The rise of modern monetary theory

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

Many of the Democratic party contenders for the US Presidency have endorsed a set of economic policies promoted by purveyors of what is called “Modern Monetary Theory” (MMT). The charismatic Congresswoman Alexandria Ocasio–Cortez, who though too young to run for President herself, has already set part of the Democrat’s agenda with the Green New Deal, has now endorsed MMT as the basis for the Democrat’s economic policy. In this she joins Stephanie Kelton, a professor at Stony Brook University, who was an advisor to Bernie Sanders in 2016 after serving as the chief economist in the US Senate Budget Committee in 2015. The archbishop of MMT is Herman Minsky’s student, L Randall Wray, whose Modern Money Theory ,(2nd edtn, Palgrave Macmillan, 2015) provides the best consolidated account of the “theory” and policy prescriptions of MMT.

These progressive “democratic socialists” — as they call themselves — have proposed a whole set of new public programmes. The question my students were taught to ask was: Who will pay for them? MMT claims that whilst this question makes sense for a household or business, it makes no sense for a government which issues its own currency and can “always afford a new programme in financial terms because it can issue currency without taxing or borrowing”. (“Modern Monetary theory explained. An interview with Stephanie Kelton”. The problem is “about whether spending to fund your programme will cause an inflation problem”, this can be triggered if “our real resources are constrained not our financial resources”. She adds that “it means that the government can safely add dollars to the economy through deficit spending”. 

On supply side measures like cutting taxes and deregulating industries to promote growth she says “all of the supply side approaches are trying to create the right environment, unleash or awaken business incentives to hire or invest. I think that gets it completely backward. Businesses hire and invest when they are swamped with customers. That means demand is the key driver. You’re talking about a completely different approach from supply side to demand driven.”

  

This all sounds very much like the old Keynesianism, and as Thomas Palley argues (“Money, fiscal policy, and interest rates: A critique of Modern Monetary theory”) much of this is old hat Keynesianism, which recognised that in a fiat currency economy, the financial constraint on governments is not the same as households or businesses, and it cannot become insolvent on debt issued in its own currency. Also, its money creation is limited by inflation which accelerates when economy’s real resources are utilised at full employment. But unlike the neo-Keynesians, MMT does not recognise the Phillips curve relating inflation and unemployment and the resulting trade-offs for public policy before full employment is achieved. Finally, the government can contain demand pull inflation by taxation and bond issuance to remove excess money from circulation.

MMT also denies the “crowding out” effects of government deficit spending. But as Robert P 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 accounting identities, they argue that “if the government were to reduce its budget deficit then the private sector’s saving would necessarily go down”. Murphy shows that as the government deficit grows, the left hand side of the accounting identity rises. “So the right hand side must grow bigger. It may happen partially because people cut down on consumption and save more, but it may also happen because private investment goes down”. That is, the equation tells us “we might see lower private consumption, rising interest rates, and real resources being siphoned out of private investment into pork-barrel spending projects”. Even in the MMT world there would be “crowding out” from fiscal deficits.

Illustration by Binay Sinha

It is two other aspects of the MMT policy package which are new. The first is their policy for full employment. They do not believe that conventional monetary or fiscal policy will do this. So, they want a programme similar to the Indian National Rural Employment Guarantee Act, as a universal national job guarantee (JG) cum employer of last resort (ELR) programme. This would provide a wage below the market wage to anyone unemployed and willing to work on any private or public project. It would be financed by a money financed budget deficit. As Wray (2015) argues this programme should appeal to libertarians, as “it is not Big Brother. It is not even Big Government…It is a purely voluntary programme, only for those who want to work. Those who will not work cannot participate…..The jobs do not have to be provided by government at all. No one has to take a job. It is consistent with the most cherished norms of freedom-loving libertarians and Austrians”, (p.245). The progressive Palley criticises the programme for political economy reasons, as it could lead to the undermining of public sector workers and public sector pay as governments substitute ELR workers for public sector workers. This and other fears adduced by Palley as undermining minimum wages and government in general are likely to make this programme appealing to classical liberals!

The second new aspect of MMT is its interest rate policy. It asserts that Wicksell’s natural rate of interest which 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 overnight rate at zero and keep it there”. (Wray,  “A Post Keynesian view of central bank independence, policy targets and the rules versus discretion debate”, Journal of Post Keynesian Economics, 2007,.138). This, of course, implies (as MMT recognises,)  the well-known condition for preventing deficit financing to lead to an explosively rising public debt ratio, namely that the interest rate on the debt (r) should be less than the growth rate of the economy (g ) will always be met, and also entail the progressive Keynesian outcome of the  “euthanasia of the rentier”. (Wray 2015, p.64).

Putting the interest rate at zero puts fiscal policy as the sole stabilisation tool, which as Milton Friedman showed, given the lags involved, discretionary fiscal policy is an inferior instrument compared to counter cyclical interest rate policy to stabilise the economy. More seriously, with inflation at high or full employment “setting the short term nominal policy rate at zero becomes a recipe for encouraging financial speculation and asset price inflation driven by debt , which ends in financial crisis”  (Palley: “MMT: the emperor has no clothes”, Feb,2014). 

My conclusions can be brief. MMT is mostly the old Keynesianism and apart from the JG/ELR programme much of what is new is unconvincing, and a dangerous template for public policy.