Marc LavoieMarc Lavoie is a professor in the Department of Economics at the University of Ottawa, where he started teaching in 1979. He got his doctorate from the University of Paris-1. Besides having published nearly two hundred articles in refereed journals, he has written a number of books, among which are Post-Keynesian Economics: New Foundations (2014), Introduction to Post-Keynesian Economics (2006), translated into four languages, Foundations of Post-Keynesian Economic Analysis (1992), as well as Monetary Economics: An Integrated Approach to Money, Income, Production and Wealth (2007) with Wynne Godley. The latter deals with and employs in its analysis the stock/flow consistent method. Lavoie has been the associate editor of the Encyclopedia of Political Economy (1999), and he has been a visiting professor at the universities of Bordeaux, Nice, Rennes, Dijon, Grenoble, Limoges, Lille, Paris-1 and Paris-Nord, as well as Curtin University in Perth, Australia. Lavoie is also an IMK Research Fellow at the Hans Böckler Foundation in Düsselforf and Policy Fellow at the Broadbent Institute in Toronto. He has lectured at post-Keynesian summer schools in Kansas City, the Levy Economics Institute and Berlin.

1) On the MMT and the Monetary Circuit Theory.
In your paper some time ago you wrote a friendly critique of MMT, you can briefly indicate the strengths and the limitations of this theory?

Essentially I am in agreement with what the MMT advocates are claiming, most notably their examination of the effects of government expenditures and taxes for the balance sheets of the central bank and those of commercial banks. Some critics argue that this used to be well-known, but obviously, until MMT advocates brought this back into the limelight it had been forgotten by nearly all of our colleagues. My only worry, as I expressed it in my article, was that in their effort to convince readers, MMT advocates were overly simplifying to the point of creating confusion among their economist colleagues.


1.a) Many detractors of MMT insist on the fact that consolidating the Central Bank and the Treasury is a mistake (a hyper simplification far from reality). The MMT economists (even Sergio Cesaratto in his recent work, respond by saying that operationally there is no difference between consolidation and not. What is your position on this?

I often say that consolidation may be justified for some purposes but not for others. When one tries to explain how spending by the government leads to commercial banks acquiring deposits (what is also called reserves or settlement balances) at the central bank, I believe that it is best to avoid consolidation, otherwise one may miss the important point that, before the government can spend, it must acquire deposits at the central bank, either by selling securities or by getting advances from the central bank where this is permitted.


1.b) In reference to the guaranteed work plans (PLG), it is true that could generate deflationary effects due to the setting of a minimum wage?

This is a point of contention between MMT advocates and some of their critics. MMT advocates believe that because the workers that do not find a job will be hired through the government’s employment of last resort (ELR) program at a fixed nominal wage, all wages will remain in line with this ELR wage. But the existence of a given minimum wage never stopped prices or wages from rising in the past. Other critics fear that the creation of an ELR program may lead eventually some governments to replace well-paid unionized jobs by low-paid ELR jobs.


1.c) Another point that is often accused of neglecting to MMT is the relationship with the foreign sector. It is said that the MMT neglects the lingering effects that trade deficit can cause to the national economy. What do you think about?

It is true that people like Warren Mosler keep saying that trade deficits mean that the deficit country is receiving additional foreign goods and services in exchange for pieces of paper promises. Still, I am sure that MMT advocates fully realize that trade deficits, all else being equal, have a negative impact on employment and economic activity. With respect to the foreign sector, I would rather say that MMT advocates tend to minimize the possible negative impact of currency depreciation, in particular for developing or emerging countries.


1.d) The monetary circuit theory, gives a central role to the function of money, which is closely connected with the real economic variables such as the level of production, corporate profits, employment etc ... In a nutshell, the circuit can be summarized as follows: issuance of bank credit to businesses; subsequent use within the economy of production (real economy); repayment of debt: money created back to the banks, with the added interest portion. In this process, where they come from interest earned?

This is the so-called interest puzzle of the monetary circuit theory. How can firms make profits and how can they make interest payments to banks? How can they acquire more monetary units than they distributed in the first place? This puzzle only exists in circuit theory because by assumption there is a sort of one-way flow. In reality, as some of the firms make profits, these are redistributed to households who spend them again in the economy; similarly, as banks collect interest payments, these interest payments are redistributed to depositors, who then spend them. My friend Gennaro Zezza, who was himself a student of Augusto Graziani, the creator of the Italian circuit theory, has explained this in a couple of articles.


1.e) What is the role of the Central Bank in the production process?

The role of the central bank is essentially (and normally) a defensive one; it must supply the banknotes and the reserves that are needed by the banking system, at the rate of interest that it thinks fit for the economic circumstances. In most countries, but until recently not in the Eurozone, the central bank is not only a lender of last resort to the banking system so as to avoid banking crises; it is also the purchaser of last resort, that is, it must purchase the (long-term) government securities that the private sector does not wish to hold, so as to keep long-term interest rates under control and in line with the target short-term interest rate.


2) The countries of the euro area, especially those ones of the south, show very low levels of growth and high unemployment rates. In this regard, the ECB, in an attempt to produce effects on growth and employment, has used unconventional instruments like the QE without, however, achieve results in this regard, other than to stabilize the euro. Also the so-called "structural reforms", which translate into practice in welfare cuts and measures against the working world, continue to be the focus of the European agenda. What, however, Europe would need?

In the early 1990s several of my European colleagues were saying that the USA were on the verge of the abyss and that the European Union was soon to overcome them. We all know what happened: the USA had the Clinton boom, while all European countries that intended to join the Eurozone struggled and suffered to meet the Maastricht criteria. Today, with all the new Pacts, Eurozone countries do not dare or are not allowed to adopt the full-out expansionary fiscal program that would be needed to raise aggregate demand and get the economy going again, as was done in the USA and in China after the financial crisis. Fiscal consolidation is still advocated by the European commission, whereas the numbers show that expansionary fiscal policy, although it would lead to an increase in the public debt to GDP ratio in the initial period, would eventually lead to a fall in that ratio. As to the ECB QE programs, they allow firms or rich investors to swap illiquid assets for money; but if they decide to use this money to pay down their debts or to invest in the stock market or abroad, this has no positive impact on European economic activity. As to the so-called structural reforms of the labour market, they are mostly aiming at the wrong target: you can train dogs to find bones, but if there are 100 dogs and 90 bones, there will always be 10 dogs without a bone. Making it easier for firms to fire workers or having better-trained workers will not create jobs if there is no increase in sales or aggregate demand.


3) Europe's social democracies have so far been unable to reform the euro zone, the Tsipras case is emblematic, with Greece now reduced to a "third world country". It 's really possible to reform the Euro and the European Union or not?

There are some encouraging signs, as the ECB, which was itself in great part responsible for the financial crisis that occurred in the Eurozone between 2010 and 2012, has showed that institutions could change. However, when it comes to the political process as such, as was demonstrated by the Tsipras Greek case, I would think that reforming the Euro and the European Union seems nearly hopeless.


3.a) Italy, in your opinion, should come out from the Euro system? If so, what would be the limits to fiscal policy of a country like Italy out of the common currency?

It is a difficult decision. A number of countries are not part of the European Union and a large number of countries are not part of the Eurozone; they don’t seem to suffer much. I would say it all depends on the rules about the currency of denomination of assets and debts, since an Italian exit would mean a depreciation of the local currency. If Italy were to move out of the Eurozone, would the debt of the Italian government be denominated in lire or in euros? But if Italy were to opt out, I am sure that other countries would soon do the same.


4) What is the relationship between economics and politics? The economy is a "non-partisan" science or responds to the class logic?

Keynes used to say that politicians were the slaves of dead economists; by contrast the famous American economist, Paul Samuelson, used to say that to understand the evolution of economic ideas one had to find where the money was. In other words, he thought that economists were following the mood of politicians and the opinions of the ruling class. Economics cannot be an objective science; we all have prejudices and biases that have an influence on the academic work that we do. This is the case both for theoretical and empirical work.


5) Target 2: what is it and how does it work?

Target2 is the clearing and settlement system of the Eurozone. When an Italian firm exports some goods to France, the payment goes through the Bank of France and then through the Bank of Italy. The bank of the exporter thus has an increase in its reserves at the Bank of Italy, while the French importer has a decrease in its reserves at the Bank of France. In this case, the Bank of France is in debt to the Bank of Italy. In other words, the Bank of Italy has a positive entry on the ledger of Target2 while the Bank of France has a negative entry, hence a negative Target2 balance. The same thing would happen if French investors transferred their bank deposits from France to Italy. When all goes well these financial movements get compensated. In the case of the Italian exporter and French importer, the Italian bank of the exporter would be making a loan to the French bank on the overnight market, so that the Target2 balances of the two countries would not change. But when banks lose confidence in each other, as happened during the Eurozone financial crisis, the banks will not lend to each other. In 2010-2012, firms and rich households from the South moved their deposits to Germany; as a result the Target2 balances of Germany jumped up while those of southern countries became highly negative.


5.a) Is there really a problem related to the imbalances of the balance of payments between the EMU countries?

There is no problem whatever associated with positive or negative Target2 balances, and this is why for a long time nobody paid any attention to them. We should expect large Target2 balances only when the interbank market breaks down. Questions started being asked about them only when various Eurozone exits became a likely possibility as a result of the refusal of the ECB to fully play its role of purchaser of last resort.


6) In Italy it is very heated debate around the public debt, seen as an evil to be fought (to reduce). Consequently also public expenditure is under attack. Can you briefly explain what is the public debt and if this creates problems for the economy or, on the contrary, it is an economic necessity?

The current public debt is the sum of all past government deficits. Italy has had a large public debt for a long time, and until the Maastricht rules of reducing it to 60 percent were put in place, nobody seemed to pay any attention to it. To have a large government debt is not necessarily a bad thing, as the debt may be associated on the other side of the balance sheet with financial assets or real assets that generate benefits to society, like roads, bridges, buildings, airports or a fine education system. MMT advocates point out, rightly so, that in a closed economy the counterpart of the public debt is the net financial assets detained by the private sector. Thus, if the private sector wishes to save more without investing more, the public sector will have to go into a deficit, for otherwise the economy will tank. This has been emphasized recently in a book by Richard Koo, a financial adviser, when describing in particular what has happened to the Japanese economy where the public debt to GDP ratio has exceeded 200 per cent. Note also that if there were no public debt, financial institutions would have no access to super-safe financial assets. Keynesian authors usually advocate a ‘functional finance’ approach to public debt: surpluses or deficits should be set in order to achieve full employment, not to achieve some arbitrary rule such as a 60 per cent debt to GDP ratio.


6.a) Also, how does the government to generate public spending?

To spend, the government must have funds on which it can draw to make its payments from its bank account at the central bank. The funds are there either because of the taxes that were collected and not spent in the past, or because the central bank has directly acquired securities issued by the government. In the Eurozone, this second possibility is forbidden, so that the national central banks and the ECB only acquire these securities on secondary markets, meaning that they must have been purchased first by financial institutions. In this case the government sells its securities, thus acquiring deposits on the books of commercial banks, and then these deposits are transferred on the books of the central bank. But this means that the deposits of the commercial banks at the central bank (their reserves) get depleted, so that the central bank has to make advances to the commercial banks. This a complication that is not needed. It would be much simpler if the central bank could acquire the government securities directly on the primary market or if the central bank could make advances to the government, as used to be the case before the advent of the neoliberal era and as is still the case in a number of countries outside of the Eurozone.


6.b) It’s correct to say that the state spends first (ex-ante) and then collects the taxes (ex-post)?

This is what is claimed by MMT advocates. Readers may have noticed the similarity with the monetary circuit presented earlier. In the standard monetary circuit, firms spend first, distributing wages, and they collect revenues from consumers afterwards. In the MMT government circuit, the state spends first and collects the taxes afterwards, the argument being that commercial banks cannot pay the taxes on behalf of their clients unless they already have accumulated reserves at the central bank. But this can only happen if the central bank has made advances to the commercial banks, or if the government has already spent, thus allowing commercial banks to accumulate reserves. As is the case with the monetary circuit, this is a logical argument. In reality, taxing and spending happen simultaneously. The only sure thing is that government spending leads to an increase in the bank reserves at the central bank, while incoming taxes lead to a fall in the bank reserves. When taxes are paid, the money used does not disappear: it goes into the account of the government held at the central bank.

As pointed out earlier, the role of the central bank is normally a purely defensive one: it must compensate for these changes in the amount of autonomously supplied reserves, so as to insure that the supply of reserves is equal to the amount being demanded by the banking system, so that the overnight interest rate remains at the level that is being targeted by the central bank. As I said earlier, the problem with the Eurozone as it functioned before 2010 was that the ECB was forbidden by the treatises to purchases government bonds on the primary market while by tradition it forbid itself to buy them on the secondary markets. This meant that the determination of long-term interest rates was entirely left in the hands of the financial markets. Between 2010 and 2012 the ECB was always reacting too late and too little to financial pressures on interest rates. Financial markets finally calmed down when Draghi and the ECB warned that they would use all their power.

Author: CSEPI 28.10.2016 (Questions edited by Aldo Scorrano and Fabio Di Lenola - Translation in italian version edited by Jacopo Foggi)