The Bund and the Paradox of Tranquility

A joy of reading about Post Keynesian Economics is that the whole basis of the subject is that economics a) must make sense for the whole system rather than for individual rational agents and b) must be empirically observable.

It is so refreshingly correct - obvious in fact. And yet Post-Keynesian economics has been relegated to an economic backwater whilst neo-classical economics, with mathematical precision, makes a mathematically precise complete hash of understanding the bigger picture.

One of the miserable things about reading about Post Keynesian economics is that they have been broadly right for 30-40 years and yet are still generally ignored.

One idea, simple but beautiful, is summed up by Marc Lavoie's term, coined in 1986 and based on Hyman Minsky's ideas, the 'Paradox of Tranquility'. To quote Lavoie in his book 'Post Keynesian Economics' (italics are mine):

According to Minsky, a stable growing economy is a contradiction in terms. A fast-growing free-market economy will necessarily transform itself into a speculative booming economy. In a world of uncertainty, without full information about the fundamentals, a string of successful years diminishes perceived risk and uncertainty. People tend to forget the difficulties encountered in the past... As time goes on memories fade and economic agents dare to take higher levels of risk. Or else, as time goes on, the risk levels as computed by engineering models of finance, such as the very popular value at risk model, appears to get smaller because the last recession is just one remote observation among a series of more recent successful years. The longer the economy is in a tranquil state of growth, the less likely it is to remain in such a state.

This was intended as a description of the equity market, but it could recently be also applied to the government bond market. 

What this paradox states is that a long period of growth with low volatility will, by its very nature, eventually lead to a crash. That the low volatility, rather than a signal of low risk, is a signal of overconfidence and thus is a signal of high risk when the confidence suddenly disappears.

I was reminded recently looking at the German government bond (Bund), which was for a long time seen as a one way bet. This is the Bund performance until April this year:

Up 19% , with 14.5% annualised returns on a 3.7% annualised volatility. The steadiness of this rise is exceptional.

Meanwhile, this was happening to the one year realised volatility since 2012:

At this point, FT Alphaville, who considered this a bubble, were running a competition to guess the date that Bunds would reach negative yields (for the record they reached about 0.06% positive yield). 

The assumption that the ECB would buy back the Bunds from you whatever the price (up to a negative 20bps yield) led to overconfidence. Narratives of pension funds forced to buy this debt even at negative yields made this a greater fool theory play (although unusually the greater fool was largely a Central Bank here).

Of course, as Lavoie states above, the longer the market appears to be calm the less likely it is to remain that way. As was found soon after:

The nature of the unceremonious crash of the Bund was not a surprise to anyone who regularly observes the behaviour of markets. All of the hedge funds that had amassed large positions now had to get out of their positions at the same time. Consensus was slow to build up but quick to reverse.

What is in store for the Bunds in future? I don't know. I don't believe that the economic growth that we will see in Europe will facilitate large rises in yields (falls in price) for a while. I may be wrong - I am not an expert here.

To me this was just an interesting example of how Post Keynesian economics has got it right and Neo-Classical economics, based as it is on efficient markets, can not explain the real world in anywhere near as realistic a manner.

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The Supremacy of Savings in our Economic System

When a politician says something along the lines of this:

People who have worked hard all their life, done the right thing and saved up money; they deserve to have the rewards of that now and they should not be penalised for having done the right thing and saved.

it is very difficult to disagree with this logic. What kind of wrong thinking person would deny the hardworking people the chance to enjoy the fruits of their hard work?

However, I am about to make the wrong thinking case...

To make my argument, the first point I need to make is about the nature of savings. What are they? Note that these people who saved up did not squirrel away food or fuel or kitchen appliances or holidays or any actual fruits of their labour. What they saved was money, which in the end is just a number on a computer screen. 

And what is money? It is an IOU from the people of the future to provide services to the holders of that money. Therefore what savers actually hold are large bundles of IOUs.

Over the past 40 years, the amount of debt has risen exponentially. Private sector debt (mortgages and corporate debt) has risen on average about 10% of GDP per year in developed economies. What does this mean? More savings every year. As soon as someone takes out a mortgage and buys my house, I have money in my bank account that didn't exist before (someone has a debt against that but it is a mortgage against a house). So the amount of savings has grown exponentially too.

So the IOUs from people in the future to people in the past have got larger and larger. The wages share of GDP has shrunk by around seven percentage points. Rents as a proportion of income have risen. The current workers are struggling to service their debt to past workers. I discuss this more here. Young people today are saddled with far more of a burden than anyone in the recent past.

An economic system must divide up the production of the economy between the people who live in it. Therefore, assuming that the amount produced remains the same, the politician above is arguing that savers deserve more of it than workers.

So, put another way, what the politician above is actually saying is this:

People who work hard in the future and do the right thing do not deserve to receive a fair proportion of what they produce because they should give most of it to savers who worked hard in the past.

In policy terms this means that savings are always protected. If banks go bust, savers are protected by the taxpayer and workers must pay. If there is a trade off between inflation and growth, inflation is kept low. 

The economy is crying out now for more money and more inflation. But printing money is seen as an attack on savers and therefore is not even considered as an option (I do not count quantitative easing as genuinely printing money as it is just a temporary swap for existing debt).

Savers have been given this primary position in the economy. They must get their money no matter whether or not the workers are reasonably able to pay them. It can be seen in the Eurozone crisis. It can be seen in the economic stagnation in the UK and other Western economies.

So the incentives are completely misaligned. Instead of having an economy where hard work and productive investment is rewarded, we now have a rentier capitalist economy where low risk and rent-seeking are rewarded. This is not capitalism as it was supposed to work.

And the cost of this I have discussed here, here and here among other places. The money from economic activity in this rentier economy is largely going to people with a lower propensity to spend (pension funds, high net worth individuals etc) and the effect on the economy is to reduce demand below an equilibrium level necessary for the economy to grow.

Young people today are entering a workforce where skilled jobs are hard to come by. High achieving university leavers are working in coffee shops. Zero hours contracts are the norm. Uber type contracts, where pay is low, competition is high and the risk is all on the individual, are seen as a necessary way to get by. The power has swung from workers to savers because no politician could countenance increasing demand by reducing the value of savings.

Until we can rebalance this position we are going to continue having a stagnating economy fuelled only by the taking out of even more private sector debt. Until, of course, we can't any more because we have another crisis. Then this might happen.

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Two Possible Outcomes When Savings Rates are Too High

In previous posts, I have described a Stocks and Flows model which attempts to model the interaction between workers and savers in an economy.

I have built a very simple version of this model in order to simulate economic outcomes. As I make clear in a previous post, I don't believe that non-linear models such as this can be used to make measurable predictions (eg. what will GDP be next year). However, as Steve Keen has showed, these models are very good for getting an idea of economic dynamics. 

Anyway, I have modeled a very simple economy with various simplifying assumptions all of which can be modified. I have kept it as simple as possible to capture the essence of the dynamic. Some of my assumptions are as folows:

• The economy does not grow (this can be adjusted by putting an investment coefficient in to the model and assuming returns on investment).
• The coefficients of spending all stay constant. There is no change in a recession/boom.
• Corporate profit share stays constant
• Debt can not be defaulted upon
• Interest rate stays constant
• Taxation is ignored
• And many many more

In this simulation, potential GDP (that is GDP at full employment) is 1. The economy can adjust to a lower GDP through deflation so, at an equilibrium lower than 1 we can still have full employment. The adjustment would presumably be painful though.

The equilibrium is the point at which GDP stays unchanged and debt does not increase or decrease - in other words, the saving for the future exactly matches the spending of existing debt.

My simulations here are of an economy where the savings rate is too high. In other words people are spending less income than they are receiving. In order to stop the economy declining, the government here increases private sector debt and government debt. This is similar to what has happened in the Western economies over the past 40 years.

Because each year the debt has gone up, so too do the interest payments. Because the marginal propensity to spend of the receivers of interest payments (eg pension funds) is much lower than that of the payers (the workers) this increases savings further.

In the end an equilibrium is reached where the total new savings from income are matched by the amount of existing savings spent. If the debt is very large, then the workers' share of income will be lower, but the pensioners' spending will make up for the workers' low consumption.

However, in order to be consistent with reality, I am putting in a limit on the total amounts of government and private sector debt. At this level, I assume that no more money will be lent. I have set these as both 250% of GDP. At this point the credit line stops but existing debts must still be serviced.

In this simulation, there are two possible broad scenarios. The benign scenario is one at which equilibrium is reached below the debt limit. This is shown below:

Good-ish Scenario:

The total debt levels off at around 400% of GDP. At this point the spending of existing debt exactly matches the savings from income. The economy is running at full capacity.

However, this benign scenario assumes that the equilibrium level can be reached before we hit the debt limit. What if we hit the debt limit before the equilibrium level is reached? This scenario is not so great. 

Bad Scenario:

As the 'debt ceiling' is hit and the savings rate is still too high, GDP starts to decline. This makes paying back the debt harder and so the next month GDP declines further. This continues until a new equilibrium is reached here at 50% of capacity.

In this scenario, public and government debt levels to GDP rise as GDP collapses. Interest payments as a proportion of GDP rise and the workers share of GDP collapses.

Eventually the economy finds a new equilibrium, but it is one in which the workers are effectively slaves of the savers and it is one where deflation, unemployment and depression will continue for a long time until the new equilibrium can be found.

And note that this contains no extra saving during a depression or overconfidence in a boom which many models suggest will also occur. This is just the result of the dynamic between savers and borrowers.

Is this scenario ridiculous? In an economy where no new money can be printed (see the Eurozone), where debts can not be defaulted upon and where no new money will be lent, it is actually difficult to see another scenario. Greece's trajectory in fact, has not been too different from this.

So the question for us is, have we hit the equilibrium yet or are we still net savers? Taking the UK as an example, Simon Wren Lewis presents the following graph of net national disposable income per head since 2008.

As can be seen, we have had no growth. But at the same time the government has been running net deficits of on average 6 % of GDP:

This suggests that there is a natural shortfall of demand in the economy that requires further borrowing to fill. On top of this, we have had zero interest rates and programmes such as Help to Buy which have encouraged private sector debt and raised asset prices.

If the economy requires all of this help to stay flat, I fear that our problems are of the deeper kind, and that we are closer to scenario 2 than scenario 1.

There is a solution though...

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Debt Causing the Stagnation; Demonstrating A Missing Empirical Link

A few weeks ago I wrote this post which showed the results of my empirical study on the effect of private sector debt on the economy. It found that a 10% increase in the level of private sector debt corresponded to a 0.15% decrease in GDP growth every year going forwards. Considering that the levels of private sector debt in many advanced economies is around the 200% level, this is a pretty big drag and on its own would explain the current secular stagnation.

I then formulated a simple model which gave a possible mechanism which could explain how debt is responsible for the lower GDP growth. 

This post here will provide further empirical evidence that the model represents a reasonable hypothesis. I realised that I started with the idea of debt causing stagnation, and then assumed that it was due to a reduction in workers share of income and that this caused the stagnation. However, on reflection, I realised that I had not empirically shown the intermediate part - that there has been a decline in workers share of GDP.

I will summarise this model here briefly. I divide the economy into 'savers' who have invested money in bonds, property, shares and put it in the bank, and 'workers' whose work in the future will pay the savers dividends, rent and interest from their future work. By definition, all value of savers savings comes from work done by people in the future. If the workers decided not to work then the savings would be worthless. 

There is nothing wrong with saving; it is an important way of transferring consumption from the present to a time when it is needed in the future, for example old age. However, my thesis is that the rise in debt - which is matched, as an accounting identity, by an equal rise in savings - has made the amount owed by the workers to the savers too high. Because of debt there are now too many savings.

Now, this would be fine for the economy (if harsh on the workers) if the savers spent the same proportion of their income as the workers. However my argument is that the marginal propensity to spend of the receivers of dividends, interest and rentals is much lower than the marginal propensity to spend of the workers who pay it (either directly or indirectly).

So I argue that the situation we are now in is one in which too much money is diverted from the workers to the savers. Workers today are burdened by corporate profit share of GDP that is very high, with interest payments on a huge amount of debt and with rental payments that are very high. This drains demand from the economy as the money is diverted to people likely to save it. 

If the savings in the economy go up then one of two things must happen. Either more debt must be taken out (either by the government or the private sector), or the economy will decline and unemployment will result. 

For the past 30 or 40 years debt has been rising on a huge scale. This has helped growth when it was taken out, but cost in the future. The rising cost had been masked, up until 2008, by even more debt and everyone was happy (with a few exceptions). Now we have reached a stage where we can't take out much more private sector debt, governments are reluctant to spend more and developed economies are in a stagantion. Even with share prices at all time highs, in many countries the economy only just stays in growth with large government deficits.

So this is where we are now. The liabilities of the workers to the savers are too high for them to afford. And the cost to the economy is that we can't get growth any more without further debt.

My model explains the empirical link between rising private (and public) sector debt and slowing growth. But I realised that I hadn't checked the intermediate points.

Specifically for the model to be correct, the following must be true:

1) Increasing private sector debt causes an increase in liabilities from workers to savers.

This would appear at first glance to clearly be true. The lower interest rates we have seen recently will reduce the servicing costs but even now, a lot of private sector debt is at as high real interest rates as ever.

2)  Therefore the workers share of GDP should go down.

I realised that I had not checked this empirically. The point of this post is to look at empirical evidence which shows that this is true.

3)  The marginal propensity to spend of the workers is higher than the savers

This is almost certainly true. Average workers (with fewer assets) tend to spend 90% of their income. Richer people spend closer to 50%. The super rich, much less. 

4) This shortage of demand is the main reason for the stagnation

The main argument I have for this is that empirically the cost of debt appears to be so high. And on its own it, if this were further verified, it could explain the entire stagnation we are suffering.

So for my thesis to be true, it would be necessary to show that 2) is true. That the workers share of GDP has come down. I realised that I have not shown this so I did some searching.

The first port of call was the St Louis Fed Fred database. Here I found the following graph for the US.

This is a remarkable graph for a number of reasons. The first is that it shows that the percentage of wages as share of GDP has gone down from around 50% until the mid 1970s to around 42.5% today. The greater corporate interest payments caused by corporate debt must have taken a large proportion of this. 

This is very important as it is verification that the thesis I put forward does hold in practise.

On top of this, the graph is interesting because they have shaded the periods of US recession. You can see that every single one of the last 10 recessions coincided with a drop in the value of compensation to workers. 

Looking on the internet, this pattern is repeated across the world. There are different ways of measuring but in every case I have seen there is at least a 5% reduction in GDP share to the worker.

But this is not even the whole story. This shows lower share of GDP going to the workers from their employers. But then even when the money arrives they still have to pay rent and interest on their houses and consumer credit. 

Martin Wolf states in a recent piece on the UK election that 70% of net bank loans outstanding are to individuals secured on property. What is the result of all this credit? House prices have rocketed. And because of the unaffordability of housing, most young people are forced to rent which has driven up rents. 

This piece of research shows how rents in the US have gone from just over 20% of income to almost 30% of income in the last 35 years.  This means that of the 42.5% still going to employees, an extra 10% is still going on rental. And in the UK the situation, due to planning restrictions on house supply is worse. This reliable source suggests that the proportion in the UK is 50%. For those not from the UK it is not a reliable source, but it does show the problem.

Yet another consequence of the rise in debt is that the banking sector becomes a lot larger. As intermediaries they take a spread on the debt between borrower and lender. This estimate suggests that the banking sector takes 9% of GDP. A reasonable proportion of this will go to highly paid employees with lower propensity to spend.

If we try to calculate the difference between the situation in 1970 and that now, making a lot of assumptions, we get the following:

Assumptions:

Marginal propensity to spend of savers and rich bankers is 40% lower than workers.

Financial sector bounty to bankers in 1970 was negligible

Rental was 20% of earnings in 1970

Housing costs have risen by 10% of income for everyone, including owners

Tax is ignored

Too many more to list, but this is only a rough estimate 

Share of GDP to workers not including very highly paid financial sector, after housing costs:

1970: Total to workers minus rental: 

50.5%*80% = approx 40%

2014: Total to workers minus rental minus 4% to banking/financial sector rich people:

42.5%*70%-4% = approx 26%

Cost to the economy in lost demand:

Difference in marginal propensities to spend times difference in share of GDP:

40%*14% = approx 5.5%

This is obviously very back of the napkin but you can see the potential cost in demand. Every year savings are 5.5% more than equilibrium (assuming equilibrium in 1970).

This saving has to be compensated for by either a rise in private sector debt, an increase in government debt or unemployment. This is, I believe, the problem the economy is currently facing. And it is all caused by debt.

I will end, as usual, with a restatement of my belief that we need to print central bank money slowly to spend and invest in the economy, stimulate growth and inflation and reduce the real burden of all the debt we have amassed.

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Is Technology Taking People's Jobs?

There has been a lot of comment recently, especially since the publication of 'The Second Machine Age' by McAfee and Brynjolfsson, about whether the robots are taking over. Citing examples of how technology can replace human input, the fear has been expressed that technology will increase the share of income going to capital and reduce the share going to labour.

In the extreme version of this scenario, robots are doing all the jobs and there are very few left for humans - the few jobs being for the people who program the robots. In this future of idleness, one would have to imagine a new way of splitting the fruits of the non-labour in order to allow humans the money to consume the bounty created by greater technology.

The recent decline in labour participation rate, coming at the same time as a rise in information technology has added to this fear. Computers replacing check-out operators in supermarkets, computers replacing check-in personnel in airports and cheque receivers at banks being replaced by online payments. Professions relying on higher education levels are no longer immune. Computers are replacing financial advisers and medical staff. You can find lists of jobs most likely to be replaced by robots, bizarrely the most likely one being telemarketer (who doesn't hang up straight away when a recorded telemarketer rings?).

Talk in the tech sector is of disruption. Everyone is looking for the next Uber of chest waxing (just press a button on your app and someone will be round to depilate you in minutes) or similar but slightly more realistic ideas. The basic idea is to use technology to enable cheaper entrants to established markets, with the cheapness based on workers who are prepared to work for less money with no job security. A future where the labour force is self-employed, always undercutting the competitor to get work and living with fear of not being able to pay next month's rent awaits us. Meanwhile the cool guys in Silicon valley take 20% for themselves and charter helicopters to have dinner in Napa.

It all sounds pretty dystopic to me, but I would like to offer a counter argument. That the long term fears that we have for the economy are based purely on the terrible economic situation that we have at the moment. Superficially unemployment is low, but this masks the people working part-time and zero-hours who wish to work full time. It masks the fall in participation rate by people leaving the labour force. And more than that, if you look at wages, it shows how people have been pushed into the bottom end of the labour market in jobs that could be done by a machine but are not because labour is so cheap. In fact, we have a real deficit of demand in the economy.

I believe, as I argue here, that this low demand is caused not by technology improvements but by debt overhang causing rent extraction which sucks demand out of the economy. I also believe that we have a way of solving this problem. But that as things stand we are going to suffer from chronically low demand for a long time.

What happens when there is chronically low demand? People who want to find work can't find work and often end up having to work part-time, zero hours on unpaid internships or whatever it takes to get by. Blame for this is then placed on immigrants or technology or scroungers whatever the fashionable scapegoat-du-jour is. 

But I feel that the whole 'Technology taking jobs' argument is a big red herring. I heard recently of an example where robots can now take blood for patients meaning that blood taking nurses are now redundant. Well, this is fine, but also I would like to wait less than three hours when I go into casualty with my kid - maybe the nurses can be put to use on other jobs that also improve patient care. Bank branches are closing down, replaced by online banks - bank tellers are made redundant. But at the same time, I can think of hundreds of ways that I could get better service in other areas. The tube could be less crowded - a better transport system could be built. Libraries are being closed. Youth clubs closed. Mental health charities could be given more funding. More carers are needed for the elderly and disabled. 

There are so many ways that life could be improved if the money was there to pay to give people jobs who do not have jobs. And many of these, machines can't replace. So I think that there will always be jobs available. It is just a case of using resources correctly - or in other words not having so much unemployment.

And the whole success of Uber (and similar) is based on people's desperation for work. If demand were high enough that everyone had jobs, then the dystopic vision of an Uber future will not become reality.

If we, as a society can effectively manage demand in a way suggested here then any savings caused by dividends accruing to the owners of the robots is negated by an increase in money supply elsewhere. We need not have unemployment and we need not worry about the future of robots taking over, but instead look forward to a future where more of our needs are taken care of.

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A Discussion on Criticisms of Modern Monetary Theory

I think that it is always good to be honest about one's shortcomings. I am not, by profession, an economist. The amount that I don't know about the theory of economics outweighs the amount I do know by orders of magnitude.

Why do I think I can make a contribution to the debate then? Because what I like to think that I am good at is simplifying systems, and the economy is just a system. And it is a system that is not working, and I think that I can see some of the reasons for this. Maybe in some ways it helps to be able to look at things without the framework that is already in place. I am not suggesting that someone with as little experience as me will have all the answers, but I do think that I may be able to help by prodding with some of the right questions.

Yesterday, I had a slight argument in the comments section of a post on Simon Wren Lewis's truly excellent blog. I am slightly embarrassed by this as he (and the fictional PK) clearly know a lot more than me and who am I to criticise? 

However, I do feel that in all of his explanations of the development of the UK economy post 2008, the issue of debt overhang is lacking. He compares the recovery from this downturn to the recovery from every other recent downturn as if they were equivalent and therefore it is solely the fault of government austerity (which I also agree with Simon  has been an economically illiterate policy). 

But in my opinion, the reason why this recovery is so different from the previous ones is that we have suffered from 25 years of monetary economics leading up to this. JK Galbraith famously said, in reference to Milton Friedman advising the Israeli government, "Any country that has Milton Friedman as an adviser has nothing to fear from a few million Arabs." Galbraith was right, but it took until 2008 for this to become apparent and still I feel that the lessons have not been learned. Private debt levels (and thus inequality) have risen to unprecedented levels.

In this post here I discuss the empirical cost of the debt - I believe that a 100% of GDP reduction in private sector debt would result in an extra 1.5% growth in GDP every year. It is difficult to overstate the significance of this, if it turns out to be true. 

In this post here, I explain the mechanism by which conventional monetary policy in the last 30 years has led to an economy with too high a rate of savings to support growth. The model explains the rise in inequality and the current secular stagnation and how it is all part of the rise of private sector debt.

Because of the debt overhang, the amount of borrowing that the government would have to do to get back to a normal trend growth is completely unsustainable. The private sector savings rate every year (due to interest payments and dividends being too high compared to wages) is so high that for the government to compensate it would have to keep borrowing too much indefinitely. Eventually the debt levels would get too high and then we would really be in trouble.

In any case, the reason I bring up my shortcomings is that after writing my previous post on why unemployment is a failure of the economic system I discovered that there was already a school of (hetereodox) economic thought saying exactly the same thing. To those more knowledgeable in economic thought than myself it will be obvious that this is Modern Monetary Theory (MMT).

I also read some criticisms of MMT on Wikipedia, which are therefore criticisms of my proposal, and wanted to counter them. My proposal was based purely on conclusions from my model of flows and what I wish to show is that actually there is no reason to think that economic management by trying to get the right level of private sector debt is in any way preferable to actually printing new money.

Just to briefly recap on my model, which is loosely based on the idea of Godley and Lavoie but with the economy divided into savers and workers, rather than into sectors.

The savers have savings, which are divided into Central Bank Cash (for which no-one in the economy has a liability), Equity (including houses etc.) and Debt. The liability to pay for all of this is on the future workers. The savings of the savers have no value at all unless the workers of the future will pay them. The workers of the future owe the savers dividends (including rental) and interest.

Because the marginal propensity to spend of workers is considerably higher than that of savers, when the dividends and rental are too high a percentage of income then the savings rate goes up and demand goes down.

The problem at the moment, as I see it is that we have a huge amount of debt. The amount owed by current and future workers to savers is too high to be sustainable by the economy and still give economic growth. I call the sustainable level 'Reasonably Serviceable Future Liabilities' (RSFL). I believe that the current level of liability of the future workers is much higher than the economy can cope with. 

The current situation looks like this:

And my proposed solution is slowly printing more central bank cash until the ratio of central bank cash to debt goes to a more reasonable proportion - thus making the future liabilities more serviceable - this would look like this:

For more details on how this works, please see the original post.

Now, the flows model is what determines nominal GDP and links one year of stocks to the next. It is discussed in full here, but the basic idea is that (starting with a closed economy - it can be extended) nominal GDP can be given by the following equation, where α is the coefficient of spending, d is total dividends (including rentals), i is interest, w is wages, L is new loans created, C is new central bank cash, ES are existing savings and γ is the proportion of existing savings spent in the year:

GDPt = αd*d + αi*i + αw*w + αL*L + αC*C + γ*ES    (1) 

The unspent income is given by:

UI = (1-αd)*d + (1-αi)*i + (1-αw)*w + (1-αL)*L + (1-αC)*C - γ*ES

The New Savings (NS) in this system are given by UI minus the transfer of existing savings to the non-spenders. Note that previously in the post, I equated UI with NS which I now realise was missing out the transfer from current savers.

The problem that we have is that, given that αw  is higher than αd and αi , then wages are too low compared to dividends and interest. Alternatively, γ is too low to compensate. In any case the unspent income component, not including the creation of any new money is:   

UI without new money = (1-αd)*d + (1-αi)*i + (1-αw)*w - γ*ES 

If UI without new money is greater than zero, then, without new money, nominal GDP will go down. 

And because of the burden of interest and dividends, compared to wages, being too high, this is happening now. And the larger the debt is, the higher the interest payments and the higher the unspent income rate will be (unless we could find a way to increase γ).

Assuming that we are targeting real GDP growth of 2% and inflation of 2% then we actually need more money in the system. 

During the era of Keynesian economics for 30 years after the second world war, the government would regulate the economic growth by using debt issued by the government. This is generally cheap to finance and so does not leave much of a burden in interest payments. In good times the government would not run a deficit and growth would be allowed to reduce the real burden of the government debt. In this time, modern monetary theory and standard Keynesian theory were effectively the same thing.

However, in the past 30 years, economic growth has largely been regulated with private sector debt. This, as I show in my post here is a much more inefficient way to stimulate the economy. It has led to huge debt build up and high levels of inequality. The burden of the debt weighs on the next year's economic growth and more debt is required to keep up growth. This positive feedback loop was able to continue until the crash in 2008. And now we are in a stagnation caused by this.

I argue that since we can't increase new loans as the cost is too high, the only way to put money into the system is to increase the new cash.

This, to me, appears to be basic mathematical logic. More money is needed. We don't want more debt. What else can we do?

Looking at the equation, there are other options. One would be attempting to increase the spending of existing savings, maybe with a wealth tax. Another might be to try to force interest rate reductions on to credit card companies, banks and pay day loan companies. A higher income tax at higher levels of income would lead to more government spending and the coefficient of consumption for this may be higher than that of the richer people.

But the overwhelmingly more obvious, simple, and easy to control is the printing (and taking away) of new money.

So I wanted to look at the criticisms of this idea.

I have taken the Wikipedia entry on criticisms:

MMT has garnered wide criticism from a wide range of schools of economic thought, both for its analytical content and its policy recommendations.Fellow post-Keynesian economist, Thomas Palley argues that MMT is largely a restatement of elementary Keynesian economics, but prone to "over-simplistic analysis" and understating the risks of its policy recommendations.^[25] In a later article, Palley criticizes MMT for essentially assuming away the problem of fiscal - monetary conflict and rebukes the MMT claim that old Keynesian analysis doesn't fully capture the accounting identities and financial restrains on government that can issue its own money; Palley shows that these insights are well captured by standard Keynesian stock-flow consistent IS-LM models, and have been well understood by Keynesian economists for decades. He argues that the policies proposed by MMT proponents would cause serious financial instability in an open economy with flexible exchange rates, while using fixed exchange rates would restore hard financial constraints on the government and "undermines MMT’s main claim about sovereign money freeing governments from standard market disciplines and financial constraints". He also accuses MMT of lacking of a plausible theory of inflation, particularly in the context of full employment using their proposed 'Employer of Last Resort' system, a lack of appreciation for the financial instability that could be caused by permanently zero interest rates, and overstating the importance of government created money. Finally, Palley concludes that MMT provides no new insights about monetary theory, while making unsubstantiated claims about macroeconomic policy, he argues that MMT has only received attention recently due to it being a "policy polemic for depressed times". ^[26] 

Marc Lavoie argues that whilst the neochartalist argument is "essentially correct", many of its counter-intuitive claims depend on a "confusing" and "fictitious" consolidation of government and central banking operations. ^[27]

New Keynesian economist and Nobel laureate Paul Krugman argues that MMT goes too far in its support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing.^[28]

Austrian School economist Robert P. Murphy states that "the MMT worldview doesn't live up to its promises" and that it seems to be "dead wrong". He observes that the MMT claim that cutting government deficits erodes private saving is true only for the portion of private saving that is not invested, and argues that the national accounting identities used to explain this aspect of MMT could equally be used to support arguments that government deficits "crowd out" private sector investment.^[29] Daniel Kuehn has voiced his agreement with Murphy, stating "it's bad economics to confuse accounting identities with behavioral laws [...] economics is not accounting."^[30]Murphy also criticises MMT on the basis that savings in the form of government bonds are not net assets for the private sector as a whole, since the bond will only be redeemed after the government "raises the necessary funds from the same group of taxpayers in the future".^[29]The chartalist view of money itself, and the MMT emphasis on the importance of taxes in driving money is also a source of criticism.^[27] Economist Eladio Febrero argues that modern money draws its value from its ability to cancel (private) bank debt, particularly as legal tender, rather than to pay government taxes.^[31]

I would say that many of these criticisms are based on an assumption that the status quo is a good system and that there is some danger in changing it. I would argue from the opposite side, that the status quo is a dangerous system and that people are unaware of the dangers in the current system.

Palley argues that MMT is a restatement of Keynesian economics. I would agree with this, but would argue that it is a necessary one when the traditional tools of Keynesian economics are difficult to use (ie. when the government debt level is already very high and people are, rightly or wrongly, scared of more public sector debt). 

I would actually argue that there is virtually no difference between this and standard Keynesian theory except that this system does not have any interest costs to the government (and hence the future workers). The government is basically allowed to borrow at zero interest and it only needs to repay if it is economically reasonable to do so. This is completely sensible and in no way more destabilising than the current system, if used correctly.

For this reason, I think that criticisms of policy recommendations or instability or danger of deficits or inflation could all be applied to the current system. At the moment, the central bank tries to control how much private money/debt is created using interest rates. Instead it would do the same with public money.

This system would need to be executed sensibly and methodically by the central bank, attempting to maintain an increase in money spent each year of 4% (2% growth plus 2% inflation). If this is done reasonably well (and there is no reason to think it would not be - the central bank currently does this with interest rates which is a more indirect method) then the control over the economy and inflation should be better than the current system.

To reiterate, there is no more risk of high inflation with a sensibly executed MMT policy than there is with the current system. In fact, due to the direct effect of printing money, rather than the second order effect of using interest rates to try to control private creation of money, I would argue that there is less risk.

In terms of crowding out private sector investments, I think that Murphy's idea is a theoretical and bogus argument similar to the 'confidence fairy' argument that austerity would bring growth. In bad times, when people are spending less, the government would spend more/tax less. In good times they would spend less/tax more. The good and bad times here are exactly when the private sector would be reinforcing this cycle with expansion and retrenchment of their own. This is why Keynesian theory is so important.

Kuehn's argument that accounting is not economics seems very flawed to me. Of course economics needs to have accounting identities. Everything must add up correctly - it is impossible for it not to. Any economic system which ignores accounting identities needs to be seriously questioned.

Overall, I feel that the case for modern monetary theory to take over from the (very similar) standard Keynesian approach is very difficult to logically refute when you look at the accounting identities and the stocks and flows in the economy as they are.

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