Alexander Douglas has written a post assessing the validity of the transversality condition underlying the canonical government bond pricing equation in conventional macro.
I have nothing useful to offer on transversality, the controversy around which seems to arise because of mathematical and philosophical disputes far beyond my competence. The limit is not actually infinity, eh? I always knew calculus was just sleight of hand! *
This issue attracts my attention because it links directly to my extreme aversion to MMT and its claim that money finance can durably relax the public sector budget constraint. That claim strikes me as absurd, which is why when debating MMT guys I try to get them first to admit that MMT holds this view I ascribe to it. But I keep failing. My experience is not that they reject my claim (about their claim) but that they ignore it. The connection here to Douglas may not seem obvious, but please bear with me.
Alexander Douglas is a philosopher at St. Andrews who seems to do a great job of looking at economics from a critical distance, having as one of his specialties the philosophy of economics. It seems to me that he knows a lot more about economics than do the specialists from whom he humbly seeks guidance on technical matters. Maybe at this early stage in the development of macro in particular, the big disputes are still philosophical. Also, Douglas seems very well schooled in math, which is the language of economics, even among many of the heterodox.
Douglas claims (elsewhere) that he likes to press his take on economics only to the point where it remains applied logic — and to leave points thereafter to the specialists. Once they bring out their “models”, particularly in macro, he is inclined to see ambiguity creeping in and to back off and watch from a critical distance. **
To me, that is a fun thought. If I read him correctly, within the government finance debate, the ambiguities begin to creep in once the economists try (or not) to relate financial flows to real resource constraints or through that channel inflation.
I am running a great risk of putting words in Douglas’s mouth here, because what he actually emphasizes are welfare considerations, which he thinks requires heroic assumptions to model. But I think his concern is generalizable to any depiction of the real side of economy. (If the idea of a welfare function being called “real” makes you laugh, then fine. If I knew more math I would probably agree.)
The way macro handles what I am calling the real side obviously varies, is the subject of great controversy and is one of several areas in which economists have not covered themselves in glory. But this does not imply that the real side can be ignored and, in particular, that resource constraints are irrelevant.
For a while we thought we could dismiss the financial channel as irrelevant, and that did not work out too well. But maybe the pendulum has swung a bit too far in the other direction? We now pay more attention to financial claims and forget that they are claims on real things.
You may not agree with that, and I concede I have not argued the point very forcefully. It will either strike you or it will not. But all of this is just by way of teeing up this excellent paragraph, which Douglas should not have put in parentheses, dammit!
(Some people have commented that this model leaves out the fact that the government has the power to create “high-powered money” with which to retire its bonds. It’s true that the textbook model doesn’t include the creation of HPM — of course the sophisticated models in the literature do. But given the optimisation assumptions, I don’t think that changes much. HPM is also just a liability of the state, and the household doesn’t want idle IOUs in its pocket at the end of time. So it will spend up all the HPM before the final moment the way you spend up all your foreign currency on the last day of the holiday — the HPM will return to the government in tax payments and get destroyed.)
Yes, some people have indeed commented along those lines. I noticed that too. And you may have noticed me noticing.
Douglas is not convinced that their claim is valid within the formal model economy he considers. And the main purpose of this meandering post is just point that out. Douglas is not hopelessly benighted and orthodox, and yet he seems to dismiss MMT as parenthetical, literally, at least in the context of this model economy.
FWIW, I would reject MMT more universally, not because of logicial difficulties that arise in a mathematical economy, but because its central practical claim ignores simple transitivity.
The orthodox view on this, which may hold even if all of orthodoxy does not, is that trying to evade the public sector budget constraint with money finance would lead predictably to inflation. That view may be wrong, but it would be something MMT would need to address directly, rather than dismissing as a mere inflation concern, probably not relevant in the current low-inflation environment.
Even if we could get MMT to focus on this issue, and in direct debate, then there would still be plenty of controversy, because we don’t really know how to model real resource constraints very convincingly. But at least we could get away from the silly claim that this is all just a simple confusion related to the benighted’s inability to understand reserves accounting and how the payments system works. ***
One final, late-occurring thought which I am not sure where to stick. A standard bit of macro theory likes to relate the budget constraint to the transversality condition. Transversality attracts a lot of criticism, I guess. But there are more than two possibilities here. We don’t have to choose between transversality and MMT. There are very good reasons for not just ignoring the path of the deficit when setting tax and spending policy.
* I was never much good at calculus, but worse still at econometrics. It did not occur to me until long after grad school that the world does not actually produce errors. The error term is a metaphor for the stuff we don’t know.
** I don’t think Douglas is as sanguine on the state of macro as this guy!
*** I have flashed this quote from Warren Mosler before and have received perhaps fair criticism for looking at his popular work rather than his more formal work. But I think this is so great that I can’t help myself. Sorry. From page 12 of the “Seven Deadly Innocent Frauds of Economic Policy:”
So, how am I uniquely qualified to be promoting these proposals? My confidence comes from 40 years’ experience in the financial and economic realm. I would venture that I’m perhaps the only per who can answer the question: How are you going to pay for it?” My book takes on this issue and encourages a return of economics study to the operational realities of our monetary system. (p. 12)