MMT And Net Financial Assets

There have been some recent characterisations of Modern Monetary Theory (MMT) which I believe are incorrect. In my view, the MMT positions are largely common sense positions, albeit phrased in an original fashion. I am luckily outside of academia, so I have little interest in the question of determining publication priority of analysis. It may be that academics within the MMT tradition would offer a more pointed defence of their analytical framework; I am just offering my interpretation of the MMT literature.

U.S. Federal Debt And Depressions

"Asymptosis" wrote the article "Does Reducing the Federal Debt Cause Financial Collapse"? He discusses the observation that U.S. Federal fiscal surpluses generally preceded depressions.

Firstly, I would not place too much weight on that observation, although it is fairly entertaining. Other countries (particularly Australia) have been able to run federal surpluses without the economy collapsing. The article then states:

What all this ignores, of course, is privately-issued debt, something that — confusingly to me — many MMTers don’t talk much about, if at all. I haven’t clarified my thinking on that issue, so I’m going to pass you for the moment to Rodger Mitchell. I haven’t thought through his ideas or data carefully, but I find it useful that he looks at private debt, federal debt, and their relationships over time — something I haven’t found well done elsewhere. 

In my view, this characterisation is misleading. Most MMT analysis discusses government policy choices; since governments have no way of controlling private money creation, private money is necessarily discussed less. However, this lead to the following tweet by Noah Smith.

Why does MMT think money can only be created by government borrowing, and not by private borrowing? http://t.co/akZUYHiBLF

— Noah Smith (@Noahpinion) August 23, 2015

Noah Smith's characterisation is dead wrong. The correct statement is that MMT holds that government money is of primary importance, while private money is of secondary importance. That is not to say that private money is not significant, but private money can lose its "moneyness" in a financial crisis. Private liabilities are inherently illiquid, and need to be backed with holdings of liquid government liabilities (reserves, bills and bonds). (It should be noted that this was emphasised by Minsky, and presumably others, and was "inherited" by MMT.)

Finally, J.W. Mason followed up with:

@RomanchukBrian But "NFAs" are not a thing. No one demands them. They are just an accounting construct.

— JW Mason (@JWMason1) August 25, 2015

I do not have enough information to fully respond to this (and other tweets). I will now attempt to respond to what I believe is the underlying thinking.

Yes, Net Financial Assets ("NFA's") are an accounting construct, but so is practically everything else in macroeconomics. My interpretation of MMT analysis is that it follows from the Stock-Flow Consistent modelling framework, and the demand to hold financial assets is critical for determining the steady-state characteristics of the economy.

Yes, those financial assets include assets issued by the private sector. However, we see that the desire to emit liabilities by the private sector is determined by the state of the economic cycle, including structural components. For example, during the housing and tech bubbles, the private sector was very happy to emit liabilities. Those "animal spirits" in the private sector with respect to net debt issuance is not under the direct control of the government. All it can do is adjust its debt issuance - (under the accounting convention used by MMT, central government liabilities are the "net financial assets" of the non-central government sector) in an attempt to adjust economic activity.

The variability of the willingness of the private sector to emit debt means that there can be no hard and fast rule relating "net financial asset" issuance to economic growth. But at the same time, I have never seen academic MMT writing asserting that such a simple rule exists. Instead, the deficit needs to be adjusted to current cyclical conditions, which is a core view inherited from Functional Finance.

(c) Brian Romanchuk 2015