1-MMT For Pakistan
Introductory Remarks: This post is 1st part of my second talk at SBP; (see MMT at SBP for first talk) . I taught a two semester course on this topic, and very little of the depth and complexity can be covered in the allotted time of half an hour. Accordingly, in this talk I cut to the chase and talk about policy implications of MMT for Pakistan, with minimal theoretical background. The first thing to understand is the difference between a Monetary Economy and a Real (non-monetary) Barter Economy.
Monetary Versus Real Economy
The key distinction has been encapsulated by Karl Marx in the formulaic expressions: C-M-C’ Versus M-C-M’. In a barter economy, money is an intermediate good, a means to facilitate the exchange of real goods. Producers & consumers start out with commodities and exchange them for money. The money is then used to purchase new, different, commodities. So you start with C(ommodities), convert surplus and less desirable commodities to money M, and then use money to purchased a more desirable, higher utility, bundle of commodities C’. In principle, money can be remove from the economy, since it is only an accounting unit which allows us to measure the value of commodities on a common scale. This is why economists insist that “money is neutral”, or “money is a veil”, which obscures the workings of a real economy.
In contrast to this, in a monetary economy, producers start with money M. They use money to purchase labor and other resources required for production of commodities C. Then they sell the produced goods in order to get more money. The GOAL of trading is to make more money, and it is NOT to get a more desirable bundle of goods. Similarly, for consumers and laborers, money is used to purchase consumption goods, but it serves an equally vital role as savings for the future which provides some partial insurance against shocks and uncertainties of the labor market. So a monetary economy is characterized by M-C-M’, and money enters essentially into the picture. It cannot be removed because making MONEY profits is the goal of firms, and making MONEY savings is one of the important goals of the consumers. Furthermore, there is a lot of uncertainty about the future – in terms of prices of goods – so that the future value of money cannot be known today. This means that prices and wages are determined in nominal terms only. Real wages cannot be known today because the value of money depends on unknown and variable prices. Taking uncertainty about the future into account creates radical changes in the theory of money; however, it is not our purpose to explore this issue in the present talk.
For our present purposes, it is sufficient to realize that the Arrow-Debreu mathematization of economic theory, created models of general equilibrium which have no role for money. These are models of barter economies, or real economies. Current favorites in Macro, the RBC and DSGE, are all barter models with no essential role for money. At the heart of the Arrow-Debrovian disaster is the idea that one can BARTER commodities across time (without use of money). This idea is full of so many errors it is hard to list them all; yet, this is the central idea of conventional macroeconomic models today.
Mind-Boggling Consequences of M-C-M’ paradigm
In a monetary economy, Production is done to earn money – Full consequences of this are MIND-BOGGLING. To understand these, Consider a CLOSED Economy. Producer spend money to hire labor, buy resources, and perhaps rent land or capital goods for the production process. After goods are produced, they are sold to the consumers/laborers. If the economy is CLOSED, money does not go into the economy and does not go out of the economy. This means that AGGREGATE HOLDINGS of money do not change. PROFIT is the increase in money in hands of producers, and SAVINGS is the increased money in hand of consumers. It is a simple accounting identity that Aggregate PROFITS+SAVINGS=0. If firms/producers make profits, it must come out of consumer savings. If consumers end up with more money than they started with, the firms must end up with less. The fundamental aggregation paradox is that, even though all firms are trying to make profits and all consumers are trying to save – increased money holdings for all is impossible in a closed economy. “Prosperity” – defined as profits for firms and savings for consumers, can only occur if additional money is injected into the system from outside.
Two Sources of Monetary Growth
A key accounting identity of MMT is that
Profits+Savings = Injections of Money = Domestic Injections + Foreign Injections.
Injections of Money come from Government DEFICITS, or from Export Earnings Minus Import Expenses.
MIND BOGGLING: Aggregate Business Profits are DETERMINED by PURELY Government Deficits PLUS Trade Performance. Prosperity – measure in terms of money profits of business and savings of consumers – is determined by trade surplus (which creates foreign money injections into the economy) and by Government Deficits (which creates domestic money injections into the economy). This contradicts our strong intuitions that profits of a firm depend on its competitiveness, efficiency in production, marketing, etc. etc. All of these factors matter at the micro level of the individual firm, but NOT at the macro level of all firms in the economy.
Foreign Injections Via Trade Surplus
Of the two possible sources of monetary growth – essential for a monetary economy – MMT focuses more on government deficits. However, we will start by first consider the possibility of using a trade Surplus for growing an economy. This is exactly the policy of export-led growth. Increasing exports over imports creates foreign injections, adding money to the economy and thereby creating profits and savings essential for prosperity.
One MAJOR problem is that this is not a policy which can be universally applicable. Net export surplus must sum to zero, so if one country runs a surplus, another must run a deficit. In an ideal and balanced trading system, all countries should strive to BALANCE their trades, having roughly equal imports and exports in the long run. Thus, with a balanced trading system, the export-led option would not, or should not, exist.
However, the current Monetary System is devastatingly unfair (see: Demise of the Dollar for more details). The Petro-Dollar is GOLD. US can print arbitrary amounts WITHOUT risk of inflation. Because the ROW (Rest-of-the-World) is willing to hold MASSIVE amounts of dollars as reserves. This is especially true after the East Asian Crisis, which showed the importance and necessity of sufficient dollar reserves to prevent devastating financial crises. As a consequence, US can run arbitrarily high trade deficits. Everyone else needs to run trade surpluses to earn dollars, to use for imports AND reserves. So in this unbalanced system, an export-led strategy is a viable option, but this is far from difficult in comparison with domestic-led growth, because this is under our own control. Because of our asymmetric global trading system, MMT has UNIQUE implications for USA, similar implications for trade surplus and dollar surplus countries. The implications are RATHER DIFFERENT from dollar shortage countries, like Pakistan
For 2nd Part of talk, see: 2-Two Sources of Monetary Injections
POSTSCRIPT: For more information about our current unbalanced trading system and how it emerged, see the brief newspaper article “A Lopsided System”. For deeper understanding, see The Vital Importance of Understanding Global Financial Architecture. This explains the rise and fall of the Gold Standard, leading up to the Bretton Woods Conference, which made the dollar the king. The continuation, Understanding Global Financial Architecture Part II, goes from Bretton Woods to the Nixon Shock, where the gold-backing of the dollar was removed, and the modern system of floating exchange rates naturally emerged as a consequence. The 30m video for the talk summarized above will be linked later. The 56m video for the PREVIOUS (first) talk at SBP on MMT is linked below: