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Are we entering an experiment in Modern Monetary Theory (MMT)?

by AslanP 3 min read11th May 202012 comments

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Disclaimer: Not an economist. Just an interested observer wishing to learn more. Apologies if I mangle the theory here.

Background:

One fairly consistent response to the COVID pandemic by national governments has been the injection of staggering amounts of capital into the economy, which is funded by government borrowing. The US stimulus package, for example, has been valued at $2.2 trillion. In Australia, where I'm from, stimulus so far equates to around 10% of GDP.[1]

To the extent that experts are commenting on this debt-financed response, they seem to be divided into highly divergent camps. Some say that this debt is creating a burden that future generations will need to repay - i.e. that we are borrowing from the future to pay for today's problem [2].

Others, including proponents of MMT, seem to take the view that government debt needn't be thought of as something that requires paying down. The only question relevant to this camp is whether the injection of money is the right thing to do in terms of managing the dynamics of the economy (consensus seems to be yes).

MMT is an idea I'd been reading a little bit about prior to this crisis (further info below), but given that most governments seem to now be following its dictates - i.e. borrowing and spending because that's the right thing to do in the present, rather than worrying about how those debts will be repaid - are we now entering a phase where we might learn whether MMT holds? Are we entering an experiment in monetary theory that might teach us more about which camp of economists is correct?


Relevance to EA:

Given the compounding nature of sustained economic growth, getting the settings right on monetary policy seems like it has the potential to significantly impact general welfare in both the near and long term.

Further, there is already an inherently longtermist angle to this debate - with many commentators appealing to the impact on future generations of excessive spending in the present.

On the other hand, if MMT holds, this should be promoted by EAs as a guide to how governments may respond to other and more severe x-risks than COVID-19. MMT has also held out as a basis for a 'Green New Deal', which is an interesting prospect.


Previous posts on MMT:

There have been some previous debate on this forum around MMT. See this post.

In that post, someone pointed to an IGM Chicago Survey to suggest that serious economists universally discount the ideas of MMT however, as I point out in the following section, that survey seemed to seriously strawman MMT's argumants.


What is MMT?

As I understand it, the central claim of MMT is that there is no need to balance a national budget in the way that one might want to balance their household or business budget. Instead, the role of the reserve bank is to 'balance the economy'.

The three core ideas [3] seem to be:

1) Monetary sovereign governments face no purely financial budget constraints.

  • NB: We are talking here about governments that issue their own currency, have a floating exchange rate and no significant foreign currency debt, such as the US, UK, Japan and Australia.

2) However, all economies, and all governments, face real and ecological limits relating to what can be produced and consumed.

  • The idea here is that if too much money is injected into an economy, then the spending power will eventually exceed the productive capacity of that economy - e.g. will outstrip labour supply or natural resources. MMT says that this is what causes inflation, not merely the injection of money into an economy.
  • As I mentioned earlier, there was an IGM Chicago Survey where economists appeared to quite universally dismiss the ideas of MMT on the basis that they would lead to rampant inflation - see link. However, when you look at the set up for that survey, it's clear that they've strawmanned MMT by suggesting that it posits no limits on borrowing and government expenditure. This second premise of MMT dispels that myth. Under MMT there is still said to be a limit on government spending/borrowing, but it is defined by reference to the productive capacity of the relevant economy, rather than by reference to any balanced budgets or the like.

3) The government’s financial deficit is everybody else’s financial surplus.

  • The idea here seems to be that there is an inverse relationship between private saving and government spending.

What are the alternatives?

The opposite view to MMT seems to be 'monetarism'. Advocates of monetarism say, among other things, that markets are best at determining the optimal allocation of resources, so the role of government should be minimised and indeed fiscal spending is not only ineffective but irresponsible. This focus on letting markets run free seems to have become the norm across most of the developed world.

A related idea to MMT is Keynsianism. However, as I understand it, Keynes was in favour of running a budget deficit only during periods of high unemployment. MMT takes this interpretation of Keynesianism further.


Related questions:

It seems troubling to me that there is so much disagreement about the fundamentals of questions around monetary theory. In fact, the more that I read, the more I feel that there is not even an agreed conception amongst different economists of what is meant by key concepts such as 'money', 'sovereign debt' or the 'economy'. And each of the viewpoints seems to be quite ideologically influenced. Is this right? How can it be that, as a society, we have such a poor grasp on concepts about money, and yet our whole society is organised around money?

Does anyone know of good resources (books, podcasts, articles, videos) where I could learn more about these ideas? Preferably resources that aren't promoting a single idea or ideology, but are fairly exploring all reasonable viewpoints.

Thanks

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5 Answers

I pretty strongly disagree with the notion that any country on Earth right now is “trying out MMT” merely by running deficits without concern for their impact on public debt levels. After all, traditional Keynesian macroeconomics recommends the exact same course during a recession. Moreover, MMT itself is far more radical than this. It recommends basically switching the functions of the fiscal taxation authority and the central bank. In particular, it holds that instead of raising taxes to finance new government programs, the central bank should simply buy government debt (i.e. print money) to pay for them, and when this inevitably leads to significant inflation, the fiscal authority (e.g. the national legislature) should address it by raising taxes (thus reducing aggregate demand) rather than having the central bank address it by raising interest rates. With respect to the long-run trajectory of interest rates, MMT’s proponents believe they should be maintained at a low, stable level (zero, according to some).

I want to emphasize how different this would look from what we’re seeing right now in developed economies facing COVID-19-induced recessions. To do this, I’ll walk through a hypothetical based on the U.S. Here (in the U.S.), MMT would likely require the legislative abolition of central bank independence. Then, it would involve the Chair of the Federal Reserve, the Secretary of the Treasury, and the Speaker of the House of Representatives (presumably) jointly announcing that from this point forward the Fed would no longer be adjusting interest rates to maximize the objectives of full employment and stable prices specified in its (now former) dual mandate. Instead, it would be (permanently) buying as much government debt as necessary to pay for fiscal programs passed by Congress while maintaining some specified target interest rate (presumably around zero — it’s hard to get much below that) irrespective of the amount that this would expand the money supply. The Speaker of the House, for her part, would announce that when this new policy caused inflation to exceed some specified rate (the Fed’s current symmetrical 2% target?), Congress would pass a tax increase to wrangle aggregate demand back in check, thus reducing demand-pull inflation and (hopefully) ensuring continued stable prices.

MMT’s proponents often argue that we can trust that what they’re defending would not cause runaway inflation because even as advanced economies around the world have radically expanded their money supplies over the last few decades (some by nearly an order of magnitude), none of those economies have struggled with elevated inflation (ostensibly indicating a persistent gap between the money supplies and the productive capacities of these economies). This is a basically fair observation, but it misses the point. Today, we understand far better than we did 20 years ago that the inflationary consequences of extraordinary monetary policy (at the zero lower bound — i.e. like now) are caused primarily by the ways in which policy affects expectations regarding the future trajectory of interest rates and inflation rates. That is to say: Policy changes that radically reconfigure market participants’ expectations regarding the long-run monetary trajectory will almost certainly yield substantial changes in the inflation rate.

This is a policy that would radically reconfigure market participants’ expectations regarding the long-run monetary trajectory (pretty much by definition). It’s true that in MMT proponents’ perfect world, we would simply raise taxes to combat this rising inflation, and if market participants trusted that would occur as described when the transition to MMT policy were first announced, then perhaps the effects of the policy announcement on market expectations would be less pronounced. However, basically no one believes that (for example) the U.S. Congress could be trusted to pass (inevitably unpopular) tax hikes merely for the purpose of mitigating the risk of runaway inflation sometime down the road (remember, good monetary policy is proactive, not reactive!), given that it has proven unable to pass tax hikes to finance overwhelmingly popular government programs for the last decade. As a result, a government declaring an MMT policy approach would wildly shift market inflation expectations, thus causing significant inflation (a self-fulfilling prophecy), demanding, presumably, an increase in taxes shortly thereafter. When this increase fails to materialize, the market’s suspicions that the national legislature was not fully committed to the elements of MMT that require economic discipline would be confirmed, and inflation would increase even further, potentially surpassing the ability of any relevant government authorities to control it.

Even if you don’t buy any of that, though, I think there are some other pretty serious problems with the notion of using the tax code to control inflation. Intuitively, it’s an idea with significant distributive implications (though, of course, controlling inflation by raising interest rates also has distributive implications, and I can imagine how a person might reasonably conclude that those distributive implications are worse). More importantly, however, it could have a pretty substantial impact on labor market incentives. Bear in mind that if your intent in raising taxes is to reduce aggregate demand, you can’t just raise the corporate rate and call it a day (at least in the U.S., that would spur some tax inversions and some deduction-hunting but probably would not have much of an impact on demand). Rather, to have the desired effect, you would need to raise income taxes. That’s fine for a while, but eventually, inflation could get so high that the tax rate required to rein it in would meaningfully reduce people’s interest in working, thus diminishing the economy’s productive capacity (and GDP, etc.). Moreover, you better trust that your tax code is well-designed; otherwise, differentially disincentivizing work in this manner could produce some pretty odd labor market distortions. (Yes, many arguments similar to this one have been grossly mis-used by conservative economists to defend empirically indefensible conclusions. As Paul Krugman himself notes, this is not such a case.)

To close, I’d just note that MMT has substantial factual and theoretical faults entirely unrelated to anything I discussed here but nonetheless worthy of consideration. For a cogent run-through of just a few, I’d recommend these three columns by Krugman (one of which is also linked above).

The short answer to this post's title is "No." All of the policies you have described fall under traditional macroeconomic stimulus, of the kind economists have understood since the time of Keynes.

I believe what you've gotten here is a very pop-econ kind of thing that ends up being reported in media, but is a terrible summary of the actual state of knowledge in economics. It's the sort of thing that people who are very smart but haven't specialized in the field will tend to pick up from reading on Wikipedia, which has an unfortunate tendency to overemphasize heterodox schools of economics and has difficulty explaining the actual consensus on these issues, typically because the consensus consists of very complicated-seeming mathematical models.

This has been the best article I can find on MMT. It's very long, but the most relevant part to your question is this:

The QE model can create a synthetic version of MMT if the government and Federal Reserve work closely together, which is what is happening now. My previous example of the Treasury sending out helicopter checks to people that are ultimately paid for by issuing Treasuries that the Federal Reserve buys with newly-created dollars (with primary dealer banks as intermediaries), is basically MMT in practice. In other words, what people think of as MMT can essentially be done in the current legal framework.

However, although QE creates new dollars out of thin air, the process still goes through the motions of pretending to respectfully treat money in the same way it was treated in the first two models, meaning something that has to be borrowed from somewhere before spent, and balanced by an asset on the other side (a Treasury security that gets locked away on a central bank balance sheet in place of newly-created dollars, forever to be rolled to the next one when it matures). For a while, those motions along with statements by officials provided many investors reasons to believe that maybe newly-created dollars would be paid back, maybe the Federal Reserve will be able to reduce their balance sheet, and so forth. Those beliefs proved to be unrealistic, but the realization that it was debt monetization is only coming years later for many people after the temporary nature of it proved permanent when quantitative tightening failed in 2019.

MMT, on the other hand, drops a lot of those pretenses of QE and just treats money as something that can be printed whenever unused economic capacity exists. It's not that fundamentally different than QE; it just cuts to the heart of it and removes some of the steps.

I am as perplexed as you are, and I share the doubts you mention in the last paragraphs.

Did you check this at Open Philanthropy?

I'm not sure about how neglected this subject is. However, if there's some sort of optimal monetary theory, this is a very hingy time to find it and implement its policy recommendations.

Maybe you could cite some bibliography. I've recently read and can recommend M. King's The End of Alchemy, SEP Philosophy of Money, and Macmillan's The End of Banking (more focused on finances, but with some good insights and recommendations about monetary theories)

I've been following some of the literature (and also blogs ) on MMT off and on for about 3 years. I sort of agree with Brad Delong (economic historian at UC Berkeley) that its 'warmed over keynesianism' (as noted in OP it it could also be called 'keynsianism on stilts'. (Unlike Keynes, MMT people say just keep printing money, all day, everyday since you can never run out. Although I mostly disagree with Niall Ferguson he pointed out this was tried in the past, and Ferguson argues in his first, and one reasonable book that it was this view that led to the collapse of the British Empire.)

MMT partly owes its creation to Arthur Laffer (of the 'laffer curve' under Reagen ('supply side economics') who argued that by cutting taxes (especially on the rich) the government raises more revenue due to economic growth---which in my view has been disproven by many mainstream economists (although Trump is following that policy).

MMT 's main founder is W Mosler --friend of Laffer--- is a wealthy hedge fund owner/manager who keeps his money off shore in tax free accounts. He more or less funded the 'economists' (eg R Wray of U Mo and S Kelton now in NYC ) who are MMT's main figure heads.

Neither has much of a background in quantitative economics---they are primarily economic historians. You won't find a single mathematical formula in most of their papers. (Instead you will find many discussions of 1800's economics --they remind me of many marxists and free market and libertarian economists who try to analyze the US or world economy of 2020 in terms of adam smith ('division of labor', 'the invisible hand', the person who makes a safety pin cooperating with someone who brings food from the farm in a horse and buggy) and marx (e.g. an example of someone exchanging 4 pounds or iron for 3 sacks of corn is supposed to explain silicon valley) .

My view is the main ideas or rationals behind MMT is to

1) stop taxing the rich (this is why they say taxes have no affect on the government budget --and there is a small element of truth in that --Mosler doesn't want to pay taxes--he says rather than take his money, government should just print more.)

2) 'help the poor' , ' people with no or low income', and the 'unemployed', by giving them a 'guaranteed job' paid for not with money from progressive taxes, but just printed by the govt. These jobs could be something like FDR's new deal , Sanders-AOC's green new deal, or they could be like indentured servitude on some billionaire's such as Mosler's plantation. (My impression is the MMT'ers like the plantation idea the best.)

MMTers are adamantly against a Universal basic Income---they feel it makes people feel better to 'work for a living' even if its on a plantation picking cotton than to just get 'free money' ---hedge fund managers have to work for their money (eg collect interest).

'Economists' like Wray and Kelton also work--they regurgitate ancient economic literature, relabel it as MMT, make podcasts, do TED talks, write blog posts, write papers in non-mathematical economic history journals , and become media stars. I don't view what they do as a very productive job.

Unfortunately mainstream economists' critiques of MMT (eg Krugman) come from a perspective which is equally flawed.

(I support a Universal Basic Income (uBI--not exactly the same as Unconditional basic income, or UBI, promoted by Yang , though the 2 can be made equivalent if viewed as a negative income tax---Hayek and Friedman) but unfortunately proponents of BI in general also have almost no quantitative analyses. Most of them just make general --but valid-- arguments that if people have a basic income they are less likely to go into a life of crime and can spend more time dealing with local issues--eg family, community improvement , etc. Studies have shown also that people with a BI actually work more than those without one---but they choose which jobs to take--and they keep them---if you are forced to work a job you don't like, you likely will quit very soon.)


The discussions around MMT, UBI or BI, and mainstream neoclassical economic theory are all ideologically biased. They all preach to their respective choirs and echo chambers--and they all have big 'megachurches' with devout followers.