Two pieces of the puzzle

Sometimes I hear economists describe a nation as facing a soft budget constraint. It’s true, but  it’s a funny choice of phrase because the literature on soft budget constraints initially was exploring how this caused monumental moral hazard and inefficiencies for firms in the soviet union and other centrally planned economies. This may have some slightly unpleasant implications for if the government explicitly acted as if the constraint they care about is inflation, at least it might under certain types of government self-financing. There is also a more interesting criticism, Daniel Kuehn contends “as James Macdonald argues, public debt has historically been an essential element in restraining government. Hoarded treasure (aside from being macroeconomically inefficient) ensures that sovereigns are unaccountable to their citizens. Citizen creditors ensure that their government stays accountable. Cutting out this debt instrument gives a sovereign all the revenue-raising power of government bonds, without any of the risk of nervous creditors restraining policy. Perhaps a robust republic can be maintained in such an environment, but if the Macdonald point is right, the chance of abuses are very real.” This is why many shudder when some MMT types appear to advocate an abolition of borrowing with politicians simply creating new money themselves directly in case they need more funds.
One good thing about my proposal, which I shall subsequently refer to as Rules Based New Money Financing of Government – RBNMFG (working title), is that it reconciles the moral hazard criticisms towards the ‘deficit owls’ with the demand sucking private debt fuelling criticisms towards the long-run budget constraint types. The committee in charge of RBNMFG is an agent of the government ensuring new money is issued consistent with a rule ensuring no output gad/no deficient demand and/or stable sectoral balances, in the same way that the judiciary is an agent of the government ensuring new laws are implemented consistent with legal precedent or a constitution. In this case the moral hazard problem is greatly diminished because there is a separation between the ‘print financing decision’ makers and the voter appeasing expenditure decision makers.
In sum we have two very useful insights:

(1) Monetary policy needs to be independent to prevent moral hazard and other problems (mainstream)

(2) Deficits might be needed for the foreseeable future to prevent the private sector going into deficit (MMT)

The MMT solution as explained in the first paragraph appeases (2) by violating (1). Mainstream solutions on the other hand might violate (2) in order to appease (1). I proposed the policy of ‘RBNMFG’ to appease both (1) and (2).

1 comment
  1. Nathanael said:

    The “private money” advocates — who spring out of a libertarian tradition, but are sensible enough to oppose the gold standard — have a solution which integrates surprisingly well with MMT. They advocate private money supplies. If the government is happily printing money to the point of inflation and beyond, the private money value will rise against the government money and people will start demanding private money — this provides a *strong* constraint on the government’s spending. It needs to spend slowly enough to avoid currency revulsion. As long as there is an alternative currency to choose from, this is a very real constraint and one which would preoccupy government officials.

    There are other problems with this (notably high transaction costs — during the Free Banking Period of the US, you had to pay a fee to convert money from ‘faraway banks’).

    I think this provides a FAR more appropriate check on the government “spending money into existence” than the current “bond-based” system. Why? The current bond-based system means that only *rich bondholders* should give a damn whether the government spends lots of money into existence. (Anyone else who cares has been brainwashed by propaganda). However, a system where inflation and currency revulsion were the risks would be one where the *common people* would care.

    Obviously, government should be for the benefit of the common people, and a democracy should be governed by what the common people believe, so….

    Class analysis is crucial here: the bond-based system is essentially a subsidy to the upper classes, no more no less, and must be treated as such. The “independent monetary policy” basically means removing monetary policy from the realm of democracy and giving it to some rich private bankers, with all the moral hazard that entails (and we’ve watched that play out quite horrifically with the bank executive bailouts since 2008) — accordingly, “independent monetary policy” is neither feasible nor desirable, due to the extreme moral hazard.

    In contrast, a clear risk of inflation and *currency revulsion* (which means that the government can’t just laugh and say “deal with the inflation!”) is a *democratic* check on the government.

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