More than a Symptom - Deficit is an Economic and Political Tool

Friday’s L.A. Times featured an article by UMKC Economics Professor Stephanie Kelton titled, Forget the ‘fiscal cliff’ (h/t Warren Mosler). The article poses an important question, “Why are we worried about balancing the federal budget at all?” Kelton lays out reasons why the government is dissimilar from households and how budget deficits can actually bolster economic growth and employment. Moving toward the conclusion, Kelton says (emphasis mine):

So in our current circumstance — a growing but fragile economy — policymakers are wrong to focus on the fact that there is a deficit. It's just a symptom. Instituting tax increases and spending cuts will pull the rug out from under consumers, thereby disrupting the income-sales-jobs relationship. Slashing trillions from the deficit will only depress spending for year to come, worsening unemployment and setting back economic growth.

While I agree with the majority of Kelton’s insights and conclusion, I emphasized a specific sentence above because it highlights an area where I believe MMT intentionally obscures the truth. To make my disagreement as clear as possible, I am not denying that the federal budget deficit is a symptom of economic circumstances. My critique is that this statement overlooks countless political decisions, before and during the economic crisis, that set in place counter-cyclical spending programs. This does not imply that programs such as unemployment insurance and food stamps are unwarranted. My point is merely that the direction and size of changes to the governmental budget has been and ultimately remains a political decision.

Despite this criticism, Kelton’s conclusion wonderfully counters the political and mainstream media perspective:

The effort to balance the books that's at the heart of the fiscal cliff is simply misguided. Instead of butting heads over whose taxes to raise and which programs to cut, lawmakers should be haggling over how to use the tool of a federal deficit to boost incomes, employment and growth. That's the balancing act we need.

Furthering the Post-Keynesian View of Wealth and Income Concentration

As frequent readers of this blog are well aware, my approach to understanding business cycles is most closely associated with the Post-Keynesian sub-disciplines of Monetary Realism (MR) and Modern Monetary Theory (MMT). The order of appearance is intentional since I find myself more frequently in disagreement with MMT when its proponents stray too far from their monetary operations expertise into the realm of policy recommendations. Though I support the government’s ability to offset private sector deleveraging with budget deficits, I find it troubling that more specifics on the distribution of funds and current tax laws are often omitted from the discussion.

Although these disagreements are meaningful, they do not discount the shared goal of promoting multi-sectoral analysis of business cycles. Thornton (Tip) Parker, at New Economic Perspectives, puts forth two ideas to further this goal. His first idea revolves around the issue of wealth and income concentration that I noted above:

The wealthy use much of their money just to make more money by gambling through hedge funds, leveraged buy-out funds, and other financial schemes.  They take some out of the economy by spending in other countries and hiding from taxes with off-shore accounts.  They are not using much to make productive investments to create more jobs that would provide good pay and benefits in this country.  Too much of what high earners receive leaks out of the Main Street economy to Wall Street, and often to other countries.

I do not think that MMT and MS consider the leak adequately. They explain why the government must create more new dollars to offset private sector and foreign surpluses.  But they do not explain how to prevent many of those dollars from flowing up and increasing the wealth concentration.  I suspect that more dollars flow out of the Main Street economy through the leak than as payments for net imports.  Just the need of many middle and lower income families to borrow ensures that some of their income will flow up in the form of interest and finance charges.  (Margrit Kennedy has recently estimated that thirty-five to forty percent of all purchases go to interest.)

The effect of concentration might be analyzed by dividing households into two subgroups, one for the wealthy (say top 10%) and one the rest.  Showing each subgroup’s surplus or deficit in relation to the rest of the private sector and the foreign and government sectors would show how much of a problem inequality really is.

I know of no easy way to do that, but conceptually, it would debunk the idea that income inequality is an envy, special pleading, or made-up class warfare issue.  It would also show that taxes can do more than just prevent inflation, they can be used to limit the leak of money out of the productive parts of the economy.

Though this research project faces significant challenges, the potential results could vastly improve current policy discussions both among Post-Keynesians and in the broader political arena.

Related posts:
Debt Inequality Remains Major Headwind To Growth
Bubbles and Busts: IMF - Leveraging Inequality
Bubbles and Busts: Forgotten Lessons from Japan's Lost Decades
Hayekian Limits of Knowledge in a Post-Keynesian World

Modern Money Regimes Redefine Fiscal Sustainability

Mitt Romney’s selection of Paul Ryan as the Republican Vice Presidential candidate ensures that a major focus of the upcoming election will be the federal budget. Many voters appear concerned that continued deficits and an increasing debt-to-GDP ratio will lead to some combination of higher interest rates, slower growth, (hyper) inflation and/or default. In a debate that was already destined to center around this mainstream view of fiscal sustainability, the selection of Ryan will only further cement incorrect theories within public knowledge.

Over the past couple years I have attempted to help further an opposing view of the federal budget, one based on theories of modern money.* Recently I stumbled upon a 2006 paper by Scott Fullwiler, titled Interest Rates and Fiscal Sustainability, which offers a surprisingly complete explanation of a modern money regime. Presenting the major departures from mainstream views, Fullwiler concludes:

“in a modern money regime such as the U. S., deficits do not crowd out but rather create net financial assets for the non-government sector, the operational purpose of bond sales is interest-rate support, and the Fed’s interest rate target anchors other short-term rates given that tax liabilities must be paid in reserve balances. As a result of these regime characteristics, the interest rate on the national debt is a monetary phenomenon that primarily reflects the current (and expected, if long-term, fixed-rate time deposits are issued) interest-rate “anchor” set by the Fed, not the size of the current or expected future levels of the debt or deficits as assumed in the loanable fund market paradigm. This monetary nature of interest on the national debt is indisputable when one considers that the federal government never needs to issue its debt as time deposits and could simply create (assuming a positive interest rate target) interest-bearing reserve balances that earn interest at the Fed’s target interest rate, as in the proposals discussed earlier. Self-imposed constraints, including legal restrictions on operating procedures or lack of political will, might keep a simplified procedure such as this from being implemented, but they do not change the monetary nature of rates paid on the national debt; the choice to issue short-term or long-term securities (i.e., non-government sector time deposits at the Fed) is simply a more complicated version of this more general or (in the case of a zero interest rate target) “natural” case. (p.26)”

For readers interested in fiscal and/or monetary policy, Fullwiler’s paper is a fantastic resource. Over the coming days it is my intention to offer a more detailed examination of the various principles outlined above with further excerpts from the paper and real-world applications. Even if the basic principles of a modern monetary system supplants current mainstream theories, clear cut policy choices will remain out of reach. The policy conversations, however, will improve dramatically and the likelihood of better outcomes will increase significantly.

* I mention theories of modern money rather than Modern Monetary Theory (MMT) to include support for Monetary Realism, Post-Keynesians, Circuitistes, Horizontalists and others that accept the basic principles laid out by Fullwiler.

Bill Mitchell - What is macroeconomics?

Today I am departing from usual practice. I have decided to use Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text by the end of this year. So each Friday I will publish the work I have been doing on it during the previous week in between the other work that I am pursuing. Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it. Anyway, this is what I wrote today.

Read it at billy blog
What is macroeconomics?
By Bill Mitchell

Mitchell is one of the premiere economists for Modern Monetary Theory (MMT). While I don’t agree with many of the policy prescriptions embedded in MMT or offered by its proponents, the operational explanation of modern monetary systems is highly accurate (IMO) and immensely important for understanding the root causes of our current economic trouble.

Targeting Inflation With Fiscal Policy

Scott Sumner, in Market monetarism: The only way out, says that

Today is a pivotal day, with market monetarism gaining enormous momentum.

While I don’t deny this claim (although I do deny the benefits are as claimed), Sumner makes the following troubling comment to support his view (my emphasis):

Don’t Keynesians also oppose deflation?  Yes, but when people call for a higher inflation target they are always referring to monetary policy, 100% of the time.  That’s right, even though Keynesians claim to believe fiscal stimulus can boost AD, and hence inflation, in their gut they really don’t believe it can be used to target inflation, and hence never even recommend it.  Here’s why this is market monetarist.  In 2009 there were three groups, conservatives that opposed stimulus, Keynesians that favored fiscal stimulus, and MMs who said monetary stimulus is the only solution.  Now the world is waking up to the fact that monetary stimulus is the only solution.

The problem with this statement is that it’s simply not true, unless one chooses to ignore all those individuals not falling within the groups mentioned. For the past couple years, as part of my reading list, I’ve been following numerous individuals in the MMT, MMR and Post-Keynesian camps. While I’m certainly not going to say all would disagree with Sumner’s claim, I’m fairly confident that many have and would refer to fiscal policy when calling for higher inflation.   

Just last month, Sumner asked Shall we target inflation with fiscal policy? Mike Sankowski, one of the founding members of MMR, offered the following comment

I am a fiscal proponent and I made a 4% inflation target as part of my fiscal spending rule.

http://monetaryrealism.com/the-tc-rule-for-fiscal-policy-screams-lower-taxes-and-more-spending/

So perhaps you mean well known fiscal proponents instead of “obscure but not for long” fiscal proponents. David Beckworth made a similar proposal at our site just last month.

This is just one example, but that’s all one needs to disprove a statement claiming support of100%.

I find Sumner’s blog to be thought provoking, in general, and admit to reconsidering my position on NGDP targeting many times. That being said, I wish Sumner wouldn’t resort to ignoring those people/positions he disagrees with (a tactic used by mainstream economists to discredit market monetarists for quite some time). Economics holds many competing theories and each may offer added value to the field. Mainstream economics has dominated the field for too long. If the ruling powers are to be overthrow, various sects of heterodox economists must work together to find common ground.


Related posts:
Finding Common Ground
NGDP Targeting: Keeping An Open Mind

Finding Common Ground

Steve Randy Waldman recently penned an encouraging post on the recent, heated debates in the econ blogosphere, posing the question, “Because the stakes are so small?” Waldman’s question refers to the common desire amongst various schools of economics to improve the current status quo in monetary and fiscal macro policy. The stakes in this game are a world with greater economic growth and less uncertainty about the future, goals that are certainly well worth the effort.

Waldman is the ultimate student of economics, striving to understand the strengths and weakness of different theories spanning Post-Keynesian, Market Monetarism, New Keynesian, MMT, Austrian and surely others. From his perspective, proponents of the different theories have much to gain from finding areas of common ground rather than arguing over their differences. The article offers a jumping off point for this discussion and is well worth a full reading.

The desire to highlight this blog post, in particular, is because my own intellectual pursuit in economics continues to include all of the various sects listed above. I’m often struck by the amount of overlap in thought process and general policy prescriptions, even if the details are, at times, worlds apart. Stemming from my personal experience, Post-Keynesians and Austrians often agree on the importance of private bank credit in determining business cycles. Market Monetarists and MMTers recognize the interplay and sometimes counteracting effects of monetary and fiscal policy. Nearly all the groups seem to prefer making both types of macro policy less ad hoc and more quickly responsive to business cycles. This is just the tip of the iceberg and I hope to read about and find far more similarities as I continue my studies.

Speaking of studies, I’m currently faced with the dilemma of choosing between two doctoral programs in economics that promote different types of heterodox economics. One program is more closely aligned with the Post-Keynesians, while the other is associated with the Austrian tradition. Waldman’s post offers hope that whichever program I chose, the opportunity will remain open to incorporate the best ideas among alternative theories. I certainly plan to seek alliances in my career and sincerely hope that many leaders in the field will follow Waldman’s lead in finding some common ground that helps improve outcomes for us all.  

Points of Public Interest

1. The Complexity of Hayek - Greg Fisher comments on similarities and differences between Hayek’s work and complex systems. Complexity theory is a fascinating subject I hope to study in the future.
2. Social Security, the Financial Crisis & Modern Monetary Theory - John Carney continues to display how MMT, in focusing on the monetary system, forgets the many ways in which government can harm real economic growth and wealth.
3. US Credit and Economic Views: It’s the Housing Market Stupid - Constance Hunter wisely notes the deflationary pressure of over $1 trillion in underwater mortgage debt. This remains a key aspect of my view that inflation will remain muted for several years.
4. Tuning In to Dropping Out - Alex Tabarrok draws attention to the lack of college graduates in STEM fields and the disappointing level of dropouts both in high school and college. Focusing subsidies on STEM majors and offering “vocational” programs are a couple potential solutions for improving education within the US.
5. GAO: Almost Half of Bailed Banks Repaid the Government With Money “From Other Federal Programs” - Matt Stoller examines the truth behind Treasury’s claims that “TARP made money.”
6. For Profit Education, Pigs at the Trough - Russ Winter looks at how For Profit Education programs are abusing the government system to earn massive profits, while loading students with debt and only graduating around 33%.
7. Josh’s Twenty Common Sense Investing Rules - Joshua Brown provides a great outline for individual investors, not traders.

Returning Economics to Reality

As I mentioned recently in the Quote of the Week, Hyman Minsky’s work on financial instability continues to play a major role in my own thinking and in several strands of heterodox economics. A dissertation advisee of Minsky’s, Randall Wray, partially founded Modern Monetary Theory (MMT) which falls within a similar realm of economic thinking. When I began exploring economic blogs nearly two years ago, MMT offered an escape from mainstream (neo-classical synthesis) thinking and provided a better fit with my perception of reality. Diving deeper into the theory, I continued to learn a great deal from the descriptive aspects but felt there lay an inconsistency with the prescriptive, political policy recommendations. Luckily Cullen Roche of Pragmatic Capitalism (who has played an invaluable role in my learning) has helped create a solution.

Just over one week ago, Modern Monetary Realism: Economics Without Politics... was launched. Attempting to remove the prescriptive aspects from MMT and basic economic thinking, “Modern Monetary Realism (MMR) is a description of the monetary system within a nation operating a fiat currency which involves an autonomous monetary system, monopoly supply of currency and floating exchange rates.” Only days after posting a primer, Understanding Modern Monetary Realism, a fascinating discussion broke out in the comments section involving Cullen and JKH, among others. Although I recommend reading through the entirety of the page, the general conclusion is that MMT relies upon a federal Job Guarantee program and corresponding nationalization of the financial sector. As with any grouping of individuals, there will certainly be some MMTers whom only align with certain aspects (myself included). Regardless, these policy positions are clearly at the heart of my concern in accepting the prescriptive measures of MMT. (I hope to elaborate on both the positive and negative aspects of MMT in a future post.)

The Great Recession has exposed many ways in which mainstream economic theories are devoid of any realistic application to our current social (human) environment. Modern Monetary Realism, in its limited time, has already made a significant impact in bringing economics back to reality. My hunch is that MMR will ultimately play an important role in defining the future direction of economics. Understanding the operational aspects of our monetary system is a critical first step in grounding policy discussions. Hopefully more widespread recognition of these descriptive factors will lead to better, more informed policy decisions in the future.    

Quote of the Week

...is from p.162-163 of Hyman Minsky’s superb book, John Maynard Keynes:

“The economy is now a controlled rather than a laissez-faire economy; however, the thrust of the controls is not in the direction envisaged by Keynes. Investment has not been socialized. Instead, measures designed to induce private investment, quite independently of the social utility of investment, have permeated the tax and subsidy system.”

“The success of a high-private-investment strategy depends upon the continued growth of relative needs to validate private investment. It also requires that policy be directed to maintain and increase the quasi-rents earned by capital—i.e., rentier and entrepreneurial income. But such high and increasing quasi-rents are particularly conducive to speculation, especially as these profits are presumably guaranteed by policy. The result is experimentation with liability structures that not only hypothecate increasing proportions of cash receipts but that also depend upon continuous refinancing of asset positions. A high-investment, high-profit strategy for full employment—even with the underpinning of an active fiscal policy and an aware Federal Reserve System—leads to an increasingly unstable financial system, and an increasingly unstable economic performance.”

Minsky has been on my mind frequently over the past few months as much of today’s economic work in Post-Keynesianism and Modern Monetary Theory stem from his unique insights about instability in a capitalist society. In Facebook's $500 Million Tax Refund and The BIG Political Lie, I was trying to shed light on the manner by which politicians control the tax system to redistribute income upwards. Minsky brilliantly expands on this concept above, noting how policy that guarantees profits (quasi-rents) from speculation leads to instability. The rise in non-traditional mortgages, extremely low levels of down payments and government support in the recent housing crisis represents a prime example of the consequences highlighted above. As long as policy continues in this manner, economic performance is likely to be volatile and current income inequality will persist or expand even further.

Points of Public Interest

1. Why Jews Don’t Farm - Steve Landsburg approaches this question from the perspective of literacy and education as hallmarks of Jewish religion. (h/t Don Boudreaux, Cafe Hayek)
2. Repulsive progressive hypocrisy - Glenn Greenwald expresses fear over Democratic support for policies, including Guantanamo and drone usage, under the Obama Administration that were highly criticized when similarly carried out by the Bush Administration. I share Greenwald’s concern that political support may become tied to individuals rather than actual policy actions. (h/t Anthony Gregory, The Beacon: “Repulsive Progressive Hypocrisy” and Why Peaceniks Should Oppose Democrats)
3. What Europe might look like without the Eurozone and EU - Bruno Frey dispels with the view that a collapse of the Euro will lead to chaos and war. On the contrary, he argues that countries will likely establish more flexible, smaller agreements that maintain free trade and may even improve European economic prospects.
4. The Top Twelve Reasons Why You Should Hate the Mortgage Settlement by Yves Smith
5. S = I + (S – I) : The Most Important Equation in Economics The “mysterious” JKH explains a key component of sectoral balances in an incredibly clear and concise fashion.
6. How Economists Contributed to the Financial Crisis John T. Harvey discussed how making math the ends rather than means of economics has led much of the discipline off course from the real world. Post-Keynesianism, especially Steve Keen, and MMT receive acknowledgement for raising awareness of the crisis in advance and, in my opinion, continue to offer some of the best insights. (h/t Tom Hickey, Mike Norman Economics)

Points of Public Interest

1. Why Limiting Itemized Deductions (Still) Makes Sense - My former professor, Diane Lim Rogers, offers her support for a proposal to limit itemized deductions to a 15 percent rate. This policy will simultaneously increase the progressive nature of income taxes, substantially reduce total tax expenditures and raise revenue.
2. The Fed Is Misleading Congress About Europe - Warren Mosler, a founding member of Modern Monetary Theory, argues that the Fed’s dollar swap lines are unsecured lending and should therefore be the responsibility of Congress.
3. Philip Pilkington: Is QE/ZIRP Killing Demand? - Pilkington describes the counterproductive efforts of Fed policy. Milton Friedman also believed ZIRP (zero interest rate policy) would restrict demand as I outlined in Deflationary Monetary Policy.
4. The Liberalism of Classical Liberalism - Peter Boettke tries to correct some typical misrepresentations of classical liberalism with a good dose of historical background.
5. Show Me the Daylight 'twixt Sanction and Tariff - Samuel Wilson considers recent trade sanctions against Iran and China, and why the two are viewed in different lights by Americans.
6. The Future of Economics - Steve Keen, a leading post-Keynesian, makes a case for incorporating disequilibrium, dynamic modeling and emergent properties into the core of future economics.
7. The European Crisis Deepen - Peter Boone and Simon Johnson, former IMF Chief, explain why current optimism is likely unwarranted and how the realistic end may include a break-up of the Eurozone.

Points of Public Interest

1. Money, credit and inflation - Sean Corrigan explains the difference between money and credit, highlighting the different nature of banks and individuals in creating credit. An often forgotten aspect of our current monetary system is that individual banks can create credit (which can turn into money) irrespective of Fed or Treasury policy. This unique ability generates the potential for inflationary and deflationary forces in the money supply outside of the federal government’s control.
2. Death by Wealth Tax - Richard Epstein argues against the proposal for a wealth tax on assets.
3. Trials and Errors: Why Science Is Failing Us - Jonah Lehrer details some failings in medicine stemming from the incorrect, basic “assumption—that understanding a system’s constituent parts means we also understand the causes within the system.” As Lehrer notes, centuries ago David Hume recognized a human desire to view the appearance of causation as an actual fact, rather than “fiction that helps us make sense of facts.” (HT: Russ Roberts)
4. Debt, Deficits, and Modern Monetary Theory - Bill Mitchell, a founding member of Modern Monetary Theory (MMT), outlines the difference between MMT and mainstream economics. These differing conceptions about public debts and very important to the public policy battles in the news today. (HT: Neil Wilson)
5. Peter Boettke on Austrian Economics - “Austrians want to talk about things like dispersed knowledge, heterogeneity, uncertainty – not just risk, but real uncertainty – and institutions, how institutions arise to allow us to cope with our ignorance and our uncertainty and to ameliorate the frictions that exist in the world.” Peter Boettke discusses contributions of Austrian economics and five books to read on the subject.

Quote of the Week

...from A JOB GUARANTEE IS NOT A “PRICE ANCHOR”, IT’S A “PRICE BUOY” by Cullen Roche, of Pragmatic Capitalism:

“Modern day economists seek the holy grail of macroeconomics which has come to be price stability and full employment.  These two features of modern macro are held up on pedestals as if giving a person a job and a steady wage is all one needs to live a happy and prosperous life.  I say these goals entirely miss the point and steal the potential lives that future generations can live.  What we should seek is the way in which we maximize our living standards.  In doing so we reach the true holy grail of macroeconomics – the thing that every human seeks – the fountain of youth, hence, more TIME.  After all, it is only through increased productivity, innovation, creativity and ultimately higher living standards that we are able to attain this (see here for more).”


Over the past few weeks, a heated debate has been raging among individuals either subscribing to or interested in MMT (Modern Monetary Theory) economics. The discussion is related to the notion of a federal Job Guarantee (JG) to promote full employment, and in theory, price stability. As Cullen points out, while these are noble goals, full employment and price stability alone do not guarantee any sort of prosperity. Democratic and Socialist governments at different points in history have attempted and, for short-periods, even achieved full employment with generally disappointing results in economic growth and public support.

Peter Cooper at heteconomist.com expands on Cullen’s view in Opposing Visions of the Future. Apart from the JG, Peter considers a Basic Income Guarantee as a means “to undermine capitalism, particularly the wage labor relation.”

Points of Public Interest

1. What’s MMT About Anyway and is the Job Guarantee Crucial to the Project? - Pavlina Tcherneva discusses the subjective policy recommendations that necessarily give Modern Monetary Theory value and offers her view on the recent debate among MMTers about the importance of a Job Guarantee.
2. How Egalitarianism Increases Inequality - Bryan Caplan makes an argument for praising the 1%.
3. The Right Kind of Hope - John Hussman highlights the poor prospects for long-run returns across asset classes and provides an update on the continually worsening European crisis.
4. Does the free market corrode moral character? - Michael Walzer compares the effects of competition on moral character within politics and markets.
5. Bastiat's Insight on Government Inaction - David Henderson explains why disapproving of government subsidies for an action is not the same as disapproving of the action itself.
6. A Challenge for Libertarians Against Federal Recognition of Same-Sex Marriage - Steve Horwitz offers his view on why supporting same-sex marriage “is fundamental to classic liberalism.”

Update (1): Responses to Two Objections to My Challenge - Steve Horwitz responds to a couple comments on the above post.

Update (2): The Job Guarantee, Kleptocracy and Blogging - Edward Harrison posts a follow-up to Pavlina Tcherneva’s comments on the Job Guarantee.

Social Security is a Ponzi Scheme?

Monday night’s Tea Party debate featured discussion about Social Security as a Ponzi scheme. Over the past several days this conversation has garnered an increasing amount of blog space. Given the extensive attention currently being paid to this topic and potential that it continues through next year's election, I decided to offer my own thoughts.

Before outlining my view, I think it’s important to clarify the criteria being considered to determine a Ponzi scheme. The following is directly from the SEC’s website:

“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.”

While I believe this definition should be used as the basis for discussion, recent commentary suggests various other definitions are being considered. If that is the case, I’d urge politicians and others offering opinions to clarify their definition. Without knowing the basis for comparison, it is difficult to judge the merit of their views. However, since alternative definitions have not been provided, the one noted above will serve as the standard for my argument.


Although I disagree with the opinion that Social Security is a Ponzi scheme, acknowledging why some may make that argument will aid in debunking the theory. The basic design of Social Security provides benefit payments to older, retired individuals that are largely funded from payroll tax revenues paid by younger, income earning individuals. When the baby-boom generation entered the work force, yearly payroll tax revenues greatly exceeded Social Security benefit expenses and a trust fund was created to “hold” the surplus funds while accruing interest. Now, as the baby-boom generation retires and starts collecting benefits, payments have begun exceeding revenues. Based on demographics, these yearly deficits will continue to widen, ultimately exhausting the trust fund. Since payroll taxes will no longer cover all benefit payments, the expectation is that Social Security cannot fulfill its current promises. Whether or not one deems this outcome to be fraud, I believe this scenario leads many to believe Social Security is a Ponzi scheme.


Having established a basic premise for calling Social Security a Ponzi scheme, the deficiencies of that argument can be set forth. In the above scenario, an assumption is made that when the trust fund is exhausted, Social Security will be unable to pay promised benefits in full. A critical error within this assumption is the apparent view that Social Security is a stand alone program, not incorporated within the federal government’s budget. To some this may seem an inconsequential difference, however this small fact is crucial to determining the eventual solvency of the program.


The US government is a currency issuer, which means that under the current monetary system, the government can never run out of dollars. Ponzi schemes ultimately fail when a sufficient amount of new funds can not be obtained to repay all investment "returns" and withdrawals. With Social Security, when payroll taxes are no longer sufficient to provide the entirety of earned benefits, the government is required to supply the difference. Since the government never has to borrow funds in order to spend, regardless of tax revenue, Social Security benefits can always be paid in full.


As long as the US government remains a currency issuer, claims that Social Security is a Ponzi scheme are as foolish as comparing the solvency of the US government to either Greece or households. Apart from self-imposed constraints, the US federal government can always repay debt denominated in dollars, including future Social Security benefits. The one crux of this argument is that excessive money printing (deficit spending) can create inflation during periods of near full-employment. Stemming from this issue, the true question regarding Social Security and all government expenditures is whether tax levels are appropriate for the chosen size of government.


Social Security benefits can be provided indefinitely and therefore suggestions that the system is a Ponzi scheme are misunderstandings, at best, or at worst, intentional misrepresentations. Too much recent time and effort has been directed at worrying about deficits, both current and future. Our nation would be better served to focus on current problems of excessive private debt and longer-term concerns about the desired size of government. Hopefully our leaders will direct their attention and the nation’s to these problems in the days ahead.

Inflation is NOT the Answer

A couple weeks ago I argued against the numerous economists calling for the Fed to establish higher inflation targets as a remedy for excessive debt. My concerns were centered around the notion that inflation does not create wealth, but rather transfers it from creditors to debtors. Since that post, several FOMC members, including Chairman Bernanke, have spoken about the current state of the economy and potential stimulative actions the Fed could take at its next meeting. Much of the commentary has been typical Fed speak, which involves saying very little in a manner that is difficult to decipher. However, parsing through words and actions has led a majority to expect some form of new quantitative easing to be announced on September 21st.

Recently, on Project Syndicate, Raghuram Rajan (finance professor at the Univ. of Chicago) penned an article titled, Is Inflation the Answer?. Rajan is effectively arguing against the same calls for much higher, short-term, inflation. Although the piece makes a brief note about the distribution effects of such a policy, the focus is on the effectiveness of creating higher inflation.

One critical factor that could hinder effectiveness is the Fed’s credibility. Having maintained a specific target for a long time, the unintended consequences of suddenly changing policy are unknown. If the target can be changed once, why not again, and again? A moving inflation target would also be difficult to explain within the realm of price stability. Were the Fed to raise the target temporarily, given its prior track record, why should the market expect inflation to remain under control? Within this realm of possibility, its fairly easy to foresee an outcome where inflation rises well beyond new targets and ultimately needs to be reigned in Volcker-style. For anyone who lived through that experience, recollections of the early 1980’s recession and double-digit unemployment are probably not pleasant.  

The other significant deterrent Rajan notes relates to the maturity length of current debt. A policy of high inflation is primarily beneficial if nominal income growth outpaces interest on debt. However, if debt needs to be rolled over in the near future (due to maturity), the new debt will require much higher interest rate payments. In that scenario, higher inflation’s impact on reducing debt burdens is minimal. As Rajan notes, this largely reduces the positive influence on government debt, bank liabilities and households with floating rate mortgages.

While I agree with nearly all of Rajan’s points in this article, one point I must argue against is the notion that “[foreign] investors might be needed to finance future deficits.” As I’ve shown numerous times before through MMT, the US government never needs to finance deficits. Aside from that opposition, I think Rajan makes a wonderful case against higher inflation. In conclusion, he adds suggestions for outright debt relief through write-downs. I remain convinced that this method of reducing debt burdens should be the primary focus of current federal policy.

Inflationary Outlook Resembles Depression Era

Yesterday I remarked that current economic troubles are reminiscent of the depression era that Keynes and Hayek lived through. At that time, Keynes believed that deflation would continue indefinitely and sought actions that might prevent a deflationary spiral. Despite Keynes' brilliance, there were many factors influencing the post-World War II global economy that he failed to foresee. An influx of cheap natural resources from abroad, expanding global trade, the baby boom generation and government deficits all helped reverse the deflationary trend and create nearly constant inflation in the US ever since.

Although the US appears on the verge of recession, Americans are more concerned with hyperinflation than outright deflation. Randall Wray, an economics professor at the University of Missouri-Kansas City (and fellow Wash U alum), explains why The prospects for inflation have not been smaller since 1930. Wray is one of the top economists today promoting Modern Monetary Theory (MMT), hence his views on inflation versus deflation deserve significant attention. As Wray points out (and I have detailed previously), a primary reason Americans fear inflation relates to a misunderstanding of recent monetary policy conducted by the Federal Reserve. One cannot accurately assess the impact of quantitative easing without understanding how bank reserves function in a modern monetary system. The linked piece offers a wonderful, yet simple explanation for the casual reader.

Ultimately, inflation or deflation is about the quantity of money chasing a certain number of goods. As Wray notes, significant unemployment, declining real income and large household debt imply the direct opposite of hyper, or even high, inflation. If Wray's outlook proves true, investors currently rushing into gold and other commodities will find themselves on the wrong end of the trade. For most individuals, this prognosis should not be taken as negatively as typical news commentary would have one believe. Over the past decade, Japan's real GDP growth averaged .8% per year, despite averaging .3% deflation. During the same period, U.S. real GDP growth averaged only 1.6%, with average inflation of 1.9%. Many other factors certainly impacted economic growth, however a majority likely favor the US, rendering the minor disparity even less noteworthy.

I urge those readers concerned about inflation or considering investing in gold to read through Wray's entire piece for a different perspective. Given the struggles presently facing the global economy, hyperinflation should be the least of our concerns. Once we stop fighting the problems we don't have, policy making can return to focusing on the problems we do.



Interesting note: During the decade discussed above spanning 2001 to 2010, the Fed almost perfectly achieved its long-run inflation target of 2% (based on core PCE inflation). Even though the Fed was successful, real GDP growth over that span was the weakest experienced since the depression. The period mentioned also witnessed violent swings in prices. One personal suggestion for the future, is that our society rethinks the goals of the Federal Reserve and monetary policy.