Friday, April 06, 2012

Making your nut: MMT is really not Monetarism

A while ago I posted why I thought, contra Interfluidity, that MMT was not monetarism. I stand by this assertion. Interfluidity countered by saying that Sumner (sort of an idiot-savant of the Monetarist school) supported a payroll tax holiday and gave a couple of links in the comments. Here's one.

In actuality, Sumner advocates for an employer side cut after holding his nose and saying it's "far less efficient than monetary stimulus". In my opinion, this is a far cry from the MMT position as a payroll tax holiday immediately as monetary stimulus is a fairy tale, but you can make up your own mind. What's more interesting is the reasoning, which shows why MMT and Monetarism as, in fact, like chalk and cheese.

Monetarist believe that the Fed can control the price level (really -- "The Fed controls the price level") although the mechanism they use for this, controlling the quantity of reserves, has no way to enter the real economy because reserves are used to payment settlement, and bank lending is not reserve constrained.

So, why do Monetarists believe an employer side payroll tax holiday will be helpful at all?
For very complicated reasons it is hard to directly cut the nominal wages of workers. But you can cut the nominal labor costs to companies very easily—just reduce payroll taxes. Now that the Keynesian fiscal stimulus has not worked, the Obama team is looking at new ideas. They are rediscovering the merits of sticky-wage theories of the business cycle, which I am one of the few economists to still adhere to
"Sticky wage theories of the business cycle" means that, since employees will not accept nominal wage cuts, in deflationary environments where real prices are falling, sticky nominal wages means that the real marginal cost of labor goes up, and employers can only respond by firing people -- hence unemployment.

It's true that nominal wages are sticky downwards, but employers fire people when sales fall because demand is not there. There's a straightforward story for why nominal wages are sticky downwards, and it should be obvious to anyone who has taken out a loan -- debt (and interest) is nominal. People carrying debt have to make a nominal nut every month.

If you have a loan which requires a payment every period, that loan balance and monthly nut is nominal, and will not change. In a deflationary environment, the real burden of nominal debt grows, which is what triggers defaults. When loans default, banks write down capital, which constrains their ability to extend further credit as bank lending is capital constrained (not reserve constrained, as Monetarists believe). As credit contracts, prices fall further, as assets that are traditionally bought on margin have a different cash price and leveraged price. Houses would cost less if mortgages were outlawed.

This is the "debt deflation" spiral and Monetarists miss it because they don't, ironically, have debt in their models. The ignore it by thinking it's just a transfer. As MMT gets bank lending right, it understands the horizontal component of money, and thus avoids this mistake.


Blogger paul meli said...

Monetraists sound like flat-earthers to me

12:39 PM  
Blogger Warren Mosler said...

Mmt shows how in general accepting lower wages doesn't add to output and employment. Employers offer jobs at lower wages continuously not to increase employment but to substitute cheaper labor for existing labor. Heck, that's what business is 'supposed to do' in the best interest of shareholders.

Warren mosler

2:50 PM  
Blogger winterspeak said...

well warren, I think it's more complicated than that. Employers want the difference between marginal product of labor and marginal cost of labor to be as large as possible, but that may mean offering a higher wage to get an even more productive employee.

So yes, all else equal, lower wages. In practice, I don't think all else is equal all the times (although sometimes, sure).

4:39 PM  
Blogger sparc5 said...

"Houses would cost less if mortgages were outlawed."

Wouldn't that mean fewer housing starts, thus there would be upward price pressure?

Would tuition cost less if student loans were outlawed?

I am intrigued by this idea, that I've also had but haven't developed much. I hope you explore it more.

6:35 PM  
Blogger Mike Sax said...

Sumner is the "idiot-savant" of specifcaly the group of Monetarists that call themselves "Market Monetarists" Krugman called them Quasi Monetarists.

For every problem in the world, Sumner says, "Raise NGDP." Everyone always protested where is his transmission mechanisn. This week he declared finding a TM is too hard but not worth the trouble anyway.

I see MMT as more or less the opposite of Sumner's MM. Monetarism is the belief in a barter economy-if only we can get NGDP right we would have a barter economy is the Market Monetarist belief- as opposed to MMT that is Chartist. Monetarism-Metallism-and Chartilism are not just like chalk and cheese but oil and water-antipodes.

2:30 AM  
Blogger Unlearningecon said...

Even if you assume real debt contracts or no debt, cutting wages simply does not act to repair the economy as it reduces AD.

8:25 AM  
Blogger paul meli said...

"Even if you assume real debt contracts or no debt, cutting wages simply does not act to repair the economy as it reduces AD"

Absolutely. Cutting wages is equivalent to increasing unemployment.

Cutting wages increases instability.

Increasing productivity tends to increase unemployment.

Most of these things that are thought to be "good" or virtuous tend to be parasitic and destabilizing if one thinks of an economy as being beneficial for the many rather than the few.

9:22 AM  
Blogger obsvr-1 said...

Henry Ford was correct when he said that he had to pay decent wages so his employees could be good consumers and ultimately be good customers.

Good corporate governance is more than just satisfying the wants (Demands) of the shareholders, executives and labor. There is a long term strategic requirement to meet a balance of shareholder, executives, employees, customers and society.

One of the problems today is that Multi-National Corps are exploiting world wide labor to meet short term Quarterly Revenue/Profit targets and are sacrificing prudent long term objectives for a healthy society. We are in a classic Globalization vs National / Local pride and patriotism.

10:41 AM  
Anonymous Anonymous said...

I am trying to work some of these issues through over here. What I want is a diagram that shows a deflationary dynamic driven by the wage setting environment in which unemployment stays fixed while inflation decreases. I keep vacillating between thinking I have got it right and then thinking I have got wrong. So I talked myself into a horizontal long run Phillips curve.

1:00 PM  
Blogger Joseph Laliberté said...

Just like Monetarism, MMT is a also a quantity-theoretic model of changes in price level. The comparaison stops there however. Reserve or currency in circulation play no role in the MMT model. Rather, net financial assets of the non governmental sector along with the desired leveraging of the non governmental sector take center stage.

You might be interested in the following blog which expands on the quantity-theoretic aspect of MMT:

6:56 PM  
Blogger M.Usman said...

This comment has been removed by the author.

7:12 AM  
Blogger Stew said...

There are so much changes to payroll cycles that cause to some extent chaos in automated systems such as SAP during payroll runs. The government has to steer clear whether it will be a tax stimulus or a payroll tax holiday so as not to make too much adjustments on employee payroll.
mortgage leads

10:42 AM  

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