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


Charleston, S.C.