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Sectoral Balances Questions from Senyek

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“The sectoral balances approach really interests me. I imagine that cumulative sectoral deficits equal sectoral debts, which must equally sum to zero. This could be incorrect, but stemming from that assumption I come up with two questions. Firstly, is it possible to reduce real sectoral debt without increasing the debt of others’? That is, for real (as in ‘not proportionally to GDP’) private debt to fall, say, is it not necessary for it to run a surplus (ie. (T – G) – (X – M) < 0))? Secondly, how do debt write-offs work in this framework - just cancelling debts feels like it blows a hole in my logic there, since the debts should still sum to zero.3) Would you recommend that the IMF's special drawing rights replace the US Dollar, among others, as a global reserve currency?4) Surely there is logic in Germany's fiscal restraint, no? Is there a link between the nature of the Euro and this self-imposed austerity? Or perhaps something that connects the BOP and Germany's voluntary surpluses. Fiscal stimulus seems to me as if it's a necessity at this point and I can't get myself to believe the Eurozone practices it not out of economic sense but out of ideology - surely there is some sense to it that I am not seeing?5) Relating to Ray Dalio's 30-minute video about the economic machine, I believe "printing money" did not refer to QE per se but rather money-financed stimulus (MFS), which is closer to Helicopter Money that instead finances government deficit instead of household consumption rather than being a misinterpretation of an asset-swap. Gali (2014 - https://crei.cat/people/gali/gmoney.pdf) illustrates the concept very interestingly – simply, how do you react to the idea of MFS?"

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Cullen Roche Posted by Cullen Roche
Posted on 05/26/2016 8:25 PM
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Hi Senyek,

I’ll try my best to answer each question one at a time:

1) Paying down debt reduces the size of the aggregate balance sheet. So, when a loan is repaid the assets of a bank shrink (so do its liabilities) and so do the assets and liabilities of the borrower (the loan goes away and the deposit is destroyed). Debt forgiveness just shrinks the total balance sheet and may or may not actually solve an economy wide problem.

2) I believe the first answer fits in well with that, no?

3) Creating a global reserve current does not solve the problems we encounter at the country specific level. If we had one political system with one currency then SDRs would make sense. But until that happens you still have country specific denominated assets that the issuance of SDRs will not directly deal with since they are ultimately funded by the local currencies in the first place. If we swapped all Euros, USD and Yen into SDRs then the system would be clean, but that would require one globally coordinated political and monetary system and that’s just not realistic.

4) Oh, there is very real logic in Germany’s view. The worry is that they will become the financier for all of Europe’s problems. In the long-run you could encounter an environment where Germans work hard and make lots of stuff and the value of their currency erodes because their neighbors don’t make stuff and go to the beach all day. In this case Germany is indirectly creating a lot of money to finance the purchases of the beachgoers without corresponding increases in output and productivity. This could lead to an overall decline in Germany living standards at the benefit of the beachgoers. It’s a fiscal transfer in essence which either occurs in real terms or nominal terms. Germany would prefer that everyone be a bit more like them and not risk the worst case scenario where inflation or debt erodes living standards uncontrollably. Frankly, I think this risk is overblown and that Germany would actually be better off by creating a fiscal rebalancing mechanism like the USA has, but I 100% understand why they’re hesitant to go down that road….

5) Money financed spending is just printing up the equivalent of T-Bills. Cash is a liability of the govt by another name. So, what’s the real difference between running a deficit and printing cash? Well, the obvious difference is that Congress can control the way a deficit is run, whereas a Central Bank that prints money is likely to just drop it from helicopters. The way the money gets distributed is important in my opinion. MFS implemented in productive spending would not be much different from a standard deficit though. So, I keep saying just run a bigger deficit no matter how we get there – lower taxes or higher spending. Who cares. Just do it! But I am not in favor of helicopter money as it skirts the Congressional process.

I hope that covers all the questions!

CR

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Cullen Roche Posted by Cullen Roche
Answered on 05/27/2016 1:46 AM
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    Cullen: “So, I keep saying just run a bigger deficit no matter how we get there – lower taxes or higher spending. Who cares. Just do it!”

    Agreed. So I think this begets a question from a question. Are we headed for nirvana?

    The democrats want to do just that AND Trump says: “we will look into that” very plan? Are the parties just questioning the priorities as to how to spend our moolah (which appears at first blush to differ)? Or, is all fiscal spending totally controlled by our Senate in our system of MR, and thus likely to be squished down?

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    Posted by Dennis
    Answered on 05/27/2016 4:15 AM
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      “is it possible to reduce real sectoral debt without increasing the debt of others”

      Yes it is possible, as debt can be reduced by debts being re payed by debtors as a subsequence of transactions with creditors.

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      Posted by Dinero
      Answered on 05/27/2016 7:25 AM
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        1+2) Yes, this is clear and makes sense, thank you, but what I’d like to know is how this happens in practice in a three-sector model: private, public, and foreign. Say a country has a permanently balanced private sector (for whatever reason) and a government balance that is inverse to the capital account balance (sectoral balances sum to zero). Over time, say after years of a public deficit, the public debt balloons and debt relief is decided on. In this model, I would assume those with the assets would be the foreign sector – they’ve been accumulating a surplus following years of public deficit. To cancel the public debt without paying it down (ie. years of public surplus/trade surplus), again assuming the sum of debts sums to zero, the foreign sector would have to renounce these assets … but without making any changes in its flow balance. How does this work in practice? That’s what I’m trying to get to: debt relief doesn’t make sense in my narrow perspective on sectoral balances because I’d instinctually suppose debt is just the sum of deficits and can only be paid down through surplus.

        3) Understandable that feasability is a concern because of the scale of what replacing a global reserve currency implies – in one swift move replacing reserve bucks with SDRs sure is unrealistic. But in a shorter term, would you espouse moves that would ease the process? I’m thinking of PBChina’s governor Zhou Xiaochuan’s comments in 2009 about how the USD as a reserve currency lead to problems worldwide (Triffin dilemma) and how SDRs as a reserve currency would have attenuated the global crisis.

        4) Sensical. More generally now, is there any link between balance of payments and public spending? Some have said the Eurozone crisis is a BOP crisis – greater North-South capital inflow caused the domestic sector to be burdened with debt until finally the central banks did not have enough reserves to keep being a currency-user. Does this relate to Germany’s commitment to budget surpluses? Or does that analysis not make sense?

        5) This question will metamorphose into another one: what would you recommend to stimulate inflation? Past iterations of QE haven’t been inflationary, growth is slow and central bank ammo is low, so what next? Negative interest rates? Or could interest rates remain low because we’re still in the deleveraging process? Debt-to-GDP is still high, I wouldn’t expect leveraging at this point.

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        Posted by senyek
        Answered on 05/28/2016 2:08 PM
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          5) Fiscal spending and not done stupid as the Japanese did (and still are) it. With “Starve the Beast” Republicans in Congress, it might actaully be possible to avoid pork-barrel spending. Possibly, not likely. Fortunately, we do have a decaying and crumbling infrastructure.

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          Posted by MachineGhost
          Answered on 05/28/2016 6:15 PM
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            Basically, we’re all just collectively waiting through attrition and reality bitchslapping for all the austerity politicians to get a clue.

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            Posted by MachineGhost
            Answered on 05/28/2016 6:18 PM
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              Hi Senyek,

              1) “I’d instinctually suppose debt is just the sum of deficits and can only be paid down through surplus.”

              This is right. Debt forgiveness is just an accounting gimmick. It reduces the current quantity of outstanding debt, but without a reduction in the deficit into a sustained surplus the debt just reflects all past deficits. The kicker is, debt is only a problem when it can’t be serviced. I don’t see why anyone would think the USA can’t service its debts. So, all debt forgiveness would do is shrink the outstanding assets of the private sector which would “solve” a problem that doesn’t need solving while hurting the private sector’s balance sheets.

              3) I don’t see how SDRs solve anything. The USD is the dominant reserve currency because it’s backed by the highest quality income stream in the world. SDRs are valuable only because a group of govts says they might be valuable. In my view, the USD is valuable because there’s a huge amount of output that backs that money and gives its holders access to. SDRs can’t even be held by the non-govt sectors so the demand for this money is govt directed in the first place. And they still have to be converted into USDs at the private sector level so it’s just an intermediation tool for govts.

              4) Well, you could argue that every economic problem is a “balance of payments” problem. For instance, I run a balance of payments surplus against other people every month because I save more than I make. Someone out there is running a payment deficit against me. If they can’t service that payment then we have a problem. We have a balance of payments crisis at the individual level. The problem in Europe is just a much bigger version of that. So yes, it’s a BOP crisis, but I’d say that any funding problem is a BOP crisis in essence. The way to solve a BOP crisis is to bailout that person or have them become more productive so they can sell their output to other people and earn an income to service their balance sheet. Germany basically wants to force Greece to become more productive rather than potentially eroding their own standard of living and just bailing out Greece….

              5) In my perfect world we’d implement massive infrastructure programs, cut middle class taxes substantially and initiate a public investment program using the govt as a funding source for private equity issuance. We really need to spur private investment and the only way to do that right now is to start directly financing start-ups and new innovations. It should be a public/private partnership though with private firms managing the process and govt providing the funding. These firms would need skin in the game though.

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              Cullen Roche Posted by Cullen Roche
              Answered on 05/29/2016 2:51 PM
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                1+2+4) Much appreciated, thank you.

                3) Interesting, thank you for clarifying. Is there any way we can overcome original sin in our current global monetary framework then? Or the Triffin dilemma? Reserve currencies must run current account deficits to finance worldwide FX reserves and this acts similarly to a gold standard (*), and if the last two decades are anything to go by, Washington consensus neoliberals were wrong to say trade deficits don’t matter.

                5) Two follow-up questions. Firstly, what about in the Eurozone or in emerging markets, specifically where these countries can’t overcome “original sin”? Considerable deficits are harder to service and sustain in these environments – or in the former case, officially frowned upon by Germany. Secondly, would you argue that tax cuts are more conducive to growth because as well as unblocking new income for spending (esp. in lower to middle income households), they also increase the size of the multiplier in this incomes? Of course this works less well when it’s the rich that receive the cuts.

                6, or rather 3 now) There are two facts truth-sayers about QE have written, opposing the hyperinflationary/money multiplier nonsense, and while those like you say QE is just an asset-swap (assets for CB reserves) I’ve heard some put it differently. Namely, Andricopoulos (**), who says that QE caused asset prices to rise and the rich “cashed in” some of this profit obtained from greater asset prices – and only a fraction of this profit went back to the real economy. This was supposed to stimulate demand and inflation, although generally failed to make an impact because the MPS was too great. So, which is it? Is QE a marginally-deflationary asset-swap for reserves, or is it some kind of asset-price stimulus? Or are both descriptions describing the same thing from a different lens? I’ve heard others apart from Andricopoulos phrase QE this way, but bring up his name to also ask you …

                4) What do you make of Andricopoulos and his (stock-flow consistent) Demand-Based Cash Flow model? He uses Godley’s thinking but divides the economy into savers and workers instead of sectors, close to how Kalecki imagined it. He errs on the side of MMT, however, and argues for permanent deficits (although for a different reason to ‘conventional’ MMT, I believe). I can’t quite tell whether or not you’d butt heads but I’d be interested to see how you react.

                (*) – https://www.coppolacomment.com/2016/03/understanding-balance-of-payments-crises.html?m=1

                (**) – https://www.notesonthenextbust.com/2016/02/latest-version-of-my-dbcf-model-paper.html?m=1

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                Posted by senyek
                Answered on 05/29/2016 7:08 PM
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                  > Germany basically wants to force Greece to become more productive rather than potentially
                  > eroding their own standard of living and just bailing out Greece….

                  Yeah, well, rising yields due to low confidence isn’t exactly how that is accomplished. If Greece could devalue its own currency, it would immediately be more productive relative to other countries. Germany is way too paranoid about inflation because they don’t understand what really causes it; you can’t reason with Chicken Littles. How about you run for Chancellor when Merkel gets kicked out next year? :)

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                  Posted by MachineGhost
                  Answered on 05/31/2016 3:51 AM
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                    Senyek, don’t conflate the QE asset swapping with the cost of credit. Lowering the cost of credit will cause yield-chasing behavior in investors which will drive up the price of all financial assets (to offer similar future expected returns). That’s not the same as saying that QE caused it. Is there a transmission mechanism to the real economy when the Fed lowers yields when it asset swaps for Treasuries “inside” or is it merely “outside” investors front-running expectations?

                    It really is amazing how ingrained Friedman’s “inflation is always and everywhere a monetary phenomenon” boogie man has become. The Germans must be petrified solid.

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                    Posted by MachineGhost
                    Answered on 05/31/2016 4:04 AM
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                      Cullen,

                      Does crowding out have a basis in the sectoral balances identity? In a closed economy, the private sector surplus (savings net of investment) is the public sector deficit (expenditure net of income), so it follows that

                      (T – G) = (I – S)
                      I = S + (T – G)

                      I assume that savings are a function of the private sector saving ‘rate’ (APS) and so shouldn’t fluctuate wildly in the short-term bar some very audacious monetary policy. So I assume private sector savings is not dependent on government deficits. Surely it follows that a greater public deficit (G > T) leads to a fall in investment – since the public sector sector deficit equals a private sector surplus and S is assumed to stay constant in the same-term. Or maybe S fluctuates as I + (G – T)?

                      Senyek

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                      Posted by senyek
                      Answered on 06/14/2016 12:49 PM
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                        Depends on what you mean by “crowding out”. The traditional concept means that the govt competes with the private sector for loanable funds which drives up interest rates. This is obviously nonsense in a world of endogenous money.

                        But does the govt compete with the private sector for scarce resources? Of course. The govt can manipulate the private sector in certain ways that “crowd out” private sector competition. That’s good and bad at times depending on the specifics…..

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                        Cullen Roche Posted by Cullen Roche
                        Answered on 06/15/2016 1:28 PM
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                          ‘Crowding out’ as in this peculiarity in the accounting identity. If I plug in numbers to simulate the accounting identity, where T, G, and S are exogenously set and otherwise constant, a rise in G leads to a fall in private investment (I). Is there any reason as to why this is in the practical world, outside of this identity? Does this even occur in the real world?

                          Also, are there any chances of my previous (two-week old) questions above being answered? Thank you for your time, it is greatly appreciated.

                          Senyek

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                          Posted by senyek
                          Answered on 06/15/2016 6:02 PM
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                            Hi Senyek,

                            Those ones got lost in the shuffle. Sorry. Here are my thoughts:

                            3) The world’s reserve currency is a current account deficit country because they are viewed as having the world’s largest stock of high quality goods and services. This means that their financial assets are among the safest and probably THE safest. So it makes sense that this country ends up in a CAD as a result. I don’t think you can really overcome this in a modern financial system so it just comes with the territory.

                            4) The EMU is unique in that it’s a version of the USA without an automatic rebalancing mechanism. The USA has a federal govt that redistributes money from the rich states to the poor states. The EMU has no mechanism. So you end up with these deflationary spirals as the adjustment.

                            5) I don’t think you can generalize about tax cuts vs spending. I mean, if a govt cuts taxes for the wealthy then the marginal propensity to consume doesn’t rise much. If, however, the govt spends a bunch of money into the pockets of middle class people who build a new research lab for R&D for cancer then the multiplier there could be enormous. It just depends….

                            6) Hard to say whether QE increases asset prices. Here’s what I now operationally. At the margin it can’t be the driver of asset prices. After all, asset prices are simply set by supply and demand. Secondary market prices are a function of their perceived future value. Demand is not just a function of supply in this sense, but that’s what the “QE leads to higher asset prices” argument is based on. I think of QE like a stock buyback. A buyback doesn’t drive prices higher necessarily. If the company’s operations decline then the stock price will decline regardless of how many shares they buyback. The same point is true of the economy and QE.

                            7) I haven’t read the paper you’re referring to. In fact, I’ve never even heard of the researcher. Sorry.

                            I’m gonna close this thread as it’s gotten messy. If you have further questions don’t hesitate to start a fresh set. It will be cleaner that way. Thanks!

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                            Cullen Roche Posted by Cullen Roche
                            Answered on 06/16/2016 1:00 PM