Saturday, November 07, 2009

An attempted truce between neo-chartalism and monetarism

I don't know what the difference is between "neo" chartalism and straight up chartalism. Either way, Nick Rowe tries to split the difference between conventional monetary policy, which focuses on the Fed setting interest rates and thus managing money in the private sector via lending, and chartalism, which focuses on fiscal policy and believes the interest rates don't make much difference.
Let's start with the short run government budget constraint.

G-T +iB = dB + dM

Where G is government spending, T is taxes, i the interest rate on B, the existing stock of government bonds, dB the change in B, and dM the change in the stock of central bank money.

Fiscal deficits must be financed by issuing bonds, or money, or some combination of the two.

One conventional definition of "fiscal policy" is a change in G or T holding M constant (bond-financed deficits). A change in M counts as "monetary policy". Suppose instead we define "fiscal policy" as a change in G or T holding B constant (money-financed deficits). A change in B is what now counts as "monetary policy".

What the new dictionary calls "fiscal policy" the old dictionary considers as fiscal policy supplemented by monetary policy. And what the old dictionary calls "fiscal policy" the new dictionary considers to be fiscal policy with a countervailing monetary policy.
It's a step forward, but implicit in this model is that M (or more precisely M0) has some bearing on private sector money. The private sector holds two types of financial assets: those issues by the Government, and those issues within itself. It is a net saver of Government issues assets, as the Govt is a net dissaver, but it carries a net zero balance of private sector issued assets (through double entry bookkeeping).

M (or M0) in Nick's model is the Government issued assets that the private sector holds. Government deficit spending funds net private savings. But private sector issued financial assets (loans, stocks, etc.) while leveraged on top of Government issued financial assets, are not Government issued financial assets re-lent out. Banks do not loan out reserves, banks make loans, and then create the related deposits once they are deposited in the banking system.

This takes M0 completely out of the model and leaves us with the straightforward position: Government deficit spending funds in the increase in the non-Government sectors net financial assets (or, if you prefer, net savings).

He is correct in his model that interest paid on privately held debt increases non-Govt savings as well. But please note, this says that low interest rates are deflationary as the reduce the amount of income/savings the private sector gets, while high interest rates are inflationary. The exact opposite of monetary theory.

Update: Do read all the comments in the thread.


Blogger Ramanan said...

Hi Winterspeak,

Didn't know you allowed comments - or maybe you just started allowing them. Btw who is Winterspeak :) ?

The starting assumption on WCI itself is inconsistent, so Nick Rowe seems to miss Chartalism altogether.

Such an assumption of finacing the deficit by both bonds and issuing currency was made by James Tobin in Money and finance in the macroeconomic process - his Nobel lecture. So it was natural that the arguments go in the monetarist's direction and into inflation.

9:43 AM  
Blogger Unknown said...

I enjoy the site and the information. Thank you.

Random question: Is it Winter's peak OR Winter Speak?

7:26 PM  

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