What innovators should know about modern monetary theory
Posted onThe Covid-19 pandemic is changing the way Governments in many countries, especially developed countries, run their economies. They have adopted the so-called modern monetary theory or MMT. A clear explanation on MMT has been written by David Smith in the Times London on August 14th, 2020. The following is the extract of the article.
Today, something is slightly different. This is in the nature of an economic version of a request show. I have had many requests to write about what is known as modern monetary theory (MMT) and this is my response. MMT has been around for some time — decades, or even centuries, according to its advocates — but it is relevant now.
My reluctance to write about it has been in part because its true believers can get very exercised when faced with criticism, even if it is constructive.
The reason for writing about MMT now is the book by Stephanie Kelton, professor of economics and public policy at America’s Stony Brook University, and one of MMT’s leading advocates. She advised Bernie Sanders, who ran Joe Biden close for the nomination as Democratic challenger for the US presidency. Her book, The Deficit Myth: Modern Monetary Theory and How To Build a Better Economy, is published by John Murray.
It is proving popular, for good reason. Not only are plenty of people interested in MMT, but it is written in a non-technical, accessible, even folksy style. It is being read by non-economists, as all the emails I have received urging me to write about it attest, as well as being on the summer reading lists for many economics students. Last time I looked, it was Amazon’s bestseller in macroeconomics and inside the online retailer’s top 1,000 among all titles.
It is arranged as a series of myth-busting chapters, although people who are aware of conventional economics do not believe many of these myths. The first “myth” is that the government’s budget is not the same as a household budget; something I thought had been buried many years ago. The same goes for most of the other myths.
The central idea of MMT is simple. It distinguishes between currency issuers and currency users. The only currency issuer in America is the US Treasury, with the Federal Reserve acting as its agent. Everybody else is a currency user.
As a currency issuer, the government has the ability to print as much money as it needs. The budget deficit itself is not a constraint, and neither is government debt. Some claim — wrongly, I think — that MMT has already been adopted in response to the Covid-19 crisis in the form of quantitative easing (QE).
In the world of MMT, the government can print enough money to cover a deficit of any size and, in extremis, to pay off all the accumulated debt of the past. The only tests of whether a budget deficit is too large or too small are inflation and unemployment. If inflation is low, the budget deficit cannot be too high, and if there is unemployment, the budget deficit must be too low.
Many people will catch their breath at this point, not least because Kelton claims that this is not just a theory but an explanation of how the world works. However, that requires us to be taken down a rabbit hole of implausibility.
If deficits can be costlessly funded and managed by the simple device of issuing currency, why do governments need to levy taxes? In perhaps the least plausible explanation of how incentives work, people apparently need to work to meet their tax obligations. If they did not have to pay tax, they would not need to work. I rather think they would, to satisfy their wants. Another reason for taxing — to redistribute wealth and income — does not wash either: you can redistribute wealth and income within the tax system without raising any net revenues by taking from the rich and giving it to the poor in tax credits.
Taxation exists in the real world to raise revenue. And borrowing by governments also plainly exists. Kelton says this is not to raise money, because governments don’t need to, but “to offer people a different kind of government money, one that pays a bit of interest”. Try telling that to US and British governments in the past, which have paid a lot of interest to fund borrowing and sometimes struggled to do so.
There is plenty more in the book. Some of it, like the policy of a job guarantee for everybody, is not so much part of MMT but an add-on to it, although at a time of high unemployment possibly a popular one.
MMT is misnamed because it is not monetary at all but almost entirely fiscal. As Kelton puts it: “MMT requires us to demote monetary policy and elevate fiscal policy as the primary tool for macroeconomic stabilisation.”
So what should we think of this? MMT has drawn robust criticism from some eminent economists. Kenneth Rogoff, a former chief economist at the International Monetary Fund, writing last year under the headline “Modern Monetary Nonsense”, described its central idea as “just nuts”. An exasperated Paul Krugman, the Nobel Prize-winning economist, described debating with MMT advocates as like playing Calvinball, a game where players make up the rules as they go along.
Larry Summers, economist and former US treasury secretary, attacked “ludicrous claims” by “fringe economists . . . offering the proverbial free lunch: the ability of the government to spend more without imposing any burden on anyone”.
I am going to be polite. We always need new, fresh thinking and nobody wants to kill off ideas clearly in a state of gestation and in no way workable in their present form. Some, like the economists above, might say it is necessary to kill off MMT because it is dangerous. There is, however, little chance of it being adopted as real-world policy. Not even Jeremy Corbyn and John McDonnell embraced MMT, despite being urged to by some supporters.
They were wise not to do so, because there are fundamental problems with MMT. It would take another book to address them fully. Kelton has fun with Margaret Thatcher’s “backward dictum” because Thatcher described a government’s finances in the way you would describe a household’s finances.
However, Kelton has more in common with Thatcher than she thinks. In the early 1980s, when the Tories launched their monetarist experiment, Thatcher thought the key driver of inflation was the budget deficit. The deficit had to be cut to reduce money supply growth and inflation. It is why people associated monetarism with “cuts”. Kelton looks at it from the other end of the telescope but applying the same principle.
The causes of inflation are many and varied, particularly when you do not use the simplifying assumption of a closed economy. Dylan Grice, whose review of Kelton’s book was republished by Albert Edwards of Société Générale, is not unsympathetic but points to the “preposterous” idea that getting the Congressional Budget Office in America, or equivalents elsewhere, to predict inflation will take care of the inflation risk from large budget deficits. Given the forecasting record on inflation, it plainly will not. As Grice puts it: “In short, MMT is a recommendation that policymakers press harcelerator without knowing where the brake is.”
He is right and, while advocates of MMT see it as a two-way street in which spending would be reined in if inflation took off, politicians may see it differently. Would it be a recipe for huge instability in the provision of public services, with public spending cut in response to rising inflation in a way that would make George Osborne’s austerity look like a tea party? Or would the government decide it could live with a lot more inflation? Either way, it would not be pretty.
