by surpluses but not reserves, then we still expect $2,506 / $16,924 = 15% cumulative inflation.”

FTPL, May I Introduce You To MMT

Another trend in thought seems to have dovetailed with the helicopter drop , and it may have influenced investor sentiment regarding the government’s ever-weakening commitment to future surpluses: that would be the growing interest in MMT. This “theory” says, sure, go ahead! Print the money government “must” spend. The state simply fesses-up, right off the bat, that it has no intention of running future surpluses.

To be clear, and perhaps more fair, economists who subscribe to MMT believe that deficits financed with money printing are acceptable when inflation and interest rates are very low. However, expecting stability under those circumstances requires a certain level of investor confidence in the government fisc. Read this for Cochrane’s view of MMT.

Statists like Bernie Sanders, Alexandria Ocasio-Cortez, and seemingly Joe Biden are delighted to adopt a more general application of MMT as intellectual cover for their grandiose plans to remake the economy, fix the climate, and expand the welfare state. But generalizing MMT is a dangerous flirtation with inflation denialism and invites economic disaster.

If This Goes On…

Amid this lunacy we have Joe Biden and his party hoping to find avenues for “Build Back Better”. Fortunately, it’s looking dead at this point. The bill considered in the fall would have amounted to an additional $2 trillion of “infrastructure” spending, mostly not for physical infrastructure. Moreover, according to the Congressional Budget Office, that bill’s cost would have far exceeded $2 trillion by the time all was said and done. There are ongoing hopes for separate passage of free community college, an extended child tax credit for all families, a higher cap for state and local income tax deductions, and a host of other social and climate initiatives. The latter, relegated to a separate bill, is said to carry a price tag of over $550 billion. In addition, the Left would still love to see complete forgiveness of all student debt and institute some form of universal basic income. Hey, just print the money, right? Warm up the chopper! But rest easy, cause all this appears less likely by the day.

Are there possible non-inflationary outcomes from ongoing helicopter drops that are contingent on behavior? What if people save the fresh cash because it’s viewed as a one-time windfall (i.e., not a permanent increase in income)? If you sit on such a windfall it will erode as prices rise, and the change in expectations about government finance won’t be too comforting on that score.

There are many aspects of FTPL worth pondering, such as whether bond investors would be very troubled by yawning deficits with MMT noisemakers in Congress IF the Fed refused to go along with it. That is, no money printing or debt monetization. The burgeoning supply of debt would weigh heavily on the market, forcing rates up. Government keeps spending and interest costs balloon. It is here where Cochrane and critics of FTPL have a sharp disagreement. Does this engender inflation in the absence of debt monetization? Cochrane says yes if investors have faith in the unfaithfulness of fiscal policymakers. Excessive debt is then every bit as inflationary as printing money.

Real Shocks and FTPL

It’s natural to think supply disruptions are primarily responsible for the recent acceleration of inflation, rather than the helicopter drop. There’s no question about those price pressures in certain markets, much of it inflected by wayward policymakers, and some of those markets involve key inputs like energy and labor. Even the median component of the CPI has escalated sharply, though it has lagged broader measures a bit.

Broad price pressures cannot be sustained indefinitely without accommodating changes in the supply of money, which is the so-called “numeraire” in which all goods are priced. What does this have to do with FTPL or the government’s long-term budget constraint? The helicopter drop certainly led to additional money growth and spending, but again, FTPL would say that inflation follows from the expectation that government will not produce future surpluses needed for long-term budget balance. The creation of either new money or government debt, loaded the chopper as it were, is sufficient to accommodate broad price pressures over some duration.

Conclusion

Whether or not FTPL is a fully accurate description of fiscal and monetary phenomena, few would argue that a truly deadbeat government is a prescription for hyperinflation. That’s an extreme, but the motivation for FTPL is the potential abandonment of good and honest governing principles. Pledging an inflation tax is not exactly what anyone means by the full faith and credit of the U.S. government.

Climate Change and Disorders of the Mind

13 Sunday Jan 2019

Posted by in Environment, Global Warming, Socialism

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Let’s hear from an environmentalist and radical animal-rights activist:

“… the extinction of Homo Sapiens would mean survival for millions if not billions, of Earth-dwelling species. Phasing out the human race will solve every problem on earth, social and environmental.”

Okay then, you first! That is an actual quote of Ingrid Newkirk, the misanthropic president of People for the Ethical Treatment of Animals (PETA), as documented by Tom Harris and Tim Ball in “Extreme Environmentalists Are Anti-Human“. I’m no psychologist, but I believe most shrinks would categorize misanthropy as a condition of general dislike for humanity that usually poses no real threat to others. Not always, however, and by my reckoning the sentiments expressed by Newkirk are the ramblings of a disturbed individual. But she’s not alone in her psychosis, by any means.

The sheer lunacy of the environmental Left is nowhere more evident than in the call for mankind’s extinction, and it is not unusual to hear it these days. Here’s a similarly deranged and tyrannical statement from the Voluntary Human Extinction Movement:

“Phasing out the human race by voluntarily ceasing to breed will allow Earth’s biosphere to return to good health … the hopeful alternative to the extinction of millions of species of plants and animals is the voluntary extinction of one species: Homo sapiens … us.“

The policies advocated by many environmentalists don’t go quite that far, but they nevertheless tend to be anti-human, as Harris and Ball demonstrate. In particular, the emphasis on eliminating the use of fossil fuels over the next three decades would consign most people , but especially those in developing countries, to ongoing lives of penury. Here are Harris and Ball:

“Of course, the poor and disadvantaged would be most affected by the inevitable huge rise in energy costs that would accompany the end of fossil fuels. … By promoting the idea that CO2 emissions must be reduced, climate mitigation activists are supporting the expanded use of biofuels. This is resulting in vast quantities of the world’s grain being diverted to fuel instead of food, causing food prices to rise — also causing the most pain among the world’s poor.“

I am highly skeptical of the risks presented by climate change. The magnitude of climate changes on both global and regional scales, even to the present, are subject to so much uncertainty in measurement as to be largely unworthy of policy action. Climate models based on “carbon forcings” have been increasingly in error, and the risks about which we are warned are based on forecasts from the same models far into the future — taking little account of the potential benefits of warming. The purported risks, and the benefits of mitigating actions, are translated into economic terms by models that are themselves subject to tremendous uncertainty. Then, the future calamitous outcomes and the benefits of mitigation are discounted so lightly as to make the lives of future human beings… and plants and animals, and their hypothetical preferences, almost just as important as those of actual human beings who, in the present, are asked to bear the very certain costs of mitigation. The entire pursuit is madness.

Last spring I had a brief discussion with an economist engaged in research on the economics of climate change at the University of Missouri. I mentioned the uncertainties in measuring and aggregating temperatures over time and place (here is one example). He said, with a straight face, that those uncertainties should be disregarded or else “we can’t say anything”. Well yes, as a matter of scientific principle, a high variance always means a greater likelihood that one must accept the null hypothesis! Yet the perspective adopted by the alarmist community is that a disastrous outcome is the null hypothesis — the sky is falling! If it weren’t for government grant money, I’m sure the sense of impending doom would be psychologically debilitating.

And now we are presented with a “Green New Deal” (GND), courtesy of a certain congressional freshman, Alexandria Ocasio-Cortez, whose apparent media appeal is disproportionately greater than her intellectual acumen. The GND would eliminate fossil fuels and nuclear power (which emits zero carbon) from the U.S. energy mix by the impossibly early 2035. That would require the replacement of 88% of U.S. energy sources in about 17 years, which would cripple the U.S. economy and real incomes. The poor would suffer the most, but of course the GND promises much more than a makeover of our energy sources. In fact, it would mandate the replacement of “non-essential individual means of transport with high-quality and modern mass transit”. Welcome to the new authoritarian paradise! All transportation and anything else requiring power would be electrified, a massive infrastructural investment. Oh, and the proposal calls for a slew of socialist programs: a federal job guarantee, a living wage, universal health care, and of course income redistribution. Interestingly, this proposal is consistent with the agenda described in the most widely-reported climate paper in 2018, which Michael Bastasch describes as a call for global socialism.

Cortez’s desperate hope is that all this can be paid for via reductions in defense spending, high taxes on the rich, and “Modern Monetary Theory”. She really doesn’t understand the latter except that it sounds expedient. Like many other leftist numbskulls, she undoubtedly thinks that printing money offers society a free lunch. But printing money simply cannot be transformed into real resources, and such attempts generally have destructive consequences. So the GND might not reflect mental illness so much as sheer stupidity. Anyone familiar with the history of socialism and the realities of public finance knows that the GND would have punishing consequences for everyday people. The so-called Yellow Vests in France should serve to warn of the affront taken by those oppressed by over-reaching government: their protests were originally motivated by a proposed increase in the fuel tax on top of already high energy taxes and other policies that artificially increase the cost of energy.

The environmental lobby has long promoted doomsday scenarios: population growth would outstrip the globe’s capacity for producing food, and resources would become increasingly scarce. In fact, the opposite has occurred. This is demonstrated by Gale L. Pooley and Marian L. Tupy in “The Simon Abundance Index: A New Way to Measure Availability of Resources“. The index is named after the brilliant Julian Simon, who famously made a bet with the doomsayer Paul Erlich on the likely course of prices for five metals. Simon was correct in predicting that markets and human ingenuity would lead to greater abundance, and that prices would fall. But the deep paranoia of the environmental Left continues today. They are oblivious to the lessons of history and the plain market solutions that lie before them. Indeed, those solutions are rejected because they rely on positive action by the presumed villains in their delusional tale: free people. The demonization of mankind, private action, and markets is not just symptomatic of misanthropy; it reflects a deeply paranoid and manipulative psychological state. These would-be tyrants are a real danger to the human race.