MMT — Krugman still does not get it!

21 Feb, 2019 at 20:47 | Posted in Economics | 41 Comments

Krugman complains that Lerner was too “cavalier” in his discussion of monetary policy since he called for the interest rate to be set at the level that produces “the most desirable level of investment” without saying exactly what that rate should be.

It’s an odd critique, since Krugman himself subscribes to the idea that monetary policy should target an invisible “neutral rate,” a so-called r-star that exists when the economy is neither depressed nor overheating. For what it’s worth, research suggests the neutral rate “may be flat-out wrong,” and Fed Chairman Jerome Powell has admitted that the Fed has been too cavalier in relying “on variables that cannot be measured directly and which can only be estimated with great uncertainty.”

But Lerner wasn’t trying to use interest rates to optimize the economy. That was a job for fiscal policy. He argued that the government should be prepared to spend whatever is necessary to sustain full employment without raising taxes or borrowing …

Krugman’s other objection is that Lerner “didn’t fully address the limitations, both technical and political, on tax hikes/or spending cuts” as a means of fighting inflation.

In fact, Lerner actually had quite a lot to say about this. Here’s the opening sentence to an entire chapter on the subject in his 1951 book “The Economics of Employment”: “We have now concluded our treatment of the economics of employment, but a word or two must be added on the politics and the administration of employment policies in general and of Functional Finance in particular” (emphasis in original) …

Where does that leave us? Paul Krugman and I agree on a great many things, but we come at certain questions from a fundamentally different place.

He believes there are inherent tradeoffs between fiscal and monetary policy. Outside of the so-called liquidity trap, Krugman adopts the standard line that budget deficits crowd out private investment because deficits compete with private borrowing for a limited supply of savings.

The MMT framework rejects this, since government deficits are shown to be a source (not a use!) of private savings. Some careful studies show that crowding-out can occur, but that it tends to happen in countries where the government is not a currency issuer with its own central bank.

This seems like a disagreement we should be able to resolve either empirically or intuitively. But who knows? As Lerner wrote, “a man convinced against his will retains the same opinion still.”

Stephanie Kelton

Few issues in politics and economics are nowadays more discussed — and less understood — than public debt. Many raise their voices to urge for reducing the debt, but few explain why and in what way reducing the debt would be conducive to a better economy or a fairer society. And there are no limits to all the — especially macroeconomic — calamities and evils a large public debt is supposed to result in — unemployment, inflation, higher interest rates, lower productivity growth, increased burdens for subsequent generations, etc., etc.

But the truth is that public debt is normally nothing to fear, especially if it is financed within the country itself (but even foreign loans can be beneficent for the economy if invested in the right way). Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt. The debt is not a net burden for society as a whole since the debt cancel itself out between the two groups. If the state issues bonds at a low-interest rate, unemployment can be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden is also not a real burden since — if used in a suitable way — the debt, through its effects on investments and employment, actually makes future generations net winners. There can, of course, be unwanted negative distributional side effects for the future generation, but that is mostly a minor problem since when our children and grandchildren repay the national debt these payments will be made to our children and grandchildren.

To both Keynes and Lerner, it was evident that the state has the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that means that it has to take on debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.