Does MMT — really — ignore expectations?

13 Apr, 2019 at 12:08 | Posted in Economics | 23 Comments

In his latest diatribe against MMT, Thomas Palley argues that there is an “inflationary bias” in MMT, that its framework “is static and has little to say about how policy affects expectations of the future,” “is silent on asset price formation,” and “ignores expectations and treats private markets​ as irrelevant.”

Hmmm …

Yours truly has to confess it is extremely difficult to recognize that description. Given its roots in the writings of Keynes, Lerner, and Minsky, it is, to say the least, rather amazing to attribute those views to MMT. Let me just quote one source to show how ill-founded Palley’s critique is on this issue:

macWhile the IS-LM approach of John Hicks tried to represent what he saw as the key elements of Keynes’ General Theory, it is clear he left out issues relating to uncertainty​ and probability that Keynes saw as being crucial in the way that long-term expectations were formed … The decision to invest is dependent on the ‘state of long-term expectation,’ which is ignored in the static IS-LM approach … Investment, among other key economic decisions, is a forward-looking process … The failure to include the crucial role of expectations and historical time means that the IS-LM framework is reduced to presenting a general equilibrium static solution that has little place in a dynamic system where uncertainty is a key driver in economic decision making.


  1. Having supported MMT for about ten years and having read about a thousand articles by MMTers, my impression is that MMT does actually ignore expectations. But so what?

    It’s near impossible to prove with any certainty what the effect of expectations is on next year’s level of inflation, thus if MMT adopts a rough and ready attitude along the lines of “Inflation is too high so let’s cut demand by an amount which past experience tells us is likely to cut inflation to an acceptable level within say two years” then I don’t see much wrong with that.

  2. Dear Lars,

    (1) Quoting MMT scripture to defend MMT scripture is a very poor defense.

    (2) MMT lacks behavioral content (including expectations) and dynamics. It’s long past time for MMT to respond to specific criticisms such as those laid out in my paper “What’s Wrong with MMT”. Regurgitating MMT’s story is not an adequate response.

    (3) Minsky emphasized behavior and MMT-ers talk a lot about Minsky. But the relationship between MMT and Minsky’s theory of financial market behavior is orthogonal. For instance, massive increases in the money supply have Minskyian implications, yet those implications are completely absent in MMT.

    (4) In my view, the ISLM model is poorly understood by Post Keynesians (and especially by MMT-ers). However, engaging in a debate about ISLM is a red herring for the current conversation which is about MMT.


    Tom Palley.

    • I am not taking sides in this big MMT versus everybody else fight, but I could not help but stumble at Thomas Palley’s first point of his comment (second from the top of this comment thread):

      (1) Quoting MMT scripture to defend MMT scripture is a very poor defense.

      I got stuck there and literally could not advance a single inch further.

      How is one supposed to defend a written body of theory if one is not allowed to quote from the written body of theory?

      I’ll repeat to make my stance clear: I take no sides in this debate. Still, I can’t help but quote Thomas Palley — begging his forgiveness — and say I find his logic puzzling. Or maybe I don’t need to quote Palley to say I find that peculiar?

      • Good point Magpie. What I should have written is:
        “The quote from Mitchell et al. is a total red herring. ISLM was weak on expectations which were treated either exogenously or mechanistically derived from past experience. MMT is even weaker. Furthermore, the weakness of ISLM is no defense for MMT’s failures on these issues.”

        • Thanks for the clarification Thomas Palley.

          But I wonder — then — how should MMT treat expectations? Should they — unlike in IS-LM — be treated endogenously?

          If so, (1) what happens to Keynes’ animal spirits?

          I am lucky that I wasn’t clear about how to treat something like expectations systematically without treating them <mechanistically, for now I can learn from you. (2) How do you treat them in your models?

  3. Dear Tom (if I may). Unfortunately, I am not at all convinced with you arguments which sound like “new classical” (e.g., behavioural – a code word for microfoundation, expectations a la Lucas critique). Of course in the current political environment, especially Kelton’s association with Sanders, MMT is presented in simplistic terms. Yours honing on that aspect, is equally simplistic. Your use of Lucas critique to discard MMT is a pity. Accepting Lucas critique basically takes one to a “no policy zone” where so-called market forces rule. Your argument of financial market’s reaction to deficit is really sad. Why should a democratic government be hostage to financial market’s whimps?

    While there is some truth in your political economy argument (e.g., difficulties in reversing tax and expenditure decisions), you veer towards a neo-classical position a la Bhagwati, Krueger and Dornbusch (macroeconomic populism, rent-seeking, etc.) and seem to favour institutional fetters such as an independent central bank or independent fiscal board. To claim that the MMT discards interest rate as an instrument of monetary policy just because they want it set at zero is wrong. It is indeed an instrument which MMT wants set at zero for particular policy goal/target in a particular circumstance.

    To say that in reality central banks are independent of fiscal authority is also wrong. Every decision by the fiscal authority affects central bank’s balance sheet and in Australia, for example, every day at around 10 am the RBA discusses with the Treasury to coordinate its monetary policy settings. Central Bank independence is a theoretical fantasy.

    MMT does not advocate deliberately creating inflation. All it asks is not to freak-out at any sign of inflation; worse not to act for fear of inflation. The fear of hyper-inflation due to money-financed deficit does not have any empirical basis. ALL hyper-inflation episodes in history can be traced to some break-down of the system, like war, revolution etc. Even the work by conventional economists, e.g. Fischer, Dornbusch, Easterly and Bruno could not find any strong links between money-financed deficits and hyper-inflation. The threshold beyond which inflation may accelerate is quite high – in excess of 40%. While Bruno and Easterly were working at the World Bank, they asked, “Does inflation harm growth?” They concluded, “The ratio of fervent beliefs to tangible evidence seems unusually high”.

    Yes, MMT is too US centric, but I see not much problems in applying it to other countries, including developing countries where balance of payments or foreign exchange could be a real constraint, highlighting the importance of export-orientation and capital control.

    • Dear Anis,

      Thanks for your interesting reply.

      (1) In my view the Lucas critique is very important & should be incorporated by PKs. Just because it was introduced by a New Classical economist does not automatically make it a bad idea.

      (2) I believe MMT’s recommendation to park the nominal interest rate is a fundamentally bad idea. It throws away a powerful policy instrument & is also destabilizing.

      (3) I have been a long-time advocate of higher inflation, & long before it became a popular idea. Check out my article “Zero is not the optimal rate of inflation,” Challenge, 1998.

      (4) My fundamental critique of MMT is its claim that sovereign government is financially unconstrained. Once that claim is walked back, MMT collapses into traditional Keynesianism. There is no there there!

      (5) The debate is not about money financed budget deficits. Keynesians have long recommended such policy in appropriate circumstances. The debate is are sovereign governments financially unconstrained?



      • Thanks Tom for responding to my comments. Yes, I am aware of your arguments for higher inflation; but we need to emphasie that this does not mean deliberate creation of higher inflation. It’s rather a matter of tolerance and understanding various sources of inflation before acting with money tightening at the first sight of inflation.
        I still don’t understand your point on interest rate – it’s no doubt a powerful instrument; but does that mean it can’t be set at zero if needed?
        As I mentioned, the problem with the Lucas critique is its implications, i.e., macro policies are irrelevant and fundamentally destabilising as rational agents neutralises them. If this is correct, what role does a govt. play other than having the right institutions, including ensuring property rights and law & order? Yes, rational expectations per se is not the problem. The Lucas result is not due to rational expectations as such, but due to the joint hypothesis (assumption) of market-clearing. Thus, New Keynesians incorporated rational expectations with rigidities in the system. As you will agree, Keynes’ own view about expectations is much more rich and superior.
        Why should a sovereign govt. with the authority of creating fiat money have financial constraint? The real constraints are real resources and balance of payments as unused domestic resources cannot be readily converted into needed foreign currencies. This point does not come out very forcefully in MMT arguments as the current debate is centred around the US which has an additional advantage of being an issuer of reserve currency.
        Finally, whether MMT collapses to old fashioned Keynesian economics is a moot question, not the strongest of your arguments. The MMTiers at least forced a rethink.
        Warmest regards

        • “The real constraints are real resources and balance of payments as unused domestic resources cannot be readily converted into needed foreign currencies.”
          You ignore the reality of the huge currency swap market, which eclipses world GDP.

          • Yes, there is a huge currency swap market; but limited to only a few countries. Size does not imply an equitable access. Most developing countries do not have significant orderly swap arrangements that can withstand a major financial crisis or large sudden capital flights.

            • Solution: expand the unlimited central bank currency swap network. It was expanded and used in the aftermath of 2008’s financial crisis to help emerging markets. Make that help line permanent …

      • “Once that claim is walked back” still not clear where you have done that

    • Dear Arnis, you wrote, “Yes, MMT is too US centric, but I see not much problems in applying it to other countries, including developing countries where balance of payments or foreign exchange could be a real constraint, highlighting the importance of export-orientation and capital control.”

      How is MMT “too US-centric” when Australian Bill Mitchell deals with both Australian and international issues, citing specifics, almost daily at billy blog and has done so for years. He has also published widely on MMT wrt international issues and is the co-author of several books on the EZ.

      Bill has also written considerably on the difference between the US as a currency sovereign and less well-developed smaller nations that are also currency sovereigns and what this implies for their available policy space. He has dealt both generally and specifically with the issues cited. Bill Mitchell also serves as an advisor and consultant to governments internationally.

      MMT is “US-centric” only in the sense that most of the MMT economists are American and the focus is on the US economy, since it is the most influential globally.

      Warren Mosler and Stephanie Kelton tend to be the public face of MMT recently and both of them are politically active in the US, so naturally their emphasis is US-centric and simplified for public consumption and apapted to specific policy. However, both have published scholarly works that address these issues in depth.

      Regarding “expectations,” this is mostly considered “relevant” and even “determinative” owing to the incorrect notion that “bond vigilantes” control interest rate setting rather than the policy rate being set by the central bank and the slope of the yield curve reflecting market assessment of future central bank policy. MMT economists have refuted that view through thorough institutional analysis. Failure to do careful institutional analysis is at the bottom of many misunderstandings in economics and finance, and one can read about these mistakes everyday in the economic and financial “news,” analysis and opinion.

      Mike Norman has built a business on trading against these errors based on MMT analysis in his MMT Trader, which I follow and which is base on taking money from those who base their trading views on false expectations resulting from wrong ideas about economics and finance. Generally, the MMT economists also have an enviable track record on forecasting in comparison with conventional economists and financial professionals. Goldman’s Jan Hazius and Pimco’s Paul McCulley are in general agreement with this view of MMT and they use the type of analysis that MMT does.

      Tom Palley claims that MMT holds that a currency sovereign is not financially constrained. This is contradicted by popular pieces such as op-eds in which MMT economists have asserted that the constraint on spending is real (availability of real resources) and as a result of scarce resources, inflation is a financial constraint that must be taken into consideration. Randy Wray has stated that the financial constraints are inflation and the exchange rate.

      There is a large stock of academic literature produced by MMT economists beginning in the 90s, and a slew of popular articles, blogs, interviews, etc., Saying that MMT has not dealt with x implies familiarity with this output. Generally, such assertions are easily refuted by reference to the literature.

      This is not to say that I am an MMT fan boy. I have criticized the MMT presentation as generally lacking in specific treatment of economic rent, rent-seeking, and rent extraction. I have also criticized MMT for not specifically addressing the role of power, which is, of course, the sine qua non of rent extraction. To the degree these issues are addressed, it is obliquely. (I assume that this is a strategic choice for political reasons. MMT is rocking the boat enough as it is.) However, these issues are especially relevant to macroeconomics as a policy science used in policy formulation and they need to be addressed both by economists, finance professionals and also politically. There is no way to deal with rising inequality of income, wealth, and class power without doing so.


      • Dear Tom
        Many thanks for your response to my comments on Palley’s critique of MMT. I am aware of the work of fellow Australian Bill Mitchel and Randall Wray. In fact, I have cited their work in my papers and UN reports (I was a ghost writer of a number of them, including the Report on the World Social Situation 2010 – Rethinking Poverty, where you will find my citation of Mitchel and Wray).
        My saying of “US centric” relates only to current hypes unleashed by Stephanie Kelton in the polarised political atmosphere of the US. This you, too, agreed.
        I have no qualm with the rest of your comments.
        Warmest regards

        • Regarding the politicization of MMT in the US, one should recognized that the MMT economists have strategized about this behind the scenes and come to certain decisions that are reflected in their public statements about MMT and its potential application to policy. The conventional approach is not going to be replaced by heterodox criticism. It will only be replaced by something that promises better outcomes. The MMT economists know this. This requires educating a public that has been subjected to the conventional narrative for decades. These issues are complicated, as the debate among economists reveals. How best to simplify them in an orderly way to begin to change public perception away from “fiscal responsibility and discipline” to policy effectiveness. Those who have a good ideas and constructive criticism should offer these either backchannel to the MMT economists that are out front on this or in social media, where more or all still have a voice. I have net it be known that I think that the issues, especially climate change and the GND, cannot be addressed effectively without bringing discussion of economic rent and power to the fore. So far, just about no one is picking up on that, or else are letting be know that this is not expedient of feasible politically. That may be so. Perhaps the MMT economists are correct on the entry point of for connecting macro with policy and politics. This is not economics but involves political science, sociology, psychology and cognitive science, and above all persuasion and rhetoric. The MMT economists are aware of this and have acknowledged it publicly in work on framing, for instance.

  4. Some of the criticisms MMT made here by Palley people here have made before – eg. I have pointed for example that it ignores power relations. For example a small country in the international trading system that wishes to industrialise an has to import vital inputs has good reasons to prefer fixed exchange rates and exchange rate convertibility is important to such countries.

    But mainstream economists don’t talk about power either. They have repeated ad nauseam that “all countries need is there own currency” .And this is where I find Palley’s critique extremely unfortunate. Citing Lucas and Krugman is unhelpful. What MMT is really trying to do is liberate the discipline from its axiomatics of which crucial ontological and epistemological questions are never asked. What kind of evidence is there for the efficient market hypothesis? It is true that prices are highly flexible in capital markets, but for Keynesians the determinants of financial market behaviour is irrational, not rational, behaviour. Keynes says himself that an understanding of such behaviour requires an understanding of psychology. Not the kind of stuff Lucas has given us. Mainstream economists are also not necessarily pro-Austerity.They have this view that somehow once we are out of the ‘zero lower bound’ and interest rates and the economy return to ‘normal’ we can just return to business as usual – aka Neo-Keynesian theory and Taylor Rules without worrying about the real reasons deeply ingrained in capitalism that lie behind financial instability that we saw during the Asian Financial crisis and worldwide in 2008.

    Palley’s critique should have been balanced. He should have pointed out that MMT has been helpful in actually attempting to look at how monetary policy and financial markets actually work. ISLM does not give us anything useful to say about this and amounts to little more than geometric gimmick. It cannot possibly be a basis for the depth of knowledge we need to understand the problems in capitalism and how to deal with it. MMT is incomplete. But in so far as that is attempting to move away from axiomatic deductivism it is a making a helpful contribution.

    • “a small country in the international trading system that wishes to industrialise an has to import vital inputs has good reasons to prefer fixed exchange rates and exchange rate convertibility is important”
      Currency swaps can give you a fixed forward exchange rate, taking exchange rate risk out of the picture.

    • Sorry that should read New Keynesian, not neo-Keynesian.

  5. Modern Monetary Theory is indeed silent on asset price formation. MMT claims that the private sector balance sheet must net out to zero; only the sovereign can issue currency. In the real world, the eurodollar is issued by private banks who are, in Snider’s terms, “offshore from everywhere”.
    “Though we cannot observe the eurodollar directly, this credit-based, bank-centric system located out there in the shadows, it makes itself known in any number of different ways. We can observe those, leaving for us “only” the job of interpretation.”
    MMT in asserting that sovereigns are monopoly issuers of their own currency, ignores the dynamics of the most important world currency around, the US dollar.
    The question is not so much whether governments are financially unconstrained, the question is: why do governments constrain themselves on social spending while liberally printing money to bail out the private sector when it gets itself into a psychological panic after having liberated itself from financial constraints?
    If you look at world money volumes, GDP is maybe a tenth of the money out there. Banks create vast amounts of credit that circulates as money indefinitely, eventually turning into Fed dollars. The uncertainties are fully hedged by matched-book players. Sometimes the hedges fail due to emotion-driven panics; the Fed has proven it can step in and supply all the liquidity demanded. The real question is, why not use this same money creation technique to fund social programs such as a truly universal basic income?

  6. Palley insists “My fundamental critique of MMT is its claim that sovereign government is financially unconstrained. Once that claim is walked back…”

    Yet he never does actually “walk that claim back” successfully. All his other statements that build on that supposed “foundation” are unsupported. It seems to be, quite literally, in his head.

    Palley also writes ” It throws away a powerful policy instrument & is also destabilizing.” Yet there is no evidence – none whatsoever – that supports propping-up interest rates artificially (and easing that propping-up) is a useful policy tool. Pure neoclassical mythology.
    And destabilizing? Saved tax-credits (mostly by the wealthy) merit no “interest” any more than a saved commodity. Eliminating the current relentless creation of high-powered money (interest payments) paid to (often wealthy) savers would greatly increase stability: That elimination would increase equality and decrease inflationary pressures from long-term, relentless HPM money injection into the economy. Proper spending (creation) of government “money” (along with proper Bank regulation, as Mosler has outlined) would reduce private-debt significantly, also greatly increasing stability (indeed, would eliminate the possibility of Minskyian instability altogether).

    Palley imagines he has “walked back” aspects of MMT when he has in fact done nothing of the sort. All of his further opinions (err… “analysis”) thus have very little relation to reality. He persists in his own imaginary world for some reason though.

  7. Robert S Mitchell and his obsession with Eurodollars- Robert – you are STILL not getting your accounting of Eurodollars right.

    Robert does ask the right question here though: “why do governments constrain themselves on social spending while liberally..?”
    Why do they?

    • Comment on trader twitter:
      “No economist today has ever studied Eurodollars nor fully understand it. It’s more political than mathematical”
      MMT economists are just as clueless as all other economists about the true size and net financial asset value of Eurodollar creation. Finance relaxes the restraints assumed by all economists (MMT and otherwise). Eurodollars are created outside the control of the Fed. MMT and other economists do not admit this real-world fact.
      In other words, MMT is as orthodox as any traditional economist in ignoring the huge volumes of private credit creation that circulates as money, indefinitely.
      Tweet quoted (the thread it’s in is very interesting):

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