Readers of my last book will know that I agree with much of the analysis and many of the policy recommendations associated with Modern Monetary Theory (MMT). I do not, however, self-identify as an ‘MMTer’.
For one thing, I am not an economist – neither orthodox nor heterodox – and it is neither of use nor of interest for me to endorse any school of economics over others from my position of non-expertise.
For another, MMTers can be unattractively cultish. As Marc Lavoie writes: “the aggressive reaction of some non-academic supporters of neo-chartalism [i.e. MMT] whenever slightly different points from their cherished views are being made, push many post-Keynesian economists to become wary or even fearful of neo-chartalism” (8). Indeed. Many MMTers – not the big names but the general following on the blogosphere – take the attitude that anybody who claims anything outside of what is stated in the manifestos is ignorant of the basics and needs to be clobbered with a sackful of shibboleths.
On the other side, mainstream economists almost invariably misconstrue MMT. Paul Krugman and Thomas Palley, to take two fairly representative examples, push the common misconception that MMT amounts largely to the claim that governments don’t need to borrow or tax because ‘they can just print the money’. If you think that that is what MMT is claiming then you don’t understand MMT. It is, however, what almost all mainstream economists to whom I have spoken think MMT amounts to. They have no interest in having this or any other of their misconceptions corrected. Thus to identify myself as an MMTer to mainstream economists would only make me a victim of their mischaracterisation.
(I don’t mean, by the way, to put Palley and Krugman on the same level. Palley’s critique comes out of a detailed examined of the MMT literature. Krugman’s construal is based on what he calls “an MMT manifesto” that turns out to be written by a non-MMTer, one who has actually written a critique of MMT. Most people would issue an embarrassed apology for making such a mistake. But then there is Paul Krugman. Needless to say, I won’t bother disputing his ‘analysis’.)
Here is Palley promoting the central misconception about MMT:
The central macroeconomic policy claim of MMT is that sovereign fiat money changes the nature of the financial constraint on government. In particular, there is no need for government to raise taxes in advance of spending as spending can now be financed in advance of taxes by having the central bank “print” (i.e. create) money. (4)
He then points out that this claim is “widely understood and acknowledged” outside the MMT community (5) Well, yes. It is an obvious truism that governments that can print money don’t need to tax or borrow in order to spend. This doesn’t stop Palley from labouring the point by using an equation:
the government budget restraint given by
(1) G – T = θ + β
G = government spending, T = net tax revenues after transfers and interest payments, θ = amount of budget deficit financed by issuing high-powered (sovereign) money, and β = amount of budget deficit financed by selling government bonds.
Thanks. We get it. Unfortunately, that’s not the point at all.
Where did Palley get the idea that this thumping truism is “the central macroeconomic policy claim of MMT”? I suspect he was confused by the statement often made by MMT types that taxes and borrowing don’t fund (US) federal spending. Palley seems to construe this as: “taxes and borrowing don’t entirely fund federal spending, since the US federal government can also just print money”. But that isn’t the claim MMTers are making.
Palley has identified the wrong contrast to the explanatory statement made by MMTers. The statement that government spending isn’t financed by taxes and borrowing is not contrasted with the statement that government spending is financed some other way (viz., by printing money). It is contrasted with the statement that the converse is the case: government spending funds tax payments and purchases of government bonds. This is most easily expressed by first rearranging equation (1) from above:
(1a) G = T + θ + β.
Palley reads this equation ‘right-handed’ (as Joan Robinson would say), interpreting it to mean that the government’s spending (G) is financed by net tax revenue (T) plus the printing of currency (θ) plus the selling of government bonds (β). MMTers read it ‘left-handed’: the equation tells us that the government’s spending finances the non-government sector’s payment of tax (T), accumulation of currency (θ), and purchasing of bonds (β).
This is a conceptual shift of extreme importance. But it is not shown in the equation itself. It is a matter of how the equation is read: left-handed or right-handed. Thus by proffering the equation as evidence that the central MMT claim is “widely understood and acknowledged” Palley shows only his own failure to understand or acknowledge that claim. The point, for MMT, is not the inclusion of the term θ. It is the way in which the whole equation is interpreted.
Why is the shift so important? If the equation is true, what difference does reading it left-handed make? Doing so gives us a new view on the central aim of macroeconomic policy. Standard macroeconomics sees two roles for government spending. First, obviously, it pays for the goods and services supplied to the public sector. Secondly, it supports aggregate demand – if and when monetary policy is insufficient for this purpose. The MMT insight – that equation (1a) should be read left-handed – gives us a different perspective on the second purpose. The point is not simply to support aggregate demand. It is, far more specifically, to finance the non-government sector’s tax payments, its purchases of government bonds, and its accumulation of currency balances.
Thinking simply in terms of aggregate demand leads standard macroeconomists to be ignorant of their own assumptions. To take one example, Palley believes that MMT has in no way challenged the standard macroeconomic policy objective of satisfying the following condition:
(2) y = y* = AD(G, T),
where y = current output, y* = output at full employment, and output itself is held to be a function, AD, of government spending and tax revenue. Palley derives (2) from the simple textbook ‘Keynesian Cross’ model. Effective aggregate demand is just C + I + G + Nx, where C is consumption, I is investment, and Nx is net exports. The government chooses G, and it determines C, I, and Nx by adjusting T. This is most easily seen by considering the ‘sources/uses’ national accounting identity:
C + I + G + Nx ≡ C + S + T, where S is private saving. If the government increases T and does not increase G by a corresponding amount, it is assumed, then something on the left side of the identity must fall: C or I or Nx (or any combination of the three) . Likewise, if the government reduces T and does not reduce G by a corresponding amount, then C or I or Nx (or any combination) must increase. That is how we get to equation (2), which tells us that the government can only increase the level of aggregate demand by increasing G or reducing T or both.
Yet here we have simply taken S as given. This is a blind spot in the New Keynesian textbook picture Palley paints (note that I do not say that Palley is himself a textbook New Keynesian). Filling it in helps us to see the significance of the MMT insight.
Rearranging the ‘sources/uses’ identity, we get:
S ≡ I + G + Nx -T.
Substituting from (1a), we get:
S ≡ I + θ + β + Nx.
The crucial MMT insight is that the whole private sector, in any given period, desires to save a certain amount – call this S*. This saving can only be financed by private investment, net sales of exports, money-creation, and/or bond-financed deficit spending. S* is, if you like, simply the inverse side of the “propensity to consume” that determines C in the standard Keynesian cross model. Where S < S*, if there is no compensating adjustment in the sources of savings, then C can fall until the gap is closed. Where S > S*, C can rise until the gap is closed.
Now introduce Palley’s next New Keynesian claim, which is that at full employment:
(3) D = G – T(y* , t) = 0,
that is, the government’s deficit will be zero, since the tax rate, t, will be such as to make G equal to T. Palley claims that “once the economy reaches full employment output, taxes (T) must be raised to ensure a balanced budget” (8).
This is another way of saying that at full employment S will be equal to I + Nx. After all, we have seen that:
S ≡ I + G + Nx – T.
If G = T, then we will have:
S = I + Nx.
But what happens if, in this condition, S* ≠ S? Suppose that S* > S. Then C can fall. Look again at the uses/sources identity:
C + I + G + Nx ≡ C + S + T.
A fall in C will mean a fall in aggregate demand (C + I + G + Nx), unless I, Nx, or G increases. To suppose that I and/or Nx automatically adjust to compensate for a fall in consumption is to revert to a pre-Keynesian assumption of permanent equilibrium. To see any role for fiscal policy at all is to imagine that a fall in C can move the economy away from full employment and that the government should in that case run a deficit to restore full employment.
Once full employment is restored, however, the government should, on Palley’s recommendation, balance its budget. The problem is that this will again mean that S = I + Nx, and if S* > S at that level then there will again be a fall in C and a dropping away from full employment. There is, in other words, no stable equilibrium at the full employment level.
The same instability will be present if S* < I + Nx. Then a balanced government budget will provoke an increase in consumption, which will move the economy past the full employment point and into inflationary territory. The government can adjust by running a surplus. But then, again, if it balances its budget it will bring about a condition in which S* < S and the move into inflationary territory will be repeated. Again, there is no stable equilibrium.
The upshot is that where S* ≠ I + Nx, if investment and sales of exports do not automatically adjust to provide the desired level of private saving, then only bond finance or money creation can make up the difference. We have seen that:
S ≡ I + θ + β + Nx.
If S* > I + Nx, then θ and/or β must be positive for S to equal S*: the state must be issuing new bonds and/or new currency. On the other hand, if S* < I + Nx, then θ and/or β must be negative for S to equal S*: the state must be retiring bonds and/or taking currency out of circulation for S to equal S*.
Palley can only legitimately claim that there is a stable full employment equilibrium consistent with a balanced budget on the assumption that, at full employment, S* = I + Nx. This assumption seems unmotivated, and standard macroeconomists do nothing to motivate it. They do nothing to explain why the psychological features that Keynes identified as mismatching desired savings to private investment suddenly stop operating once full employment is reached.
Since John Hicks, the ambition of New Keynesianism has been to restore all the classical assumptions by adding to them the qualifier “at full employment”. The classical idea that investment always supplies the desired level of overall savings, while rejected as a general thesis, is gloriously restored at full employment. Proper Keynesians know, of course, that Keynes’ General Theory is general. All that what I have called the MMT insight shows is what every proper Keynesian knows to be true: that desired savings are a mysterious thing and that no automatic mechanism supplies them under any conditions.
Thus to this extent MMT is simply a reversion to traditional Cambridge Keynesianism. Lavoie, in the article I linked, points out that “Robinson could be considered as an honorific developer of modern monetary theory.” (14) Still, the reversion is useful. It pinpoints the precise point at which New Keynesians strayed from the path of righteousness. If I am attracted, as a non-economist, to any economic school at all, it is traditional Cambridge Keynesianism. But to MMTers I can say, with Bunyan:
Yea, may this Second Pilgrim yield that fruit,
As may with each good Pilgrim’s fancy suit;
And may it persuade some that go astray,
To turn their feet and heart to the right way.