Monthly Archives: June 2013

Firestone Backfiring More

So I happened to get a reply from Joe Firestone on my reply to his blog post.

I don’t have too much patience for going back and forth but a few points stand out.

I created a situation in which the current account balance of payments is at 4% of GDP, private sector balance is at 2% of GDP and the government budget balance at 2% surplus.

Joe Firestone thinks it is necessarily a contraction. Here is quoting him:

Ram, in the situation you’ve described, the Government is running a surplus of 2%, so it’s destroying net financial assets that would otherwise be flowing to the private sector if it had a smaller surplus, a balanced budget or a deficit. The budget surplus isn’t high enough, given the size of the trade surplus, for the Government to be causing a negative accumulation of NFAs in the private sector; but that doesn’t mean that the Government’s fiscal policy can be called “expansionary.” In fact, it’s contractionary relative to even a balanced budget, much less a deficit.

[boldening: mine]

First Firestone confuses “private sector”. According to him the private sector has a negative net accumulation of financial assets! (when given it has +2%!).

Second he fails to understand that the budget deficit is an endogenous variable – he has been conditioned to think that a surplus budget is necessarily contractionary. He cannot see that in the given situation fiscal policy can be expansionary. Firestone seems to compare it with a situation in which the budget would have been in deficit or surplus. Actually he should be comparing it with the previous periods. Moreover, even if compared to a situation where the budget could have been in balance or in deficit (future scenario) it doesn’t mean 2% surplus is more contractionary. All that matters is how the private sector responds to the expansion. A fast expansion can improve private sector expectations about the future and they may respond by higher production than the case if the government indicated a weaker expansion. [update: a fast rise in production due to a faster expansion – meaning a combination of higher expenditure and/or tax rate cuts may bring the budget into surplus because of higher total taxes resulting from higher national income, as compared to a less expansionary policy]. Plus there are other things such as deregulation, monetary policy etc. You cannot conclude 2% surplus is more contractionary than a balanced budget.

But more generally to the basic point, he concedes that net HPM creation is not NAFA even though this was an important point in his post.

So he says;


Net HPM creation is not equal to private sector NAFA.

Again, I didn’t say or imply that it is. if you think I have, then please quote me.

Here is from his original post:

High-powered money includes cash money and reserves emanating from the Government, including the Federal Reserve. If there’s no deficit spending the Government is destroying as much money through taxation as it is spending/creating. And so, it is not doing any net high powered money creation.

He uses the example of a balanced budget to show that balanced budget does not do “net high power money creation” – as if a deficit does net high powered money creation.

Fact is even if the government is in deficit, the HPM created due to expenditure minus taxes is offset by bond issuance. So even a deficit doesn’t directly do any net high power money creation.

Now, imagine a closed economy situation with 10% reserve requirement instead of 0%. Also assume the private expenditure is rising relative to private income and the private sector is in near zero balance. This leads to higher domestic demand and higher bank borrowing. Banks will need more reserves due to higher borrowing to satisfy higher reserve requirements. In such a situation the central bank would provide HPM to banks but the government budget is balanced as a mirror image of the private sector balance.

So we have a situation in with a balanced budget and net HPM creation!!!

But some souls are forever confused!

Once again, fiscal policy is highly important and the most important thing driving real demand generally speaking but no overkills please.


There is the question – what is net high power money creation.

First, since the government’s expenditure, taxation and bond issuance and actions of the central bank lead to creation/destruction of HPM, net can simply mean the flow of high powered money or ΔHPM in any period of accounting. Here deficit is not needed for ΔHPM to be positive.

Second, Joe Firestone perhaps is thinking of non-borrowed reserves. Again, even in this situation, a deficit is not needed for non-borrowed reserves to be positive. Let us say in one period, the government’s budget balance is zero and banks require more reserves. In this case, the central bank can create HPM by outright purchases of government bonds, so again balanced budget doesn’t imply zero increase in nonborrowed reserves in any one period.

There is always a third possibility but then what is it?

Helicopter Drops And Furnace Burns

Milton Friedman famously used helicopter drops to get money in the system as he couldn’t articulate how money is created and maintained that it is exogenously determined by the central bank or that it should be (as if!) and blurred the two.

I came across the original today – The Optimum Quantity Of Money written by him in 1969.

In addition to helicopters he also has furnaces which the government uses to burn money!

Helicopters appear on pages 4, 5, 11, 13 and 15.

Milton Friedman - Furnaces

(click to go to the book’s Google Books site)

Firestone Backfiring – An Unfriendly Critique ;-)

Firestone's Gun

Joe Firestone’s gun

Joe Firestone has a blog post critiquing Marc Lavoie’s critique of Neochartalism.

Among other things, he seems to have issues with Marc Lavoie’s critique of the Neochartalist claim [which he quotes] that

. . . the creation of high powered money requires government deficits in the long run; . . .

Firestone states:

High-powered money includes cash money and reserves emanating from the Government, including the Federal Reserve. If there’s no deficit spending the Government is destroying as much money through taxation as it is spending/creating.

The trouble with Neochartalism is that Neochartalists and “MMT” fans go to over-overkill levels to show the importance of fiscal policy. In general it is a mix of doublespeak and outright incorrect statements and it is highly unacademic and unscholarly.

Firestone is mixing various things. HPM or “high powered money” is different from the net financial assets created by deficit spending of the government.

To see this point, first imagine an open economy in which there is a current account balance of payments surplus of say around 4% of GDP for over 10 years or so (some proxy for “long run”) and the (domestic) private sector “NAFA” – net accumulation of financial assets is around 2% of GDP. The government budget will be in surplus – as a matter of accounting. This needn’t cause any trouble for the private sector.

Of course this doesn’t take away the role of fiscal policy and in no sense is the above statement meant to propose a policy for the government to be in surplus. In fact since the government’s budget balance is endogenous, it could well be the case in the above situation that the government’s fiscal policy is expansionary.

HPM is a different matter. The central bank can easily provide banks with reserves via open market operations or direct lending. Deficit spending is not really needed.

It may also be the case that while taxes flowing into the account of the government at the central bank is “destroying” more HPM than what expenditures is creating, net redemptions of government bonds (as the government is retiring debt) is creating HPM.

Now consider another case but a closed economy.  Assume that the private sector NAFA is negative for many quarters/years and the government’s budget is in surplus. This by itself is not a problem for HPM but may become unsustainable because the nonfinancial sector can start to have liquidity pressures – i.e., financial assets/income of the private nonfinancial sector may start to deteriorate even though net wealth/gdp is not falling (wealth includes nonfinancial assets such as firms’ fixed capital and households’ houses) and this may lead to more financial fragility.

Again, fiscal policy can be expansionary even with a surplus budget because the government budget balance is endogenous. Cannot be found from the above given data.

But Firestone blurs such matters giving the reader an impression that the private sector is losing assets and sees a reduction in output and income. And to the basic point, this has really little to do with HPM.

Firestone is highly confused and muddled when he says

Lavoie seems to think that net high powered money creation isn’t necessary for an economy, even if it is good to have.

Net HPM creation is not equal to private sector NAFA.

In fact typically the government’s cash flows do not affect the HPM when looked over larger time intervals. Expenditures add to HPM as the government moves its balances from its account at the central bank and taxes do the opposite. Bond issuances reduce HPM and redemptions increase it. Over short intervals, the flows are offset by central bank operations. Also for the wonkish, this needn’t always be the case: when there is a flow out of the government’s account at the central bank, it can simply lead to reduction of banks’ daylight overdrafts instead of increasing HPM. Firestone confuses cash flows with deficits.

Nice New Blog From Nick Edmonds: Reflections On Monetary Economics

Nick Edmonds, an ex-student of Wynne Godley from the 80s has a nice new blog Reflections on Monetary Economics.

I especially liked his posts on central bank asset purchases or QE – Modelling QE and The Short Rate, the Long Rate and the Exchange Rate which use Tobin’s theory of asset allocation. He also uses the preferred habitat or market segmentation theory of the yield curve for analysis of effects of QE on asset prices such as equities and on the exchange rate.

A lot of times people just hand-wave away effects by using the expectations theory in which long term rates are expectations of short term rates. Nick’s posts however use both market segmentation and expectations and show how this is useful in understanding the effects of central bank LSAPs/QE.

Flow Of Funds: New Look

The United States Statistical Release Z.1 now has a new look and more data. It now includes the Integrated Macroeconomic Accounts.

United States Flow of Funds

According to the Intergated Macroeconomic Accounts site (which was available separately but online only):

These tables present a sequence of accounts that relate production, income and spending, capital formation, financial transactions, and asset revaluations to changes in net worth between balance sheets for the major sectors of the U.S. economy. They are part of an interagency effort to further harmonize the BEA National Income and Product Accounts (NIPAs) and the Federal Reserve Board Flow of Funds Accounts (FFAs).

The structure of these tables is based on the internationally accepted set of guidelines for the compilation of national accounts that are offered in the System of National Accounts 1993 (SNA).

So now you can look at things such as households’ capital gains easily from the Z.1. Such as from the table below:

Z.1 Selected Aggegates For Total Economy And Sectors (click to expand and zoom if needed)

Trending: #SteveKeen

The always excellent JKH has written a nice post on Steve Keen’s latest QE model in a blog post titled The Accounting Quest of Steve Keen.

JKH has a nice way of summarizing what mainstream macroeconomics is all about:

The neo-classical concepts of exogenous money and the money multiplier and loanable funds and ISLM and supply/demand equilibrium are part of the fog within which mainstream has constructed some economic imagery that is in fundamental conflict with the facts of accounting logic and real world financial measurement.

The post has nice things to say about flow of funds so you may want to read generally.

Coincidentally Steve Keen is trending in Twitter for other reasons. Noah Smith seems to have concluded that Post-Keynesianism is a giant hoax.

Here is a tweet from him:


Scott Fullwiler has a nice way to describe Smith:


Lars Syll has a nice post quoting Jamie Galbraith on the status of the profession. Go Read.

Paul Krugman has a follow up blog post Non-Prophet Economics putting down Keen’s achievements. But Krugman is clueless about how money works and his post is a silly defense of his models.

Krugman is a part of the problem is my view.

Here is Krugman – clueless about how banks work: Here is Randy Wray quoting Krugman. Krugman says:

the self-proclaimed true Minskyites view banks as institutions that are somehow outside the rules that apply to the rest of the economy, as having unique powers for good and/or evil… First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn’t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage… Yes, a loan normally gets deposited in another bank — but the recipient of the loan can and sometimes does quickly withdraw the funds, not as a check, but in currency. And currency is in limited supply — with the limit set by Fed decisions. So there is in fact no automatic process by which an increase in bank loans produces a sufficient rise in deposits to back those loans, and a key limiting factor in the size of bank balance sheets is the amount of monetary base the Fed creates — even if banks hold no reserves…

So Krugman is clueless about money creation on which he pontificates everyday.

Here is another Keen article from today in which he quotes Justin Wolfers’ poking fun.

It shouldn’t be forgotten of course that the economists Robert Pollin and Co who spotted errors in Reinhart and Rogoff’s paper promoting world-wide fiscal contraction by faking a 90% threshold are themselves a mix of Post-Keynesianism and other heterodox schools as per this Washington Post article Inside the offbeat economics department that debunked Reinhart-Rogoff.

Go for it Steve Keen. Whatever criticism you are taking – including from me – beat ’em

I like this Tweet by Ann Pettifor: