MMT

Basics

 * Four facts (when monetarily sovereign)

1 Only (consolidated) Gov can create currency/reserves

 * That is, issue currency/create money; usually by crediting the recipient’s own bank with additional reserves at the central bank

2 Gov can print endlessly

 * Purpose of taxation ≠ raise funds, but to reduce the capacity to spend of the domestic non-government sector, i.e. to restrain AD and thereby defend the national currency.
 * Limits:
 * The expectation that the monetary authorities will let the government default raises the default risk premium and the interest rate on government debt
 * If AD is excessive, the purchasing power of the national currency will decline: each unit of it will purchase fewer domestic goods and services, fewer assets and less foreign currency
 * (When monetarily sovereign) Size of national debt only matters to the extent that it affects domestic inflation & X-rate against foreign currencies. In a closed economy, provided the government can compel the use of its sovereign currency, it can never go bankrupt
 * In an open economy, even with a sovereign currency, there is a risk that monetizing the government deficit on a large scale will lead to a collapse in the exchange rate. In this case, the government may not be technically bankrupt, but its currency may become almost worthless
 * The challenge is to ensure that the power to create money is not abused
 * The government can also issue interest-bearing bonds. If investors are reluctant to hold these bonds, the government can purchase them using money created by its own central bank.

3 Gov destroys currency through taxation

 * Or convert them to other Gov token via bond sales
 * Put differently, a sovereign currency is in demand exclusively because people must pay their taxes in this currency - Taxes drive money

Government debt & deficits

 * When the government is sovereign in its monetary policy and debt is dominated in its own currency, the only technical risks of high public debt are exchange rate risk and inflation risk.
 * The structural (i.e. cyclically-adjusted) primary budget = (discretionary) fiscal stance; with exogenous influences such as business cycle and interest rate changes excluded, it's a better gauge of whether fiscal deficit is expansionary or not
 * Indicated as primary fiscal deficit ratio (in % of GDP), available in Ameco of European Commission
 * When the government runs a deficit to pay for expenditure, it is borrowing from the general public. Two arguments for deficit-financed spending (e.g. cancer research): fairness (later generations benefit from the investment, thus should share in paying) and efficiency/tax smoothing
 * Intertemporal budget constraint: A limit stating that the discounted present value of taxes minus the discounted present value of outlays (excluding interest on the debt) must equal the current stock of debt outstanding.
 * The deficit depends on both the level of real GDP and the stance of fiscal policy
 * Government bond yield = Risk free nominal interest rate + risk premia
 * Need to decompose changes in the deficit into changes due to fiscal policy and changes due to the level of economic activity → cyclically adjusted budget deficit/full-employment deficit, which is difference between outlays and revenues calculated under the assumption that the economy is operating at potential GDP (=real GDP when the labor market in equilibrium & capital goods are not lying idle)
 * Cyclical deficit because it is due to the state of the business cycle
 * Structural/standardized deficit: stance of fiscal policy has changed (i.e. expansionary fiscal policy)
 * Reductions in GDP, other things being equal, lead to increases in the budget deficit
 * A balanced-budget amendment would force the government to conduct procyclical fiscal policy
 * Stabilizing role of deficits: Changes in government purchases directly affect aggregate expenditures because they are a component of spending, and changes in taxes indirectly affect aggregate demand through their effect on consumption
 * Fiscal drag: government's net fiscal position (spending - taxation) fails to cover the net savings desires (spending gap) of the private economy (earnings - spending & private investment) → lack of (state spending/to excess taxation) AD leads to drag on economy/deflationary pressure
 * One cause of fiscal drag may be bracket creep, where progressive taxation increases automatically as taxpayers move into higher tax brackets due to inflation → inflation increases revenues from individual income taxes and social security contributions on account of the fiscal drag
 * Fiscal theory of the price level: in contrast to Monetarism where monetary policy is necessary&sufficient for price stability, here government fiscal policy affects the price level: for the price level to be stable (to control inflation), government finances must be sustainable
 * Debt-to-GDP ratio: $$\tfrac{D_t-1\text{ debt stock in bn dollars}}{Y_t-1\text{ output in bn dollar}}$$
 * Actual debt-to-GDP ratio: $$\tfrac{1+i_t}{1+y_t}*d_t-1$$
 * Interest-growth differential: r-g

Government debt stock
than the (growth-adjusted) interest rate—which is what would happen if debt and interest were systematically paid by issuing new debt. Under the no-Ponzi game condition, debt and interest payments cannot be postponed forever.
 * For explanation of Maastricht criteria methodology of evaluating government debt, see (from p. 59)
 * Δ gov_debt between two years = interest paid on the stock of debt, primary deficit, and other factors (deficit-debt adjustments)
 * For ratios to GDP, the change in debt is then mainly determined by the primary balance and the difference between the interest rate and the GDP growth rate. If the interest rate-growth differential (r-g) is strictly positive, a primary fiscal surplus is needed to stabilise or reduce the debt-to-GDP ratio (the higher the initial debt level, the higher the necessary primary surplus). Conversely, a persistently negative differential (r<g) would imply that debt ratios could be reduced even in the presence of primary budget deficits (lower than the debt effect induced by the differential).
 * In general, models are based on the assumption that the inter-temporal budget constraint holds, i.e. the present value of future primary surpluses should equal the current level of debt (no explosive debt paths)
 * For explanation of formulas etc.
 * Implicit interest rate: average interest rate payable on total debt. If interest-growth differential > 0, rising debt (i.e. primary surplus needed to keep debt-to-GDP ratio stable)
 * Snowball effect: how interest rates and growth affect gross debt
 * The typical debt accumulation equation: $$ Δ d_t = \left( \frac{i_t-g_t}{1+g_t} \right) d_{t-1}-pb_t+dda_t$$ has three components: snowball effect, primary budget balance ratio and deficit-debt adjustment
 * Where
 * $$ Δ d_t $$ = change in the government gross debt-to-GDP ratio
 * $$i_t$$ = nominal interest rate charged on government debt
 * $$g_t$$ = nominal GDP growth rate
 * $$b_{t-1}$$ = debt-to-GDP ratio in the previous period
 * Thus, $$\left( \frac{i_t-g_t}{1+g_t} \right) d_{t-1}$$ = the “snowball effect” which, in turn, has 3 components
 * Interest effect (positive influence on snowball-effect, i.e. making debt bigger): $$\left( \frac{i_t-g_t}{1+g_t} \right) d_{t-1}$$
 * Growth effect (neagtive influence on snowball-effect/reducing debt): $$- \left( \frac{g_t}{1+g_t} \right) d_{t-1}$$
 * Inflation effect (neagtive influence on snowball-effect/reducing debt): $$- \left( \frac{π_t-g_t}{1+g_t} \right) d_{t-1}$$
 * $$pb_t$$ = primary budget balance (surplus) ratio
 * $$dda_t$$ = deficit-debt adjustment as a share of GDP (also: stock-flow adjustment) is the difference between the change in government debt and the government deficit, comprising factors that affect debt but are not included in the budget balance (such as accumulation or sale of financial assets, changes in the value of foreign debt owing to exchange rate changes and remaining statistical adjustments)
 * It seems intuitive that outstanding government debt should increase in line with the deficit. Discrepancies between deficit and borrowing requirement stem from:
 * The deficit is different from the amount a government needs to borrow (the borrowing requirement) due to financial investment.
 * Differences between the borrowing requirement and the actual change in debt are due to changes in the value or volume of Maastricht debt that arise independently of any transaction, e.g. the value of outstanding government debt declines when an appreciation of the domestic currency reduces the nominal value of debt denominated in foreign currencies
 * Effect of inflation: weak or negative inflation would push up real interest rates—potentially above real GDP growth, contributing to the rise in the debt-to-GDP ratio but, conversely, inflation also raises nominal GDP in the denominator of the debt-to-GDP ratio and reduces the burden of the existing stock of debt. Thus, the two effects might cancel each other out
 * The key measure for inflation here is the GDP deflator and not the consumer price index which is often used in other contexts. This is because the calculation of nominal growth is based on information on the development of the prices of the goods and services produced in an economy and not on the development of the prices of the goods purchased by a typical consumer
 * Overall, sensitivity of debt-to-GDP-ratio to the inflation rate is a function of size of the pass-through from low inflation to nominal interest rates & size as well as structure of debt. When pass through from low inflation to nominal interest rate = 1 → Fisher effect (i.e. expected nominal interest rate = sum of expected real interest rate and the expected rate of inflation). When inflation is positive (π>0), the interest rate effect is smaller because the real interest rate is reduced by inflation as now the nominal interest rate reacts less than 1-to-1 to π
 * Distinguish inflation-sensitive and non-sensitive (e.g. when foreign-currency denominated) part of debt stock
 * The no-Ponzi game condition (also called transversality condition) essentially means that the government does not service its debt (principal and interest) by issuing new debt on a regular basis. Over the long term, the present value of debt must decline towards zero, it implies that, asymptotically, the debt ratio cannot grow at a rate equal or higher

Government expenditures

 * Not easy to categorize government spending as Gov consumption vs. Gov investment: e.g. space shuttle (investment?) and teachers' wages (consumption?)
 * Generally, politicians have a strong incentive to classify expenditures as investment rather than consumption, to justify deferring payment

Interest expenditure

 * Interest rates on government debt are a policy variable just as the decision to issue government securities in the first place
 * How fast and strong a tightening of financing conditions translates into higher interest expenditure depends on several factors: maturity structure, interest rate conditions (variable/fixed interest), extent of new borrowing and current interest rate level
 * Snowball effect: are interest rates smaller than nominal GDP (r<g)?
 * Net interest expenditure = interest paid less interest received on assets
 * The implied interest rate on the national debt is calculated as interest payment (t) / stock of national debt (t-1)

Monetary vs. fiscal dominance

 * Monetary dominance means, broadly speaking, that the monetary authorities do not let monetary policy be influenced by the needs of the fiscal authorities. Monetary dominance is often modeled by assuming a fiscal rule that ensures that the government is always solvent conditional on monetary policy following its own objectives (what (Leeper (1991)) calls a passive fiscal policy).
 * Distinguish between soft -or ex ante - monetary dominance (the fiscal authorities avoid a conflict) and hard - or ex post - monetary dominance (when challenged, the monetary authorities let the government default)
 * An increase in the (gov) default probability can be self-fulfilling because it raises the interest rate and the service of debt, making it more likely that the government default. Calvo (1988) presents this point in the context of a two-period model.
 * Fiscal dominance: fiscal authority does not react to changes in amount of debt and monetary policy does not react to deviations of inflation from target → fiscal solvency ensured by inflation (i.e. the real value of debt remains constant)
 * Monetary dominance: CB manipulates interest rate to achieve inflation target while fiscal policy passively reacts by stabilizing debt
 * With fiscal dominance, CB purchase of govies decreases the rate of inflation; with monetary dominance, it increases rate of inflation
 * What determines regime-switching? Is there uncertainty as to which regime currently prevails?

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