John Cochrane: "Magical Money Theory"This book review is now available without a paywall (published last month at the Wall Street Journal). It underperformed my expectations; the only substantive content I can draw from it is that John Cochrane is not a fan of the expansion of government.
From that perspective, all one really needed to read of this review is this passage:
In a revealing moment, Ms. Kelton admits that “MMT can be used to defend policies that are traditionally more liberal . . . or more conservative (e.g., military spending or corporate tax cuts).” Well, if so, why fill a book on monetary theory with far-left wish lists? Why insult and annoy any reader to the right of Bernie Sanders’s left pinkie?
In summary, John Cochrane got annoyed with the left-wing political economy of the book, and then phoned in the rest of the review. Given the editorial slant of the Wall Street Journal, that is probably all the target audience needed to know. As such, John Cochrane's view is largely covered by Michael Edesess' review that I covered earlier.
Otherwise, signalling political affiliations is not enough to qualify as an academic review. I will just cover a few points of annoyance.
John Cochrane complains:
That effect is compounded by her refusal to abide by the conventional norms of economic and public-policy discourse. She cites no articles in major peer-reviewed journals, monographs with explicit models and evidence, or any of the other trappings of economic discourse. The rest of us read and compare ideas. Ms. Kelton does not grapple with the vast and deep economic thinking since the 1940s on money, inflation, debts, stimulus and slack measurement. Each item on Ms. Kelton’s well-worn spending wish list has raised many obvious objections. She mentions none.
This is an unusual complaint about a popular book that made the New York Times Bestseller list. Very few modern academic tracts make that list. Demanding that Kelton cite "major peer-reviewed journals" is bizarre when everybody knows that neoclassical economists have blocked post-Keynesians from those "major" journals in a raw academic power grab. The reality is that those "major" journals have devolved into a bubble that has offered very little in the way of tangible results in macroeconomic theory for decades. Why would Kelton cite literature that is viewed to be incorrect by MMTers in a popular book about MMT? If Cochrane wants critiques of the mainstream literature, the post-Keynesian academic literature is filled to the brim with them.
Complaining that Kelton does not cite neoclassicals when there is no evidence that John Cochrane read even a single MMT paper (free online search engines exist) can only be described as chutzpah.
At least one passage can be described as bad faith. Cochrane:
To Ms. Kelton, developing nations suffer a “deficit” of “monetary sovereignty” because they “rely on imports to meet vital social needs,” which requires foreign currency. Why not earn that currency by exporting other goods and services? “Export-led growth . . . rarely succeeds.” [Emphasis mine] China? Japan? Taiwan? South Korea? Her goal posts for “success” must lie far down field.
Let us take a look at the quoted passage. This is what Kelton actually wrote (from Chapter 5; I do not have a page number since I have the ebook version):
Export-led growth may be framed as an employment policy for various countries [emphasis mine], but it rarely succeeds.It goes without saying that success as an employment policy has only a limited relationship to a country "earning" foreign currency.
The following attempt to analyse the bond market by Cochrane is best described as "muddled."
[...] The Fed could stop paying interest on reserves. But in conventional thinking, these steps would result in a swift inflation that is equivalent to default. Ms. Kelton asserts instead that these steps “would tend to push prices lower, not higher.” She reasons that not paying interest would reduce bondholders’ income and hence their spending.The old "everybody will sell at the same time" story, which ignores the identity that for every buyer, there must be a seller. All that can be done in secondary trading is rearrange holdings; the stock of debt remains unchanged. Meanwhile, bonds are typically held by institutional funds -- and bond managers do not have the right to go out and buy goods and services. One could try to tell a story about bond pricing (presumably private, since the presumed scenario is after a Treasury buyback). With the risk-free rate locked at zero, pretty well any conventional pricing model suggests that interest rates for high quality bonds would be low.
The mistake is easy to spot: People value government debt and reserves as an asset, in a portfolio. If the government stops paying interest, people try to dump the debt in favor of assets that pay a return and to buy goods and services, driving up prices.
Otherwise, all that is left of interest are the complaints about inflation risks. Cochrane:
The second half of that decade—Lyndon Johnson’s Great Society and Vietnam War spending, inflation’s breakout, Richard Nixon’s disastrous price controls—is AWOL. Did we not try MMT once and see the inflation? Did not every committee of worthies always see slack in the economy? Did not the 1970s see stagflation, refuting Ms. Kelton’s assertion that inflation comes only when there is no “slack”? Don’t look for answers in “The Deficit Myth.”
This sounds legitimate, but it completely misses the boat. Anyone with even slight familiarity with post-Keynesian economics would know that they split from the mainstream (including the Old Keynesians) before the 1970s. MMT arise later than the 1970s, and so the developers were aware of the inflationary episode. It should be no surprise that MMTers analyse the 1970s inflation differently than Cochrane, and if one wants to question them on that, one would need to read the literature. MMT is new because the proponents of MMT do not want to make the same mistakes as the Old Keynesians.
I now turn to the next critique.
What if banks broke the buck?James Culhan wrote "What if banks broke the buck?" He argues that private banks can limit the power of the sovereign.
Put simply, inflation is the fall in the market value of money. But money itself takes many forms - government money, central bank money, commercial bank money, to name a few. Yet they all share the same characteristic - they are vouchers.This is an interesting story, as I believe that a variant of this happened in the United States historically (sorry, I need to find the reference!). If my memory is correct, cheques ("checks" in American) might not be cashed at par outside their local area.
In normal times these vouchers are fungible - they maintain value equivalence.
What if you went to your bank to deposit $100 in notes and the bank only credited you with an $80 deposit? In other words, it applied a discount to state money. Surely this breaks a bank’s obligation to honour convertibility between state and bank money? But no, banks only need to maintain dollar-for-dollar conversion for withdrawals. No problem - later on, when you withdraw your $80 deposit the bank would be only too happy to give you $80 in notes!
Unfortunately for Culhan, his story will not work. The domestic currency is a legal unit of account, and is the basis for debts and legal settlements. Banking system laws and regulations enshrine the principle that cheques and cash clear debts at par. (I was supplied the following reference by Rohan Grey: "The Case of Mixt Monies: Confirming Nominalism in the Common Law of Monetary Obligations" by David Fox, URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1763741 I have not yet had a chance to read it.)
As the cryptocurrency believers have demonstrated, it is fairly easy to create private tokens and pretend that they are "money." (Whether or not such tokens are money lies in the eye of the beholder.) However, the private banking system is built around a payments system: and that unit of account is shared between governments and the banks. All cheques and transfers within the system are at par, and that represents every single governmental transaction.
Can a bank try to mess around with its customers by refusing to take government banknotes at par? Since the bulk of cash redemptions are done by businesses, the banks would be having a little chat with lawyers representing most of the bricks and mortar retail industry. Good luck with that one. Meanwhile, this just represents banks gouging non-banks; government payments will clear at par.
The only way this story sort-of works is for private banks to switch over to a new currency; either an existing foreign currency, or a brand new one. They can try, but who guarantees the payments system? Since private debts are extinguished via the existing payments infrastructure, a new currency would have exactly the same legal status as in-game currency in multiplayer video games. It is easier for a domestic economy to switch over to a foreign currency, but there are remarkably few examples for countries with large existing stocks of domestic private debt.
Households and firms have large debts denominated in the domestic currency. It would be suicidal for banks to try to redenominate cash flows within the economy in a new currency. As such, they are trapped in exactly the same way as other taxpayers.
Although this attempt to critique MMT falls flat, there is other grousing about "private money," and this could be worked in.
(c) Brian Romanchuk 2020
If my commenting gets tiresome, let me know. Much of this depends on how robust, and technically sound, the legal system is. Fraud and abuse of power happens all the time, the issue is how bold these people are and what are the consequences.ReplyDelete
"Breaking the buck" fails for the simple reason that banks are, in fact, much more dependent on government than vice versa. It has always been such. The accountants must always conform to political authority. A banker's actual power is tenuous and indirect, as "Game of thrones" demonstrates, for example.
The worst outcome is that bankers, insiders, etc, actually succeed in completely controlling/corrupting financial machinery. This is because they cannot really sustain a functioning system for very long that has been corrupted. It simply devolves very quickly. As long as they are comfortable and reasonably secure, there is no reason to attempt this, and every reason not to.
The reality is, revolutionaries are much more inclined to attempt to completely take over political systems and financial machinery, but again, without legitimate well thought out plans, they have short attention spans and relatively little staying power.
The easiest means of control is just pushing soft and vague self-serving narratives, and that's what those who criticize the central message of MMT are all about. "The government is broke". "What if people don't buy bonds?". "We are burdening our grandchildren with debt".
Really, the only sound critique to be made of MMT, is that it doesn't go far enough, that it's legal and political analysis is fairly basic and oversimplifies society. You could also say it is hard to extrapolate claims to alternative universes with different policy structure, and that it doesn't provide much depth on the effects of different tax schemes(property tax, income tax, land value tax, etc).
I mean, but for all that, MMT does so much better at describing most of these issues than any other coherent school of thought out there. I have tried to push the envelope myself a little bit, but it is difficult, and often end up seeing the logic of other MMT commentators. Most economists are unduly obsessed with statistics and the scientific method, but then fail at very basic critical thinking skills. Very few of them have ever tried to debug computer code, which punishes you hard if you try to oversimplify logic or make very broad assumptions. They claim MMT is vague about inflation and not empirically or statistically sound, all why trumpeting around a 2 or 3 variable statistical regression, that only works from decades of social indoctrination on market participants, which at its core is not much better than reading tea leaves.
You can train basically any type of Pavlovian response into financial markets if you push it hard enough. This is the great fraud of modern economics, that it is prescriptive much more than it is descriptive. That it tries to collate very broad variables with implausibly oversimplified logic, simply through sheer force of will and repetition. There is no game theoretic reason for individual investors to disrupt herd behavior based on incoherent logic, and they have every reason to go along for the ride.
Comments are welcome.
I have just one point to respond to: "Really, the only sound critique to be made of MMT, is that it doesn't go far enough, that it's legal and political analysis is fairly basic and oversimplifies society." I'm not sure I entirely buy that, certainly on the legal side. MMT is the only area where I see legal people opining on economic issues; most economists just plain make stuff up. Beyond that, people mainly discuss a narrow range of MMT, focused on operations/fiscal policy. But if we accept it is part of the broad post-Keynesian tradition, it's broad-based. However, the academics doing some of that work are post-Keynesians who are critical of MMT, but that's just academic politics for you.
Certainly, the legal analysis in terms of federal operations etc, is there. However, my opinion is that local social issues are often overlooked or oversimplified. Most communities have enough wealth, regardless of how the monetary system is operated, to allow for full employment, etc.Delete