Does MMT — really — ignore expectations?

19 Jul, 2020 at 12:59 | Posted in Economics | 7 Comments

A view yours truly often encounters when debating MMT is that there is an inflationary bias in MMT and that its framework ignores expectations.

Hmm …

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 the 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. The effect of expectations, as Keynes described in the GT, can easily be represented by shifts in the MEC schedule and liquidity preference function.

    These two relationships are at the base of the IS/LM analysis so that changes in expectations can easily be represented by shifts in the IS and LM curves.

    • But is that interesting? Or is this merely a gimmick within a gadget. It seems to be that Keynes in his later career was far more interested in the actual psychology going on here. The effects on capitalism, including interest rates and employment, of the psychology of the masses and powerful political and other players. Fear may push up interest rates, or lower them, as banks only lend to institutions that already have capital (or perhaps ultimately that which is convertible into gold and US dollars). Perhaps his opinions were getting closer to Marx: capitalism is inherently unstable and prone to crisis:

      :….subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct. The forces of disillusion may suddenly impose a new conventional basis of valuation.”

      (classical theory – and probably things like ISLM) …”pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.

      Does this Keynes want gadgets to understand things, or does he want something deeper; something that’s actually interesting?

      Perhaps he did:

      “Perhaps the reader feels that this general, philosophical disquisition on the behaviour of mankind is somewhat remote from the economic theory under discussion. But I think not.”

      As Skidelsky evidently notes, there are crucial things missing here – power, institutions, morality… These may not be peripheral matters, ignorable so you can proceed with formalistic restriction. For true understanding they are probably at the heart of the matter.

      I am not sure ISLM or neo-classical theory is going to help here. Any attempt to force it into such thinking will render such inquiry tautologous and meaningless. And I am not yet convinced by MMT either.

    • Nanikore,
      “…is this merely a gimmick within a gadget.”
      Yes, so what? Gimmicks and gadgets can be fun and useful.
      Keynes was happy enough to consider, in the GT, shifts in the schedules as a means to understanding the effects of expectations. If it’s good enough for him, it’s good enough for me.
      And I am sure he would want to go deeper as you suggest.
      But we are talking about unquantifiable uncertainties – what can you expect to find?
      Use what you have and hope for the best.
      All the other elements you mentioned can be dragged into consideration. They are vague indistinct elements. How do you quantify their effects? How do you measure them?
      Models are all that we have to begin to give us some direction.

      IS/LM was more or less endorsed by Keynes and certainly not rejected out of hand.

  2. Inflation is easily hedged using inflation swaps, Treasury Inflation Protected Securities, and Cost of Living Adjustments. The Fed can easily buy and sell inflation swaps in the open market to set breakeven rates where it wants, just as it sets interest rates by buying and selling reserves. Expect the Fed to figure the inflation swap thing out eventually. Or, Congress could tell them to use inflation swaps to provide inflation hedges for anyone who fears inflation’s unwanted effects and can’t find private inflation swap sellers.
    @ Henry Rech:
    Shifts can’t be predicted? You’re better off using inflation break-evens as an indicator of market expectations regarding inflation. And as mentioned, the Fed could easily manipulate inflation break-evens using existing open market instruments.

  3. The Job Guarantee maintains an army of reserve labour that can be deployed against private sector entities using low end unskilled labour that raises prices.

    Firms know that and therefore refrain from raising prices – pushing quantity expansion instead.

    Expectations is baked into the very basis of the countercyclical stabiliser in every MMT book. Half the argument for doing jobs rather than income comes from the threat mechanism – almost all of which is expectations based.

    Cognitive Dissonance amongst the mainstream can be the only answer.

    • First, as to “JG maintains an army of reserve labour..”, so does unemployment. Ergo JG achieves nothing there that unemployment doesn’t also achieve.

      Second, I’m baffled as to why “low end unskilled labour” would “raise prices”. What WOULD raise prices would be using UNSUITABLE labour: e.g. using skilled and well paid labour where unskilled labour can do the job concerned. But that’s not what’s involved here.

      Third I was pleased to see Simon Wren-Lewis on twitter the other day attacking the idea that JG counters inflation in any significant way. That’s what I’ve been saying for years.

      Fourth, I’m not TOTALLY opposed to JG. But what I do think is that 95% of those who advocate JG haven’t the faintest idea what they’re talking about.

  4. “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.”

    Well quite, and the crucial point is that expectations are linked to historical time. Capitalism is arguably dynamic and inherently unstable – in which case it is actually tautologous to say it can’t be understood in a static framework.

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