William Mitchell, L. Randall Wray, Martin Watts-Modern Monetary Theory and Practice_ An Introductory

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Unformatted text preview: Modern Monetary Theory and Practice: An Introductory Text William Mitchell, L. Randall Wray and Martin Watts © William Mitchell, L. Randall Wray and Martin Watts, 2016 First published in 2016, Centre of Full Employment and Equity (CofFEE) The University of Newcastle Callaghan, NSW 2308, Australia First Printed by CreateSpace 2016 An Amazon company Table of Contents Chapter 1: Introduction 1.1 What Is Economics? Two Views 1.2 What is Macroeconomics? 1.3 Macro and the Public Purpose Appendix: Advanced Material Chapter 2: How to Think and Do Macroeconomics 2.1 Introduction 2.2 Thinking in a Macroeconomic Way 2.3 What Should a Macroeconomic Theory be Able to Explain? Appendix Chapter 3: A Brief Overview of Economic History and the Rise of Capitalism 3.1 Introduction 3.2 An Introduction to Monetary Capitalism 3.3 Tribal Society 3.4 Slavery 3.5 Feudalism 3.6 Revolts and the Transition to Capitalism 3.7 Capitalism 3.8 Monetary Capitalism 3.9 Global Capitalism 3.10 Economic Systems of the Future? Chapter 4: The System of National Income and Product Accounts 4.1 Measuring National Output 4.2 Components of GDP 4.3 Equivalence of Three Measures of GDP 4.4 GDP versus GNP 4.5 Measuring Gross National Income 4.6 GDP Growth and The Price Deflator 4.7 Measuring CPI inflation 4.8 Measuring National Inequality Appendix: Advanced Material Chapter 5: Sectoral Accounting and the Flow of Funds 5.1 Introduction 5.2 The Sectoral Balances View of the National Accounts 5.3 Revisiting Stocks and Flows 5.4 Integrating NIPA, Stocks, Flows and the Flow of Funds Accounts 5.5 Balance Sheets 5.6 The Flow of Funds Matrix Appendix Chapter 6: Introduction to Sovereign Currency: The Government and its Money 6.1 Introduction 6.2 The National Currency (Unit of Account) 6.3 Floating versus Fixed Exchange Rate Regimes 6.4 IOUs Denominated in National Currency: Government and Non-Government 6.5 Use of the Term ‘Money’: Confusion and Precision Chapter 7: The Real Expenditure Model 7.1 Introduction 7.2 Aggregate Supply 7.3 Aggregate Demand 7.4 Private Consumption Expenditure 7.5 Private Investment 7.6 Government Spending 7.7 Net Exports 7.8 Total Aggregate Expenditure 7.9 Equilibrium National Income 7.10 The Expenditure Multiplier Chapter 8: Introduction to Aggregate Supply 8.1 Introduction 8.2 Some Introductory Concepts 8.3 Price Determination 8.4 The General Aggregate Supply Function 8.5 Some Properties of the General Aggregate Supply Function (AS) 8.6 Factors Affecting Aggregate Output per Hour Chapter 9: Labour Market Concepts and Measurement 9.1 Introduction 9.2 Measurement 9.3 Categories of Unemployment 9.4 Broad Measures of Labour Underutilisation 9.5 Flow Measures of Unemployment 9.6 Duration of Unemployment 9.7 Hysteresis Appendix: Advanced Material Chapter 10: Money and Banking 10.1 Introduction 10.2 Some Definitions 10.3 Financial Assets 10.4 What do Banks Do? Appendix: Advanced Material Chapter 11: Unemployment and Inflation 11.1 Introduction 11.2 What is Inflation? 11.3 The Quantity Theory of Money 11.4 The Phillips Curve 11.5 The Accelerationist Hypothesis and the Expectations-Augmented Phillips Curve 11.6 Hysteresis and the Phillips Curve Trade-Off 11.7 Underemployment and the Phillips Curve 11.8 Demand-Pull and Cost-Push Inflation 11.9 The Conflict Theory of Inflation 11.10 Raw Material Price Increases 11.11 Cost-Push and Demand-Pull Inflation Summary 11.12 Incomes Policies Appendix: Advanced Material Chapter 12: Full Employment Policy 12.1 Introduction 12.2 Full Employment as a Policy Goal 12.3 Unemployment Buffer Stocks and Price Stability 12.4 Employment Buffer Stocks and Price Stability 12.5 Alternative Policies for Promotion of Employment Appendix: Advanced Material Chapter 13: Introduction to Monetary and Fiscal Policy Operations 13.1 Introduction 13.2 The Central Bank 13.3 The Treasury 13.4 Coordination of Monetary and Fiscal Operations 13.5 Taxes and Sovereign Spending 13.6 Currency Sovereignty and Policy Independence Appendix: Advanced Material Chapter 14: Fiscal Policy in Sovereign Nations 14.1 Introduction 14.2 Functional Finance versus Sound Finance 14.3 Fiscal Policy Debates: Crowding Out and (Hyper)Inflation 14.4 The Debt Sustainability Debate 14.5 Conclusion: MMT and Fiscal Policy Chapter 15: Monetary Policy in Sovereign Nations 15.1 Introduction 15.2 Modern Banking Operations 15.3 Interest Rate Targets versus Monetary Targets 15.4 Liquidity Management 15.5 Implementation of Monetary Policy 15.6 Unconventional Forms of Monetary Policy 15.7 Monetary Policy in Practice 15.8 The Advantages and Disadvantages of Monetary Policy 15.9 Central Bank Independence 15.10 Horizontal and Vertical Operations: An Integration Chapter 16: Policy in an Open Economy: Exchange Rates, Balance of Payments and Competitiveness 16.1 Introduction 16.2 The Balance of Payments 16.3 Essential Concepts 16.4 Aggregate Demand and the External Sector – Revisited 16.5 Trade in Goods and Services, Product Market Equilibrium and the Trade Balance 16.6 Currency Crises 16.7 Capital Controls Appendix: Advanced Material Appendix: Methods, Tools and Techniques A.1 Overview A.2 Basic Rules of Algebra A.3 A Simple Macroeconomic Model A.4 Graphical Depiction of a Macroeconomic Model A.5 Power Series Algebra and The Expenditure Multiplier A.6 Index Numbers A.7 Annual Average Growth Rates A.8 Textbook Policy Regarding Formalism Table of Tables Number Heading Table 2.1 Average annual real GDP growth by decades, per cent Table 2.2 Average unemployment rates by decade, per cent Table 4.1 Items in Australian CPI, September 2013 Table 4.2 Hypothetical data for basket of goods and services Table 4.3 Gini coefficients for several OECD nations, 2004 and 2012 Table 7.1 Consumption ratios, OECD nations, 2005-2010, per cent Table 7.2 Expenditure chain volume measures in national accounts (Australia) Table 7.3 The expenditure multiplier process Table 7.4 Simulating changes in the multiplier components Table 9.1 OECD underemployment, per cent of labour force, 1990 to 2014 Table 9.2 Labour market flows matrix Table 9.3 Gross flows in the US labour market, December 2015–January 2016, millions Table 9.4 Total inflow and outflow from labour force states, US, December 2015 to January 2016, millions Table 9.5 Labour market state transition probabilities, US, December 2015 to January 2016 Table 15.1 Target interbank rates for developed economies Table 16.1 Australian balance of payments, various years, current prices Table 16.2 Comparison of international prices Table A.1 Employment in Australia, 2000-12, thousands Table A.2 Employment indices for Australia, 2000-12 Table A.3 Compound growth rate calculations Table of Figures Number Heading Figure 2.1 Comparative unemployment rates, per cent, 1960 to 2015 Figure 2.2 Real wage and productivity indexes, Australia, 1971 to 2015, March 1982=100 Figure 2.3 Household debt to disposable income ratio, Australia, per cent, 1998 to 2015 Figure 2.4 US Federal Reserve Bank monetary base, 1959 to 2015, US dollar millions Figure 2.5 Government fiscal balance as % of GDP, Japan, 1980 to 2015 Figure 2.6 Gross and net public debt as % of GDP, Japan, 1980 to 2015 Figure 2.7 Japan overnight interest rate, per cent, July 1985 to December 2015 Figure 2.8 Japan government 10-year government bond yield, per cent, 1990 to 2015 Figure 2.9 Inflation and deflation in Japan, per cent, 1980 to 2015 Figure 4.1 The Lorenz curve Figure 5.1 UK sectoral balances, 1960 to 2014 Figure 5.2 A stylised sectoral balance sheet Figure 5.3 A uses-and-sources-of-funds statement Figure 5.4 A complete sector uses-and-sources-of-funds statement Figure 5.5 A stylised three sector flow-of-funds matrix Figure 5.6 A graphical sectoral balances framework Figure 5.6a Deriving the private domestic sector balances Figure 5.6b Private domestic surpluses and deficits Figure 5.7 Sustainable space for sovereign governments Figure 5.8 Sustainable space for governments constrained by fiscal rules Figure 6.1 The Minsky – Foley pyramid Figure 7.1 Aggregate supply Figure 7.2 The consumption function Figure 7.3 The aggregate demand function Figure 7.4 An increase in the intercept of the aggregate demand function Figure 7.5 Changing slope of the aggregate demand function Figure 7.6 Planned expenditure and equilibrium income Figure 7.7 The multiplier process Figure 7.8 Impact of a change in government spending on equilibrium expenditure and income Figure 7.9 Impact of a change in the marginal propensity to consume on equilibrium expenditure and income Figure 8.1 The employment-output function Figure 8.2 Output, sales and national income Figure 8.3 The general aggregate supply function (AS) Figure 8.4 US manufacturing output per person employed Figure 8.5 US manufacturing output per hour of all persons Figure 9.1 The labour force framework Figure 9.2 Labour force participation rate and annual real GDP growth – Australia, 1980 to 2015, per cent Figure 9.3 Unemployment rate and average duration of unemployment (weeks), US, February 2008 to October 2012 Figure 10.1 US Treasury yield curve (February 3, 2016) Figure 10.2 A typical bank balance sheet Figures 10.3, 10.4, 10.5, 10.7, 10.9 & 10.11 Bank A balance sheets Figures 10.6, 10.10 & 10.12 Bank B balance sheet Figures 10.8 & 10.13 Central bank balance sheet Figure 11.1 Velocity of M2 money stock (M2V), US, 1950-2012 Figure 11.2 The basic Phillips curve Figure 11.3 The unemployment-inflation choice set Figure 11.4 The shifting US Phillips curve - 1948-2012 Figure 11.5 The expectations-augmented long-run Phillips curve Figure 11.6 Annual Australian unemployment rate, Treasury and OECD NAIRU estimates, 1960-2015 Figure 11.7 Inflation and unemployment, Australia, quarterly data, 1978-2015 Figure 11.8 Inflation and unemployment and underemployment, Australia, quarterly data, 1978-2013 Figure 11.9 Short- and long-run Phillips curves Figure 12.1 The sacrifice ratio and disinflation episode Figure 12.2 Sacrifice ratios with persistence and hysteresis Figure 12.3 The Job Guarantee and the Phillips curve Figure 13.1 Balance sheets associated with net government spending Figure 13.2 Balance sheets associated with net government spending Figure 15.1 Unemployment rate and inflation rates for Australia, 1980 – 2015, per cent Figure 15.2 Vertical and horizontal macroeconomic relations Figure 15.3 Horizontal and vertical components of the money supply Figure 16.1 A simple bi-lateral foreign exchange market Figure 16.2 Net exports as a function of real national income Figure 16.3 Equilibrium national income with a change in world income Figure 16.4 Mexican peso depreciation, December 1994 Figure 16.5 Real GDP growth in South East Asia, 1980-2005, per cent per annum Figure A.1 Consumption function Figure A.2 Slope of consumption function Figure A.3 Employment index numbers, Australia, 2000-2012, 2000=100 Figure A.4 Real wages and productivity, 1978- 2012, March-quarter 1978=100 Common Abbreviated Terms Abbreviation Term BER Buffer Employment Ratio BLS Bureau of Labor Statistics CD Certificate of Deposits CPI Consumer Price Index C Consumption CAB Current Account Balance EMU Economic and Monetary Union (EMU) of the European Union ERM Exchange Rate Mechanism (European) EAPC Expectations-Augmented Phillips Curve X Exports FOMC Federal Open Market Committee (US) GE General Equilibrium GT General Theory (Keynes) GFC Global Financial Crisis (2008) GBC Government Budget Constraint G Government Spending GDP or Y Gross Domestic Product GNI Gross National Income GNP Gross National Product S Gross Saving M Imports Mh Stock of High Powered Money Ms Stock of Money Y Income (if not used for Gross Domestic Product) ISLM Interest-Saving Liquidity Preference-Money Supply Model (Hicks) I Investment JGBs Japanese Government Bonds JG Job Guarantee also known as Employer of Last Resort program MRU Macro-equilibrium unemployment rate MPC Marginal Propensity to Consume m Marginal Propensity to Import MMT Modern Monetary Theory NIPA National Income and Product Accounts NRU Natural Rate of Unemployment NAFA Net Acquisition of Financial Assets NX Net Exports FNI Net external income flows NI Net National Income NNP Net National Product NC New Classical e Nominal exchange rate NAIRU Non-Accelerating Inflation Rate of Unemployment NGO Non-Governmental Organisation OMO Open Market Operations OECD Organisation for Economic Co-operation and Development OPEC Organisation of Petroleum Exporting Countries OER Owners' Equivalent Rent PDI Person Disposable Income PI Personal Income PS Personal Saving P Profits QE Quantitative Easing QTM Quantity Theory of Money RATEX Rational Expectations hypothesis RBC Real Business Cycle R Real exchange rate ROW Rest of World SM Scandinavian Model SRPC Short-Run Phillips Curve T Taxes W Wages YC Yield Curve About the Authors Professor William Mitchell William Mitchell is a Professor of Economics at the University of Newcastle, NSW, Australia and inaugural Director of the Centre of Full Employment and Equity (CofFEE), an official research centre at the University. He has held that position since the centre's inception in 1998. He is the co-founder of CofFEE-Europe, a sister centre at Maastricht University, the Netherlands, where has been a visiting professor since 1992. He has published widely in refereed academic journals and books in the areas of macroeconomics, labour economics and spatial econometrics and regional analysis. He has received regular research grant support from national competitive grants schemes operated through the highly competitive Australian Research Council. He also has extensive experience as a consultant to the Australian government, trade unions and community organisations, and several international organisations (including the European Commission; the International Labour Organisation and the Asian Development Bank). His latest book European Dystopia: Groupthink and Denial on a Grand Scale, was published by Edward Elgar (UK) in May 2015. The Spanish translation will be published in May 2016 and a Finnish translation in November 2016. He is on the editorial board of the Journal of Post Keynesian Economics, the Economic and Labour Relations Review, and the Australian Journal of Labour Economics. He writes a daily economics blog covering international and national issues, which enjoys a high profile. It was ranked 43rd among the top 200 Top 200 Influential Economics Blogs in the World in 2013, when the index was last compiled. Professor L. Randall Wray L. Randall Wray is Levy Economics Institute Senior Scholar and a professor of economics at Bard College. His current research focuses on providing a critique of orthodox monetary theory and policy, and the development of an alternative approach. Wray is the author of Money and Credit in Capitalist Economies, 1990; Understanding Modern Money: The Key to Full Employment and Price Stability, 1998; and Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, 2012 (2nd rev. ed., 2015). He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008. He is the Co-editor of the Journal of Post Keynesian Economics and his most recent book is Why Minsky Matters: An Introduction to the work of a maverick economist, Princeton University Press. Wray taught at the University of Missouri–Kansas City from 1999 to 2016 and at the University of Denver from 1987 to 1999, and has been a visiting professor at the Universities of Paris, Bergamo, Bologna, and Rome (La Sapienza). He holds a BA from the University of the Pacific and an MA and a Ph.D. from Washington University, where he was a student of Hyman Minsky. Professor Martin Watts Martin Watts is Research Associate of the Centre of Full Employment and Equity (CofFEE) and Professor of Economics at the University of Newcastle, Australia. He has had a long term interest in contemporary macroeconomic theory and policy, and the development of Modern Monetary Theory as an alternative perspective. In recent years has published in a number of heterodox economics journals, including the Journal of Post Keynesian Economics, Economic Issues, Journal of Australian Political Economy and The Economic and Labour Relations Review. He is on the Editorial Board of the Journal of Post Keynesian Economics and Gender, Work and Inequality. His other areas of research include the conceptualisation and measurement of segregation and spatial interaction models of commuting behaviour. Watts taught at Monash University (1975-1990) and commenced employment at Newcastle University in 1991. He holds a B.A. from Essex University, an M.A. from Manchester University and a PhD from the University of British Columbia. Chapter 1: Introduction Chapter Outline 1.1 What is Economics? Two Views - Orthodox, neoclassical approach - Heterodox; Keynesian – institutionalist – Marxist approach - What do economists do? - Implications for research and policy 1.2 What is Macroeconomics? - The MMT approach to macroeconomics - The macro model - Fiscal and monetary policy - Policy implications for sovereign nations 1.3 Macro and the Public Purpose - Concluding thoughts on the public purpose Appendix: Advanced Material - 1. The minimum wage debate - 2. The structure of scientific revolutions Learning Objectives 1. Recognise that macroeconomics is a contested discipline with two broad schools of thought, which differ in terms of their perspectives on the effectiveness of markets and the role of Government. 2. Understand that macroeconomics analyses the behaviour of aggregates, such as employment, unemployment, GDP and inflation, whereas microeconomics studies the behaviour of individual economic agents, notably households and firms. 3. Acknowledge that social science disciplines (e.g economics and politics) and physical science disciplines (e.g. physics and chemistry) each have their own language in the form of concepts and theories, which provide the basis for understanding, not merely describing, relevant phenomena. 1.1 What Is Economics? Two Views US President Harry Truman is said to have sought a one-armed economist because he was so frustrated by the propensity of economists to provide policy advice framed as ‘Well, on the one hand, X, but on the other hand, Y’, where ‘Y’ typically would be the precise opposite policy path to ‘X’. The story is, of course, funny but it does bring up a problem that is ubiquitous to all social sciences. Even if we know the result we would like to achieve (say, smarter and happier kids), we do not know with certainty which policy choices would produce the desired outcome. Since the main topic of the social sciences—human behaviour—is complex, we often do not understand its causes, or even its nature, and much less do we know how to influence it in a desired manner. Economics is as difficult as the other social sciences, such as psychology and political science as it concerns human behaviour in a social sphere that we designate as ‘the economy’, which itself is hard to define and to delineate from other spheres of social interaction. Unfortunately, economics is sometimes equated to something like the ‘study of business decision-making’, or even relegated to a narrow sub-discipline as a ‘decision science’ in a highly artificial hypothesised world of hyper-rational automatons that maximise pleasure and avoid pain. Some even see economics as just a branch of mathematics, a view fuelled in part by the heavy use of mathematics and models in much of the discipline. This textbook will take a broader perspective of the economics discipline, including it within the social sciences. While we do think it is useful to carve off ‘the economy’ from the rest of social life, and to apply ‘economics’ to the study of that area of life, we recognise that the division is necessarily arbitrary. In truth, there is no completely separate sphere of ‘economic life...
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