Monday, March 14, 2011

Comment on MMT approach to sectoral balances

Yves links to an MMT-oriented site ( this morning that delves into the issue of “sectoral balances,” which are related to the national income and product account identities.  I find that any argument based on an identity is weak to begin with, but the conclusions forced upon this identity by the blogger are not necessary.  Here’s the basic idea:

Sectoral Balances 101

I have written before on this blog about the idea of sectoral balances (as has my fellow blogger Delusional Economics). As you may recall, this is a basic accounting identity which states that in any economy over a fixed period of time, the following must hold true:

Private Sector Balance + Government Sector Balance – Current Account Balance = 0

  • The private sector balance is the excess of savings over expenditure for businesses and households.
  • The government sector balance is government tax revenues less spending.
  • And the current account balance is (in simplified terms) a country’s exports less its imports.

I buy this.  Fact is the U.S. has been running both private and public sector deficits for a long time.  By one estimate I heard at a conference recently, all but one year of positive real GDP growth in the prior decade would not have occurred without home mortgage equity extraction.  And we all know the government has busted its budget royally, accelerating under Bush II and Obama especially.

One thing about identities is that they don’t really capture real economic forces.  Say we wanted to balance the government’s budget.  Rewriting, we have

                 (-)          +                    (-)                =               (-)
Private Sector Balance + Government Sector Balance = Current Account Balance

So if we left the private sector balance alone, all we have to do is reduce the current account balance!  Then we’d only be borrowing to support our private over-consumption!

See how misleading this is?  The problem with balancing the budget in the near term is that it puts the nail in the coffin of effective demand.  Government workers are fired across the land.  Retail sales collapse.  Unemployment shoots up.  Confidence collapses, multiplier and multiplier-accelerator effects proliferate, private investment evaporates, and we are in a more serious depression than we’re in now.

The MMT solution, of course, is to continue printing our “monopoly money” (really!) until inflation becomes a problem, which they say is far away.  This is a Ponzi scheme, as the dollar is the reserve currency.  We are exporting our fiscal failures.  Carry trade excesses are inevitable, as is major blowback from the rest of the world when they get tired of holding our fiscal feces.  War-induced inflation is more probable in the near term.

The one inescapable implication of the identity above is that when as a nation you’re spending more than you make, you must borrow from the rest of the world.  To remedy that requires an across-the-board belt tightening.

Given that, the only long-run solution is to rebalance domestic demand to avoid the country splitting apart (see on “the gathering storm”).  In the intermediate term this will require mitigating extreme income inequality with more progressive taxation; a poverty level dole for families displaced by the depression offered as workfare; a decent education for the kids; and an extension of Medicaid in lieu of the ridiculous “solution” forced on the Democrats by the health insurance industry.  Otherwise we will destroy our most valuable asset, our human capital. 

What we have now is socialism for the rich.  Let’s call a spade a spade.  The banking bailouts were the largest transfer of wealth from working taxpayers to the rich in the history of the world, as Barry Ritholtz ( never tires of pointing out.  “Winner take all” compensation schemes are everywhere.  The rich have manipulated virtually every aspect of taxation and corporate governance to their benefit.  No nation is better than its treatment of its poor.  (A deeper question:  Does the nation-state still have any power, when multinational corporations run the world?)  America ignores the lessons of history at its gravest peril.

What we need is a little more “socialism” for the rest of America.  Or, as Adam Smith and I would prefer, a return to a capitalism within a framework of upgraded “moral sentiments” on the part of all Americans.

Cain asked the question, “Am I my brother’s keeper?” 

Do you know the answer?


  1. "The one inescapable implication of the identity above is that when as a nation you’re spending more than you make, you must borrow from the rest of the world."

    When a nation sells another nations stuff, it can either take stuff in return or buy up real assets, or else postpone these options by saving in the currency of the importing country, or selling the currency and giving someone else these options in that currency zone. What difference does it make whether the trade is done in the short term or longer term, or even if the currency is sold, and someone else takes the turn?

    If the exporting nation decides to save instead of completing the exchange immediately, it can save by either holding reserves or securities. Generally, nations hold securities because of the higher interest.

    This simply involves moving the reserves gained from the sale of stuff into securities, which is just switching asset composition and term structure iaw portfolio preference. When the exporting country decides to use the savings, the securities get switched back to reserves. This is similar to moving funds from a deposit account to a time account or CD and back. No borrowing or lending involved.

    Where is the "borrowing?" A monetarily sovereign government that is the monopoly provider of nonconvertible floating rate currency funds itself with issuance, not revenue or financing.

    Assuming that S=I (domestic balance) and a CAD (external deficit), the country experiences demand leakage due to the CAD. This will reduce demand in the amount of the leakage, resulting in an output gap and ensuing unemployment. The country can fill that leak by running a deficit equal to the CAD in order to maintain output at full employment. At full employment, imports are a benefit in real terms of trade, since there is no job leakage.

    Could the currency depreciate if the CAD is large and persistent. Yes. But then the country's export position improves and the trade gap closes under a floating rate system.

    Too much saving at the top? Tax economic rent and return the funds to circulation through public investment.

  2. "The MMT solution, of course, is to continue printing our “monopoly money” (really!) until inflation becomes a problem, which they say is far away."

    Actually, this is not the MMT solution. Within the framework you (correctly) laid out above, it becomes obvious that as the public sector increases it's deficit, this increases surpluses to the private sector. The increased private sector surpluses are necessary to allow for private sector deleveraging and spending. Part of the issue with how the current deficit is being allocated is it is getting trapped on corporate balance sheets. A higher deficit targeted at over levered consumers, such as a payroll tax holiday, would do the trick. A payroll tax holiday, which would be considered the preferred MMT solution, if you insist on assigning a solution to MMT, is very, very different than "printing our “monopoly money” (really!) until inflation becomes a problem".

    I think the piece you are missing, is the belief that the US "must borrow from the rest of the world". This is false, under an MMT framework. MMT recognizes a sovereign government that issues it's own currency (such as the US) is not required to borrow first to spend. In fact, it is impossible for the US to borrow first, then spend. Once it is recognized that spending is not funded with 'borrowing', then it becomes clear the entire concept of borrowing from the world is not correct. In fact, the US (and Japan, UK, Australia, etc) issue government securities as a reserve drain, not to fund spending. Issuance of government securities is nothing more than a monetary operation, not a fiscal operation.

    "The banking bailouts were the largest transfer of wealth"

    Could not agree more. Glad to see others recognizing this.

  3. "The one inescapable implication of the identity above is that when as a nation you’re spending more than you make, you must borrow from the rest of the world. To remedy that requires an across-the-board belt tightening."

    No it doesn't require "belt tightening" and you are not really borrowing from the rest of the world. The rest of the world is selling you stuff, meaning giving their goods and services to you for the numbers that you can just make up as many as you please. You are now benefiting from the imports in real terms. That doesn't mean that you can't work yourself and you have to make up less of those numbers.

  4. Why would a nation with the unlimited ability to create dollars must borrow to pay its bills? And why would it borrow the dollars it previously created?

    Though the writer of this post is ignorant of Monetary Sovereignty, the readers might like to learn about it, in which case you can see a one-page summary at

    Then, if you'd like to learn more, go to:

    Rodger Malcolm Mitchell

  5. For an overview of why MMT is Ponzi economics, IMHO, refer to my comments above and the previous remarks including comments at


  6. There are semantic points here that are often elided, often without a problem in discussions of domestic economies, but which may make the MMT position sound unreasonable in international trade. Have had a similar discussion with Tom elsewhere about the right way to say these things. The point is to understand the mainstream terminology in correct accounting, in MMT terms. There is nothing to MMT but accounting. If you believe in accounting and arithmetic, you believe in MMT = Abba Lerner’s Functional Finance. Abba Lerner’s 1951 Economics of Employment has very clear explanations that may be more palatable to people more used to mainstream parlance.

    The MMT/Functional Finance position is indeed that there is real borrowing from abroad going on when a nation imports. And yes, to remedy that - to repay the "loan" - requires "belt tightening." But the kind of belt-tightening that occurs when you are training for the Olympics. Which is usually considered good belt-tightening. Not the kind of belt-tightening that is usually meant, which is belt-tightening by self-imposed starvation, anorexia.

    The real borrowing by the government occurs when currency is issued in return for something. Something real is exchanged for a government IOU. The real borrowing by the nation occurs when it imports. It gets real stuff, and China or Japan say, get dollars = IOUs= US government debt. Exchanging these dollars for bonds is a sideshow – it is just money-changing, like exchanging a twenty for two tens, not real borrowing. These dollar IOUs are redeemable, are convertible, by the US economy. They can buy our stuff, we can export to them. So the USA does owe China & Japan – it owes them the stuff they will buy with their hoarded dollars in the future.

    But in the idiotic, preKeynesian way that states run their economies nowadays, the "belt-tightening" "loan repayment" by Japan redeeming the US IOUs for US exports would in fact pull the US out of a depression, and would cause prosperity in the US. It would only be a real world loss if the US were at full employment already - and then we would all be much richer and have no trouble paying off our dollar – IOUs.
    Calgacus/Some Guy

  7. Yes! If the Japanese or Chinese started selling Treasuries and spending all those dollars in the US economy, we'd be better off. But it's not a fair exchange if we dilute the value of the dollar and it falls on world markets. They *might* have wanted to spend it, the putative reserve currency, on oil, for example, or German machinery. You say, "But the dollar devaluation is good for the US! Our imports increase!" Yes, maybe, but we have stiffed our creditors, who have to buy American goods now at inflated prices relative to what they got when they sold us their goods. It's a Ponzi scheme. In the end, if don't use war to destabilize every other part of the world and its currency,the dollar will be worth a tiny fraction of what it was when these trading partners transacted with us, and no one will want to use the dollar as a reserve currency. Or take dollars from us in trade except at deep and continuing discount.

    I like the "tax rents" part of MMT, and some other parts, but whenever you give someone the power to print money, the moral hazard will destroy the currency, fractional reserve fiat money or government fiat money.

    And any theory based on accounting with recognizing instability in the unit of account is clearly inadequate.

    Thanks for commenting.


  8. I should say, "without recognizing instability in the unit of account." it's late.

  9. BB - The great Abba anticipated and answers your objections in his wonderful book which I strongly recommend to anyone.

    The Japanese & Chinese hoard their dollars willingly. The US using functional finance to prevent depressionary side effects does put pressure on US currency to depreciate. But Lerner explains that the depreciation will not hurt the Japanese & Chinese economy more than the negative "blowback" effects to them of their "exporting unemployment" and depression to the US. The right way of looking at it is that depressions & demand shocks are contagious, so every nation has an international obligation to use functional finance to stay out of depressions.

    Every theory is inadequate. But accounting and arithmetic are very good theories. You can't get the "real" stuff right without getting the nominal stories right, which only MMT does. The instability in units of account in international trade is hard to understand. But the strength of a currency is ultimately backed by the strength of the economy, and as long as we print just enough money to get to full employment and a strong economy, but not inflate, we aren't stiffing anyone. If we are the only ones using functional finance, then our prosperity could be so robust that our currency strengthens, instead of depreciating!

  10. I find particularly distasteful the idea that high-saving countries are somehow to blame for our problems. Talk about "passing the buck"--twice. Get real.

    The Austrians have a word for what MMT is proposing and what Bernanke is practicing: "crack-up boom."

    That's where we're going, I'd wager. Gentleman's bet for lunch in five years?

  11. Countries that save another country's currency to the point of causing macroeconomic effects are responsible for these effects. Of course that is a small part of the US's current problems.

    Geoffrey Ingham succinctly expresses the same paradox of thrift idea that Lerner described for international trade: "Saved money, as a store of value, eventually loses value through its deflationary effect on wealth creation". China, Japan or anyone else's saving causes the dollar depreciation. It is in no way cheating them to print more money to offset this. The problem for the last 100 years or so is that governments have refused to print enough money, not printed too much. The postwar golden age was the exception, and then taxes were high enough to not necessitate big deficits.

    If the Japanese or Chinese started selling Treasuries and spending all those dollars in the US economy, we'd be better off. We would be worse off if we had full employment already. If we did not, as now, we would be better off.

    The amounts of money that should be printed to fix the US economy's problems or offset trade deficits is piddling in comparison to the amount of bank credit money circulating. There is no reason to believe it would substantially dilute or depreciate the value of the dollar.

    I am all for taxing the rich, the majority of which are criminals one way or another.

  12. Deficits are not only bilateral. China is not responsible for American deficits, public or private, or the problems they create.