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.