Modern Monetary Theory: a silver bullet for the left?

I have been reading the Economist regularly since 1974. I would find it hard to live without it. But I’m generally disappointed with the modern paper: its analysis lacks penetration, and its default setting is a mediocre version of neoliberalism with a few softened edges. But one of its regular columns stands out: Free Exchange. This discusses new thinking in economics in an open way that does not dismiss challenges to the conventional thinking that dominates the rest of the paper’s coverage. Last week it took on an idea that is increasingly fashionable on the left in America: Modern Monetary Theory (or MMT – its advocates love their TLAs).

This new strand of thinking on macroeconomics winds conventional economists up quite a bit, including those like Paul Krugman who are usually considered to be on the left. This is mostly because MMT’s advocates are deliberately provocative, disregarding a whole series of economic conventions, such as the use of mathematical models, and a complete lack of interest in finding common ground.

So what is MMT? I have discussed it here before, but in essence it suggests that the purpose of taxes is not to raise funds for public spending, which can be done by “printing” currency, but to stop the economy from overheating and the currency suffering from unacceptable levels of inflation. This is a reversal of the modern “neo-Keynesian” consensus (which I will call NKC since TLAs are clearly the thing), developed in the 1990s and still maintaining its grip, which suggests that the job of taxes is to fund government spending, while the job of monetary policy is to police inflation.

MMT has been seized on by the left (for example by Congresswoman Alexandria Ocasio-Cortez) because it suggests that the conventional arguments for austerity economics are bogus. Governments (or at any rate those that have their own currencies) don’t need to worry about budget deficits as long as inflation remains dormant. The magic money tree exists and is ready to nourish an expanded role for the state. Interestingly here in Britain the Labour leadership, represented by shadow chancellor John McDonnell, has resisted taking up MMT, in spite of entertaining other innovative economic thinking. I’m not entirely sure why that is, but Mr McDonnell is acutely aware of the dangers of his party being painted as wacky with the nation’s finances.

In fact the gap between MMT and the NKC is not as big as either its advocates or its critics suggest – much of it is linguistics. This is something that the Free Exchange columnist grasps, instead of falling for the wind-ups on both sides:

Speaking with MMT’s adherents is sometimes like watching a football match with friends who insist the ball remains stationary while every other element in the game, including the pitch and goalposts, moves around it.

The Economist Free Exchange 14 May 2019

Behind the kerfuffle the MMTers are onto four truths that conventional economists should be perfectly able to understand.

First: conventional monetary policy, which primarily operates through manipulating interest rates, is at best a blunt instrument for managing the economy, and at worst positively destabilising. It depends on managing levels of private debt, and often allows it to build up to excessive levels by promoting asset bubbles.

Second: public debt is much less destabilising than private debt, provided that it is denominated in the country’s own currency. Indeed many countries are able to sustain levels of public debt that used to be thought of as impossible – Japan being a prime example.

Third: fiscal policy (i.e. managing levels of public spending and taxation) is a much sharper instrument for managing the economy than monetary policy. It is much easier to direct extra demand to the weaker parts of the economy where is is less likely to cause problems. It may also be easier to direct extra spending towards productive investment (for example in clean energy or social housing) rather than inflate bubbles and the pay of unscrupulous intermediaries like bankers.

Fourth: across the developed world there is much greater headroom for additional government spending than is commonly supposed. This is because of a phenomenon referred to as “secular stagnation”, described by such conventional economists as Larry Summers, who describes MMT as “voodoo economics”. When the Financial Times’s veteran economics writer Martin Wolf thinks that the British government should borrow more to spend on clean energy projects because of secular stagnation, you should know something is up.

So MMT certainly has something going for it, once you look past the wind-ups. What are the problems? It is being embraced as an answer to austerity policies, with the suggestion that spending more on public services and benefits does not mean putting taxes up. But MMT doesn’t say there is unlimited scope for extra public spending – it says this is limited by the resources that the economy has access to. But there is little discussion about how you tell that an economy was is living beyond its resources – simply that this would lead to inflation. Supporters of the NKC suffered a similar complacency because of low inflation levels before the great financial crisis of 2008. Doubtless eventually excess would lead to inflation, but in a globalised economy there is likely to be financial instability first, perhaps driven by foreign currency borrowing. With record levels of employment and a large trade deficit it is not self-evident that the British economy isn’t at the limit already – though if extra public spending was carefully targeted it would stimulate production rather than cause prices to go up or imports to increase.

Which leads to a political issue. Under any economic theory it is clearly the case that governments can borrow too much, and that eventually printing money causes more problems than it solves. At worst this leads to cases where ruling elites and their supporters continue to live well and entrench their power, while the rest of the country becomes impoverished (think of Zimbabwe and Venezuela at the extreme, or the lesser cases of Turkey now and Argentina under the Kirchners). That is why developed world governments operate within political constraints to stop them spending too much. MMT is being used as an argument to remove those constraints, and that would end badly unless they were replaced by robust alternatives. This does not seem to be a conversation that the supporters of MMT are taking on.

There is a middle way. If, as Mr Wolf suggests, government borrowing is directed to support investments that will help economic wellbeing in the long run, then the risks of the economy going out of control are much lower. And if these investments can be biased towards areas where local economies are weak, that is even better. That means institutional controls are needed to ensure that current spending and taxation remains within limits, and to ensure that investment projects are worthwhile. But such institutional constraints are anathema to the left.

If something sounds too good to be true, it usually is. MMT is a useful challenge to stale conventional thinking on managing the economy. But even if its supporters are right that the economic arguments for austerity are flawed, we should not be blind to the political problems of giving governments too free a hand to spend as they please.

17 thoughts on “Modern Monetary Theory: a silver bullet for the left?”

  1. MMT like Keynsianism works fine in theory. When the economy is entering recession, Government should spend more than it receives (counter-cyclic spending) and Chancellors usually recognise this. The problem occurs when the economy is booming and the Government should be reducing spending (or increasing taxes). Chancellors rarely act on this; the most recent example is Gordon Brown who created his ‘Golden Rule’ of only borrowing to invest on average over the economic cycle, then sabotaged it by repeatedly extending the length of the economic cycle to avoid falling foul of his rule.

    Politics dictates that a booming economy at election time favours the re-election of the Government, while recession favours the Opposition, and that is the problem. A one-Party state could implement either Keynsianism or MMT successfully, but it is difficult to see any Chancellor in a multi-party democracy willingly damaging the chances of re-election for the sake of doing the right thing for the economy.

  2. Matthew,

    A useful article I think!

    However, both yourself and Laurence Cox are tending to view MMT as something which can be opted in, or out of, to a greater or lesser extent. My background is science and engineering so, for me, as a scientist, a theory is either right or it isn’t. So to say that MMT proponents are “provocative” and have no “interest in finding the middle ground” is missing the point entirely. That’s not how science works. And I do applaud any attempt to make Economics less political and more scientific. The key question is, or should be, “is it right?”

    If you think it isn’t then, fair enough, explain why and if there is a genuine flaw in the Theory it can be addressed. Laurence’s “MMT like Keynsianism works fine in theory” is quite nonsensical from a scientific POV if we take into account the implied “but” that comes later. It’s like saying Einstein’s Relatively works fine in theory but…….

    If anything works fine in theory it has to be able describe reality. If it doesn’t then it isn’t fine in theory at all. No doubt Gordon Brown made mistakes in his handling of the economy. So we need to ask ourselves if MMT can explain what they were and what he should have done instead. So there can’t be a “middle way” once we start thinking logically and scientifically. We either chuck out MMT because it’s wrong or we keep it because it’s right and allowing for any necessary corrections that we might have to make to keep it right as new data becomes available.

    It shouldn’t be just the left that is keen to embrace MMT. The right want smaller government and they think that economic austerity is the way to achieve it. It should be obvious that it’s not working. Austerity creates more people who are dependent on government benefits. If they’d care to study MMT they’d know where they were going wrong. It’s not that hard to figure out.

    1. I don’t see it that way Peter. You say that we should approach this as a matter of scientific truth, but pose the question as if it was a matter of religious faith. Do I Believe? My answer to that is I’m waiting for the evidence. The frustration of mainstream economists is with MMTers who refuse to take their theory into testable propositions that can be measured against evidence, or make predictions that may be right or wrong (or at least predictions that don’t take massive risks with the economy). Instead they engage in a sort of theological argument about the meaning of tax. Just say to an MMTer that spending should be funded by tax and await the detonation. You are unlikely to get a careful appraisal of the evidence. That is a pity because there some very interesting ideas that come up through MMT, and mainstream macroeconomics badly needs more challenge.
      My “middle way” wasn’t about the theory itself, but about the policy implications. As you have pointed out MMT isn’t necessarily a left wing idea, but it is being used to justify budget deficits in developed economies. My middle way says yes to the deficit but also says that it shouldn’t just be used to fund tax cuts or benefit increases or unfounded public services – but in investment projects especially to combat carbon emissions. This works both in MMT and NKC.

      1. OK I know there are some MMTers who haven’t quite grasped what MMT is all about and can create a bad impression.

        However, I’m not sure why you think the meaning of tax for a currency issuer has anything to with theology. If the currency issuer can issue currency why does it need tax to be able to spend? It doesn’t. It taxes to create a demand for the currency and prevent inflation. It’s all perfectly logical.

        1. Simples. Additional spending by the government causes stress on national economic resources and so inflation, foreign currency loans or other destabilising factors. Taxes are needed to create the orderly adjustment required. It sounds theological because MMT and NeoKeynesianism often say very similar things, but their supporters accuse each other are talking nonsense.

  3. ALL spending, by the export sector, the domestic sector and government is a call on national resources. MMTers often accuse neoliberals, quite justifiably IMO, of pretending that it’s only Government spending which is a call on those resources.

    To keep the economy functioning there has to be that call. So it’s not a bad thing. You shouldn’t use the word inflation quite so early in your argument. Inflation can be caused by any type of excess spending, just as deflation and recession can be caused by deficient amounts of spending. That’s where the Govt has an important role to spend less when others are spending more and vice versa.

    I would regards MMT as a type of Post Keynesianism. Not neo-Keynesianism which is essentially just a dressed up sort of monetarism. ie neoliberalism. I don’t worry too much about what they say. They were responsible for reducing interest rates to such a low level that we have a huge private sector debt bubble.

    1. Yes it’s much more complex than the incremental picture I was painting. At the margin new government spending is a new call on resources, and the need for taxes depends on a much wider picture. To me that is mainly semantics. The most powerful part of MMT isn’t its insight on tax and spend, but on the failure of conventional monetary policy to do anything useful in the long term. But there are plenty of facts to support that critique and so it should be perfectly possible to use scientific methods to develop it. My perception, which may be unfair, is that most MMT advocates are not interested in developing such evidence because it means engaging with orthodox economists on their own terms. I know that’s not true of all of them though.

      1. Like many MMTers I haven’t come from an economics background. Except I’ve always been interested in it. In my first year at uni we had to choose one non scientific module and I chose economics. Which arguably shouldn’t have been considered non-scientific! I did toy with the idea of switching courses and spoke to a Prof in the Economics dept and he wanted me to do the first year again which was problematic with grants. So that didn’t happen. Also I thought that Keynes had more or less sorted out the problems and I didn’t foresee the change to come.

        When I was doing my MSc (not Economics!) I knew enough to argue with Sir Keith Joseph when I attended a talk he was giving an the importance of ‘money supply’. That would have been ’74 I think. I told him that he was ignoring the other factors that were important. So I was pleased to have been right about that. But I never really understood what the monetarists were on about and why their view was ever considered orthodox. I’d had similar but not well developed thoughts of how the system really worked to what I read later with MMT. So as soon as I came across that it was really plain sailing as far as I was concerned. It just seemed so logical that I’ve never really been able to see why anyone has a problem with it.

        1. Funnily enough I came across Sir Kieth Joseph in the flesh in about 75 when he visited my school. I was a Tory supporter in those days and sympathetic. In those days monetarism came into fashion because we clearly needed fresh ideas because conventional management was an even bigger failure than it is today. The only thing that troubled me about it was that it was justified on a mathematical identity – which my scientific training told me was no basis for a useful theory. In fact it was a theory about the velocity of money, for which there was no real evidence and the whole edifice collapsed as soon as it was applied to the present rather than the past. In fact the key theoretical development was around equilibrium unemployment and inflation expectations. But that part of the theory doesn’t seem to work any more in modern globalised markets and the gig economy.
          My interest in economics came out of my interest in politics and history and training in science – chemistry especially. I opted for the science instead of economics but didn’t make a success of it at university and so went into accountancy. I still tried to get to grips with economics mainly by reading the Economist, but realised I needed some formal training if I was going to be able to engage with the professionals. So when I retired early I went take a degree at UCL.

  4. No discussion of MMT can be complete without some discussion of the Job Guarantee. MMT proponents do recognise “fresh ideas” were needed in the 70s because inflation had been allowed to get out of hand. But the ideas weren’t really that fresh. Just a throwback to pre Keynesian times.

    The Job Guarantee is more than just an optional extra in the same way that the Universal Basic Income might be for orthodox economists. It is an anchor against inflation. As Warren Mosler explains in the link I previously supplied:

    “…….if, for example, the UMKC started paying 2 buckaroo per hour rather than 1, the buckaroos would probably exchange for $7.50 each rather than the current $15.00 each.”

    So the hourly rate paid to JG defines the worth of buckaroo.

    The JG could be extremely socially useful, in that everyone who wants work could qualify. At present employers tend to always hire off the top. They’ll always prefer young, able bodied people. Being reasonably attractive and personable always helps! This creates a problem for older people who lose their jobs. Those with mental disabilities are particularly hard hit. I’ve read that less than 10% of those with Down’s Syndrome are in employment, but many more are capable of making a useful contribution to society.

    The JG isn’t without its problems. I have some of my own! But I’d say we need to give the concept some thought.

    PS Terms like “money printing” , “magic money tree” are politically pejorative and are generally are used to mislead by neoliberals. They should be avoided in any serious and impartial discussion. In the modern era, ALL money, except perhaps loose change, is either created in a computer or it is printed. That should be obvious to anyone.

    1. I haven’t properly investigated the job guarantee, but I agree that is an interesting idea. I dislike the idea of UBI in the context of a developed economy because it suggests that money is at the root of all good (it may still be useful in places like Rural India). The job guarantee has the potential for serious human engagement, which is the key to making the world a better place.

      I hate the expression “printing money” but I occasionally find it useful: but I try and use inverted commas. It is actually a deeply misleading metaphor and I think economists who should know better are among the misled. “Magic money tree” is pejorative but still useful I think. It attacks the idea that our unlimited ability to create money means that society has access to limitless resources. Money and resources aren’t the same thing.

  5. Money and resources aren’t the same thing.

    Agreed. That’s why it should be “magic resources tree” !

    In other words if we don’t have enough teachers or doctors or nurses, or whatever, we have a resource constraint.

    But the mainstream is thoroughly confused about this. On the one hand our economy can’t manage without an everlasting influx of cheap labour. On the other, the robots are going to come to take all our jobs so we have to pacify the masses with a UBI !

  6. I’ve just done a little bit of research into the concept of “secular stagnation”. I’d heard of the term in connection with the so-called “productivity puzzle” which isn’t a puzzle at all. My first inclination was to think that the Neo Keynesians had just invented a fancy name for the pickle they’d got themselves into now that interest rates were so low they couldn’t lower them any any further, and blow up the debt bubble a little more.

    I don’t think I was far wrong.

    1. Bill Mitchell would save his readers a lot of trouble if he just said “I agree with Larry Summers”. He really ins’t saying anything different: low interest rates are due to a lack of private sector investment, which could be down to a number of things (Summers emphasises the issue of inequality) for which the answer is more government spending. But instead of taking the idea as evidence that MMT is right he has to go off on a not very coherent diatribe that it’s all more rubbish put out by those evil neo-Keynesians. I really can’t warm to the man!

      But essentially you are right. It is the neo-Keynesians at last owning up to the hole they’ve dug themselves into.

  7. @ Matthew,

    I don’t think you’ve got it right. I’ve met Bill a couple of times. I organised a meeting for him to speak at the Lab Party conf in Brighton in 2017.

    There would be very little agreement between him and Larry Summers. LS talks about a zero lower bound as if its just a temporary aberration. Bill would say that we’ll always be stuck on with low interest rates unless something really drastic happens, like a WW2 event to cause huge levels of Govt spending. neokeynesianism has come to the end of the line.

    Bill wouldn’t agree with your “low interest rates are due to a lack of private sector investment”. Bill would say that interest rates are low because the Govt wants them low. They aren’t set by market forces. And has wanted them low since the 2008 GFC to try to get some growth back into economies.

    1. I’m probably not being fair on Bill Mitchell. All I know about him is through his blog, which I’ve only known occasionally, and which I find annoying! My knowledge of Summers isn’t much better either – I’ve read a few of his pieces for the FT, and read further reports of him by Martin Wolf and the Economist. But I’ll stick to my perception that you and Bill are exaggerating the differences between yourselves and Summers (and the more perceptive orthodox economists) when it comes down to the economics.

      Summers’s description of the current version of secular stagnation (which I think he says predates the crisis) is not that of a temporary aberration. In fact that the whole point of the fuss he’s making. Policymakers can’t just wait for it to go away. And I haven’t read him say anything about any zero lower bound – I don’t think he’s saying that inflation should be bumped up so that there can be negative real rates (though I think Krugman may be saying that – as he certainly did of 1990s Japan). Bill may be clear about what is causing it, but Summers is very guarded about causes – that’s a difference I suppose between being careful and jumping to conclusions without reviewing all the evidence. And I don’t think Summers suggests that government/central bank policy has nothing to do with low interest rates. But I would be really surprised if Bill Mitchell says that a demand gap between savings and investment doesn’t influence interest rates either. After all that is surely what was happening in the 1930s (though I’m not an expert on that era). Of course the two are linked. The govt hopes to stimulate demand for investment through low interest rates. It hasn’t worked so rates stay stuck. The govt cuts rates because of low investment, such as after the GFC. As well as the politics of the housing market, of course.

      Incidentally while Summers is consciously re-using the term “secular stagnation” from that era, he is not suggesting that what is happening now is the same as what was happening when the term was coined. He just uses it as an attention-grabbing device.

  8. @ Matthew,

    Well Larry Summers talks about the zero bound in this article.

    He also talks about the ‘natural rate of interest’. I don’t believe there’s any such thing. The rate of interest to create a stimulus in the economy is always going to be lower than the previous one. Your comment “The govt hopes to stimulate demand for investment through low interest rates. It hasn’t worked so rates stay stuck”

    It has worked to an extent. The economy isn’t in as bad a shape as it was 6 or 7 years ago. But I would say its not the absolute rate of interest that creates the stimulus – it’s the rate of change. So when rates a lowered we see a stimulus to the economy as the extra borrowing results in extra spending. But then the rate of change afterwards is zero again and so the stimulus wears off. So you’ll need another reduction to get another stimulus. You’ll always end up at the zero bound. If the rates are increased at all that acts as a depressant to the economy.

    So central banks will perhaps think there is too much private debt in the economy, think that they have to raise rates to discourage borrowing and end up creating a recession or even a crash.

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