May 22, 2020
Modern monetary theory has moved to center stage in the debate about the proper role of monetary policy. Whether you are a strident believer or a ferocious detractor depends largely upon your political persuasion. The left-wing of the Democratic Party has latched onto the idea because it could not find a way to pay for expensive programs like health care for all, a free college education, or a “Green New Deal” without resorting to middle-class tax hikes. The detractors are the more conventional Keynesian economists who fret about the possibility of hyper-inflation.
The basic idea of modern monetary theory (or MMT) is that a government can achieve full employment or pay for any government program simply by printing enough money. One of its founders, Warren Mosler, says that, “No financial crisis is so deep that a sufficiently large increase in public spending cannot deal with it.” Like it or not, that is exactly where we are today with Congress already having passed an initial $2.0 trillion stimulus package, a second round of $0.5 trillion, and a third round of stimulus in the works. Government debt has skyrocketed — but does it matter?
The idea of MMT is that the appropriate level of government spending is that which produces full employment. If the government is not at full employment, boost government spending. Its supporters argue that the U.S. government can never be forced into insolvency because it can simply issue more debt. Hence, a balanced budget is not a necessary requirement for a healthy economy. They note that in recent years budget deficits have been rising but inflation has been falling, thus all the fuss about rising budget deficits causing a cumulative increase in debt outstanding is misplaced. After all, the government has run budget deficits in 46 of the past 50 years, inflation remains well in check, and the Treasury has had no difficulty selling its debt. So what’s the problem? In the eyes of MMT advocates a $1.0 trillion deficit is a good thing because it represents $1.0 trillion of government spending which boosts aggregate demand. In fact, deficit spending on productivity enhancing projects such as education, infrastructure, and research and development will boost potential GDP growth and therefore accelerate growth in our standard of living. But in the real world of politics most government spending today does not boost productivity.
Some suggest that the MMT crowd believes that deficits do not matter, they contend that deficits do matter. Excessive aggregate demand will eventually cause inflation to rise. Rising inflation is, in their mind, the only relevant constraint on government spending. Once that happens, the government simply curbs deficit spending by raising taxes, cutting spending, or imposing stringent regulations on business and financial institutions.
To the MMT supporters the Fed’s role has disappeared. Its job is only to keep interest rates at 0%. Rather than monetary policy and the Fed being the primary tool for adjusting the pace of economic activity, that role would fall to fiscal policy and our elected representatives in Washington.
As we see it, MMT can deliver short-term benefits when the economy is on the skids – such as now – but at the expense of equally challenging economic costs down the road. The current mix of monetary and fiscal policy seems to work fairly well. Periods of economic expansion have steadily gotten longer from 2 years in the early 1900’s to a decade or so today. While not perfect, the Fed has done an excellent job of extending the periods of prosperity. Why fix what is not broken? The current downturn is not the result of inappropriate monetary or fiscal policy. It was caused by a virus which has spread around the globe and all governments have struggled with an appropriate response.
Right now the object should be to safely re-open the economy. In a prolonged period of unemployment workers lose their skills and families end up with increased debt. The loss of small- and medium-sized businesses destroys someone’s life’s work, not to mention that they are a major source of job creation. A prolonged recession would also discourage capital spending and business investment. For these reasons, it is important that politicians and the Fed get the economy back on track quickly. Additional debt is an outgrowth of that stimulus. It has already happened, so let’s figure out how best to deal with it. MMT? Or more a conservative Keynesian policy?
But at some point, inflation is bound to rise. In the MMT world with all economic policy now resting in politicians’ hands, it is difficult to see them choosing to raise taxes or cut spending enough to curb inflation. Better to let the Fed do that job.
While MMT is not the right route to go, they do raise some valid points. In a world where interest rates will remain low for the foreseeable future, perhaps a moderate increase in debt is not as problematical as the Keynesians seem to suggest. Should be an interesting discussion!
Stephen Slifer
NumberNomics
Charleston, S.C.
Hi Steve,
This is an interesting point. MMT has been gaining traction, although I would argue it’s both sides of the political spectrum. Since Newt and his “Contract with America” the Republican’s have been taking big about debt, usually when a Democrat is in office, and then not delivering. I hear the arguments for it, but it’s still unsettling. The idea that you save money for a rainy day is too ingrained, and I believe it’s ingrained for a good reason.
We have many examples of MMT -failing- in other countries. We usually just call it something like “Venezuela”, pre WWII Germany, or current examples of hyperinflationary spending that lead to major disruptions in society. The U.S. benefits it’s hegemonic economic and military status. I think that’s a key reason MMT has caused few issues to date. However the more we continue to turn away from international agreements to focus on “America First” the more we attrit away our soft power by encouraging other countries to look elsewhere for partners. Thus in my opinion the longer we rely on MMT (admittedly measured in decades) the more risk we run.
Certainly now is the time time to spend, we need to get the economy back on it’s feet and moving forward. I wish we’d spend on infrastructure so we’d get multiple benefits from the new debt, but it looks like that’s not in the cards.
Whoever ends up president after the next election, I hope they gather a strong team around them and plot a logical course out of the mess we find ourselves in. It would be good for the U.S. to find itself a beacon for admiration again rather than pity. https://www.irishtimes.com/opinion/fintan-o-toole-donald-trump-has-destroyed-the-country-he-promised-to-make-great-again-1.4235928?mode=sample&auth-failed=1&pw-origin=https%3A%2F%2Fwww.irishtimes.com%2Fopinion%2Ffintan-o-toole-donald-trump-has-destroyed-the-country-he-promised-to-make-great-again-1.4235928
No one that ever went on a spending binge acknowledged that they might lose control and have high inflation.
The MMT proponents say that they’ll know how to reign things in if inflation gets above a certain point. Well it got above a certain point at the end of Lyndon Johnson’s time in office with all of his “guns and butter” spending in the mid-1960s and we went through three presidents [Nixon, Ford and Carter] before we had one with the “guts” [Reagan] to have the head of the Fed [Volker] ring it out. Does anyone remember 1982 with 15% interest rates for single family dwellings and 18% rates for co-ops in Manhattan? I do and it was brutal.
Does anyone think this MMT bunch would be willing to tackle something like that?
Stephen, it is always good to read your well thought out analysis of the current economic situation. I really appreciate your thinking. I was wondering how we overspent like crazy to support our role in WWII? The country must have gone way overboard in spending without the normal revenue to the government. Some how the country managed to get through that situation. Does that WWII experience give us any hope for today?
Thanks again for your insight.
Hi Walter,
I mentioned that very experience with Volcker in the original write-up. I pulled it when I found it was getting far too long. The politicians couldn’t (probably did not want to) rein in inflation. It was the courage of Paul Volcker to push short rates to 20% that did it. (I was at the Board of Governors of the Fed at the time). I have a hard time imagining a group of politicians at some point in the future being willing to do that.
All the best.
Steve
Hi Darrel,
We did have excessive war-related spending during WWII and debt to GDP peaked at 106.3% I can’t seem to insert a chart into these comments. I will send it to you via e-mail. But it was easier then to cut spending because so much of what had driven it to a record high level was war spending. Once that was eliminated and the economy grew quickly as we helped to rebuild Europe, that ratio fell quickly. This time so much of our spending (70%) is on entitlements which will much harder to shrink. I still think we can get through this. With near 0% interest rates for the foreseeable future and nominal GDP growth of, say 5% (3% real and 2% inflation), that ratio should decline. Could issue some 100-year bonds. Or perhaps interest-only bonds? But if the Democrats win in November it seems likely that they will use deficit spending to finance all sorts of expensive projects.
All the best.
Steve
Hi Chris,
It was really tough to talk about MMT in a short article. Too many aspects of this. But I tried. Clearly, your examples of Venezuela, Germany, and Argentina would be perfect examples of the dangers. To just conclude that they would raise taxes to tackle inflation sounds nice, but would probably be almost impossible to actually achieve.
With interest rates near 0% and likely to stay there for the foreseeable future and nominal GDP growth of, say, 5% (3% GDP and 2% inflation?) the debt/GDP ratio should begin to shrink. I would love to see the next president tackle the entitlement issue. If you are going to rein in spending that is the only way to make it happen. Trade entitlement cut for increased infrastructure perhaps?
Looking forward to November, I am not sure I like either candidate. But then again, somebody is at least willing to run. I wouldn’t take it if they actually offered it to me. Who actually wants that job?
All the best.
Steve
Hi Steve,
I can’t imagine wanting that job. The knives would be out from day one. I think all of the sacred cows would need to need to be looked at, entitlements, defense and taxation. As you know, one interesting aspect of MFT is that as long as the government spending goes back into the U.S. economy, it’s not a total loss. You do get some economic benefit including the opportunity to tax a portion of the money paid out. To the extent we can entice foreigners to invest in our debt while we use the money domestically to invest in growth we’d come out ahead for a while. Let’s just hope the powers that be suddenly become rational and join together in comity to solve these problems.
Best,
Chris
Hi again,
I always have a problem with the notion that foreigners will no longer buy our debt. If they do not want U.S. dollars, where to they go? Want to put it in Chinese yuan? Yen? British pounds? Euros? Not a lot of good options.
I agree. I think longer term the u.s. status as the world reserve currency is in danger if the current trends continue. However I would think we’re at least 10 to 25 years from that at the earliest. If it ever does happen, my guess is it will be an e-currency of some sort that will gain pre-eminence. After all, they don’t really want to buy debt, they want a stable way to store value.
Somethings I’ll never understand #1 My dates for my high school prom #2 The mass shooting in Las Vegas #3 Why debt and deficits don’t seem to matter and contrary to the laws of economic gravity have no effect on inflation