Monetary Realism

Understanding The Modern Monetary System…

Monetary Policy Distortions

Over at Naked Capitalism, there are two interesting posts up, and I’d like to point out an important link between them.

One is an interview with Jamie Galbraith “Finance as Wealth Transfer Mechanism” who says this:

“The act of extending credit – a macroeconomic force – generates fees and capital gains and other incomes that accrue, largely, to the top strata. You can see this very plainly in US data, but also in most other countries we’ve looked at, from Brazil to China. In sectoral data, it shows up in the fact that rising inequality is closely associated with relative gains by the financial sector.”

The other post is by…Dan Kervick. We said we will take good ideas from anywhere, and well, Dan has some great points in this post:

“People frequently rail against the pork barrel spending and earmarks that result from the legislative process. But the pork barrels don’t worry me nearly as much as handing our economy over to another generation of theory-addled elitists like Alan Greenspan. As part of the democratic process, representatives come from all over the country to look for the resources to deliver the things their constituents want and need. They wrangle and haggle. And yes, in the process they land a few “bridges to nowhere.” But most of what they get are bridges to somewhere. The people in New Hampshire might not like the way the people in Georgia use their share of our national resources, and the people in Georgia might feel the same way about the people in Oregon. But the end result is that things get built; people are hired; public goods are created; national and local needs are met; things get done.”


I’ve railed about the anti-democratic tradition running though economics over at Traders Crucible. Then I wrote about a long list of practical problems with Monetary Policy in this post. Turns out Jamie identified another major problem with using Monetary Policy – the high fees flow to one group of people.

Here is a full list of problems with monetary policy:

  • promotes debt slavery
  • works very slowly
  • ignores the lowest 30% of earners
  • anti-democratic look here.
  • difficult to manage
  • It must – must – end in a massive real estate bust – which destroys the primary store of value for the lower 80% of the population.
  • Difficult to observe effectiveness
  • Uses real estate lending as a transmission mechanism
  • Indirect instead of direct action
  • Promotes a rentier class
  • Promotes a massive banking system
  • Zero lower bound
  • Can’t be very effective in a real estate crash.
  • Promotes the military industrial complex to the exclusion of social welfare
Jamie Adds:
  • high fees
  • fees flow to rentier class (slightly different than Neil’s version)
This post is titled “Monetary Policy Distortions”. I created this list of suckage for Monetary Policy just to help people start thinking about the downside of Monetary Policy. But it also functions as a nice list of monetary policy economic distortions. 
“The principal argument for monetary policy is that, by modifying asset supplies and thus asset prices, it induces households and businesses to boost their spending on things that they almost bought anyway. Thus–for marginal policy shifts, starting out at a first-best optimum, and if the relative distribution of wealth corresponds to social welfare (or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)–monetary policy will not push you far away from the free-market optimum.

Fiscal policy, by contrast, works through expanded government purchases ΔG. These must be financed by distortionary taxes to amortize the debt in the future. These taxes do drive a wedge between the social and the private values of output in the future. And what the government buys is determined by a political rather than by an optimizing economic logic. [2]”

He’ll be here all week, folks! But more seriously, his caveat here is outrageous

“or if questions of the relative distribution of wealth are left to a more openly political process and walled-off from technocratic macroeconomic questions of stabilization policy)”

I’ll translate to human readable language

“If you just ignore biggest ways Monetary Policy distorts every credit related transaction, it causes less distortion than Fiscal Policy. ”

It’s time for the economics profession to fess up on what it’s doing. It’s time to recognize Monetary Policy chooses winners and losers just like Fiscal Policy chooses winners and losers.

We need a way to move forward in the world. Ignoring the basic facts how Monetary Policy actually moves from central bank operations into the real world isn’t helping. And it also doesn’t help most of economics doesn’t even have room for the financial system in the model.

This is why it’s hard for economists to find the distortions, they don’t include the sectors where these distortions happen in the basic models of the economy.

In this case, I fully agree with Scott Fullwiler. Here is JKH on this idea:

“What is ground zero for language in economics?

Is it the language of economists and accountants or the language of the street or some language in between?

My own view is that there is a default ground zero language inherent in:

C + I + G + (X – M) = C + S + T

Furthermore, and here is where I’m totally with Scott Fullwiler, accounting logic is a necessary measurement infrastructure for all of economic thinking – at least the thinking that matters, which is coherent thinking.”
I’ll put out a hat tip to Clonal Antibody on this one too. He’s showed me a few eye-popping charts on what happened when usury laws were shifted from state to national control, which is another distortion of monetary policy on our real world economy.


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17 Responses

  1. Detroit Dan says

    Good discussion. Thanks!

  2. Mike L Sax says

    Great post Mike I’ve been trying to figure out this issue a lot lately of fiscal vs. monetary policy.

    Here’s what I looked at today

    Would you say that optimum Fed policy would be Mariner Eccles back in the 30s and the Fed more generally till about 1970-as Galbraith says?

    • Michael Sankowski says

      Thanks C!

      Mike Sax,

      I do like to think the elder Galbraith would approve of our project here. We’re first trying to see what’s real about our economy, and then trying to make honest and pragmatic policy suggestions based on that.

      It’s hard to tell what perfect policy would be. Right now, it’s a no brainer to spend more and tax less, but that’s not a long term plan in the slightest.

      When I read Kalecki on the prospect of full employment, I am struck by how simple it all seems when he says it, and how complex full employment would be in real life.

      Getting there requires way more than spending the proper amount or a government job. The beer game shows this – getting jobs here isn’t just about the jobs, its about a host of related support structures.

      These are overtly political decisions and would be industrial policy related. And this, while it might seem like I am advocating a politcal act, isn’t policital at all.

      2012 China reminds me of 1950’s United States. Building roads everywhere, supporting businesses abroad through a huge array of programs, subsidizing energy and providing any infrastructure possible to get business.

      • Erik V says

        I certainly agree that our government could be doing a lot more to support our infrastructure, R&D, and creating a tax and regulatory environment that attracts business instead of repels it.

        However, I wouldn’t want to emulate China. The US in the 1950s wasn’t building ghost cities or unsafe public transportation where hundreds of people get killed on trains.

        I think we could get to perhaps 3.5% unemployment by implementing most of the good ideas we have, and then after that it would require some real creativity to get to truly full employment, if in fact it is possible.

        • Michael Sankowski says


          Agreed – its not exactly the same, but there are some similarities. We had a far more agressive industrial policy back then, just as China does now.

          I would not want to imitate China either. This is one of the reasons we broke up with MMT – we think too much reliance on the public sector ends up looking much like modern China, or the massive build out of interstate highways we have today.

          3.5% unemployment is probably right at the frictional level of unemployment. If you have problems getting a job when UE is 3.5%, the problem is probably something like mild mental illness and not lack of opportunity.

          In that case, giving someone a job might be helpful, but it might not too. It’s a matter of what help is best for those people at that point, not “Get everyone a job”.

          Even Kalecki doesn’t recognize this as a problem. Mild mental illness is a problem for at least 5% of the population.

        • Erik V says

          Yeah, I agree. Many people in the MMT movement accuse us of being pure evil if we say that even one person might not have job, but it would be extremely difficult past a certain point.

        • Dan M. says

          I still love the movie, “Dave,” though. Should be the official movie of MMT.

    • Cullen Roche says

      Hey Mike Sax. Nice thoughts. Just to give credit where credit is due – Mike Sankowski wrote the first part of the quote in your article. Not me. :-)


  3. beowulf says

    “the “currency” printing entity runs a deficit with currency and no bond/loan/asset attached”.

    In one sense, this is impossible since currency itself is basically a bearer bond. On the other hand, if the Fed set up a dual exchange rate system (as Ravi Batra has suggested), the Fed would be, in effect, printing currency to subsidize US exports. I doubt they can do this without Tsy’s approval but they wouldn’t have to go to Congress first.

    Dr. Batra explained how the dual exchange rate could work: “For instance, we could unilaterally set the exchange rate at 5 Yuan to the dollar for export of U.S. manufactured goods to China and leave the floating exchange rate of 8.1 Yuan alone for imports, tourism, and other matters. America can import cheap and China can import cheap. This way our export prices could fall by 38 percent in China, which will then sharply increase its U.S. imports. We could take similar action with each country where America has a large trade imbalance.”

    • Fed Up says

      “In one sense, this is impossible since currency itself is basically a bearer bond.” Can you expand on that one? I could be wrong about this, but I thought a bearer bond was a debt security.

  4. Fed Up says

    “Here is a full list of problems with monetary policy:” … where all new medium of exchange has to be borrowed into existence???

    savings of the rich = dissavings of the gov’t (preferably with debt) plus dissavings of the lower and middle class (preferably with debt)

    “C + I + G + (X – M) = C + S + T” After rearranging and “wordifing”, I believe that means:

    current account deficit = gov’t deficit plus private deficit plus 0(zero)

    The last one being my add, the “currency” printing entity with no bond/loan/asset attached.

    I believe that assumes there is a stock of medium of exchange that flows and all new medium of exchange has to be borrowed into existence (because of the 0[zero] I added. I don’t see why there can’t be a current account deficit, a gov’t deficit of 0(zero), the private sector saves, and the “currency” printing entity runs a deficit with currency and no bond/loan/asset attached.

  5. Erik V says

    If you look at a comparison on marginal effective tax rates on various forms of investment is almost makes you want to puke. There is essentially no tax on residential real estate investment due to the all the subsidies cited above, whereas the tax on non-corporate business is in the 20s% and over 30% on corporate investment. So we subsidize the hell out of non-productive depreciating assets, while tax the hell out of firms that actually make things. This is mostly a fiscal policy problem, but monetary certainly plays its role in subsidizing housing.

  6. beowulf says

    What’s especially distortionary is that 70% of all bank loans are for mortgages. Leaving aside all the tax benefits given to homeowners (no cap gains on first $500k, deductions for property taxes and mortgage interest), since the market crash over 95% of all new mortgages are backed by Uncle Sam.

    100% reserve bank reformers like Michael Hudson make the case that govt bank accounts should handle deposits while banks loan out money supplied by investors. Maybe they have it backwards considering that two thirds of the time (70% of 95%), the investor is really the US Govt. Congress recently converted the student loan guarantee program into a direct loan program. Student loan interest (and not merely the losses) now flow to Tsy. Perhaps they should do the same with mortgages.

    There’s no question that the govt has completely warped and distorted the housing market and that the economy would be better off if it had never put its thumb on the scale. But we are where we are. Since Congress is determined subsidize the housing market, the question becomes what provides the best value to the taxpayer. Let’s say, there’s $10 trillion in mortgages outstanding with an average interest rate of, say 5%. If Tsy collected the interest, it would drain reserves (and reduce the deficit) by $500 billion before the IRS has to collect dollar one in income taxes. Incidentally, providing its citizens with 5% mortgages is how Pennsylvania’s colonial govt funded itself prior to (and shortly thereafter) the Revolutionary War.

    • beowulf says

      There’s actually a third interesting post up today, Matt Stoller’s excellent article “Fighting Over the American Home: Handcuffs versus Hope and Change.”

      I just finished reading it and this part vaguely reminded me of something else I read recently… :o)
      “Many of them [“right-wing investors”] are idealistic from the capital markets perspective, and point out that there will be no private mortgage market in a few years, that it will simply all be government-supplied credit. They fear, rightly, the day when whether you can get a mortgage will be subject entirely to political whims.”
      I’d say that day arrived years ago, pretending it hasn’t is like a big hug for Jamie Dimon.

  7. ksondere says

    Love this site. And Mike, I think this is my favorite post so far! As you’ve identified the dangerous trends occurring from monetary policy distortions and lack of understanding. Our capitalist system has really become a financialist economy. You mention something that I have thought about for years now. It appears to me that we have degraded into two-dimensional financials/real estate economy. Where real estate just supports our financialism.

    Does it bother anyone else that the only real measure of an improving US economy now is apparently new housing starts? Is that all we really do in the country now? And is that because we can’t export houses out of the country?

    Anyway. Just a very thought provoking post. Thanks

    • Michael Sankowski says


      Thanks! I work as much as I can on it until my wife yells at me to get off the computer.

      It bothers me very much housing has such an impact on the rest of our economy. Why doesn’t making stuff besides housing or doing things have more of an impact?

      Monetary policy transforms any economy into a real estate economy run by banks. That’s more distortionary than socializing the steel industry.

    • just an auditor says

      I don’t think housing starts only serves as an indicator of the real estate market. I think it also gives us an idea of household formation, which can be an bigger indicator for growth in the overall real economy.