Unmasking Modern Monetary Theory

Government loosed from financial constraints, full employment to the last man and woman willing to work, and all with no inflation to speak of. Welcome to the alluring world of Modern Monetary Theory (MMT). My purpose is to deconstruct and demystify MMT; to explain where it fits in macroeconomic theory; to assess its strengths and weaknesses; and to bring out the threat it poses to economic and political freedom. I can’t get close to being exhaustive. However, I believe I can provide a more complete and comprehensible account of MMT than generally appears in the popular press.

In brief, MMT is an economic theory which postulates that permanent full employment can be achieved through the application of (whatever-it-takes) expansionary fiscal policy, allied with accommodative monetary policy. Vitally, a third component of MMT is an employment buffer scheme to prevent inflation from getting out of hand. People are taken onto the public payroll during economic downturns and released into the private-sector during upturns. Finally, MMT requires that debt issued to support public spending is denominated in domestic currency; which, of course, governments can create at will, removing any risk of default.

Professor Stephanie Kelton of Stony Brook University in New York is one of the leading proponents of MMT. She provides a description of MMT in a short video on CNBC (March 4, 2019). It’s a little learning which would leave most watchers still in the dark. I mention it only because of a telling comment in the broadcast. She rejects the idea that MMT uses taxation to fight inflation but adds that people say this all the time. She is right that people mischaracterise MMT in this way. I have read numbers of commentaries which do that. For example, Hettie O’Brien, the New Statesman’s online editor, did it in a piece on February 20 (“The surprise cult of Modern Monetary Theory”) and she quotes Professor Jonathan Portes of King’s College London doing the same thing. The question is why people get something so fundamental so wrong.

This essay appears in the latest Quadrant.
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One of the reasons is that economic theories hatched within academia are not always clear to those outside of the inner circle. For the most part this doesn’t matter. In this case it does. MMT has escaped from academia. Professor Kelton advised the Bernie Sanders campaign in 2016. The precocious new de-facto leader of far-Left Democrats, Alexandria Ocasio-Cortez, of Green New Deal notoriety, is apparently a fan of MMT; though how much of it she understands is an open question. Jeremy Corbyn and his shadow chancellor flirted with MMT before reverting to more orthodox Keynesianism. At one point, echoing MMT, he favoured the Bank of England printing money to fund national infrastructure and public housing.

It is important to understand the allure of MMT to those with a socialist bent. As I will explain, it might become increasingly alluring to those on the political Left in failing economies locked inside the eurozone. It is a Trojan horse in waiting. At the same time, it is somewhat comforting that a socialist like Corbyn found it too hard to swallow; at least for now.

For the most part I am guided in my absorption of MMT by three of its leading proponents; one of whom, Professor Bill Mitchell of the University of Newcastle (Australia), is credited with having invented the term MMT. The others are Kelton and Professor Randall Wray of the University of Missouri–Kansas City. My main references are Mitchell (Full Employment Abandoned, 2008); Wray (Modern Monetary Theory, 2012); and Kelton (“The Failure of Austerity: Rethinking Fiscal Policy,” in Rethinking Capitalism, 2016).

So far as I can tell, those wedded to MMT are a ginger group of Keynesians, or of post-Keynesians as they are equivalently called these days. They accept the principal Keynesian doctrine that aggregate demand drives the economy but do not accept the same limitations on government action as do orthodox Keynesians. An internecine struggle is afoot.

I will start with a very brief account of the claimed provenance of MMT before setting out its main elements. I will then impart context by comparing MMT with orthodox Keynesianism and also with free-market macroeconomics. Finally, I will look more closely at the import and practicality of MMT.

MMT is of very recent origin. It is a twenty-first-century theory; at least it is under the heading of MMT. Gravitas is added to a new theory if its origins can be traced to earlier times. The deeper its roots, the less likely it can be construed as faddish. According to its proponents, elements of MMT can be found in the work of economists of the past. Three are prominent.

The longest intelligible lineage of MMT goes back to “Chartalism”, developed by a German economist, Georg Friedrich Knapp, at the beginning of the twentieth century. Chartalism argues that money is primarily a creature of government and finds its value in exchange and as a store of value because government will accept it in discharge of debts it is owed.

Later in the century, Abba Lerner, a better-known economist in the then newly-minted Keynesian mould of the early 1940s, developed a theory of “functional finance”. Its central idea is that spending, taxing, borrowing and money issuance on the part of government should be “taken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound”.

Finally, Hyman Minsky, another well-known Keynesian economist, writing from the 1960s to the mid-1990s (he died in 1996), is brought into the frame by Wray in a working paper published by the Levy Institute in January 2018. It is not at all clear to me from Wray’s account that Minsky, if he had lived on, would have supported much of MMT. However, he did refer to circumstances in which there may be “a need to supplement private incomes with socially provided incomes, so that civility and civic responsibility are promoted”. Consistent with this, Wray argues that Minsky supported government having an “employer of last resort” role to reduce unemployment. As I will explain, this idea is an integral part of MMT, as also are the ideas stemming from Chartalism and functional finance.

Some orthodox Keynesians suggest that MMT is either saying things that are wrong or saying well-known things as though they are new. American economist Thomas Palley (“Critics of MMT are right”, Review of Political Economy, 2015) is a leading example. Leaving for now the assertion that MMT is saying things which are wrong, I don’t wholly agree that it is saying things which are all well known. Yes, there is nothing which doesn’t fall out of or can’t be derived from conventional economics. Nevertheless, some things are put in a way that has instructive novelty. This is certainly the case when it comes to taxation.

MMT has a number of interrelated elements. A good place to start is with taxation; specifically, with the proposition that government expenditure provides the wherewithal to pay taxes. Commonly this is put the other way around; that government taxes in order to fund its expenditure. But, MMT has a point and one that I admit to not having until now appreciated.

With the demise of gold as a medium of exchange, companies and individuals need access to “base money” in order to pay their taxes. Government will accept no other. This money comprises cash (notes and coin) and deposits held by banks with the central bank. Companies and individuals don’t usually turn up at the taxation office with bags of cash. They write a cheque on their bank account or use some electronic system to bring about the same transaction. Their bank account is debited. However, the actual payment to the taxation office is made by their bank in drawing down the deposits it has with the central bank, while the central bank correspondingly credits the taxation office’s account.

Now, to complete the circle, base money is only created when government spends more than it collects in taxes or when the central bank purchases securities from the private sector. Central banks do not normally take private-sector risk onto their books. Therefore, except in abnormal circumstances, central banks purchase only government securities. Such securities would not be held by the private sector and be available for purchase unless government had previously spent more than it had collected in taxes, and borrowed the shortfall. Thus, MMT is right, government must spend before it can tax. And, to my mind, this is a novel and instructive way of looking at things. The next MMT proposition, again featuring deficit spending, also has novelty but is not quite so instructive.

The proposition is that deficit spending is required to underpin increases in private-sector net saving. In the assumed absence of cross-border capital flows, this proposition is axiomatically true and, again, is a way of putting things which I had not previously come across. To make the proposition clear, my savings held in, say, a bank are matched by the obligation of the bank. Savings in the private sector, taken in isolation, are therefore exactly offset by corresponding debts. There is no net saving. On the other hand, deficit spending results in the issuance of government securities. My savings held in such securities are not matched by an offsetting obligation on the part of another entity in the private sector. QED, government dissaving (deficit spending) is a necessary concomitant of increases in net private sector savings. What import does this have? There’s the rub—not much. True, net private sector savings will remain stuck without deficit spending but the absolute size of savings and economic growth won’t; and that, in the end result, is what counts.

My reason for bothering with a proposition which, though true, lacks import is that it forms a part of a tangled web of specious Keynesian reasoning in the innards of MMT. Let us suppose that the amount the private sector desires to net save is greater than the amount of deficit spending. In other words, the gap between the desire to save within the private sector and the lesser desire to borrow and invest is greater than the size of the deficit. What gives? What gives, according Keynesianism (and MMT), is the level of production. A lower level of production means a lower level of income which, in turn, will bring desired net private savings down to the level of whatever is the prevailing deficit. The equilibrating variable is production and, by extension, employment.

Put another way, a desire to save more is equivalent to a desire to spend less. In this Keynesian (and MMT) worldview, the economy is driven by spending—by so-termed aggregate demand. If the private sector’s demand falls and is not offset by increased government demand, lower production and unemployment will result. The answer, of course, is for the government to increase its demand by upping deficit spending. At this juncture there is little or no difference between MMT and orthodox Keynesianism. As we shall see, they soon part company.

Both MMT and orthodox Keynesianism have full employment as their primary goal. In achieving this goal is there any limit to deficit spending? There is for Keynesians. But for proponents of MMT government deficits and debt are of no concern. Kelton points to Japan where government debt is well over 200 per cent of GDP and yet life goes on. Debt, she points out, is a reflection of the private sector wishing to save and the government obliging this wish by taking up the slack in its deficit spending and by, correspondingly, issuing securities which the private sector holds as assets. Much is made of government debt having its counterpart in private-sector asset holdings.

Will future generations suffer? No, Kelton explains, because they will inherit the assets to match government debt. Will the government ever default? No, not if the debt is denominated in yen in the case of Japan, Australian dollars in the case of Australia, British pounds in the case of the UK, and American dollars in the case of the USA. The governments concerned have inexhaustible access to their “printing presses”. And all this is true, by the way, so far as it goes. Complexity is added by bringing in the foreign sector. Let us suppose that boosting demand through deficit financing causes imports to outstrip exports, as well it might. Proponents of MMT remain sanguine. They are not overly concerned about trade deficits.

Imports exceeding exports, they point out, means that the population concerned is enjoying the use of more goods and services than it is producing. Suppose a chronic trade deficit results in a falling exchange rate, which, in turn, increases the price of imports, and inflation more generally by engendering a wage-price spiral. Again, MMT encompasses a unique way of dealing with this, which I will come to. It goes to the heart of MMT’s policy prescription. A brief segue into instruments and targets adds context.

Instruments and targets are part and parcel of any macroeconomic theory. You need at least as many instruments as you have targets. The main targets are full employment, low inflation and external balance. The main instruments are monetary policy, which conventionally nowadays is mainly directed to controlling inflation; the floating exchange rate to achieve external balance; and, in keeping with the still prevailing dominance of Keynesianism, fiscal policy to moderate unemployment. MMT does not adopt the conventional model. It is time to put its elements together, including its crowning element: a scheme to ensure that jobs are always available for those who want to work.

A first point to emphasise is that MMT requires that government predominantly borrows in the currency it issues. This means that it can never default, however much it builds up deficits and debt. Note that Greece, Italy, Spain and Ireland, to name four heavily indebted countries in the eurozone, don’t fit the bill. They do not have licence to “print” their own money and could not embrace MMT. Socialists in those countries, enamoured with MMT, as well might they become, would first need to engineer an exit from the eurozone or, as Joseph Stiglitz among others suggests (Guardian, June 18, 2018), issue their own competing currencies. This would be against the rules; but it bears watching among struggling eurozone countries forced into implementing austerity measures to reduce their budget deficits and debt.

MMT has a completely relaxed view about the size of government spending, deficits and debt. To hark back to Abba Lerner, the primary goal is full employment—where full employment means precisely that and not some feckless halfway house. Balancing the budget is of no moment. When countries are in charge of creating their own base money, apropos Chartalism, they are not subject, it is claimed, to the financial constraints of households and businesses. Debt clocks and austerity are passé to proponents of MMT.

Deficit spending is geared towards achieving full employment. Monetary policy is similarly targeted. The official interest rate is set and kept low by the central bank to encourage private investment. External balance is achieved by a floating exchange rate. That leaves inflation. Kelton is right, MMT does not allocate the instrument of taxation to control inflation. That is not to say that it is ruled out in all circumstances but it is not part of the main game.

Inflation can be a problem if demand is stimulated too much by deficit spending. One transmission mechanism, as I have noted above, is through a falling exchange rate and rising import prices. More generally, the interplay between demand and inflation can be portrayed graphically by the Phillips Curve. The Phillips Curve is named after New Zealander William Phillips who in 1958 set out the results of an empirical study of unemployment and wage rates. When demand outstrips supply, unemployment falls and wages are bid up. Wage increases flow into prices, which can lead to further wage claims and so on. Rising import prices add to the brew.

Proponents of MMT do not deny the possibility of so-called “demand-pull” inflation. Though they rather point to “cost-push” inflation, caused, for instance, by rising oil prices, as being more likely to cause serious inflation. Nevertheless, when you have nothing less than complete full employment in your sights, too much money chasing too few goods, as the old definition of inflation goes, could become quite a problem. How to solve it?

The answer among proponents of MMT is for the government to run an employer of last resort program; which, recall, according to Wray, Minsky anticipated. The program is also more universally termed the jobs guarantee (JG). I will use the latter term. Mitchell (as following Mitchell does Wray) likens the JG to the operations of the defunct Australian Wool Reserve Price Scheme, which attempted to stabilise prices by having the Australian Wool Corporation buy (or sell) wool when prices fell below or (rose above) a support level. As I will explain, this gives a sense of the principle involved but not the sheer scope.

According to Wray, “A government which issues its own currency can always afford to hire unemployed labour.” This is an apt mission statement for the JG. The JG is a universal jobs program funded by the government. It guarantees a job at a “uniform basic wage” for all who are willing to work. The assumption is that this wage will be eminently livable but will, on average, fall a little below wage levels normally available in the open market.

The JG is meant to work as an automatic economic stabiliser. If the economy falls into recession the unemployed will be given work in the program. No more unemployment queues or spiralling downturns. In expansionary periods, workers will move out of the program into the open market and thereby moderate inflation. If inflation starts to take off, wages will rise in the open market and thereby attract workers from the program. The additional supply of workers will tend to dampen wage rises and inflation. Instructively, in dampening wage rises, the JG bears comparison in its desired effect with Marx’s reserve army of the unemployed (brought about, in that case, primarily by capitalism’s progressive replacement of men with machines). Both keep wages from soaring.

Note the beauty of the program. It ensures full employment with the use of limitless supplies of government money while, at the same time, keeping inflation in check. Note also that “pump priming”, government stimulus spending to counter recessions, which is the main orthodox Keynesian policy response, is rendered not nearly so central in the scheme of things.

The bare bones of the JG, sketched above, hardly do justice to its scope. Official estimates put the number of underemployed (those unemployed plus those working fewer hours than they would like) at 11.6 million in the US in August 2018. The comparable figure in Australia in September 2018 was 1.1 million. These figures do not include those who have given up looking for work nor are they reflective of the numbers out of work during recessionary times. The JG would be a massive program. It would have the direct employment effect of needing an army of bureaucrats just to run it.

Certainly, proponents of MMT recognise the challenge. “Some critics have argued that the program could become so large that it would be unmanageable,” Wray says. However, he counters by arguing that the program can be decentralised—“to local government, local not-for-profit community service organisations, parks and recreation agencies, school districts and worker cooperatives”. I will come back to the manageability of the JG after I add more context by briefly pinpointing the differences between MMT, orthodox Keynesianism and free-market economics

Orthodox Keynesianism places demand at the centre of economic affairs, as does MMT. The essential difference in my view is that Keynesians do not have the same cavalier approach to deficits, debt and money creation as do proponents of MMT, and accept the inevitability of some residual permanent unemployment. Free-market economists are not in the same ballpark. They approach economic affairs from the supply side, not the demand side. An illustration will best draw out the differences.

Assume an advanced economy falls into a recession. The goal is to help the economy recover and to mitigate the depth of future recessions.

Keynesians respond to a recession by government spending. They tend not to be too fussy about where the money is spent. Nobel Prize-winner and Keynesian economist Paul Krugman, interviewed on the US radio station NPR in late 2010, when the so-called GFC or Great Recession was still wreaking havoc, said the US government should implement another stimulus of at least the size of the previous one (US$787 billion). When asked what it should be spent on, he replied typically that it didn’t matter, provided it is spent. The objective, you see, is to boost aggregate demand. One dollar spent, whether here or there, equivalently boosts aggregate demand.

Keynes was worried about investment and consumption expenditure becoming chronically insufficient to underpin full employment. Hence, in the longer run, Keynesians give government a much larger and more intrusive role in the economy than do free marketeers. However, unlike proponents of MMT, they need to take account of the trade-off between reducing unemployment and wage and price inflation as portrayed by the Phillips Curve. Accordingly, they support public infrastructure spending, skills training and public education to reduce bottlenecks and thus push down the rate of unemployment beyond which wages and prices will begin to accelerate. This gives more leeway to boost demand.

Free marketeers are more relaxed than Keynesians; though they are not at all averse to sensible public investments in infrastructure, in skills training and in education. They believe that complex industrial economies periodically fall into recessions either as a result of shocks or as a matter of course and will right themselves; and more quickly if government regulations don’t get in the way. They believe also that a system of fewer regulatory obstacles works in the long run too to support competition and new business development. I should mention that both Keynesians and most free marketeers (Austrians not so much) advocate easing monetary policy to counter recessions. As I have said, MMT has interest rates parked at a very low level throughout the cycle.

For free marketeers, and I fit into that broad category, the idea that stimulus spending by government will cure recessions is plain silly. That I once bought this nonsense decades ago is a matter of shame. I blame it on my university teachers (why not?) and my own gullibility. Apart from the sheer waste usually involved in these hastily-drawn-up expenditure programs, they interfere with price and wage adjustments. As Steven Kates expertly explained in the March issue of Quadrant, recessions are the result of a mismatch between goods produced and those demanded. The market will adjust and sort that out. Spraying large dollops of government expenditure here and there will hinder, not help.

As to MMT, it has quite a different take on recessions than does either Keynesianism or free-market economics. Once its elements are in place, MMT automatically handles recessions. When you have unleashed unlimited spending power and money creation and have the JG, it is hard to imagine that things can go too wrong. Or can they? I will finish up by suggesting where they might go wrong.

A first point to make is that while government debt is mirrored to a varying extent by government securities held by a section of the population of the country concerned, they are generally not held by those of modest means. So, I don’t believe we should be as relaxed as Skelton seems to be about the regressive distributional effects of interest payments faced by future generations. Furthermore, pushing an economy to the point of full employment through government action, inevitably results in imports outstripping exports. Foreigners are called upon to fill the gap as creditors. In part, they will hold debt issued by the government concerned. About 30 per cent of US federal government debt is held by non-residents. The comparable figure for Australia is 56 per cent (as reported for the December quarter 2018 in the last budget papers). How do interest payments on this debt not impose a burden on future generations? Clearly, they do.

Second, MMT correctly asserts that default is never forced on a country issuing debt in its own currency. However, at some point it is likely that a surfeit of debt will be issued. Higher interest rates will be demanded on further debt issuance. In those circumstances, the central bank could forestall higher rates only by buying securities; in modern parlance by quantitative easing. It is hard to imagine that this would not eventually produce ungovernable inflation when it is married with a policy of guaranteeing full employment. The assumed saviour of course is the JG, which aims to produce full employment without necessarily requiring the government to engage in too much inflationary spending, borrowing and money creation.

Without the JG, MMT eventually collapses into just a novel and instructive way of putting things, with dire consequences for inflation if put into practice. Without the JG, it is also hard to make the case that it is other than an ill-disciplined take on orthodox Keynesianism. But with the JG, it is lots more than Keynesianism. In fact, it contemplates a significant takeover of economic activity by government; that is, if it were to ever work as planned, which is not even remotely likely.

Take Australia. Based on the current level of underemployment plus those who would be drawn into the labour force, upwards of 1.5 million people with varying skills would need to be employed by the government on a large number of projects nationwide. All would be employed on the same wage, by any number of different bodies, doing a wide variety of work, needing a wide variety of skills; all paid by and under the ultimate management of the federal government. What could possibly go wrong? Almost everything.

Fraud, rorting, waste, agitations for better wages and conditions for those engaged in JG projects, to name a few. But consider the difficulty of paying an across-the-board uniform basic wage, which must hover below wages paid in the open economy yet above whatever is the social welfare payment for those remaining out of the workforce. Furthermore, when the open economy suffers a downturn a whole range of people of different skills would be thrown out of work. Projects would need to be found which matched those skills and in the very places where the unemployed lived and had their children in schools. It would be unimaginably complex. Colloquially speaking, the idea is a crock; a Left-centric academic wet dream.

But back, so to speak, to the less than rational world in which we live. Socialism is a bad idea; an empirically-demonstrated ruinous idea. Yet it lives on in sections of academia and among the young. Gallup in the US recently found that 51 per cent of those aged from eighteen to twenty-nine favoured socialism. According to a YouGov survey, an estimated 63 per cent of those in the same age group voted for Corbyn-led Labour in the UK’s 2017 general election.

Equally, MMT has a growing following. It also promises to relieve earthly suffering. Under the managing hand of government, it promises permanent full employment without inflation; and a living wage for those with least skills. Debilitating economic cycles of any materiality are gone, as are the curses of entrenched long-term unemployment and youth unemployment. I happen to think that this promised outcome, however unrealistic, will find appeal among the leftist political class who, if they can’t quite sell socialism, might see MMT as the next best alternative. It might be mistaken to overestimate the discernment and intelligence of the political class as a whole, never mind those of utopian mindset.

Peter Smith is a frequent contributor on economics and wider topics. He wrote on “Christianity and the Economic Order” in the January-February issue