Lessons for Corbyn in “Lerner’s Law”

I’ve seen a couple of references to “Lerner’s Law” on Twitter in the last couple of days and thought “What’s that?”. Before anwering this question, let’s wind back a bit.

Who is Lerner?

Abraham (Abba) Lerner was a Russian-born British economist, who, writing in the 40s and 50s developed a theory he called “functional finance“. JM Keynes was aware of some of this work, and there is evidence he agreed with much of it. Unfortunately Keynes died before really exploring Lerner’s ideas. If he had, maybe what we think we know about “Keynesian economics” would look a lot different today.

Lerner’s functional finance is a key plank of what is today called Modern Monetary Theory (MMT), and it was one of MMT’s key figures Warren Mosler who I first saw mention “Lerner’s Law”:

So what is Lerner’s Law?

I’m not sure it’s actually known widely as such, but what Mosler alluded to was a passage from Lerner’s 1951 work “Economics of Employment”. Bill Mitchell quotes this passage in his latest book “Eurozone Dystopia”. I found the relevant section here. Bill writes:

“Lerner’s work also contains a very clear message for progressive thinkers who are reluctant in the current debate to think outside of the confines that the neo-liberals have created. For example, Labour politicians in the United Kingdom confront the austerity debate with claims that they would ‘fix the budget’ over a longer time period to avoid the massive damage that immediate austerity brings. Of course, even debating the ‘health’ of the fiscal position in terms of some financial ratios is ceding ground to the conservatives, ground that is illegitimate. Lerner (1951:15) called progressives who argued in this way ‘proponents of organised prosperity’ and argued:

A kind of timidity makes them shrink from saying anything that might shock the respectable upholders of traditional doctrine and tempts them to disguise the new doctrine so that it might be easily mistaken for the old. This does not help much, for they are soon found out, and it hinders them because, in endeavoring to make the new doctrine appear harmless in the eyes of the upholders of tradition, they often damage their case. Thus instead of saying that the size of the national debt is of no great concern … [and] … that the budget may have to be unbalanced and that this is insignificant when compared with the attainment of prosperity, it is proposed to disguise an unbalanced budget (and therefore the size of the national debt) by having an elaborate system of annual, cyclical, capital, and other special budgets.

Progressives should first and foremost seek to educate the public about how the economy and money actually operate and what opportunities the government has to act on our behalf to advance our wellbeing. If we think in this way, then options that have been constructed by the neo-liberals to be ‘dangerous’, ‘radical’ or ‘taboo’ will start to appear reasonable and grounded in reality.”

So simply stated, Lerner’s Law would be something like “If you try to present your ideas cloaked in the language of you opponents, it will do your cause great damage”.

This offers a lesson to Corbyn and his supporters. Corbyn has manfully tried to present policy ideas that currently sit outside what is thought ‘possible’ within the current orthodoxy. He has done so though while trying to present himself as being enthusiastic about balancing the budget, or at least the ‘current’ budget. He has also talked about how he would ‘pay for’ his policies by raising taxes on the rich. Both of these are examples of disguising ‘new doctrine’ as old as Lerner wrote, and leave him open to attacks from those holding on tight to the old.

Mosler, in his Tweet embedded above invokes Lerner’s Law to criticise the idea of “People’s Quantitative Easing” as proposed by Richard Murphy and adopted by the the Corbyn campaign. It takes an idea that is actually quite revolutionary (Overt Monetary Financing), and cloaks it in the language of something that was on the unorthodox edge of current orthodoxy (Quantitative Easing). This has opened it up to all kinds of criticism (for example the recent FT letter signed by 55 economists).

When it’s suggested that ‘progressives’ should adopt different language to try and explain alternative policies, it’s sometimes replied that this is a hopeless cause as the current orthodoxy is so ingrained in the public’s minds. Lerner has an answer to this (quote also referenced from Bill’s book):

The scholars who understand it [the “new doctrine”] hesitate to speak out boldly for fear that the people will not understand. The people, who understand it quite easily, also fear to speak out while they wait for the scholars to speak out first. The difference between out present situation and that of the story [The Emporer’s New Clothes] is that it is not an emporer but the people who are periodically made to go naked and hungry and insecure and discontented – a ready prey to less timid organisers of discontent for the destruction of civilisation.

Let’s speak out!


Smaller state ≠ smaller deficit

A lot of the commentary around the recent Autumn Statement has been around how the plans to move the government’s budget from deficit to surplus over the next 5 years will involve cuts and a rolling back of the state to 1930s levels of expenditure.  This doesn’t make a lot of sense to me however, because lower government spending as a proportion of GDP does not mean the deficit would be lower. You can just as easily have a 5% deficit with government spending 50% of GDP as you could if they were only spending 35%. The two just aren’t related. For example, Denmark’s government spends about 57% or GDP, but has a budget deficit below 1%. The US government on the other hand spends about 40% of GDP, but has a deficit of over 5%.

It’s probably not possible (even if it were desirable to do so) for the UK to reduce its deficit for the foreseeable future. It has a large trade deficit because countries like Germany, China and Japan have based their economic strategy on exports, so to really cut its deficit, the UK would have to rely on the private sector (households and businesses) taking on more debt. This could work for a while, but as recent history shows us, it’s not really a sustainable economic model. We would probably crash again before the budget was balanced.

So what is this talk of massive cuts all about if it’s not about the deficit? It’s already transparent to many, but it seems to be about ideology. Proponents of a smaller state have given up trying to argue for this on its merits and are instead trying to frighten people into accepting cuts. Will this work? I think not because even if the public did accept further cuts, it’s not a strategy that’s likely to create a smaller state, rather one with worse public services with the cracks being covered by expensive sticking plaster solutions. To really shrink the state would require those in power to forget about the deficit and introduce some huge tax cuts at the same time as spending cuts.

The size of government should be a political question, not a numbers game. What services should the government provide and what should be left to the private sector. Warren Mosler puts it well in his book:

“…the way I see it, we first set the size of government at the “right” level of public infrastructure, based on real benefits and real costs, and not the “financial” considerations. The monetary system is then the tool we use to achieve our real economic and political objectives, and not the source of information as to what those objectives are. Then, after deciding what we need to spend to have the right-sized government, we adjust taxes so that we all have enough spending power to buy what’s still for sale in the “store” after the government is done with its shopping. In general, I’d expect taxes to be quite a bit lower than government spending, for reasons already explained and also expanded on later in this book.”


What a Good Economy Should Look Like

I came across this video earlier today and thought it was worth sharing. It’s an audio extract from a longer talk given in Italy by Warren Mosler, who is one of the founders of Modern Monetary Theory (in the same way some bands are big in Japan, Mosler is big in Italy!). Mosler describes in one minute what a good economy should look like, and in light of George Osborne’s announcement today of his ‘commitment’ to full employment, it seemed apt. Does his description sound remotely like what we have today? I think not! The full video and transcript are here.

Another way to think about government debt

The Tory Party conference is coming up, so expect to hear lots about how they literally saved the country from becoming like Greece, tackling the deficit head on and paying down Britain’s debt. The reality’s a little different though. Mercifully, and despite their better efforts, the deficit has remained high, as the government’s cuts have been offset by higher welfare spending and lower tax take. The high deficit seems to be supporting the economy just enough to allow a weak recovery at the moment. The national debt however, continues to grow.

All the main parties want us to fear government debt and play on our wish for our children to have a better life by constantly talking about the burden we are placing on future generations. To a large extent, this scaremongering has worked. Most people hate austerity, but accept “there is no alternative”. We must get the deficit down.

But should we be thinking about government debt as placing a burden on our children? How will we pay it back? For an alternative viewpoint, the following is an extract from a book called the “Seven Deadly Innocent Frauds of Economic Policy” by Warren Mosler. Everyone can and should read this book for free here. I’ve replaced some words to make it fit for the UK i.e $s to £s or the Fed to the Bank of England.

“Next, you need to know what a U.K. government bond (gilt) actually is. A U.K. government bond is nothing more than a savings account at the Bank of England (BoE). When you buy a gilt, you send your pounds to the Bank of England and then some time in the future, they send the pounds back plus interest. The same holds true for any savings account at any bank. You send the bank pounds and you get them back plus interest. Let’s say that your bank decides to buy £2,000 worth of gilts. To pay for those gilts, the BoE reduces the number of pounds that your bank has in its current (reserve) account at the BoE by £2,000 and adds £2,000 to your bank’s savings account at the BoE. (I’m calling the gilts “savings
accounts,” which is all they are.)

In other words, when the U.K. government does what’s called “borrowing money,” all it does is move funds from current accounts at the BoE to savings accounts (gilts) at the BoE. In fact, the entire £1.4 trillion national debt is nothing more than the economy’s total holdings of savings accounts at the BoE.

And what happens when the gilts come due, and that “debt” has to be paid back? Yes, you guessed it, the BoE merely shifts the sterling balances from the savings accounts (gilts) at the BoE to the appropriate current accounts at the BoE (reserve accounts). Nor is this anything new. It’s been done exactly like this for a very long time, and no one seems to understand how simple it is and that it never will be a problem.”

So rather than a burden, a more realistic way to think of the national debt is as the financial savings of the private sector. It’s not something we should be overly concerned about. Over the last few years, the private sector has been demanding to save (lend money to the government) as it has not been able to find profitable investments in the real economy. It wanted risk-free assets, and nothing is more risk free than putting money into a savings account at the BoE. This huge demand for risk free savings has keep the price of those savings high (and the interest rate low). So when the government boasts about keeping interest rates low, this has been a prize for failure rather than anything to be proud of. In a strongly recovering economy, the demand for risk free savings (gilts) will fall, so interest rates will rise. This will be a good thing as it will mean we should see more investing in the real economy.

When we hear politicians talk about the economy, up is down, left is right and black is white. The truth is often the complete opposite of perceived wisdom, so read Mosler’s book and have your mind blown.


Warren Mosler on Modern Monetary Theory

Thought I’d share this video of Warren Mosler being interviewed by Marshall Auerback on Modern Monetary Theory. If you don’t know who Warren Mosler is, you should! Warren discusses (among other things) the government’s role as issuer of the currency, the meaning of deficits and the job guarantee. He is great at simplifying economic concepts although what he says goes against everything we usually hear about the economy. Mosler is talking about the US, but in the UK, the system is much the same. Give it a watch.

Reinhart and Rogoff on Austerity (Or what they should have said)

The names Reinhart and Rogoff have been heard a lot lately. A widely cited paper they authored which suggested that high debt was associated with low growth was recently found to contain some embarrassing errors which invalidated its findings. That the errors were found by a grad student named Thomas Herndon added another layer of interest to the story.

R & R have been spending a lot of time defending their work since then and yesterday, they were given space in the FT to give their views on austerity. The title of the article is “Austerity is not the only answer to a debt problem”, but they then use the body of the article to prove otherwise and push austerity (although with some qualifications). Warren Mosler, one of the founders of the economic school of thought known as MMT, welcomed their article, but added some amendments of his own to make it a more accurate representation of the actual situation developed economies face. You can read Mosler’s post herebut I found it a bit hard to follow the flow, so I thought I’d reproduce it here as a single body of text with Mosler’s additions in bold:

Austerity is not the only answer to a debt problem

By Kenneth Rogoff and Carmen Reinhart

May 1 (FT) — The recent debate about the global economy has taken a distressingly simplistic turn. Some now argue that just because one cannot definitely prove very high debt is bad for growth (though the weight of the results still say it is, likely via the reaction functions of governments and not the high debt per se), then high debt is not a problem. Looking beyond the recent public debate about the literature on debt we have already discussed our results on debt and growth in that context the debate needs to be reconnected to the facts.

Let us start with one: the ratios of debt to gross domestic product are at historically high levels in many countries, many rising above previous wartime peaks. This is before adding in concerns over contingent liabilities on private sector balance sheets and underfunded old-age security and pension programmes. In the case of Germany, there is also the likely need to further cushion the debt loads of eurozone partners as they are ‘users’ of the euro the way US states are ‘users’ of the dollar, and not the actual issuer of the currency like the ECB, the Fed, the BOE, the BOJ, and the rest of the world’s central banks. Some say not to worry, pointing to bursts of growth after the world wars. But todays debts, while they pose no solvency risk for the issuer of the currency will not be dealt with by boosts to supply from postwar demobilisation and to demand from the lifting of wartime controls.

To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched if there remains a choice, that is, as is always the case for the issuer of the currency. Faced with, at best, haphazard access to international capital markets and high borrowing costs, periphery countries in Europe face more limited alternatives, as is the case for ‘users’ of a currency in general, including the US states, for example.

Nevertheless, given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand and low interest rates, (which are confirmation by the CB policy makers who set the rates low that they too believe demand is weak) where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis. Additionally, weak demand can be addressed by tax reductions, recognizing that counter cyclical fiscal policy of currency users, like the euro zone members, requires funding support from the issuer of the currency, which in this case is the ECB.

Ultra-Keynesians would go further and abandon any pretence of concern about longer-term debt reduction without a credible long term inflation concern, as for the issuer of the currency inflation is the only risk from excess demand. This position has been in the rhetorical ascendancy in recent months, with new signs of weaker growth. It throws caution to the wind on debt with regards to solvency (as is necessarily the case for the issuer of the currency) and, to quote Star Trek, pushes governments to go where no man has gone before (apart from war time, when the importance of maximum output and employment takes center stage). The basic rationale of the mainstream deficit doves (not the ultra Keynesian MMT school of thought) is that low interest rates make borrowing a free lunch.

Unfortunately, the mainstream believes ultra-Keynesians are too dismissive of the risk of a rise in real interest rates. No one fully understands why rates have fallen so far so fast (apart from the Central Bankers who voted to lower them this far and this fast, and in some cases provide guarantees to other borrowers), and therefore no one can be sure for how long their current low level will be sustained, as it’s a matter of second guessing those central bankers.

John Maynard Keynes himself wrote How to Pay for the War in 1940 precisely because he was not blas about large deficits even in support of a cause as noble as a war of survival. Debt is a slow-moving variable that cannot and in general should not be brought down too quickly. But interest rates can change rapidly. All it takes is a vote by central bankers.

True, research has identified factors that might combine to explain the sharp decline in rates (in fact, all you have to do is research the votes at the central bank meetings). Greater concern by central bankers over potentially devastating future events such as fresh financial meltdowns may be depressing rates. Similarly, the negative correlation between returns on stocks and long-term bonds, while admittedly quite unstable, also makes bonds a better hedge. Emerging Asias central banks have been great customers for advanced economy debt, and now perhaps the Japanese will be once more. But can these same factors be relied on to keep yields low indefinitely? In the end, it’s all a matter of the central bank’s reaction function.

Economists simply have little idea how long it will be until rates begin to rise. If one accepts that maybe, just maybe, a significant rise in interest rates in the next decade due to inflation concerns might be a possibility, then plans for an unlimited open-ended surge in debt should give one pause if he does not see the merits of leaving risk free rates near 0 in any case, as there is no convincing central bank research that shows rate hikes reduce inflation rates, and even credible theory and evidence to be concerned that rate hikes instead exacerbate inflation. 

What, then, can be done? We must remember that the choice is not simply between tight-fisted austerity and freewheeling spending. Governments have used a wide range of options over the ages. It is time to return to the toolkit.

First and foremost, only governments who fail to recognize that these are merely matters of accounting that don’t themselves alter output and employment must be prepared to write down debts rather than continuing to absorb them. This principle applies to the senior debt of insolvent financial institutions, to peripheral eurozone debt and to mortgage debt in the US. Additionally, for Europe in particular, any reasonable endgame will require a large transfer of public goods productionfrom Germany to the periphery which in fact would be a real economic benefit for Germany. The sooner this implicit transfer becomes explicit, the sooner Europe will be able to find its way towards a stable growth path.

There are other tools. So-called financial repression, a non-transparent form of tax (primarily on savers), may be coming to an institution near you. In its simplest form, governments cram debt into domestic pension funds, insurance companies and banks by removing governmental support of higher rates from their net issuance of debt instruments, particularly treasury securities.Europe is there already and it has been there before, several times. How to Pay for the War was, in part, about creating captive audiences for government debt. Read the real Keynes, not rote Keynes, to understand our future.

One of us attracted considerable fire for suggesting moderately elevated inflation (say, 4-6 per cent for a few years) at the outset of the crisis. However, a once-in-75-year crisis is precisely the time when central banks should expend some credibility to take the edge off public and private debts, and to accelerate the process bringing down the real price of housing and real estate. It is therefore imperative for the central bankers to make it clear to the politicians that there is no solvency risk, and that central bankers, and not markets, are necessarily in control of the entire term structure of risk free rates, and that their research shows that rate hikes are not the appropriate way to bring down inflation, should the question arise.

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very promising ideas for simplifying the tax codes.

There is a scholarly debate about the risks of high debt. We remain confident in the prevailing view in this field that high debt is associated with lower growth but must add that the risk is that of misguided policy response, and not the level of debt per se. Certainly, lets not fall into the trap of concluding that todays high debts are a non-issue as we must be ever mindful of the possibility of excess demand using up our productive capacity. Keynes was not dismissive of debt. Why should we be?

The writers are professors at Harvard University. They have written further on carmenreinhart.com

A vast improvement I think!

Must Reads for Opponents of Austerity

Economics can seem a bit impenetrable to the lay person. Partly, it seems to me, this is deliberate on the part of economists to complicate the field – baffle with bullshit you might say. Accessible texts are difficult to come across; ones worth reading even more so. Economics and economic policy are too important to leave to the economists and politicians though, particularly since the dominant paradigm in economics has failed us so badly.

Whilst Eurozone countries are faced with a choice of austerity or default/Euro exit, there is no sound economic rationale for austerity in the major nations outside the Eurozone. High debt and deficits do not create an inherent risk of default, nor do they need mean higher taxes in the future, or place a burden on our grandchildren. These basic truths are emphasised by a branch of economics known as Modern Monetary Theory (MMT). There are a lot of passionate opponents of austerity on the left of the political spectrum, but I feel they don’t yet have the weapons necessary to argue effectively the case for an alternative. I think an understanding of MMT can provide a sound basis for making that case.

Here I just want to draw attention to two great primers on MMT. Both written by Warren Mosler, they are easily understood by the average reader although the ideas presented will seem counter intuitive at first. The first is called “Soft Currency Economics”. It can be read on Mosler’s website here. Here is an extract:

“The purpose of this work is to clearly demonstrate, through pure force of logic, that much of the public debate on many of today’s economic issues is invalid, often going so far as to confuse costs with benefits. This is not an effort to change the financial system. It is an effort to provide insight into the fiat monetary system, a very effective system that is currently in place. The validity of the current thinking about the federal budget deficit and the federal debt will be challenged in a way that supersedes both the hawks and the doves. Once we realize that the deficit can present no financial risk, it will be evident that spending programs should be evaluated on their real economic benefits, and weighed against their real economic costs. Similarly, a meaningful analysis of tax changes evaluates their impact on the economy, not the impact on the deficit.”

The second primer is called “The Seven Deadly Innocent Frauds of Economic Policy”. This can also be read for free via Mosler’s website here. Here are the ideas Mosler calls “innocent frauds”:

“1. The government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.

2. With government deficits, we are leaving our debt burden to our children.

3. Government budget deficits take away savings

4. Social Security is broken.

5. The trade deficit is an unsustainable imbalance that takes away jobs and output.

6. We need savings to provide the funds for investment.

7. It’s a bad thing that higher deficits today mean higher taxes tomorrow.”

Mosler is an American, and writes for a US audience, but the arguments he presents are equally applicable to the UK (or Canada, Australia, Japan etc). Please read and let me know what you think.


Soft Currency Economics

7 Deadly Innocent Frauds

Mosler’s Mandatory Readings