by Scott Fullwiler, New Economic Perspectives
In the comments section of my last post, Neil Wilson linked to this piece by Paul Krugman from last fall. It’s a useful lecture in that it shows mainstream economists are beginning to understand that currency issuers under flexible exchange rates (a term he actually uses) are not generally subject to bond vigilantes, a condition that applies only to nations without their own currencies, debt in other currencies, and/or fixed exchange rates.
In the paper, as he’s done before, he cites DeGrauwe 2011 as the “seminal” paper demonstrating that Eurozone nations are subject to bond vigilantes while others like the US, Japan, and the UK would not be. I’ve got nothing against DeGrauwe 2011 aside from his own failure to cite heterodox literature that preceded him by decades in some cases. Ok, so I do have something against it, but not in terms of content (though I haven’t read closely so perhaps I’d find something). And in fairness Krugman’s suggestion that DeGrauwe 2011 is “seminal” could be due to the fact that the latter provides a model (though the Kelton/Henry paper I cite below does, too; though it’s quite different, it would not be difficult to build on in the direction DeGrauwe 2011 moves) — and we all know that neoclassicals have difficulties discussing anything outside the context of a formal model (not that models aren’t extremely useful for many things, but they should not be the tail that wags the dog, and for neoclassicals they are essentially that).
The key point, however, is that Krugman attributes the following contributions to DeGrauwe 2011, all of which had been previously examined and noted by MMTers and others:
“countries that retain their own currencies are less vulnerable to sudden losses of confidence than members of a monetary union – a point effectively made by Paul De Grauwe (2011)” (p. 2)
“The seminal paper in this area is De Grauwe (2011), who pointed in particular to the comparison between Spain and Britain, which have similar levels of both debt and deficits, but pay very different interest rates. De Grauwe argued that the crucial difference was that Spain lacks a lender of last resort, leaving it vulnerable to self-fulfilling liquidity crises: investors might pull back from a euro zone nation’s debt, fearing default, and in so doing drive that nation’s borrowing costs so much higher (and depress that nation’s economy so much, reducing revenues) that they provoke the very default investors fear. This can’t happen in Britain, he suggested, because the Bank of England can always step in to buy government debt in a pinch.” (p. 5)
Regarding the final point from DeGrauwe/Krugman on the UK’s ability to have the Bank of England act as a “lender of last resort,” I actually pointed this out in 2010 when I provided a general view of how interest rates on the national debt were determined for sovereign currency issuers (see here, last page — no doubt other MMTers and heterodox economists had noted this, too):
One can then think of three different degrees or “forms” (to borrow the taxonomy used by financial economists in describing the efficient markets hypothesis) related to deficits and interest on the national debt for a currency issuer under flexible exchange rates. The “strong form” deficits would be where the Treasury has an overdraft or similar at the Fed and interest on the national debt is essentially at the Fed’s target rate or on average a bit higher if the Fed issues time deposits to drain reserve balances. While the “strong form” is operationally “pure,” it is again obviously not current law in the US. The “semi-strong form” deficits would be where the Treasury is not provided with overdrafts and must issue its own securities to have positive balances in its account before spending again while the securities issued — given their zero-default-risk that results from operational realities and the fact that any “constraint” on the Treasury is self-imposed — mostly arbitrage with the Fed’s target (for short-term Treasuries) and the expected target rate (for longer-term Treasuries) aside from some technical effects (like convexity) and some demand/supply issues (like maturity and liquidity at different maturities). Examples of the “semi-strong form” would be here and here. The “weak-form” deficits would consider that bond markets might at some point choose to repudiate even a currency-issuer’s debt with zero default risk (the “semi-strong form” does, too, but presumes the effect is temporary as arbitrage relationships would over-rule at least in the medium-term), but recognizes that the Fed always has the ability to set the market rate on Treasuries as long as it is willing to buy all quantities offered at its bid price (and has no operational or even legal constraint for doing so). Examples would be the Fed’s “Operation Twist” or the Fed prior to the Treasury Accord, or in the non-currency issuer case, consider how the recent EMU crisis quickly faded once the ECB began purchasing the debt of troubled member nations.
Particularly in the case of economics, the failure to cite heterodox literature perpetuates the marginalization of heterodox economists from the top journals, which then marginalizes them from the top university positions — and this further influences future economists studying at these top institutions and publishing in top journals and teaching yet another generation to similarly marginalize heterodox economists. One need only read Krugman’s blog posts mentioning heterodox criticisms of neoclassicals to see rather quickly the contempt with which he and the rest of the profession holds heterodox economists. In short, our research is all that we have to build our careers, and the same goes for our students — if it’s ignored or otherwise passed over by those that control the top-ranked journals and hiring in top institutions, then we have virtually no recourse.
Unlike years prior, since 2008 it’s rather clear to many (if not to neoclassicals) the importance of alternative ideas, frameworks, and methodologies — including MMT and the dozens of other approaches — that could contribute to building a new, more relevant field of economics. But the mainstream of a field that didn’t see the crisis coming has doubled down, essentially rewriting history by declaring that nobody could have seen the crisis coming, and that virtually nobody did. (Of course, it’s true that neoclassicals couldn’t have seen the crisis coming given that their models do not include a financial system — so in that sense they aren’t lying, just obviously casting their net too narrowly, by design.)
Consequently, ignoring the literature by MMTers and others that preceded DeGrauwe 2011 is just another example of deliberate marginalization. Thanks to the blogosphere, neoclassicals have heard of us. They’ve even read our stuff and written critiques of us.
In order to help folks out, I’m going to list a sampling here of material by MMTers and related individuals that explained the difference between currency issuers/users and exchange rate regimes that preceded DeGrauwe 2011. There are frankly too many of them to list here given my time constraints today, so the list is far from exhaustive and includes only those that I can think of off the top of my head right now. Also, I’m only mentioning MMTers (and some friends) here even as there are a number of Post Keynesians that also understood some of the problems with the Eurozone.
- Wynne Godley, Maastricht and All That (1992)
- Charles Goodhart, One Government, One Money (1997)
- Warren Mosler, Exchange Rate Policy and Full Employment (1998)
- L. Randall Wray, Understanding Modern Money (1998)
- Charles Goodhart, Two Concepts of Money (1998)
- Mathew Forstater, Introduction to Symposium on The European Economic and Monetary Union (1999) (note other papers in the symposium, too)
- Stephanie Kelton, The Role of the State and the Hierarchy of Money (2001)
- Stephanie Kelton and Edward Nell, The State, the Market, and the Euro, (2003)
- L. Randall Wray, Is Euroland the Next Argentina? (2003)
- Stephanie Kelton and John Henry, When Exports Are A Benefit and Imports Are A Cost—The Conditions Under Which Free Trade Is Beneficial (2003)
- Stephanie Kelton, Convergence Going In, Divergence Going Out? (2003)
- Scott Fullwiler, Sustainable Fiscal Policy and Interest Rates Under Flexible Exchange Rates (2008)
- Stephanie Kelton and L. Randall Wray, Can Euroland Survive? (2009)
- Yeva Nersisyan and L. Randall Wray, Deficit Hysteria Redux (2010)
- Dimitri Papadimitriou, Yeva Nersisyan, and L. Randall Wray, Endgame for the Euro? (2010)
- Yeva Nersisyan and L. Randall Wray, Does Excess Sovereign Debt Really Hurt Growth? (2010)
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