THE GREAT ‘MODERN MONETARY THEORY’ DEBATE!
Notes from http://economicsjunkie.com/
Debt: The First 5000 Years by David Graeber (not an MMT book but really helps MMT understanding)
Modern Money Theory by Randall Wray (Dense and Academic)
The 7 Deadly Innocent Economic Frauds by Warren Mosler (Super simple quick read)
The central idea of MMT is that governments with a fiat currency system under their control can and should print (or create with a few keystrokes in today’s digital age) as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.
Some say such spending would be fiscally irresponsible as the debt would balloon and inflation would skyrocket. But according to MMT, large government debt isn’t the precursor to collapse we have been led to believe it is, countries like the U.S. can sustain much greater deficits without cause for concern, and a small deficit or surplus can be extremely harmful and cause a recession since deficit spending is what builds people’s savings.
MMT theorists explain that debt is simply money the government put into the economy and didn’t tax back. They also argue that comparing a government’s budgets to that of an average household is a mistake.
While supporters of the theory acknowledge that inflation is theoretically a possible outcome from such spending, they say it is highly unlikely and can be fought with policy decisions in the future if required. They often cite the example of Japan, which has much higher public debt than the U.S.
According to MMT, the only limit the government has when it comes to spending is the availability of real resources, like workers, construction supplies, etc. When government spending is too great with respect to the resources available, inflation can surge if decision-makers are not careful.
Taxes create an ongoing demand for currency and are a tool to take money out of an economy that is getting overheated, says MMT. This goes against the conventional idea that taxes are primarily meant to provide the government with money to spend to build infrastructure, fund social welfare programs, etc.
MMT says that a government doesn’t need to sell bonds to borrow money, since that is the money it can create on its own. The government sells bonds to drain excess reserves and hit its overnight interest rate target. Thus the existence of bonds, which Mosler calls “savings accounts at the Fed,” is not a requirement for the government but a policy choice.
Unemployment is the result of government spending too little while collecting taxes, according to MMT. It says those looking for work and unable to find a job in the private sector should be given minimum-wage, transition jobs funded by the government and managed by the local community. This labor would act as a buffer stock in order to help the government control inflation in the economy.
Support for MMT grew in large part thanks to the internet, where economists explained the theory on popular personal and group blogs, the idea of a trillion-dollar coin was widely discussed and supporters shared a clip of former Fed Chair Alan Greenspan saying pay-as-you-go benefits aren’t insecure because “there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.”
Tax revenues are not used for government funding under MMT, similar to when a business uses its revenues to pay for its expenses. Rather, taxes are used to control inflation. A widely disliked tax policy among many is increasing taxes, which is why Snyder says the bearish case for MMT is “taxes never go up because they’re unpopular and inflation runs rampant.” But this is a fundamental principle of MMT: When there is too much demand in the economy, taxes must be raised to subdue demand.
MMT begins with the government budget constraint under a system of fiat money. According to Mitchell, Wray, and Watts (hereafter MW&W), the standard approach, which relates the present value of tax revenue to the present value of government spending and the government debt, is misleading. They write, “The most important conclusion reached by MMT is that the issuer of a currency faces no financial constraints. Put simply, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due.” (MW&W, p. 13) As a result, “for most governments, there is no default risk on government debt.” (MW&W, p. 15)
WHY CAN’T YOU JUST PRINT MONEY?
First, in our current monetary system with interest paid on reserves, any money the government prints to pay a bill will likely end up in the banking system as reserves, and the government (via the Fed) will need to pay interest on those reserves.
That is, when the government prints money to pay a bill, it is, in effect, borrowing. The money can stay as reserves
forever, but interest accrues over time. An MMT proponent will point out that the interest can be paid by printing yet more money. But the ever-expanding monetary base will have further ramifications. Aggregate demand will increase due to a wealth effect, eventually spurring inflation.
Second, if sufficient interest is not paid on reserves, the expansion in the monetary base will increase bank lending and the money supply. Interest rates must then fall to induce people to hold the expanded money supply, again putting upward pressure on aggregate demand and inflation.
Third, the increase in inflation reduces the real quantity of money demanded. This fall in real money balances, in turn, reduces the real resources that the government can claim via money creation. Indeed, there is likely a Laffer curve for seigniorage. A government that acts as if it has
no financial constraints may quickly find itself on the wrong side of this Laffer curve, where the ability to print money has little value at the margin.
Faced with these circumstances, a government may decide that defaulting on its debts is the best option, despite its ability to create more money. That is, government default may occur not because it is inevitable but because it is preferable to hyperinflation.
This discussion brings us to the theory of inflation. I have been adopting the mainstream view, explained most simply by the quantity theory of money, that a high rate of money creation is inflationary. Proponents of MMT question that conclusion. They assert that “no simple proportionate relationship exists between rises in the money supply and rises in the general price level.” (MW&W, p. 263)
This assertion overstates the case against the mainstream view. In U.S. decade data since 1870, the correlation between inflation and money growth is 0.79. Cross-country data exhibit a similarly strong correlation. (Mankiw, 2019, pp. 109-110)
PEOPLE ARE FALLIBLE AND SUSCEPTIBLE TO CORRUPTION
NOTHING WRONG WITH UNEMPLOYMENT
MMT proposes that a country with its own currency, such as the U.S., doesn’t have to worry about accumulating too much debt because it can always print more money to pay interest. So the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.
In fact, MMT breaks with liberal orthodoxy by saying that while taxes on the wealthy are good for lessening inequality, they aren’t essential to pay for government spending. Another misconception is that MMT says deficits never matter. On March 13 the University of Chicago Booth School of Business published a survey of prominent economists that misrepresented MMT that way, leaving out its understanding that too-big deficits can cause excessive inflation. The surveyed professors roundly disagreed with MMT as described. MMTers cried foul.
Modern Monetary Theory says the world still hasn’t come to terms with the death of the gold standard in 1971, when President Richard Nixon declared that the dollar was no longer convertible into gold. In the modern era of “fiat” currency, MMT says, the U.S. and other big economies no longer need to worry about having enough gold to back their paper money, so they’re free to print however much they need.
MMT claims to be the legitimate heir to the theories of Britain’s John Maynard Keynes, who created the field of macroeconomics during the Great Depression. Keynes coined the term “paradox of thrift.” His insight was that while any single household can dig itself out of a hole by cutting spending when its income falls, the economy as a whole cannot. One household’s spending is another’s income, so if everybody cuts back, no one gets paid. What you get then is a depression—a situation only government can fix because, unlike the private sector, it can afford to spend freely, putting money in people’s pockets and thus getting the economy back on track.
Britain’s Wynne Godley developed the concept of sectoral balances, which focuses on the accounting truth that when the government runs a deficit, the nongovernment sector must run a surplus, and vice versa.
MMT rejects the modern consensus that economies should be steered primarily by the raising and lowering of interest rates. MMTers believe that the natural rate of interest in a world of fiat money is zero and that pegging it higher is a giveaway to the investor class. They say tweaking interest rates is ineffectual because businesses make investment decisions based on prospects for growth, not the cost of money.
To stabilize employment, MMT would add a federally funded, locally administered job guarantee. Government would employ more people in slumps than in booms. Pavlina Tcherneva of Bard College’s Levy Economics Institute is refining the plan. Representative Alexandria Ocasio-Cortez, the Democratic Socialist from the Bronx who’s in her first term in Congress, supports the job guarantee and says MMT should be “a larger part of our conversation.”
MMT challenges a core principle of conventional economics, which is that an increase in budget deficits will tend to raise interest rates, all else equal. Just the opposite, it says, sounding a bit like the White Queen from Alice in Wonderland. When the government spends more, the private sector gets the money and puts it in the banking system. With more money in the system and no increase in demand for it, interest rates will tend to fall, not rise, MMT says. That is, unless the government chooses to soak up reserves by selling bonds, which it doesn’t have to do.
The reason the government doesn’t need to sell treasury securities, or levy taxes, to spend money is that the central bank, under the control of the treasury, can pay for everything by conjuring up electronic money. In MMT’s ideal world there would still be taxes, but their main purpose, aside from lessening inequality, would be as “offsets” to keep inflation under control. Taxes would drain just enough money from consumers and businesses so total spending in the economy won’t be excessive.
MMTers hold that inflation isn’t primarily the result of excessively strong growth. They blame much of it on businesses’ excessive pricing power. So before trying to choke off growth to kill inflation, they would try to break up monopolies and stop banks from making too many loans. “The more actively we regulate big business for public purpose, the tighter the full employment we can achieve,” three MMTers wrote in a letter to the Financial Times’ Alphaville column that was published on March 1.
MMT’s critics argue that trying to use fiscal policy to steer the economy is a proven failure because Congress and the president rarely act quickly enough to respond to a downturn. And they say politicians can’t be relied upon to impose pain on the public through higher taxes or lower spending to squelch rising inflation. MMTers respond that they also oppose fine-tuning and instead want to use automatic stabilizers—including the jobs guarantee—to keep the economy on track.
STEPHANIE KELTON (MMT, ADVISOR TO SANDERS: Kelton wrote the article “Congress can give every American a pony (if it breeds enough ponies)”, which appeared in The Los Angeles Times.”
Critics of MMT reject its reassurance that a country with its own currency doesn’t need to worry about deficits. After all, it’s been proven that a nation that loses the confidence of the world’s investors will see its currency plummet. As recently as 1976, the U.K. was forced to appeal to the International Monetary Fund to stabilize the value of sterling.
MMT argues that by insisting the government rein in its spending to “balance its books” we’re hobbling ourselves with a lack of investment, an underperforming economy, and all the unemployment and lost opportunities that go along with that. Instead, MMT says, the government ought to be able to create all the new money it needs as long as that does not generate inflation.
To understand where MMT is coming from, it’s useful to start with two recent occasions when chairmen of the US
Federal Reserve admitted that the government can print all the money it needs, and nothing bad happens. Central bankers almost never say things like this, which is why the statements are so interesting.
If creating new money out of thin air creates inflation, why was there no inflation when Ben Bernanke created $1 trillion in assets to save the banks during the financial crisis? ($1 trillion is actually the lower end of the bailout estimate. A paper by the Levy Economic Institute argued the cost was as high as $29 trillion.)
Japan runs a deficit of 240% of GDP, and yet has no inflation
In Europe, Sweden, Denmark, Switzerland, and the 19 countries in the euro currency area, imposed negative interest rates to flush money out of bank accounts, in hopes of generating inflation. At the same time, the European Central Bank hosed the continent with €2.5 trillion ($2.5 trillion) in “quantitive easing” (new money, but with a fancy name).
ZIMBABWE: “Of course if you keep spending and you can’t produce goods to meet that spending you’ll get inflation, and if you keep spending on top of that you’ll get hyperinflation,” he says.
It is the lack of goods — or labour, or capacity — that triggers inflation, MMT argues.
That’s why there was no inflation in the West in the last 10 years. All that extra money from the Fed and the ECB was put to use, making the recession slightly less awful than it could have been. There are still people without jobs, and plenty of unused “capacity,” in the US and Europe. And as long as that remains the case it is unlikely that inflation will happen.
“The existence of unemployment is clear de facto evidence that net government spending is too small to move the economy to full employment,” wrote Phil Armstrong of York College in 2015. “[The government] must use its position as a monopoly issuer of the currency to ensure full employment.”
When the private sector fails to provide full employment, MMT advocates support the idea of a “jobs guarantee” that provides government-funded jobs to anyone who wants or needs one. The spending on such a program would be capped when the economy reaches full employment.
“When do you know that the government has spent enough? When the last worker has walked into a job guarantee office to pick up a job,” says Mitchell.
Forms of federal job guarantees have existed in the past. In 2002, Argentina introduced the Jefes Programme, which offered a job to the head of every household and paid a basic wage. Jefes participants worked on local community projects such as building and maintaining schools, hospitals and community centers; baking, sewing clothing, and recycling; and repairing sewers and sidewalks.
In 1933, President Franklin Roosevelt began rolling out his “New Deal,” which provided a wage to unemployed people to build schools, hospitals, airports, roads, bridges and other infrastructure. And during World War 2 most Western governments spent heavily on military and armaments to finance the war.
Traditional economists regard this type of thinking as highly inflationary and damaging to free markets. If the government is printing as much money as it takes to buy up all the unemployed labour, then the private sector will be starved of workers. Employees will be pulled out of productive, efficient, market-driven companies into inefficient government jobs. Wage inflation will spiral as the government’s new money pours in and workers demand higher pay in the private sector.
Although the stereotype of MMT is about inflationary spending, the reality is that MMT-ers take inflation very seriously. At full employment, except for imports, the economy’s resources are all used, according to L. Randall Wray. Any further spending will be inflationary.
It’s not the money that’s the problem. It’s whether the economy has enough people and goods to supply the demand that cash creates.
MMT-ers also propose that tax policy should become an anti-inflationary monetary tool. If there is too much money in the economy the government should tax some of it, thereby taking it out of circulation. (When you pay taxes, the money is literally destroyed, Mosler says. “If you pay by check, they debit your account and those funds are gone. Just like shutting off a light switch. If you somehow paid with actual cash with old paper bills, they would send them to be shredded. You can buy shredded dollars online.”)
MMT-ers argue that the “household” metaphor is exactly backwards, because the government has to create the money first in order to spend it, and only after it is in circulation can it be taxed back.
Four reasons the government is obviously not like a household
- The government can create its own money and set the price at which that money is available to the markets. It therefore has monopoly power on the fundamental underlying prices of everything in the economy. Any debts denominated in its own currency can be paid with its own currency, or can be settled by the creation of new money in that currency.
- The government creates money in order to spend it, according to Mosler. The government does not impose taxes in order to find money, in other words. Mosler told Business Insider that “spending” and “creation” might as well be the same thing, in the MMT framework.
- Taxes make money valuable. Money is only valuable when a government has the power to command that taxes be paid in the currency it operates. If everyone has to pay tax, then everyone needs to earn money. A government can create all the money it wants, and it can also tax back all the money it wants, keeping prices stable. The government thus has two levers to propel or retard the economy — it can vary taxes and spending, up or down, in concert or independently.
- The government need not balance its books the way a household does. Governments create and spend money but they do not tax back 100% of that cash. That’s why, at any given time, a government will be running a deficit. The deficit is merely the difference between all the cash the government has spent and all the taxes it has collected. A deficit signifies that the private sector — you and me — is holding the difference. So if the government is in deficit the flipside is that the private sector is in surplus. Similarly, if the government is in surplus it must mean that the private folks are in deficit — using debt or their savings to get by, because total payments to the government are more than the government’s spending.
Even if everything MMT proposed were true, and money creation and deficit spending were not inflationary at the national level, runaway inflation might still kick in if foreign investors decide that MMT is going to make your nation’s currency worthless, your government bankrupt, and your central bank default.
DOWNSIDES OF MMT
Political bias: If the central bank follows the government’s direction, it could face accusations of political bias or corruption, erode people’s trust in financial regulators, and struggle to make painful decisions in the short term that benefit the economy in the long term. Central banks in Venezuela, Zimbabwe, and Argentina all printed money to please politicians in recent years — resulting in hyperinflation and economic collapse.
Lack of discipline: The government might not spot when the economy has reached full capacity, or lack the discipline to stop spending, leading to inflation.
Politically impractical: Relying on taxation to extract money from the economy and cool it down could well be politically infeasible in countries where tax hikes are deeply unpopular, such as the US. If households are feeling the pinch of higher prices, politicians might be more inclined to cut their taxes than raise them.
Tax policy already has an important role: Tax policy plays an important role in redistributing money from the wealthy to the poor. Repurposing it to reduce the money supply could mean those effects are overlooked.
Foreign debt: If the government holds a significant amount of debt in another currency, printing money and depreciating its currency could make that debt harder to pay off and even force it to default.
FX markets maybe skeptical: Printing money with reckless abandon could also make investors wary of currency volatility and inflation, leading them to ditch the currency for foreign exchange, gold, and other assets.