IS-LM and MMT The core issue at the heart of debates between the heterodox Modern Monetary Theory (MMT) approach and more mainstream macroeconomics is how the financial economy and the real economy interact. As a consequence we see Keynesians of various hues attempting to illustrate their response to MMT with the standard orthodox Keynesian IS-LM model of the economy, which attempts to illustrate this interaction graphically.
The IS-LM model, as elaborated by various economists after Keynes, consists of upward and downward sloping curves in income (Y) and interest (r) space. (See Figure 1) The downward-sloping IS curve illustrates the inverse relationship between the cost of physical capital (summarised by r) and GDP (Y) where investment is assumed to be the major variable in the latter. The upward-sloping LM curve is a somewhat more complex concept but essentially proposes that given a fixed supply of money, a higher Y leads to a higher interest rate on bank deposits. This interest rate is assumed to feed through to the price demanded for financial capital in such a way that it can be considered as variable r for the purposes of the model. The model is thus somewhat vague in what r is really standing for. Further criticism is that a fixed supply of money is an unrealistic concept; the quantity of money supplied in a modern monetary economy being endogenous to its demand. It is also pointed out that the model mixes up stocks (of money) and flows (of income). Despite these criticisms, the IS-LM structure has been used to characterise MMT ideas in terms of the slopes of the two curves – in its extreme a vertical IS curve (implying investment as independent from any rate of interest) and a horizontal LM curve (implying a technically unlimited supply of money).
A Matching Flows Approach A better way of approaching the real/money interaction might be to work from the viewpoint of two linked flows – that of money and that of its exchange counterparts. We start off with the economy in a steady state, with constant flows of money on one side and of real goods and services and speculative assets on the other. (See Figure 2) There is no distinction between consumer goods and services and productive capital goods in this model, since this is regarded as an arbitrary distinction between goods that have a spectrum of durability and of the timing of flows of utility and/or monetary return. What we will distinguish are goods purchased for use, and those (speculative assets) purchased for resale at (expected) higher prices.
Last year a strange bit of ‘neoliberal’ propaganda
surfaced in the New Scientist of
all places. In what purported to be a report of recent research, Washington
University psychologist Pascal Boyer has written of how the ‘human mind is
designed to misunderstand the mass-market economies we have created’.
He says ‘evidence from psychology and anthropology…reveals
that people have an intuitive mental template for how exchange…should occur’,
and that these are evolutionary in origin. This template has arisen because,
humans evolved to be highly co-operative…[a]nd our ancestors shared resources, especially when it came to goods with highly variable availability… Trade mostly took place between people who knew each other, or between groups that shared repeated exchanges. Technology was simple enough that they could track how much effort was involved in making most things, and verbal communication…was used to select the most co-operative partners with whom to do business. As a consequence, ‘we have a strong sense of fairness, and intuitively expect and prefer that the proceeds of a joint effort be shared in proportion to each participant’s contribution’. Moreover ‘we intuitively consider it beneficial to extend small favours to trading partners rather than exploiting their weak positions, because of expectations of long-term interactions.
In my last piece on Brexit I somewhat underplayed the role
of a second referendum – suggesting that it would only probably come into play
after a further general election, probably one that Labour won.
Things have moved on from then in that the negotiations
have coalesced into a deal with which, rather remarkably, neither the desires
of the ultra-Brexiteers for a clean break with Europe, nor those of the DUP for
the guaranteed absence of Irish Sea trade barriers, are satisfied. This took
some doing, and now gives Labour the potential role of maintaining a
Conservative government that otherwise might fall – one they will not, and
effectively cannot, play.
David Andolfatto recently constructed a model intended to ‘reconcile’ (or I think more accurately to distinguish between) ‘mainstream’ and ‘heterodox’ views of the macroeconomic importance of money and banking. More specifically, he wants to answer the question: does the ability of banks to ‘create money’ when they issue loans give bank lending a greater impact on aggregate demand than other forms of leverage? His conclusion is that in general it does not. I believe his model is wrongly specified to determine this question – it essentially pre-decides by its structure. To demonstrate this, I have identified the features that he omits from his model and attempted to incorporate them within the structure of the model he himself uses. My full response is in the form of a downloadable pdf. Continue reading David Andolfatto on Money and Banking→
Donald Trump is coming to Scotland. He claims a special link to this country due to his Lewiswoman mother, Mary Anne Macleod. How should we respond to his visit – is it really an unacceptable violation of our liberal democratic culture for this American President to visit the UK and Scotland in particular? Is it right to think we should protest against him?
Today Theresa May’s Cabinet are meeting at Chequers (the UK Prime Minister’s out-of-town residence) in an attempt to thrash out a final Brexit negotiating position with the European Union. As they do so, the biggest threat to Brexit seems not to be a realisation of its purposelessness, although that will surely come soon enough, but the process difficulty. This difficulty is entailed by a government reliant for its parliamentary majority on Northern Irish members who as extreme Unionists will not accept any further differentiation between rules and regulations applying between the UK mainland and their own country, as well as on extreme Brexiteers who will not stomach any residual taint of the EU single market and customs union. This sets up an irreconcilable clash with the EU’s shared commitment with its member, Ireland, who are adamantly opposed to any agreed additional barriers between the north and south parts of the island. This opposition is both a matter of historical principle, as well as a practical concern over a reinstated ‘hard’ border being a focus for re-emerging intercommunity violence. Indeed Ireland and the EU both believe, a belief that implicitly is currently shared by the UK government, that the Good Friday Agreement (GFA) of 1998 commits all involved parties to the status quo in regard to the Irish border. Continue reading Brexit Endgames→
At the root of the ‘Brexit’ mess is a possibly unprecedented act of self-serving recklessness by the leader of a government in a democracy. It is in large part one which lays bare the sham of the UK’s primary democratic process – its system for electing representatives to its governing Parliament. For some years the electoral prospects and the cohesion of the UK Conservative party have been threatened by a relatively small, but vociferous and unscrupulous cabal of individuals and groups opposed to the idea of mutually beneficial co-operation with other European countries – either because it was a proxy for a mixing of UK (read English) ‘culture’ with that of ‘foreigners’ of different ethnic or religious identity or it was a plutocratic rejection of the co-operation for setting anti-exploitation rules as a basis for national and economic competition, or in quite a few cases – both.
In the winner-takes-all electoral system created by First-Past-the-Post (FPTP) the leaking of Conservative Party support (and even Parliamentary personnel) toward the United Kingdom Independence Party (UKIP) led by Nigel Farage was not an incremental risk but an existential one. The party risked being out of power perhaps indefinitely and even being reduced to a rump of MPs with little compensatory chance of UKIP allies, as the right of centre vote became split, allowing more EU-friendly left of centre parties to dominate. The Conservative Party, having little in the way of clear principles or ideas to bind it, requires the prospect of power and career advancement above all else to unite its members – particularly its Parliamentary contingent.Continue reading The EU, Democracy and Brexit – Part 2→
This is the first of three blog posts examining the past, present and future of the UK’s decision to leave the European Union.
The Role and Nature of the European Union
The great divide in politics (and perhaps human affairs in general) is between co-operation and competition – whether between individuals, businesses or countries. The role of co-operation is to pool decision-making for a greater shared benefit, including the benefit of avoiding foreseeable future conflicts. The role of competition is to pit resources, techniques and organisational structures against each other to find the ones that work best. The degree to which one or other is favoured – even to the extent of fetishisation – tends to define political outlooks.
There are two main arguments for the pre-eminence of co-operation, all else equal. Firstly, it is potentially less wasteful – all resources, techniques and structures are focussed on common goals, whereas under competition the losing approaches may have consumed much with little useable output. Secondly any worthwhile competition requires a co-operative base – to determine the winning criteria, and to set the framework of rules that makes the result meaningful. (Note that this latter even applies to the ultimate competitive scenario – that of war; conventions generally exist to avoid the destruction of the civilisations and the planet that are being fought over.) Continue reading The EU, Democracy and Brexit – Part 1→
The eminent philosopher Harry Frankfurt has issued a small book comprising parts of two essays written some decades ago (On Equality, 2015, Princeton University Press). The stimulus to this publication is the recent work of Thomas Piketty on economic inequality in the developed countries, and Frankfurt’s view that
It is, I believe, of some considerable importance to get clear about these matters. Appreciating the inherent moral innocence of economic inequality leads to an understanding that it is misguided to endorse economic egalitarianism as an authentic moral ideal. Further, it facilitates recognition of why it may actually be harmful to regard economic equality as being, in itself, a morally important goal.
We will see however, that Frankfurt strips the concept of ‘economic inequality’ so bare as to render it meaningless more or less by definition, and that what he does regard as important inevitably brings us back to economic inequality as a highly significant issue as it manifests in the real world. Continue reading Harry Frankfurt Gets It Wrong On Inequality→
Ann Pettifor is a director of Prime Economics, which advocates for a more Keynesian view of macroeconomics, and has been involved in development and environmental economics for many years. In The Production of Money: How to Break the Power of the Bankers (Verso, 2017) she correctly identifies that ‘money enables us to do what we can within our limited natural and human resources’, and so ‘creates economic activity’ rather than being a result of it. It does this by creating the finance needed for productive employment and investment. Bank finance ensures that there is never a ‘shortage of money’ and so we are only limited by humanity’s capacity and the physical ecosystem. Yet when 95% of the money in existence has been created by the commercial banking system, whose aim (quoting Michael Hudson) ‘is not to minimise the cost of roads, electric power, transportation, water or education, but to maximise what can be charged as monopoly rent’, this power must be rigorously regulated. So much should be uncontroversial today and I have written about this here. Continue reading The Production of Money: How to Break the Power of Bankers – by Ann Pettifor→