Possibly the best thing you will read all week.
Thirlwall’s Law, and all that…
The reason many Post-Keynesians are not modern monetary theorists is essentially a fear of floating exchange rates; a belief that even monetary sovereign nations are generally constrained in terms of their achievement of full employment and shared prosperity by the trade balance (this is what Thirlwall’s Law, which Bill Mitchell has addressed a number of times on his blog site, is all about); and what to me is a romantic attachment to an idealised fixed exchange rate system, where trade surplus countries are forced to boost their own spending to eliminate their surpluses, and allow trade deficit countries to return to balanced trade without a severe slump, currency devaluation, or both.
They dream of Keynes’ bancor system, which was rejected by the all-powerful Americans in 1944, and which would be rejected now by the all-powerful Germans, even just within the EU, and has not a chance of ever being adopted globally.
For modern monetary theorists, trade imbalances result from a decision of surplus countries to exchange their goods and services for financial liabilities issued by deficit countries. The deficit countries remain in a position to maintain full employment, as long as the government is prepared to deficit spend sufficiently to meet the net savings desires of its own private sector and the rest of the world. It is not about surplus countries funding the needs of deficit countries. It is about deficit countries funding the savings desires of surplus countries.
Won’t this eventually lead to a catastrophic depreciation in the domestic currency? In general, no. It has been shown many times since 1983 that you cannot make money trading on the foreign exchange market, and certainly not over a reasonably short time horizon, by selling the currencies of trade deficit countries in the expectation of depreciation. Not even if you could somehow learn next year’s trade balance in advance could you do this. Exchange rates are driven by speculative capital flows in what is the world’s largest financial market, especially for widely traded currencies like the Australian dollar or the British pound.
Isn’t it the case that you can’t run a current account deficit on your balance of payments for long? No. Australia has done so since the early 1970s. It doesn’t even raise your external debt to GDP ratio forever. That is not how the maths works.
What if the pound or the Australian dollar did depreciate?
Well, they have at times, significantly and over short periods, as we know. The impact of even a major depreciation of these currencies on their consumer price index measures of inflation has been shown to be minor. There are a variety of reasons for this, one of which being the tendency for seller to price to the local market and absorb the impact of changes in exchange rates themselves, rather than pass them on to customers. The global economy is now a complicated and complex system, and supply chains are distributed across many countries, and can be managed to react to changes in exchange rates.
To the extent that firstly a growing deficit feeds depreciation (which is a big if) and secondly that this impacts the price level in a significant way (another big if), this has implications for domestic real incomes. Another way of saying almost the same thing is that if the rest of the world stops giving us goods and services for our pieces of paper, then we will have less to consume.
This need not limit our ability to produce though. Our real incomes may be affected, but our ability to achieve and maintain equitable full employment would not be.
Which brings me to a short paper many of you may have seen, because I know a lot of people read the excellent Real World Economic Review:
Leon Podkaminer, “Trade imbalances are undesirable: a note”, Real-World Economics Review, issue no. 80, 26 June 2017, pp. 193-196,
This paper is misleading, like a lot of what non-MMT Post-Keynesians have to say on this issue, and in this particular case confuses correlation with causation. The world economy has grown less quickly since the 70s than before, and trade surpluses and deficits have increased. The author argues that higher trade imbalances act as a constraint on economic growth. The first sentence is a fact. The second sentence mistakes correlation for causation.
In a simple two country model with no government, the author argues that trade imbalances constrain growth if the fraction of changes in income feeding through to changes in consumption (the marginal propensity to consume) in the deficit country is above that in the surplus country. There are no wealth effects in his model, so no stock-flow consistency, and there is no government. Models without governments have nothing useful to say about growth.
He argues more trade should have stimulated higher growth, according to neoclassical economics, when it has done the opposite.
He is confused because the stimulus in neoclassical economics is of course all supply side, while his simple model is about demand.
Of course, growth is demand determined but potentially supply constrained, but no model of demand which excludes government has anything useful to say.
No model which does not define monetary sovereignty and distinguish between currency issuers and currency users has anything useful to say.
So unfortunately this paper by a well-meaning academic has nothing to say.
Growth has been lower since the 1970s due to neoliberalism, and economic policies approved of by the newclassical branch of neoclassical economics, sure. But not because of global trade imbalances.
Enforced trade balances of close to zero could only fail to constrain growth in a world of co-operation and wise and co-ordinated fiscal policy, or where surplus countries were forced to reflate. Neither of these is a remote possibility.
The author states that his final conclusion
“could be that the basic paradigms of the international economic order need to be changed. The reformed international order should be capable of enforcing more balanced trade among nations. The major trading nations must not be allowed to compensate deficient domestic demand (and stagnant wages) with huge trade surpluses that destabilize their partners. Under the reformed world economic order the expansion of global trade could then be expected to support global growth. Of course, the basic paradigms of domestic macroeconomic policy-making in major countries would have to be overhauled too if these countries were to follow the externally balanced growth paths.”(Laski and Podkaminer, 2012 and Podkaminer, 2015.)
Well, good luck with that!
Overhauling basic paradigms world-wide would be great. Might take a while, though. And persuading surplus countries that “The major trading nations must not be allowed to compensate deficient domestic demand (and stagnant wages) with huge trade surpluses that destabilize their partners” is not likely to happen until well after all the Post-Keynesians in the world have passed on. In the Keynesian long run, when we are all dead.
In the real world, it is best to maximise your monetary sovereignty, in the case of most countries. This means keeping your own currency and a floating exchange rate, and using fiscal policy to deliver full employment.
It does not mean ignoring external economic relations. In many countries, it ought to mean planning to reduce dependence on a narrow range of export products with volatile prices and on imports of food, energy and other basic necessities, again with potentially volatile prices. And it ought to mean reducing external debt denominated in foreign currency, and avoiding the issuance of any further such debt in the government sector, and limiting it in the private sector.
Trade imbalances in themselves do not limit the ability of a nation with full monetary sovereignty to achieve and maintain full employment.
For countries without full monetary sovereignty, the issue is how to go about achieving that state. Without it, you lack full independence and the ability to effectively manage your own economic affairs. You are at the mercy of other nations, or institutions like the ECB, or financial markets.
You are not fully free.
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