I should be one of the only people who has read nearly every word on Warren Mosler’s site, www.moslereconomics.com. The students in my Spring 2010 Harvard course, “The US in the World Economy,” joined me in most of this effort. We spent two courses going over the readings in the “Mandatory Reading” section of the website. It was a somewhat risky use of class time, but I think it turned out to be worthwhile.
I wanted to cover Warren’s writings mainly because his thinking is so contrary to conventional wisdom and also in its own way so logical, that if you don’t agree with him, you had better be able to articulate why. If not it might be best to conclude that it is your own economic thinking that is in error. In trying to figure out whether you agree or disagree with Warren, you can’t help but improve your economic thinking.
I will not be able to do Warren’s ideas justice in this space. I will do my best to provide a quick and dirty summary of his ideas, and provide a brief outline of my criticisms.
Warren’s focus is overwhelmingly on the economy’s aggregate production function. He views a failure to make use of this production function in the short-term (resulting in unemployment and excess capacity) to be the worst form of economic mistake. He feels that in modern Western economies this form of economic error is committed far too often in the name of price stability and/or budget orthodoxy.
Warren argues convincingly that today’s thinking about macroeconomics, especially by non-specialists such as journalists and politicians, tends to be a muddled mix of economic wisdom today’s era of fiat currencies and flexible exchange rates and from yesterday’s era (pre-1971) era of gold-backed currency regimes. Warren believes that we pretend that governments that have fiat currencies and flexible exchange rates have constraints –such as the need to balance budgets and current accounts over time — that in fact they don’t have.
Warren is running as a Democrat and has little patience for President Obama’s current policies. Warren believes that the Obama administration has pursued “impossible trickle down policies that would have made even Reagan blush.” He notes that, “There is no connection between funding the banks, and the incomes of people trying to make their payments.” Warren strongly favors fiscal stimulus over monetary stimulus (in fact he thinks monetary stimulus is almost entirely ineffective), and in the current environment he favors a policy of a payroll tax holiday. This is expensive (around $1trillion per year) but it’s highly effective as stimulus as it immediately increases paychecks (by 15% or so for those making <$100k if employers pass on their savings) and it focuses on those people most likely to spend. It also has equity benefits as it eliminates, if only temporarily, a highly regressive tax.
Warren is fond of noting that the US government, as the issuer of currency, can spend without limit. He favors government spending at times when such spending can lift the economy towards full employment. His thinking fits broadly under the New Keynesian rubric. Warren’s writings maintain the assumption that the Federal Reserve (as the only branch that can issue currency) and the Treasury (which spends) are independent in name only, and that institutional restrictions such as debt ceilings and no overdraft provisions can be safely ignored. I see no reason to disagree with Warren, though he should point out that, at least in theory, the Treasury can go broke.
I feel that Warren is a bit cavalier about the issue of central bank independence. Perhaps his practical experience has led him to believe that central bank independence is a fiction in all countries. The academic studies I have seen, though, tend to show a positive relationship between measures of central bank independence and long-term economic growth.
Warren assumes that the government can invest effectively. This is no doubt true in theory, but, in my view, the evidence doesn’t support it. In my view, there is nothing correlated with high inflation rates so well as high budget deficits. There are a number of possible reasons for this, but the most compelling to me is that government tends not to spend money effectively.
I gave a simple illustrative example in class. Suppose that an economy consists of 1 million people all employed and earning $100 per year. The gdp of the country is $100 million in a year (let’s call that year 2008). As the clock is turning to 2009, there is some sort of bizarre financial market shock that causes 40% of the population to lose their job the next day. The government is considering a policy of hiring all 400,000 workers for the year 2009 and paying them $100/year. If these people can be put to work by the government in efficient ways, this is no doubt a good idea. But suppose the government hires 400,000 people and in fact those people do nothing at all — then you will have $1million dollars chasing $600,000 is real output, for an inflation rate of 67%. This is a trivial example — but the evidence suggests that something like it plays out regularly!
Much of Warren’s work is sheer genius and I would advise all financial market participants to wade through it, particularly his writings “Tax Driven Money” and “The Natural Rate of Interest is Zero”. If you are trading bonds with Warren, I’d suppose that you will probably lose, because I can’t imagine that his understanding of the logic and mechanics of money and banking is often matched.
Warren has a level of optimism about the United States that I don’t share. He is not particularly worried about the dollar. He thinks that the world demand for dollar assets is firmly grounded. By contrast, I think the dollar could tank at any time and, if that happened, I think it would be very damaging for the typical American and I don’t think there would be any countervailing forces pushing towards dollar strength. The US economy is unviable in the realm of international trade and a big decline in the dollar (let’s say 50% over two years) would not make it substantially more viable. The only immediate consequence would be a huge increase in the dollar price of oil, and our demand for oil is mostly inelastic. Warren underplays the oil/commodities angle, in my view, but he does recognize that the true costs of perceived budget irresponsibility would be a run-up of oil and commodity prices, and he favors pursuing an aggressive energy policy.
Overall, I suspect that Warren would be in agreement with the views expressed by Richard Duncan in his (incredibly brilliant) new book, The Corruption of Capitalism. Duncan argues that, since the alternatives to running very high deficits in the US in coming years is economic collapse, US policy will assuredly be to run high deficits for quite some time, and, given that we are to run monster deficits over the next 7-10 years, we might as well use a good bit of that money to fund aggressive research and development in industries of the future. Duncan argues that the government should spend $1 trillion over ten years in each of these three areas – nanotechnology, alternative energy, and biotechnology. Duncan knows this is politically unfeasible, but he suggests that the alternatives to effective government investment aren’t pretty.
I’m beginning to have doubts on the wisdom of running large deficits for extended periods. I will have a blog about this in the next couple of weeks. Essentially, my thinking is that the economic case for running very high deficits in the US over the next seven years or so is weakly better than the economic case for running moderate deficits. There are also, however, political risks to running high deficits for extended periods, and I think these move the pendulum away from the “very high deficit” policy. I’ll have more on this in a later blog. For his part, Warren does seem to recognize the dangers of big governments — he notes that, too often, governments equate “very high deficit spending” with “big expansion of government”, when in fact aggressive tax breaks (like his plan to temporarily kill the payroll tax) work at least as well.
Fisher Black encouraged students to “imagine a world without money”. Money often clouds thinking and prevents people from seeing through to the underlying reality. At the end of the day, an economy is only as good as its underlying production functions. Warren, I think, believes that improving an economy’s long-term levels of human capital, physical capital, and technology are the really important things, and we often lose sight of these calls by introducing somewhat muddled thinking about money and government finance.
I like Warren’s tendency to occasionally throw out barbs of insight, no necessarily connected to the material at hand. As an example: “The monetary system will burn up whatever fuel can be produced until the marginal person starving to death has sufficient political power to stop it” (Warren notes earlier that biofuels link food prices to fuel prices).
Warren says that we “don’t owe China anything more than a bank statement.” He thinks default to foreign lenders unlikely and unnecessary, and argues that these debts are mostly numbers in an account until foreigners convert them into real assets or real goods and services, which requires a willing seller. Warren implies that the debt to the Chinese will be inflated away to some extent, but he underplays the cost of this inflation to the rest of the economy. I find his attitudes here, as in many other areas, a bit too cavalier. For example, he implies that the entitlement crisis is overstated because, when push comes to shove, the government can always fund Social Security or Medicare at any level it desires just by printing a check. The problem, though, is that entitlement benefits can’t be inflated away — they require a real transfer in purchasing power. Warren recognizes this fact, but underplays it to support his broader argument that there is no use pretending that we have to pay for things like entitlement programs with taxes or borrowing, when in fact we have many more degrees of freedom than that. We can choose to pay for programs with any combination of an inflation tax, a real tax, or borrowing, and the exact amount that we “pay” for the programs will in reality be determined by how much that add to or subtract from our broader societal capabilities.