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The Fed and the Pay Czar’s Executive Compensation Restriction Plans

2009 October 23
by Ian Welsh

So, the Fed has unveiled its plan.  Details are somewhat sparse, but as best I can tell:

  • It won’t significantly reduce pay
  • It will concentrate on risk management, which is to say trying to tie pay to longer term measures rather than shorter term measures
  • The big banks will have to give their compensation packages to the Fed upfront, but the review will be confidential.  Only the bank and the Fed will know the contents of the review.
  • Small banks will have their pay reviewed when they are examined.

Meanwhile, Feinberg, the pay czar, has restricted compensation at bailout recipients.  Cash compensation is restricted to 500K a year until they pay back the bailouts, but once they do they can receive more, and they do have bonuses tied to various goals given by the treasury till then.

I am skeptical.  The end result of Feinberg’s plan will simply be that the companies will pay off the bailouts as fast as they can, even if that means borrowing the money at higher rates than the feds have loaned it to them.

As for the Fed’s plan, it requires us to trust the Federal Reserve to really restrict pay and to really understand what type of compensation creates long and short term risks. Given the Federal Reserve’s track record in understanding systemic risk, which indicates they have no understanding of systemic risk worth speaking of, I’m skeptical that they can do this.  And that assumes one trusts the Fed to tell its friends in the banks they can’t have what they want, which, again, given their track record, is questionable.  Especially when the Federal Reserve itself seems to essentially be run by Goldman Sachs.

Furthermore, the Federal Reserve is confused.  When they say it’s not about “social equity” it’s about risk, what they mean is “we don’t mind them getting paid a lot of money if it doesn’t lead to risky behavior”.  But receiving enough money in a year or 3 years to retire inevitably means that people will engage in risky behavior because they don’t need the job.  They may want to keep it, they may like it, but if their company goes under, at the end of the day, they’re still going to be rich, rich, rich—and never have to work another day of their lives.  And, after all, even if they do blow it, this crisis shows that the government will probably bail them out so they probably will keep their jobs.

Paul Volcker, the last good central banker the US had, is right.  This finicky micromanaging won’t work.  He’s right to want to break the banks back up, dividing retail banking from investment banking. And while as far as I’m aware he hasn’t suggested high marginal taxation as a solution to the perverse wage incentive issue, that’s my suggestion.  Just tax every dollar after 1 million, on all income equally and with no deductions, at 90%.  Tax every dollar after 5 million at 95%.

The objection to this sort of taxation, or any other severe restrictions on excessive pay is:

But, bowing to concerns that too heavy a hand could lead to a mass exodus of executives, both the Treasury and Fed policies will permit top earners to reap millions of dollars.

This is insane.  These executives are the folks who lead the world to the greatest financial crisis since the great depression.  The goal shouldn’t be to keep them working, the goal should be to convince them to quit.  Let some middle managers take over, it is beyond comprehension that they could cause a greater disaster, and if they are only earning a few hundred K a year, they’ll have every incentive to turn their banks around so they can keep their jobs, which they’ll actually need to keep unlike the current generation of overpaid, incompetent, executives.

These executives’ management lead to the greatest destruction of wealth and the largest job downturn in post-war history.  They did so by pushing products and practices which were frankly fraudulent. In a sane world, huge criminal investigations would be ongoing and most of them would be spending all of their time huddled with their lawyers, rather than sending out millions of dollars worth of lobbyists.

However, as a second best scenario, their pay should be restricted, and if that makes them leave, well, that’s a bonus.  Let them go work for companies in any country stupid enough to want them.  Hopefully if not operating from the US anymore they’ll only be able to trash their new host economy, and not the entire world economy.  These men and (a few) women, are parasites who feed off and damage their hosts.  They are not a benefit to the country or company they work for, but an active hazard.

I’m glad to see the Fed and Feinberg doing something.  But it’s not nearly enough, and it won’t be sufficient to stop the same suspects from causing yet another financial crisis.

44 Responses
  1. Howard permalink
    October 23, 2009

    If by all income you mean to include capital gains I think that is ok, but think your 1 million number for the 90% bracket is a bit low – I would put it at 2 million so as not to discourage entrepreneurship. I also assume you mean to jump straight from the 38%(?) current high for earned income to the 90% mark at the cut in point.

    On the other hand I would argue that earned income should be taxed at something near the rates currently applicable, capital gains on all returns on investment up to 5 % at something like the rates currently applicable but that all returns exceeding that 5% should be at your 95% rate, with exceptions for principals in start-ups and lesser but significant exceptions for investors in start ups (the risk being far greater and the need for innovation matching that risk), with start-ups being defined in a way to preclude abuse by existing corporations.

  2. John B. permalink
    October 23, 2009

    Wow. What a post. I love it. Thanks Ian for putting into words what many of us think and feel about this insane situation we are in…

  3. Ian Welsh permalink
    October 23, 2009

    Howard, not necessarily bad ideas. Yes, I do mean capital gains taxes. I might allow slightly lower tax rates for investments held for long periods – at least 5 years, with the lowest rates for 10 years.

  4. October 23, 2009

    Reminds me of Atrios:
    Nobody Could Have Predicted…
    That these people were complete tools..”. 2009…edicted_23.html

    Who? Obama? Summers? Bernanke? Geithner? Feinberg?

    Atrios – for paying attention to the sideshow? Fix the system, and executive compensation will get fixed as a result.

    We are all tools of the oligarchy until we can keep our eyes on the real money, and the power structure that extorts it. It is folly to discuss the intricacies of the bait. The first rule about this kind of “regulatory posturing” is that you don’t discuss the posturing, you just indentify it as such and focus on the power structure. Qui bono?

    Quote: “Whenever we read an article about the health dangers of butter, we would immediately run out and buy as much butter as we could find,” she told me. “We knew it meant there was about to be a butter shortage.” In other words, Russians looked only for the agenda, the motivation behind the assertion. The actual truth was irrelevant.

  5. October 23, 2009

    James Kwak over at Baseline Scenario hit “Too Big To Stay Regulated” in the context of financial industry reform. There is a concept in evolutionary biology, I believe coined by John Maynard Smith, about “Evolutionary Stable Strategies” – behaviors that will increase the probability of their own persistence. A popular phrasing is that “celibacy is not hereditary”.

    In the context of so-called democracy, the concept could be defined as “lobbying-proof regulation” – in other words, the problem with the financial or the health “related” industries is that they are “Too Big Too Regulate” – no law, no executive order, no agency will be able to withstand the lobbying efforts financed by the out-sized profits resulting from the industries’ dysfunctions.

    Simply put: corporate lobbying is fundamentally incompatible with both an open society and an efficient economy, it will ruin both democracy and the market. As Simon Johnson, Jared Diamond, James Galbraith and others have pointed out, oligarchy, kleptocracy and dysfunctional elites are the consequence.

    Big O has to change the incentive structure, he has to drastically improve accountability to shareholders, he has to extend anti-trust from monopoly to cartel to too-big-to-regulate, and he has to break up the existing networks by investigation followed by prosecution for fraud.

    Problem is, the Goldman network extends straight into his administration, by his own choice. It is pretty clear that he does not want to do any of the above. Unfortunately for him, any dyanmics that cannot go on forever will not – even if you manage to print yourself into one last re-bubble.

    Consequently, Congress would need to put an end to the claim that money has any connection to free speech, and restrict campaign contributions to volunteer time. Rolling back the fraud of “corporate personhood” and the pretense that money is free speech is crucial – if any citizen can only contribute volunteer time, not money, the wealthy elites loose a lot of their leverage.

    But what applies to corporations applies to people – individual wealth can be “Too Big For The Law”, and fundamentally incompatible with a democracy. In an open society truly based on merit, inherited wealth would be confiscated to pay for free education gated only by aptitude and effort. If the spoils of greed cannot accrue across generations, who cares about how much money a person can grub – death will level them all. But right now, Congress is bought and paid for, and the Great Open Society is coming to a grinding halt.

    Obama is not a man who contemplates meaningful change. He wants to win the game, not change the rules he mastered. He does not mind that the game is rigged, as he has always been able to rig it for his own benefit. Or more precisely, others – Daschle, Lieberman – rigged the game on his behalf (e.g. see the 2004 convention).

    By their sponsors know them. If politicians had to wear stickers and labels from their biggest donors — think Formula One – during every speech, vote and public appearance, the world would be a different place.

  6. Ian Welsh permalink
    October 23, 2009

    Yes, a significant and loophole free inheritance tax is needed. And yes, Obama is bought and paid for by the financial lobby, and as far as I can tell, he likes them as well.

  7. October 23, 2009

    “Just tax every dollar after 1 million, on all income equally and with no deductions, at 90%. Tax every dollar after 5 million at 95%.”

    I agree.

    Practically speaking, it won’t happen. Obama ruled out reverting the Bush tax cuts immediately, and he has shown no inclination to even return to Reagan era tax income levels.

    I still think that doubling down on the so-called “Death Tax” is the better target: a 100% tax on gifts and inherited wealth above a lifetime limit of one million dollars, revenue earmarked to fund schools, libraries, colleges, universities, stipends, and communications infrastructure. Let them eat merit.

    If they are born *that* much better than the rest of us, the inbreds of wealth won’t need their parents’ money.

  8. October 23, 2009

    The US has arrived at late stage capitalism, where competition has been replaced by oligopolies and monopolies. Then non-productive rent-seeking trumps entrepreneurialism, and wealth gets concentrated at the top. Ad hoc solutions are not going to work. The system either has to be reformed or it will implode due to its internal contradictions, and a new system will arise from the ashes. It would be better to reform the system before implosion, because the result of implosion will be very painful for a whole lot of folks. However, given the level of corporate system capture through buying influence and the revolving door, effective reform is virtually impossible. The Obama administration is already compromised and shown itself ineffective to force real reform.

    So prepare for the worst. The financial sector is still leading the US over the cliff through excessive leverage and imprudent risk-taking owing to moral hazard created by government guarantees in the event of failure. Nothing has changed, and indeed, things have just gotten worse through consolidation. This consolidation results in oligopoly (top tier control) and monopoly (GS). The joke going around now is that GS no longer has to buy the US government. It is the US government.

  9. Howard permalink
    October 23, 2009

    Revision of the tax structure, however, is not an ad hoc solution but, combined with the obvious recognition that corporations as creatures chartered by the state are subject entirely to regulation by the state as opposed to natural creatures (persons) who are subject only to what regulation the constitution allows, would provide for the sort of institutional changes you (and I) believe necessary. They could set us on the path to recovery now or could provide a template for a healthy revamping once we have hit bottom.

    The chance of getting these sort of changes are, however, slim to none for the reasons you suggest.

  10. October 23, 2009

    @ Howard

    Modern monetary theory describes how the monetary system works in the case of a government with a sovereign currency that is non-convertible, with flexible exchange rates. There is a vertical component and a horizontal component. The vertical component is government and the horizontal component is the non-governmental sector (private and external).

    The banking system is fundamental to the horizontal sector, since it controls the supply of money on the principle: loans create deposits. (No reserves necessary to get the process going.) Here it is key to note that nongovernmental banks do not and cannot create net financial assets because it is at accounting identity that debits and credits net to zero.

    On the government can increase and decrease the net financial assets of the non-governmental sector. It does this by increasing and decreasing banks reserves. Spending increases bank reserves, taxes decrease reserves. Government bonds merely serve as a store of excess reserves of the non-governmental sector at interest. The other way that the government controls excess reserves and therefore short term interest rates is through CB market operations.

    The important point here is that the government spending is not revenue constrained, so that neither debt (borrowing) nor income (taxes) are required for spending. The only limit on spending is inflation, which only occurs when the net financial assets the government creates exceed the capacity of the economy to produce. As long as there is an output gap (cum unemployment and underemployment) there is no inflation.

    The purpose of monetary policy is to regulate short term interest rates. Long term rates are determined in the market place based on demand for investment capital. Thus, monetary policy is a blunt instrument but one that acts quickly.

    Government spending (deficits) inject funds into the economy in a targeted way, increasing bank reserves. Taxes take funds out of the economy in a targeted way, decreasing bank reserves. Spending and taxation are sharp instruments, but they are slow because they involve the political process. The political process also allows them to be dulled.

    According to modern monetary theory, the approach of the government (especially Treasury and CB working in tandem) must be holistic rather than ad hoc. But to do this, one has to understand modern monetary theory. The world is still operating as if it were prior to 1971. Moreover, neoliberal theory is used to advance the interests of capital as if this theory were empirically justified, when it is not. It’s conclusions have been discredited and its assumption are based on the perspective that the chief purpose of a modern economy is capital accumulation. Worse, neoliberalism equates its bogus theory with ideal political policy.

    So I not against progressive taxation, regulation, etc. My point is that until principles that describe how the economy actually works are put it place, not of these is sufficient to do more than forestall the inevitable. Without understanding how modern money works, most “solutions” are most likely to be counter-productive, because they are based on erroneous views.


    Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth by Wynne Godley, Marc Lavoie

    Understanding Modern Money: The Key to Full Employment And Price Stability by L. Randall Wray

    Bill Mitchell’s billy blog

  11. October 23, 2009


    For a quick tour of MMT (modern monetary theory), see Bill MItchell, Stock-flow consistent macro models.

  12. someofparts permalink
    October 23, 2009

    Where I live I get to see the costs to my friends and neighbors up close and personal. Guess that’s why I’m so flip about guillotine jokes. The people around me suffer nightmarishly and I think, what awful thing could happen to any of the culprits at Goldman that would be a bit worse that what they have done to so many people?

    But then if I try to talk about any of this with folks at work who are far from well-to-do, but still have jobs and health insurance, they go off about how our problems are caused by those welfare moms. And they are still as proud and defensive about that kind of ignorance as they ever were.

    I don’t think their ignorance means I deserve to go broke, or that anyone else does. Still, I despair of a solution when I see how determined so many people still are to insist that the U.S. Titantic is the greatest boat ever.

  13. Ian Welsh permalink
    October 23, 2009

    Not 100% sure I entirely buy modern monetary policy. What I will note is that for most of the post Breton Woods period, the Fed would deliberately engage in monetary policy designed to undo whatever the fiscal authority was doing. If the fiscal authority was doing a stimulus, the Fed would sterilize that money. It was profoundly anti-democratic, seemed to be designed primarily to stop widespread wage increases from happening and helped create what was called the “banker’s classic COLA” (cost of living adjustment) as well as steep general income inequality.

    The monetary policy you describe also seems to treat deficits as separate from debts – once the output gap is gone, the debt will still remain.

    I think how one does deficit spending is as important as the amount, and I think that’s something that a lot of economists forget except when talking about multiplier effects. Multiplier effects are important, certainly, but it’s equally as important that the stimulus create a direction for the economy which private industry can trust will last, so they can invest in it longer term.

    I would also argue that at this point, raising taxes would actually be beneficial to the economy, especially if it was steeply progressive, but even where it isn’t. Ordinary people don’t have pricing power, money given to them is simply taken away from them immediately (see interest rates, credit card and inflation, real not BLS BS). The velocity of money has fallen through the floor, getting that money moving again is necessary, and that means having government spend it and spend it on people who will spend it. Tax away, spend away.

    The upper bound of US deficits is actually what the rest of the world is willing to put up with.

  14. October 23, 2009

    Ian, I really suggest you study MMT thoroughly. It is based not on assumptions but on national accounting identities. I was suckered by the prevailing paradigms until I happened upon MMT quite accidentally. While I was skeptical to begin with, I took the time to go through this stuff carefully. I’m still in the process, but I’m getting the drift. The basics are actually amazingly simple because it’s just a matter of accepted accounting principles. Nothing really new here. It’s just an exposition of how a monetary system actually works in terms of stock and flow.

    I am not an economist and don’t pretend to be able to answer questions about MMT with any authority. However, Australian economist Bill Mitchell is very gracious on his blog and is open to answering both questions and objections. He has already dealt with the most questions and objections, since the same one keep coming up, and he simply directs one to the relevant blog. Moreover, his political perspective is definitely left. He emphasizes, however, that MMT is not political in that rest on no assumptions, just description of national accounting in a fiat system with flexible exchange rates.

    For example, you say that raising taxes can be beneficial to the economy. What MMT says is that taxes decrease net non-financial assets, so that if the economy is underperforming, taxes should only be used in a targeted way to reduce heat in isolated areas. So, taxing excess profits or income can be an appropriate response. However, the decrease in net financial assets that taxation involves requires increases in spending (deficits) to offset the decrease so that the result is a net increase. Otherwise, the decrease in net financial assets will result in under-capacity, hence increased unemployment, in an environment in which the non-governmental sector wishes to net save. So it is appropriate for the government to tax at the top to decrease excessive risk-taking while increasing spending at the bottom through, say, unemployment benefits. However, according to MMT, taxation is not needed to fund the deficit created by “spending.” The two are simply instruments for increasing and decreasing net financial assets (bank reserves) of the non-governmental sector.

    Another example, you say: “The upper bound of US deficits is actually what the rest of the world is willing to put up with.” This assumes two things. first, that currencies need to be defended, but this is no longer true for non-convertible currencies with flexible rates. (Paul Krugman attacks this objection from a different angle in todays NYT column.)

    The second assumption is that the US needs to borrow to spend. It does not. The US government could conduct its business of increasing and decreasing bank reserves (non-governmental financial assets) without issuing Treasuries at all, rather just by crediting and debiting accounts. Bill Mitchell deals with the underlying rationale in Zimbabwe for hyperventilators 101.

    Regarding debts and deficits: “Debt” does not apply to the government in the same way it does to the non-governmental sector. Households and firms need to finance debt from income, or drawing on saving, or selling assets. The government is not revenue or asset constrained in a modern fait regime when “borrowing” (issuing debt) in its own currency. For example, the government does not have to raise revenue through taxes to pay its obligations. It creates, destroys and services the obligation simply with accounting entires that affect bank reserves. Its constraint in increasing net financial assets is not to exceed the value of real output. This doesn’t happen when there is an output gap.

    I strongly urge all to read Stock-flow consistent macro models, where Bill Mitchell goes through the national accounting pretty simply. It’s a pretty quick read, although for those not familiar with some of the concepts, it may take a couple reads to grok. This where I would begin anyway.

    Bill’s blog is also a must read for people on the left in my opinion, since he destroys neoliberalism and shows the way to national prosperity with full employment without inflation through the government’s ability to manage net financial assets in an economy while influencing the non-governmental sector in a targeted way through deficits and taxation. He is not just an academic. He is now in Kazakhstan advising the government. Moreover, many savvy people comment, and they, too, chime in on questions.

  15. Ian Welsh permalink
    October 24, 2009

    I’m suspicious. I’ll take a look, but I’ve found that economists who use accounting identities as if they are economic realities miss some actual realities.

  16. gtash permalink
    October 24, 2009

    Jeez, I wish I knew what you guys are talking about! And I mean that in a good way. But back to bankers’ compensation: the gist of Ian’s post is that the current proposal is ineffectual window-dressing. That is abundantly clear to me. I read that Paul Volcker says he is more than willing to speak when spoken to about the subject of bank regulation, but he isn’t going around “knocking on doors”. He reminds me of Elizabeth Warren insofar as media treatment goes: the canaries in the coal mine are singing, but the sound isn’t making it out of the coal mine. The miners keep pouring in. What to do?

  17. Ian Welsh permalink
    October 24, 2009

    Elizabeth Warren has been pretty active. A friend of mine knows her, and says she’s been pretty shocked at how she’s been treated. Unlike us dirty hippy bloggers who expect to be right and ignored by “real people”, Elizabeth Warren thought she was a real person who would be listened to. She’s finding out she’s not. That pisses her off.

  18. October 24, 2009


    completely agree and want to second you re the critical importance of stock-flow consistent macro models! (i do disagree a bit with some of the details of your comment, more that later — i’m looking forward to a fun discussion!).

    also second your recommendation re billy blog (i’ve even linked to it here before — on the topic of the recent japanese elections iirc). although i think steve keen’s critique of the mitchell/wray/mosler MMT is also important (it’s the only critique i’ve found so far that i buy), i think both have a lot to offer in terms of trying to understand the economic world we actually live in.

    after last september, i decided i really needed to try to teach myself some macro econ in order to have a clue what was happening. the massive amount of nonsense makes it harder than it has to be, but the insights of various heterodox post keynesians have made the most sense / been the most helpful to me (even if they don’t all agree with each other).

  19. October 24, 2009

    selise, glad to hear that you are in. I agree that in addition to Bill Mitchell, people need to be aware of Steve Keen, Warren Mosler, and Randy Wray.

    This understanding of heterodox economics needs to be widely disseminated before neoliberalism blows up the world. For example, many on the left viscerally oppose neoliberal economic policy, but unwittingly mouth neoliberal shibboleths because they are the familiar memes of an established narratives. Cognitive scientist George Lakoff has warned against perpetuating the framing of the right that has become established. In this sense, many on the left are intellectually captured by the neoliberal memeplexes of the right that favor accumulation of capital by disadvantaging people who work for a living, i.e., everyone else.

    I’m a fan of Steve Keen , too. Blog: Steve Keen’s Debtwatch. Everyone on the left really needs to read his book, Debunking Economics, meaning debunking neoliberalism.

    I’m sure you know that Steve recently proposed a debate with Bill Mitchell in order to compare, contrast, and clarify their positions but others may not. The links to Steve’s blog are contained in Bill’s first post. Steve also comments on Bill’s posts (as do some other very smart people). Here are the links to the posts on billy blog.

    In the spirit of debate …

    In the spirt of debate … my reply

    In the spirit of debate … my reply Part 2

    In the spirit of debate … my reply Part 3

  20. October 24, 2009

    Ian, Big Money is doing all it can to marginalize Elizabeth Warren, if it can’t get rid of her outright. She is at the top of their enemies list. Most significantly, she is now becoming a folk hero of the populistleft. She is just about the only one in the administration that gets it, is willing to say so, and speak truth to power. We are already seeing slogans, “Elizabeth Warren for President.” She has a bright future in the progressive movement, and I hope she later goes into politics.

  21. Ian Welsh permalink
    October 25, 2009

    Read the billy blog post. I’m going to have to dig more. My sense right now is that the model doesn’t deal properly with the effects of borrowing – or rather, of time . But to be really sure I’ll have to do some math. It also doesn’t seem to match up very well with actual historical performance in the past 30 years (for example, his Japan example is way odd.)

    I’m also not sure that money creation works quite the way he says and the model doesn’t seem to deal with velocity of money well (or at all) either. The question of leverage is mentioned a few times, but not really dealt with (if the government isn’t running deficits (leaving trade neutral) then leverage in the private sector must build up is all he says, but that seems inadequate to deal with the actual way money is created which is always leveraged.)

    Of course, this is a simplified model he’s using.

    Anyway, this’ll take some time. Maybe I’ll get that textbook tjxfh mentioned (er, no, not for $112, now there’s a fucked up market–textbooks. This should be a $30 hardcover at most).

  22. October 25, 2009

    @ Ian

    1. Mitchell doesn’t deal much with borrowing because he is primarily interested with the vertical relationship between government and non-government, where government provides net financial asset through increasing and decreasing bank reserves. In this model only the private sector borrows in the sense of banks issuing loans, thereby creating deposits. Government “debt” is not debt in the same sense, since the government services its own obligations, not the private sector. Government “debt” is just a way that the CB drains excess reserves in order to set the targeted short term (overnight) rate. Mitchell emphasizes that while government “debt” is essentially irrelevant since the government can do the same thing without it using other means. If fact, he recommends that the US discontinue issuing Treasuries, since they just cause confusion in people’s minds, who think that taxation is needed to service them, which is not the case. Regarding private debt, which is a horizontal factor limited to the private sector, Mitchell does say that this is important, but that government policy can decrease the tendency to over-leverage and, of course, regulation and oversight can be established at the governmental level also, since it controls the working of the banking system. Steven Keen deals in depth with the way debt functions horizontally, within the private sector.

    2. Money supply is neither created nor controlled vertically by the CB. This is a horizontal function of banks. Loan create deposits and reserves are added later. Steven Keen, who is a Circuitist, focuses on the horizontal aspect. (See the debate between Bill and Steve, as well as and others in the comments, to which I posted links above.)

    3. Bill uses a simplified model in his work for popular consumption, but as he says, unlike neoliberal simplifications that are misleading, his model is not because a more complex model just articulates the accounting identities further. Randy Wray also presents a simplified model for popular consumption in Understanding Modern Money: The Key to Full Employment and Price Stability. (BTW Modern Monetary Policy is available on Google Books <a href=”here“>. Of course, all these folks write professional books and articles, too. Many of their articles are available free at The Levy Institute of Baird College here. Godwin and Lavoie book is expensive, but they publish articles at Levy that are available free. There is really a huge amount of info on the net on this. I’ve just begun to scratch the surface. For example, there are a lot of others that publish at Levy that I haven’t mentioned.

    Finally, all these folks are really friendly and open. They answer questions freely on their blogs. In fact, there is a lot of excellent information in the comments on the various posts. I’ve already posted links to Bill Mitchell ad Steven Keen’s blogs above. Randy Wray blogs at Economic Perspectives along with William K. Black. Warren Mosler blogs at The Center of the Universe.

    It’s hard to puzzle a comprehensive presentation out of the blogs, though. For a comprehensive overview, I suggest reading Randy Wray’s Understanding Modern Money at Google, or picking up a used copy through (a bot that searches a number of bookseller databases). I got mine at Powells for $15, for example. Wray sums it all up in the preface and intro, a short read. When one sees where he is going with this — full employment with price stability — I think all progressives will be excited. Moreover, this model destroys the neoliberal myth that “government “spending” is necessarily damaging to the economy because it necessarily leads to increased taxation and crowding out, and is ineffective anyway on Ricardian principles. The Neo-Chartalist conclusion is that it is possible to have universal education, universal health care, and a safety net through deficits, along with a vibrant economy with price stability, when modern money system is properly understood and used to advantage. The basic insight is that deficits are growth-promoting, while only deficits in excess of real capacity are inflationary; government surpluses are contractive and in excess, deflationary. Balanced budgets are growth-neutral. Allocation of deficits is political, and there is no barrier to a progressive society economically if there is political understanding and will.

    IMHO, this knowledge and perspective needs to be widely circulated among progressives (and everyone else). Too many progressives are all fired up about what’s happening (and not happening) but they don’t have a comprehensive economic solution because they don’t have a clear view of economics, having been brainwashed by neoliberal memes. Worse, most people are still thinking and writing in terms of the neoliberal memes because that is the prevailing paradigm and established narrative. For example, Bill Mitchell observes that the frame, “taxpayer-funded” is just wrong. Taxpayers don’t fund anyone or anything. Taxes decrease net financial assets. If you send cash to the IRS in payment of taxes, they will just account for it with a ket stroke decreasing bank reserves and burn it. Really. Steve Keen also destroys a lot of this erroneous thinking and verbiage in <Debunking Economics.

    As you may have noticed, I’m pretty stoked up about this.

  23. Ian Welsh permalink
    October 25, 2009

    We’ll see. I have some respect for stock flow theories as I understand them, but I have a gut feeling there’s some important points missing, mostly on the time dimension and how money is actually created.

  24. Scott R. permalink
    October 25, 2009


    I have a bit of a hard time getting my mind around some of these abstract concepts. Especially the “Job Gaurantee” aspect that is at the heart and soul of MMT. Any chance you can put them in a concrete context? How about explaining how MMT would have been applied in 2000 when Georgie took office.

    We had a budget surplus…, but the DOT.COM Bubble had burst, the economy was headed toward recession. George E. started a war in Iraq to get the economy and some jobs going via the military-industrial complex…, he pushed the mortgage industry into supplying home loans to people who could never pay them off to keep the only other significant manufactoring industry left in the US ( housing) going. That the latter effort resulted in the bankster crisis is irrelevant to the question at hand.

    If George E. would have applied MMT theory instead of the measures he chose…, what would it have looked like? It goes without saying that ANYTHING would have been better than what we have now. And I am not sure ANYTHING can fix it now.

  25. October 25, 2009

    @ Scott R

    Several points are necessary in understanding how MMT operates. The first is that government and non-government (domestic private and foreign) stand in a vertical relationship such that government deficits create a net financial surplus in the non-governmental sector. This means that government spending provides high power money (HPM) through bank reserves and physical currency. Physical currency only enters the economy have banks exchanging reverses for currency. Basically, government deficits (spending) create bank reserves. When the government spends, the Fed increases bank reserves. This is a net increase in financial assets. (If the government taxes, then bank reserves decrease.)

    Secondly, banks operate horizontally in the non-governmental sector. They increase the money supply by making loans, which automatically increase deposits. They then allocate the required reserves. Reserves are not prior to money creation. However, banks cannot increase or decrease net financial assets, since loans and deposit always net to zero. Banks just provide the “grease” for the economy, whose net financial assets are determined by government monetary policy, decreasing net financial assets).

    Third. while the Treasury uses fiscal policy to increase and decrease net financial assets through spending and taxation, the Fed uses monetary policy to set the overnight rate, the base interest rate. Low interest rates for bank reserves make bank lending less expensive to banks, who must hold a share of reserves against deposits and loans create deposits. This rate influences bank behavior, especially their lending rates, which operate on a spread.

    Bill Clinton followed the advice of Robert Rubin and ran a tight ship to keep the bond market (the wealthy) happy, but the government surplus withdrew net financial assets from the economy leading to a contraction (recession) in the early Bush administration. Bush correctly cut taxes and ran a deficit. However, the Fed kept rates too low too long, taxes were not increased when the economy picked up, and deficits expanded due to wars. The result was asset inflation that lead to bubbles and you know the rest. So from the point of view of MMT, Bush stared on the right course in the face of recession but because Bush policy was for the wrong reasons according to MMT, the loose policy was continued too long, resulting in housing and commodity bubbles. The Fed missed the inflationary trend since was looking at domestic prices, dampened by cheap imports, and low wage pressure, due to global labor arbitrage.

    The other problems that occurred have nothing to do with MMT. For example, the government, acting on a neoliberal anti-government bias, failed to regulate the financial industry properly, so that excessive debt was created, a lot of which now cannot be paid down, at least on time without restructuring. Some never will be paid. Ben was correct in taking a lot of this toxic waste on the Fed’s books to prevent a global meltdown, which was otherwise inevitable if liquidation were forced by neoliberal principles. The stimulus was also correct according to MMT, although insufficient. MMT would say that there is no problem using government deficits for necessary rescues and also to close the output gap as soon as possible to reduce unemployment and underemployment. The problem now is that the government is not committing enough quickly enough, and the fear is that neoliberal shibboleths will force a contraction in government policy too soon. Of course, the policy has to tighten at some point, but too soon will result in a double dip recession, and if contraction is too severe, a depression will ensue.

    The funding of the military-industrial complex is another issue. Note that the deficit hawks don’t mind spending on “defense” and banker bailouts. They just hate social spending. The shows that the allocation of deficits is a political problem that needs to be resolved a political level. The US has to decide how it wants to allocate its financial assets, whether to education, health care and social welfare that benefits the public purpose or to socialism for the rich. Neoliberal nonsense is convincing the public of the latter, or else that spending on social programs will crowd out investment and raise taxes, both of which are untrue.

  26. October 25, 2009

    Ian, I would formulate some questions and head over to Bill and Steve’s blog and ask them. As you say, the models are simplified, and so to get t0 the nitty gritty, it is often necessary to ask the experts. They are both gracious about answering questions and objections.

    They see it as vital for folks to get this stuff if the world is to change. Bill’s blog today is about his trip to Kazakhstan and how the developing world is getting screwed unnecessarily by the neoliberal ideology of the IMF and developed countries. It doesn’t have to be this way.

  27. October 25, 2009

    @ Scott

    The job guarantee is central to Randy Wray’s book, Understanding Modern Money, which can be read at Google Books. (Link above.) There is also a concise entry on it at Wikipedia here, with references to pursue. It’s hardly a new idea. I remember Robert Theobold proposing this back in the late ’60’s, early ’70’s. There are different proposals out there, but Wray’s is current and he has presented it for popular consumption in his book. Bill Mitchel also has a book out on it entitled Full employment Abandoned.

    The basic idea is that under the current neoliberal thinking and policy, price stability requires a buffer stock of unemployed. (According to NAIRU, full employment is ~ 6%.) Therefore, the chief mandate of the Fed is to target interest rates, using unemployment as one of its tools. However, history shows that this is an impossible goal, and MMT explains that this is because neoliberal ideology is flawed. Therefore, MMT suggests that instead of trying to set an elusive interest rate to maintain price stability, the government set a base price for labor at the bottom (minimum wage), at which it is always prepared to hire, so anyone willing to work can, even if underemployed.

    Wray then seeks to demonstrate how this price stability of labor will result in full employment (about 2%) while keeping inflation under control (as long as the government deficit does not exceed real resources). The non-government domestic sector can generate imbalances, but it cannot create either inflation or deflation because net financial assets are government-controlled as monopoly provider of the sovereign currency in its own economy. The government can address these horizontal imbalances through a variety of tools, in order to make sure that they don’t become excessive in either direction. This ability, of course, presupposes that the neoliberal anti-government model be shown for what it is, a set of baseless ideological assumptions that favor the accumulation of wealth at the top.

    If this were in place in 2000, when the bubble popped, there would have been an automatic stabilizer that would have increased the government deficit spending at the bottom, where it is most effective in increasing the net financial assets that had been depleted by the Clinton surpluses. Instead, W. decreased taxes on the wealthy, ramped up the deficit for defense spending, and the Fed used monetary policy to reflate the bubble, as would be expected on neoliberal ideology that favors wealth. INitially in stoked the economy but, continued to long and too much, led to asset bubbles.

    MMT could encourage government mortgage programs under certain circumstances, but would not encourage imprudent lending practices. The point of extending loans instead of grants is that they can reasonably be repaid. If there were a job guaranteed with a truly subsistence wage, even the lowest income earners would be able to afford a properly structured loan, especially if government subsidized affordable housing, which otherwise would not be built since it is not very profitable. The point of subsidies is that they encourage socially useful projects that would not be undertaken for profit. Such programs can also be used to employ people on the job guarantee. People without needed skills can be trained, which is an investment in education that improves the work force.

    If Clinton had been following MMT, he would not have allowed a surplus to cause a contraction in the first place. He was operating on the neoliberal shibboleth that running surpluses is fiscally responsible and economically provident. But once the error was discovered, it could have been corrected by increasing the deficit and using government spending in the economy after targeting where funds could best be used efficiently and effectively (instead of handing the bulk of it to the rich and generating asset bubbles).

  28. selise permalink
    October 25, 2009

    argh! i had a long comment just go “poof.”



    This understanding of heterodox economics needs to be widely disseminated before neoliberalism blows up the world. For example, many on the left viscerally oppose neoliberal economic policy, but unwittingly mouth neoliberal shibboleths because they are the familiar memes of an established narratives.

    amen, amen!

    i am trying to clear my mind, but it’s really hard.

    some random stuff (i’m too tired to try and reconstruct my lost comment):

    i think you must be way ahead of me. just last week i got steve keen’s book and all the rest of my reading has been online (agree great stuff at levy, and also at steve’s site). at some point i will try to take a look at the books you’ve recommended. iirc, aren’t bill and randy coming out with a new book soon?

    fwiw, i actually wonder if a question i asked at at steve’s blog in sept, and the resulting bit of discussion, might not have helped instigate steve and bill’s debate collaboration you linked to :


    re your discussion with ian on taxes. imo increasing taxes right now would be a v big mistake. for people (or firms) who are struggling to keep up with servicing their debt, increasing taxes may make that impossible and so force bankruptcy (or distressed sale of assets — can you say deflation?). so long as a significant portion of the private sector wants to save or pay down debt, deficit spending is necessary and should be targeted to the debtors (not the lenders). increase taxes only in a very targeted way (as you suggested).


    If Clinton had been following MMT, he would not have allowed a surplus to cause a contraction in the first place. He was operating on the neoliberal shibboleth that running surpluses is fiscally responsible and economically provident.

    warren mosler, in his 7 deadly innocent frauds essay has an amusing story involving larry summers and al gore on this topic (it’s the 3rd fraud):

    i think these ideas are spreading. a few weeks ago paul rosenberg had a nice mini series of economics posts at open left interspersed with some non-econ posts. one of the non-econ posts, three types of crazy, kinda as joke, i quoted from godley and wray’s, “is goldilocks doomed?” to claim that clinton’s surpluses were crazy:

    …the notion that a federal budget surplus is sustainable, and that it promotes economic growth, must be abandoned. Given the realities of the U.S. trade imbalance, public sector surpluses are consistent with economic growth only so long as the private sector’s financial situation deteriorates at an accelerating pace.

    only to have paul agree ! and he had a later post already written on a paper that referenced godley and wray!

    here’s the series of posts (i think ian may be interested, if he hasn’t already read them):

  29. selise permalink
    October 25, 2009


    re time and money creation. steve keen is your guy for dynamic non equilibrium modeling and he’s got a great post on money creation, “The Roving Cavaliers of Credit,” (money multiplier model is wrong):

  30. selise permalink
    October 25, 2009

    p.s. ian, do i need to let you know i’ve got a comment above to tjfxh that’s been caught in moderation? thanks!

  31. Ian Welsh permalink
    October 26, 2009


    no I get alerted. I just wasn’t online at all for the last while.

    My instincts tell me that raising taxes is the right thing to do for pricing power reasons. I also don’t agree with the deficits don’t matter mantra.

    I will add that I know for a fact that Stirling thinks raising taxes on the rich right now (and probably even a bit on the middle class) is the right thing to do.

    Of course, Stirling doesn’t believe the US (or most other nations) have a fiat currency by the strict definition, for various reasons.

    Taking this tangle apart is going to take some work, and it may be a few months before I get to it, but I’ll see about doing so. For what it’s worth, and what I’ve read, I think stock flow macro has some insights, but it makes me uneasy, and I don’t think it’s quite right.

    Keen’s article is excellent, it’s long been evident that the central bank didn’t control money creation anymore, and indeed the link between assets and loans made it clear they never did entirely, but I didn’t see the picture as clearly as he lays it out.

  32. October 26, 2009

    selise, thanks for the links.

    Regarding raising taxes now. While raising taxes decreases net financial assets and is counterproductive when fighting deflation, there is a case for targeted tax cuts, like a windfall profits tax, both to cool asset values rising too quickly due to loose Fed policy, and also for equity reasons — people are getting mightily pissed as Main Street suffers and Wall Street prospers.

    Regarding asset values. There were a couple of interesting posts at Zero Hedge about the Fed’s stoking the equities and bond markets here and here. The Fed is obviously trying to reflate assets in order to deal with a mountain of toxic debt. IMHO, this is a fool’s errand. Congress should step in with a windfall profits tax that dampens this nonsense that is repeating past mistakes. This would also go a long with to quelling populist anger at the cozy relationship of government and the financial sector.

    Offsets. The Congress should then allocate the amount that it taxes the financial system to repairing the damage that the financial system wrought on the real economy, throwing millions out of work and even on the street. That would put the funds back in the system, where it would be spent instead of used for speculation, e.g., driving up commodity prices like oil.

    Of course, if there are going to be no claw backs, and there are not, then excessive salaries and bonuses should also be taxed and that offset in the same way. Good luck on that though.

    According to MMT, government spending and taxation can be used not only to increase or decrease net financial assets but also in a targeted way to modulate economic activity, stoking where needed and dampening sectors like finance where things are getting too hot, even in an overall cold environment. This is where MMT differs from neoclassical monetary theory, which seeks to do everything with monetary policy alone. MMT emphasizes the limitations of monetary policy and shows how fiscal policy can be used more efficiently and effectively. But the idea that tax revenue “funds” spending and bond interest has to be dispelled, because that’s not how it works at all in a sovereign fiat system.

    I’m afraid that this is way beyond the brain power of Congress though, where all taxes are still “bad,” and the way to be “fiscally responsible” is to cut social spending, since military spending is totally responsible and should always be raised as much as possible.

  33. Ian Welsh permalink
    October 26, 2009

    Also people are doing the wrong things with their money, and that goes all the way down the chain. Right now when the economy heats up, people use oil.

    That’s not good. Tax the money away, use it to restructure the economy. We have bottlenecks on growth right now, and we cannot have good growth (aka, a per 70’s economy) till we deal with them.

    And I’m 99% convinced MMT is wrong that any level of deficit spending is possible. Any attempt to push it beyond what other central banks, oil money and the rich will tolerate and they will retaliate in various ways (dumping assets, going on buying strikes, raising the price of oil, etc…) It may be possible in theory, but in the current situation it is not possible because of the current structure of flows in the economy.

    Of course tax policy should be targeted. Likewise money for doing things we want more of should be cheap money, and money for things we want less of should be expensive money (as in the proposals I wrote of in the past for the Fed to make direct loans for certain purposes. Your first house on a vanilla mortgage – sure. Investment properties-go to the retail banks, thanks. Junk food-no. Good food-yes. Etc…

    It has to be made so that the way you get rich is by creating new things and/or making people happy, not by playing trading games. Everyone cannot, should not, be playing arbitrage and/or leveraged bubble games—they add very little value to the system at this point, since in most cases the gaps are small. And of course, you tax negative externalities at full value, and put lower taxes on people creating positive externalities.

  34. October 26, 2009

    Ian, I agree that a lot of policy based on what actually works instead of erroneous ideology that favors established wealth cannot pass muster politically and will be mightily opposed by wealth. But neither could a middle class tax increase, especially in this environment, e.g., to raise the opportunity cost of oil. The way to do this would be to put an excise tax on petroleum products especially gasoline, but that’s a political non-starter, too. For example, there is a current push in the US to tax sugared sodas, which are creating an epidemic of obesity and diabetes. The industry has pushed back hard with TV ads decrying it as a tax hike on ordinary people’s “food.” As long as the “taxes are bad” mentality prevails, politicians in the US consider raising taxes to be political suicide. Through propaganda induced ignorance and bias, the middle class is acting against its own interest and killing itself. The mostly Austrian populist solutions proposed by people like Ron Paul would be even worse, leading to crippling depression and consolidation of assets at the top.

    There is not a lot of understanding or will to correct the poorly designed flows in the economy. The Obama administration proposed reforming health care, financial, energy, climate change, and education, and we see how difficult it has been and how much political capital in has cost to tweak health care just slightly and even that is not a done deal yet. Will there be much more left for the other things. My feeling is that the system is going to have to crash first before real reform can be build on its ashes.

    MMT does not claim that any level of deficit spending is possible without consequences. It simply states that a sovereign is free to “spend” and “borrow” without offsetting revenue increases (taxation), and the only constraint is keeping the nominal in balance with the real.

    The point is that economic policy based on MMT is capable of producing full employment with price stability, which neoliberalism denies, claiming that an buffer stock of unemployed is needed to keep wages in check and inflation down, inflation being essentially caused by wage inflation. Neoliberalism is just loading the game in favor of capital at labor’s expense. If MMT is correct, there is no genuine economic justification for this exploitation of labor. It’s a bogus argument based on gratuitous assumptions that favor capital.

    Of course, all the things that you object would happen would likely take place as long as neoclassical ideology is equated with economic policy. That is why it is so important to set the record straight about neoliberalism and break its lock on global society. It’s virtually impossible to do anything significant to better conditions overall under a neoliberal regime because it is geared to the wealthy and has the populace brainwashed into thinking that neoliberalism is economic science comparable to physical science and engineering.

    But the dire consequences that neoliberals predict don’t necessarily turn out that way. Bill Mitchell cites the example of Argentina, which defaulted and came out fine, despite the predictions of doom. And once the economy came back from the disease forced on it, so did foreign capital, regardless of what they had said previously. Greed trumps revenge.

  35. Ian Welsh permalink
    October 26, 2009

    I predicted Argentina would be fine too. For rather different reasons. But Argentina did not and does not rely on the sort of privileged position the US does.

  36. BCNurseProf permalink
    October 26, 2009

    I have tried to keep up with this, as I think it’s incredibly important for me to understand, but I’m still lost. I read this by Numerian today:

    and I wonder about what it can contribute to this discussion.

  37. Ian Welsh permalink
    October 26, 2009

    I’ll probably write an explanatory post at some point. Basically conventional neo-classical economics is bs. I’ve believed that since grade 11 when I first read about utility maximation and rational expectations and clearing markets and so on and so forth.

    The post-Keynesians that tjxfh linked to argue for accounting identities as fundamentals. Say there’s an economy made up of only two people – you and me. if you’re running a surplus (saving) then I must be running a deficit. So if you take an economy made up of two aggregates – the government and the private sector, if the government is running a surplus, then the rest of society (private sector) must be running up debts. If so, then to keep the same level of activity going they MUST leverage up.

    Now, if money is flowing out of the society that exacerbates the situation (ie. if you have a balance of payments issue) and if it’s coming that helps. Blah, blah.

    In one sense this is completely true, it’s just an accounting identity issue. I am suspicious of it meaning as much as the post-Keynesians say because, for example, similar arguments are used in trade “well, if they’re running a surplus with us, and we a deficit with them, they have to use those dollars for something…” And that’s highly misleading because they can buy debt, or they can use those dollars entirely outside the US to trade amongst themselves (one reason why dollars not being traded in oil is bad is because then those dollars are more likely to come back to the US.) In addition, what they bought from the US was usually future income streams packaged as securities in various fashions. Which is a ponzi game.

    These aren’t the issues with post-Keynesian accounting identity economics. (In fact, I’d say stock vs. flow, and the effects of rapid changes in flow is where I think their model has issues) but it’s why I’m suspicious of accounting identities as economic entities on their own, even as treating countries as economic entities has always struck me as at least half wrong.

    However, they have some strong and important insights, and I don’t really know enough of the theories to properly rip them apart. I intend to rectify that oversight, and hey, it may be that they hold together perfectly and correlate properly with reality. Not sure at this point.

    In particular, if you follow one link, I would recommend reading Selise’s last link:

  38. October 26, 2009


    What Numerian has deftly described (as usual) is a giant Ponzi scheme set up by Wall Street. The scheme is set up in in a way that when it blows up, as it does every now and then, the government has come in and bail them out because they are too big to fail and would take the whole US economy down with them (and the global economy, too). I believe it was William K. Black that recently compared this scheme to the scene in Blazing Saddles were the sheriff put his pistol to his own head and says, “Don’t move or I’ll shoot.” WS is holding the country and world hostage as if it were a suicide bomber.

    How did things get this way and what can be done? A fundamental principle of neoliberalism aka neoclassicism aka free market economic is that markets are always in equilibrium internally and only fail due to external shocks, in which case they are self-correcting. Therefore, the government should not regulate the “free market” in any way, shape, or form. This was the Thatcher-Reagan formula for “growth.”

    Being unsupervised, greedy people did pretty much what you’d expect. Now that they have been called out, they are daring politicians to do something because they hold the purse strings to the country.

    As long as the fundamental principles (read “erroneous assumptions”) of neoliberalism go unchallenged the system is headed over the cliff. The wealth don’t really care since they will be more or less isolated from the debacle that the rest will have to endure, and they will end up picking up the pieces and owning more than ever. Unless there is a populist revolt. The problem with populist revolts is that the new leader may be a demagogue like Hitler or Mussolini.

    This does not bode well unless neoliberal ideology can be dislodged, a different economics established, and the system reformed from the top. Obviously, there is going to be a whole lot of resistance to that.

  39. BCNurseProf permalink
    October 26, 2009

    Thanks to the both of you. I’m not sure I will be able to put all this together, but these things do help. Numerian has also posted more in response to my question. I will follow this debate closely, even though it means toggling between sites. It seems to point to the cliff rapidly approaching. Would you both agree? Thanks.

  40. BCNurseProf permalink
    October 26, 2009

    Oh. Then there’s this about the Canadian Government being the largest sub-prime lender in the world:

    How long can the Conservatives keeping this going?

  41. Ian Welsh permalink
    October 26, 2009

    Wow, I had no idea. Fucking idiots. The Canadian government cannot afford any significant defaults on that amount of mortgages. 500 billion! That’s the equivalent of 5 trillion in the US, but we don’t have nearly the credit capacity the US has nor can we just print money. Even a 5% default rate would be disastrous, a 10% rate catastrophic.

    Good God. May Harper burn in hell.

  42. BCNurseProf permalink
    October 26, 2009

    We’re in trouble now, I see. Could you develop a post on this and help get the word out?

  43. Ian Welsh permalink
    October 26, 2009

    I mostly have an audience in the US. Will think on it.

  44. October 26, 2009

    Debt deflation’s a bitch.

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