Wren-Lewis vs MMT

12 Jun, 2019 at 09:43 | Posted in Economics | 6 Comments

Simon Wren-Lewis is obviously upset because some MMTers have called his economic policy proposals (providing the theoretical foundation for Labour’s Fiscal Credibility Rule) “neoliberal”. Neoliberal or not, what he does have to say about MMT and his own mainstream economics makes it clear what the debate really comes down to:

MMT’s key idea is that fiscal policy (changing taxes and government spending) is better suited to stabilise the macroeconomy than a central bank setting interest rates.

corbynAlmost without exception, advanced economies use interest rates set by an independent central bank to control output and inflation … A fundamental problem with today’s way of doing things occurred during the Global Financial Crisis. Interest rates fell to a level that became their lower bound … It is now received wisdom among academic economists that when interest rates hit their lower bound, fiscal policy needs to provide a large stimulus to the economy. Labour’s fiscal credibility rule is the first in the world to formalise this. If interest rates hit their lower bound, the normal rule is suspended and a fiscal stimulus occurs that is sufficient to end the recession. Labour’s rule is therefore designed to prevent austerity happening again.

MMT wants to go one step further. It wants to use fiscal policy to stabilise the economy at all times, and not just when monetary policy is out of action.

In Wren-Lewis world we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

What Wren-Lewis and other mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

For the benefit of Wren-Lewis and other latter-day​ ‘New Keynesian’ mainstream economists, let’s see what a real Keynesian economist has to say about crowding out and government deficits:

Fallacy 3
Government borrowing is supposed to “crowd out” private investment.

The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

It is true that MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfil our basic economic objectives — full employment and price stability.

That governments can spend whatever amount of money they want is a fact. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much of government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary.


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  1. It shows miserably how little has been learned from the financial crisis. For such economists, the era before the financial crisis was ‘normal’. But of course the problems that existed in capitalism were building up over decades before the event. Low and zero interest rates are merely yet another symptom. They are not something that can ever be used exclusively or even primarily to stabilise national economies. This is also related to the fundamental classical/neo-classical/neo-liberal view that fundamentally an economy is equilibrated through prices – in this case the price of credit.

    Macroeconomic policy is not something that can be left to unelected technocrats that look at a social system like an economy as if it was a problem solving exercise in David Romer’s textbook. It requires real multifaceted understanding and engagement. No, we cannot go back to Taylor Rules and estimates of ‘output gaps’ if we are going to face the very serious economic problems and associated political fallout we face today.

    • The zero inflation and zero interest rates can also be a symptom of money changing from bills to online credit cards. Money demand works differently when using credit cards.

  2. Output and employment are crass, materialistic, orthodox public policy goals. The rise in suicides and homelessness show that we microfoundations want more spirituality from life. Economics fails to deliver a good reason to live. We don’t see Wren-Lewis or Kelton as successful examples. We don’t want to live petty, shallow lives as they do. We must abandon economics as a guide for public policy.
    The supply curve for the best money in the world is vertical: see http://subbot.org/misc/econ/vertical_supply_curve.png
    The most important price, that of reserves, is arbitrary. There are no supply constraints, only arbitrary and fickle psychological constraints. Inflation came down in the 1980s because the oil embargo ended and Reagan ran high deficits signaling he was serious about winning the Cold War. Volcker’s interest rate meddling had little to do with inflation control.
    Inflation is a constraint that strikes fear into economists, but we know how to solve inflation: index incomes to price rises, and/or use inflation swaps. Economists such as MMTers and Wren-Lewis simply lack the imagination to understand how we can neutralize inflation without needing interest rates or taxes. Economists are holding back society with their orthodox, mindless focus on output and employment.

    • You might start with economic is not a moral crusade, it how we got here in the first place E.g. capital paying rhetorical sophists to tilt reality, then generational effects compounded it w/a side of geopolitics to boot.

    • It’s politics not economics that sets the agenda. The government earns it right to rule by fulfilling it’s duty to look after the well-being of every person in the nation.
      Understanding economics is crucial to getting it right. MMT scrapes the neoliberal crust off the economy.
      No household analogy. Money is Not scarce. The federal government is monetary sovereign it cannot go broke while resources are there. All. Currency is deficit spent into existence etc so there is no excuse to cut payments as the government can make to such entitlement that help the poor
      Is deficit spent inmyo

  3. The last four decades of economic history have shown that monetary policy is much less effective than fiscal policy for achieving true full employment with stable prices and sustainable resource use.

    We should retire monetary policy, implement a Job Guarantee, and rely entirely on fiscal policy to maintain those three core macroeconomic goals (true full employment, stable prices, sustainable resource use).

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