Follow-up Post: Some Philosophy Lessons for Economists…

Long ago I took a course called “Economic Analysis for Political Philosophers” with Jo Wolff and Shepley Orr at University College, London.

think I remember Wolff saying something to the effect that he often felt a suspicion that economists don’t know the difference between necessary and sufficient conditions, but charity bid him put the thought out of his mind. If that is what he said, I’m beginning to know how he feels.

All that neochartalists claim – all that we need to claim to support our further claims – is that the imposition of tax in a currency is a sufficient condition for the currency being accepted in payment for goods and services.

Suppose the state wants to buy labour from us using its currency. If we have no inherent desire for the currency, then the state can create one for us, by imposing a tax payable only in the currency and threatening imprisonment for non-payment. Now we need to sell labour for the currency in order to pay the tax and stay out of prison. This is the standard neochartalist story. Taxation is a sufficient condition for the acceptance of the currency in exchange for goods and services. (Is it a sufficient condition for the general acceptance of the currency? Maybe not, but what business is that of the state? If we want our own medium of exchange to use for private purposes, we can create it.)

Now is taxation a necessary condition of currency acceptance? It need not be. We might have our own reasons for wanting the currency, in which case we would sell our labour for it regardless of the tax.

Has any neochartalist ever suggested that taxation is a necessary condition for acceptance of the currency? On the contrary, we actively deny it. If it were a necessary condition then balanced budgets would be incompatible with unemployment in the state currency at a given wage.

After all, if we had a total tax liability of £X/year, and the state spent a total of £X/year buying our labour, and nobody wanted pounds for any other reason than paying tax, then there would be no unsatisfied demand for the currency and nobody would be seeking more paid work in the currency. If the state either increased its spending or reduced the tax burden, then the excess supply of currency would drive down its purchasing power with regard to labour, and there would be inflation.

The reason why balanced budgets can and usually do lead to unemployment is precisely that taxation, within a given period, is not a necessary condition of demand for the currency within a given period. Suppose the state spends £X/year and people hold onto some portion of it for their own purposes. If the state also taxes £X/year then there will be some people needing pounds to pay taxes who aren’t able to get them. They will be willing to sell goods and services in exchange for pounds, but they won’t be able to get them if the state won’t increase its spending and others holding onto pounds aren’t willing to part with them.

Some people reply that this can’t be the right explanation in real life, since people who are unemployed aren’t the ones with tax liabilities. I’m not sure if this is deliberate obtuseness, but I can only reply: Don’t be silly!

Think of the following case. A has a tax liability that she can’t service out of current income. She borrows enough to pay her tax from B, who has a collected surplus of currency. Now C comes along needing food. A sells it to her on credit. C is now unemployed – she needs to earn currency to repay her debt to A – even though A was the one with the tax liability.

The real situation is much more complex, but the structure is fundamentally like that. And so neochartalists say that unemployment is caused by the state running deficits that are too small for people’s combined tax liabilities and savings desires.

Are they right to say that? Of course the situation could be resolved without the state increasing its deficit. B could, for instance, simply donate the currency to A; and A could donate the food to C. So the state’s small deficit is not a necessary condition of the unemployment. Nor, for the same reason, can it be said to be a sufficient condition.

So why do neochartalists call it a cause? I don’t want to give a lecture on the philosophy of science, but the notion that causes are equivalent to necessary and sufficient conditions faces grave and, in most contexts, thoroughly unnecessary difficulties.

R.G. Collingwood once gave the example of the AA man telling you that the cause of your engine overheating as you drove up a steep hill was a loose high-tension lead. To this, Collingwood notes, one could reply that the loose lead was not a sufficient condition of the engine’s overheating, on the grounds that you could have flattened the hill by stamping on it and then driven up comfortably on three cylinders. Nor was the loose lead a necessary condition of overheating, since even with the lead properly connected you could overheat the engine, say by setting fire to it.

So is the AA man wrong? Well, he is speaking in a context where it is obvious which things you are and are not likely to wish or be able to control. You can (I hope) control your impulse to set fire to your engine, and you can’t easily control the gradient of the hill. If you’ll permit me some jargon, causal statements are in many contexts interest-relative. Right now you’re interested in mechanical adjustments to your engine, not in the possibility of flattening hills or lighting fires.

The neochartalists find the operation of a currency to be one of these contexts in which causation is interest-relative. There might be various ways in which full employment in the state currency, along with price stability, can be achieved. But the most easy and reliable one is to scale the deficit to the right size. We’re interested in what can be easily and reliably done. And so we say that the cause of unemployment is the state – the currency-issuer – failing to spend enough to cover tax liabilities and savings desires.

I won’t say it’s as simple as that. What I will say is that it’s as simple as you want it to be. And for my part I have bad digestion when it comes to overcomplicated recipes.


12 thoughts on “Follow-up Post: Some Philosophy Lessons for Economists…

  1. Nick Rowe

    Thanks Alex.
    “The reason why balanced budgets can and usually do lead to unemployment is precisely that taxation, within a given period, is not a necessary condition of demand for the currency within a given period.”

    1. A balanced budget (the equality between two flows) tells you nothing about how big the stock of currency is, and whether it is bigger or smaller than the stock demanded.
    2. A balanced budget doesn’t even tell you that the stock of currency is constant over time, since the central bank can buy or sell bonds to increase or reduce the stock.
    3. And that’s leaving aside the fact that the commercial banks also produce demand deposits that are also used as a medium of exchange (and in the olden days some used to produce currency too).
    4. Empirically, for example Canada went from a big budget deficit in the mid-1990s to a big budget surplus, without it causing a recession and mass unemployment. That’s because the Bank of Canada responded appropriately.

    Nevertheless, in an important sense we are on exactly the same side, because we both agree that recessions are caused by an excess demand for the medium of exchange. And we use the same sense of “cause” as your AA man and the HT lead (the HT lead is the thing that isn’t working the way it is supposed to work and which is fixable). But I emphasise the *stock* of money and blame the central bank’s monetary policy, while you emphasise the net flow of currency and blame the government’s fiscal policy.

    Switching metaphors slightly, Keynes talked about “magneto trouble”. True story: my alternator (modern version of magneto) failed 100kms from home on a Sunday afternoon. It was too difficult to replace the alternator on the side of the road, so I bought 2 new batteries, and limped home that way. I replaced the alternator the next day. Fiscal policy is like me buying new batteries; it’s a bodge. Monetary policy is like me replacing the alternator; it’s the real fix.

    1. axdouglas Post author

      Thanks for that.

      As per Brian Romanchuk’s comment below, when the alternator is as volatile and subject to unpredictable surges as the private debt market, I’d rather run on batteries thank you very much!

  2. David Chester

    In order to make things right we need to loo9k at the whole problem and all the parts of our social system. Analogies or otherwise, the whole is more than simply the money side. What about the control of opportunity; of access to land so that everybody gets an equal chance to work?

  3. grkstav

    “Empirically, for example Canada went from a big budget deficit in the mid-1990s to a big budget surplus, without it causing a recession and mass unemployment. That’s because the Bank of Canada responded appropriately.”

    Did Canada not run a sufficiently big current account surplus at the time it went from a “big budget deficit” to a “big budget surplus”? Was there also, perhaps, an increase in the indebtedness of the Canadian domestic private sector during that period, such that combined the move from a big budget deficit (of the government sector) to a big budget surplus was ‘offset’?

    1. Brian Romanchuk

      That was the era when there was a technology investment boom, and the housing market started to develop a head of steam. So yes, rising private sector indebtedness allowed for the fiscal surplus. (I think the external balance was improving as well.)

      I am unsure whether fuelling housing bubbles is an example of monetary policy doing a great job of regulating the economy.

  4. Brian Romanchuk

    One interesting example is a petro-state. It could have a currency that is solely supported by oil revenues. Are those revenues “taxes”? (I would view them as a tax on foreign consumers of oil, but I am sure some people would disagree with calling that a tax.) So yeah, we need to distinguish the necessary and sufficient conditions.

    1. NeilW

      What’s particularly entertaining is that there is little difference between a Petro-state supported by ‘oil revenues’ and a deficit state supported by foreign saving. In one the export product is oil, in the other the export product is safe savings.

      It’s only economist blinkers that stop them seeing the two products as largely equivalent. And therefore the issues being somewhat similar.

      1. piphase

        Are they really largely equivalent? Isn’t there an expectation that those buying safe savings can return them in exchange for cash whereas those buying oil are going to burn it and never take it back?

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