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The rise of modernmonetary theory



Published with the kind permission of the author

Much of what is new in MMT is unconvincing and a dangeroustemplate for public policy

Many of the Democratic party contenders forthe US Presidency have endorsed a set of economicpolicies promoted by purveyors ofwhat is called “Modern Monetary Theory” (MMT).The charismatic Congresswoman Alexandria Ocasio–Cortez, who though too young to run for Presidentherself, has already set part of the Democrat’s agendawith the Green New Deal, has now endorsed MMT asthe basis for the Democrat’s economic policy. In thisshe joins Stephanie Kelton, a professor at Stony BrookUniversity, who was an advisor to Bernie Sanders in2016 after serving as the chief economist in the USSenate Budget Committee in 2015. The archbishop ofMMT is Herman Minsky’s student, L Randall Wray,whose Modern Money Theory ,(2nd edtn, PalgraveMacmillan, 2015) provides the best consolidatedaccount of the “theory” and policyprescriptions of MMT.

These progressive “democraticsocialists” — as they call themselves— have proposed a wholeset of new public programmes.The question my students weretaught to ask was: Who will pay forthem? MMT claims that whilst thisquestion makes sense for a householdor business, it makes no sensefor a government which issues itsown currency and can “alwaysafford a new programme in financialterms because it can issue currencywithout taxing or borrowing”. (“ModernMonetary theory explained. An interview withStephanie Kelton”. The problemis “aboutwhether spending to fund your programme will causean inflation problem”, this can be triggered if “our realresources are constrained not our financial resources”.She adds that “it means that the government can safelyadd dollars to the economy through deficit spending”.

On supply side measures like cutting taxes andderegulating industries to promote growth she says“all of the supply side approaches are trying to createthe right environment, unleash or awaken businessincentives to hire or invest. I think that gets it completelybackward. Businesses hire and invest whenthey are swamped with customers. That meansdemand is the key driver. You’re talking about a completelydifferent approach from supply side todemand driven.”

This all sounds very much like the oldKeynesianism, and as Thomas Palley argues (“Money,fiscal policy, and interest rates: A critique of ModernMonetarytheory”) much of this is oldhat Keynesianism, which recognised that in a fiat currencyeconomy, the financial constraint on governmentsis not the same as households or businesses,and it cannot become insolvent on debtissuedinitsowncurrency.Also,itsmoneycreation is limited by inflation whichaccelerates when economy’s realresources are utilised at full employment.But unlike the neo-Keynesians,MMT does not recognise the Phillipscurve relating inflation and unemploymentand the resulting trade-offs forpublic policy before full employment isachieved. Finally, the government cancontain demand pull inflation by taxationand bond issuance to removeexcess money from circulation.

MMT also denies the “crowding out”effects of government deficit spending. But as RobertP Murphy of the Mises Institute shows (“The Upside-Down World of MMT")is based on their peculiar definition of “savings” as“net private savings”. From national income accountingidentities, they argue that “if the government wereto reduce its budget deficit then the private sector’ssaving would necessarily go down”. Murphy showsthat as the government deficit grows, the left handside of the accounting identity rises. “So the righthand side must grow bigger. It may happen partially because people cut down on consumption and savemore, but it may also happen because private investmentgoes down”. That is, the equation tells us “wemight see lower private consumption, rising interestrates, and real resources being siphoned out of privateinvestment into pork-barrel spending projects”.Even in the MMT world there would be “crowdingout” from fiscal deficits.

It is two other aspects of the MMT policy packagewhich are new. The first is their policy for fullemployment. They do not believe that conventionalmonetary or fiscal policy will do this. So, they wanta programme similar to the Indian National RuralEmployment Guarantee Act, as a universal nationaljob guarantee (JG) cum employer of last resort (ELR)programme. This would provide a wage below themarket wage to anyone unemployed and willing towork on any private or public project. It would befinanced by a money financed budget deficit. AsWray (2015) argues this programme should appealto libertarians, as “it is not Big Brother. It is noteven Big Government…It is a purely voluntary programme,only for those who want to work. Thosewho will not work cannot participate…..The jobsdo not have to be provided by government at all.No one has to take a job. It is consistent with themost cherished norms of freedom-loving libertariansand Austrians”, (p.245). The progressive Palleycriticises the programme for political economy reasons,as it could lead to the undermining of publicsector workers and public sector pay as governmentssubstitute ELR workers for public sectorworkers. This and other fears adduced by Palley asundermining minimum wages and government ingeneral are likely to make this programme appealingto classical liberals!

The second new aspect of MMT is its interest ratepolicy. It asserts that Wicksell’s natural rate of interestwhich equates the rate of return on capital (productivity)with the private rate of time preference (thrift)is zero. So, the central bank should “set the overnightrate at zero and keep it there”. (Wray, “A Post Keynesianview of central bank independence, policy targets andthe rules versus discretion debate”, Journal of PostKeynesian Economics, 2007,.138). This, of course,implies (as MMT recognises,) the well-known conditionfor preventing deficit financing to lead to an explosivelyrising public debt ratio, namely that the interestrate on the debt (r) should be less than the growth rateof the economy (g ) will always be met, and also entailthe progressive Keynesian outcome of the “euthanasiaof the rentier”. (Wray 2015, p.64).

Putting the interest rate at zero puts fiscal policyas the sole stabilisation tool, which as Milton Friedmanshowed, given the lags involved, discretionary fiscalpolicy is an inferior instrument compared to countercyclical interest rate policy to stabilise the economy.More seriously, with inflation at high or full employment“setting the short term nominal policy rate atzero becomes a recipe for encouraging financial speculationand asset price inflation driven by debt , whichends in financial crisis” (Palley: “MMT: the emperorhas no clothes”, Feb,2014).

My conclusions can be brief. MMT is mostly theold Keynesianism and apart from the JG/ELR programmemuch of what is new is unconvincing, and adangerous template for public policy.

Source: Business Standard