The power and poison of MMT

8 Jan, 2022 at 11:31 | Posted in Economics | 12 Comments

MMT includes both problematic propositions and perfectly reasonable — even highly useful — positions.

Notice (Press Briefing): Abenomics and the Japanese Economy (November 17,  2014) | 公益財団法人フォーリン・プレスセンター(FPCJ)In the latter category, the idea that stands out is essentially functional finance theory. Proposed by Abba Lerner in 1943, FFT holds that, because governments borrowing in their own currency can always print money to service their debts, but still face inflation risks, they should aim to balance supply and demand at full employment, rather than fret about balancing the budget. In Lerner’s view, well-targeted deficit spending is an effective way for governments to “maintain prosperity” …

But MMT and FFT are not synonymous. MMT includes two additional propositions that, in my view, are unsound. The first is that monetary policy should be conducted in such a way that it facilitates fiscal-policy decisions, such as by maintaining a constant (very low) interest rate.

This expresses a crucial feature of post-Keynesian economics: interest rates, rather than money supply, are the key variables. This defies conventional economic thinking, which focuses on the interaction of stock and flow variables and the role of expectations …

MMT’s second problematic proposition – that governments should provide a job guarantee in order to maintain full employment, while mitigating inflationary pressures – is even harder to defend. It simply moves too far in the direction of socialist labor allocation, and enables governments to wield excessive control over workers’ wages.

Koichi Hamada

Yours truly is — to put it mildly — not overly pleased with Hamada’s characterization of MMT.

To maintain the view that “interest rates, rather than money supply, are the key variables” that should somehow defy “conventional economic thinking” and be a crucial post-Keynesian view is just plain wrong. Since at least two decades that is a standard mainstream position in macroeconomics and is certainly not something particularly post-Keynesian. And to characterize a job guarantee as something that has anything to do with socialism is rather far-fetched.

What Modern Monetary Theory (MMT) does is more or less what Knut Wicksell tried to do more than a hundred years ago, when he in 1898 wrote on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise). The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.

In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover, and taxing and borrowing are degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​

In the mainstream economist’s 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 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!

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  — a policy objective. The size of public debt and deficits are what they are when we try to fulfill our basic economic objectives — full employment and price stability.

Governments can spend whatever amount of money they want. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary. Most proponents of MMT argue that the aggregate demand impact of interest rate changes is​ unclear. Their effect depends​ on intricate and complex relations (especially distributional) and institutions, which​ makes it realiter impossible to always be able to tell which way they work. Public budget deficits and higher interest rates may cause inflation to go up — or go down. And if so, the​ neoliberal dream​ of the efficacy of central bank inflation targeting​ is nothing​ but a fantasy.

Contrary to mainstream theory, finance in the world of MMT — and people like Keynes and Minsky — precedes investment and saving. What is ‘forgotten’ in mainstream theory, is the insight that finance — in all its different shapes — has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies​ and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, simply isn’t enough.

All real economic activities depend on a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channelling money/savings/credit — are more or less left in the dark in modern mainstream formalizations of economic theory.

12 Comments

  1. Are the instruments of marketable sovereign or national debt a form of money on a continuum with currency and demand deposit money? What are their functions in the financial system? What is MMT policy prescriptive guidance for managing a marketable national debt?

    I have seen wild claims from some MMT advocates about there being no need for bills, notes and bonds and these connected to ideas for dissolving the standard separation of treasury / central bank control centers.

  2. Is MMT’s inflation theory pretty orthodox? What is MMT’s policy prescription for the current US? If full employment has ostensibly been reached, is raising taxes MMT’s remaining policy prescription (are job guarantee effects limited by full employment?)?
    .
    Is real heterodoxy saying that inflation is noise (see Fischer Black), and using Turkey’s current policies of indexation to fight inflation? Would full indexation, coordinated among world central banks, remove nominal inflation constraints?
    .
    Since all purported proofs of rational pricing fail, why not treat inflation as noise, index fully, and handle shortages by crowdsourcing decentralized standalone production solutions that neoliberal firms are loath to research because selling subscriptions to centralized production gives them more power?

    • Robert,
      .
      Inflation is not noise.
      .
      It is not some economic element which has no explanation.
      .
      Inflation is an important feature of a macroeconomic system.
      .
      Fischer and Black’s capital asset pricing models are not macroeconomic models.

    • Henry,

      May I suggest you (re-?)read Fischer Black’s (note that this is the name of a single individual) “Noise”, particularly the third section, titled “Macroeconomics”?
      .
      https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.1986.tb04513.x
      .
      《If we allow the price level and rate of inflation to change, then there are many equilibria, but there are no rules to tell us how one is chosen over another. There is no logical story explaining how the change in money will cause a shift from one equilibrium to another.
      .
      If monetary policy doesn’t cause changes in inflation, what does?
      .
      I think that the price level and rate of inflation are literally indeterminate. They are whatever people think they will be. They are determined by expectations, but expectations follow no rational rules. If people believe that certain changes in the money stock will cause changes in the rate of inflation, that may well happen, because their expectations will be built into their long term contracts.》
      .
      How can you prove to me that inflation is not noise?
      .
      [May I note that Roger Farmer seems to have, perhaps unknowingly, arrived at many of Black’s conclusions regarding multiple equilibria and the importance of (noisy) beliefs in price formation?]

    • Robert,
      .
      Firstly, Black uses neoclassical general equilibrium models.
      .
      I can’t see how macroeconomic behaviour can be explained by neoclassical general equilibrium models. Mainstreamers have a different view.
      .
      Black uses the term “noise” inappropriately I believe – he should use the word “uncertainty” exclusively instead.
      .
      His notion that inflation is given by expectations most people could live with to some degree except there is more to it than that.
      .
      In my book, because it is given by expectations, does not make it noise.
      .
      And I can say to you, prove to me inflation is noise.
      .
      (Farmer plays with DSGE models so that should say enough.)

  3. Lars writes:
    .
    “MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. ”
    .
    MMT cites as evidence for this position the subdued inflation performance of the world economy in the last 20 years in the face of massive creation of money by central banks. MMT sees this as a form of macroeconomic miracle.
    .
    World inflation has been subdued because of globalization and the gross mal-distribution of income that pertains in most western economies.
    .
    Globalization has undermined the power of western labour and also resulted in the abundant supply of cheap goods..
    .
    Mal-distribution of income has reduced the income available to the vast majority of consumers in the west. Consumption can only be kept up by borrowing which inevitably limits future consumption as debt is repaid.
    .
    The burgeoning inflation of recent times is making MMTers feel uneasy. It should not be happening. To rescue their position, MMTers are now proposing that prices policies be adopted to control inflation.
    .
    Lars continues:
    .
    “At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government.”
    .
    I suggest Lars is misrepresenting MMT. MMT, if its statements are to be believed, considers that inflation is inimical to sound policy and should be mitigated at all times. Inflation becomes MMT’s ultimate deficit spending constraint.

  4. “The point of economics as a discipline, is to create a language and methodology for governing that hides political assumptions from the public” – Matt Stoller writes in his anti-monopoly newsletter Big

  5. “Proposed by Abba Lerner in 1943, FFT holds that, because governments borrowing in their own currency can always print money to service their debts, but still face inflation risks, they should aim to balance supply and demand at full employment, rather than fret about balancing the budget.”
    .
    It is worth noting that in the 1970s/1980s, Lerner changed his view. In the stagflation context of the times he came to the view that avoiding inflation is paramount.

  6. MMT’s core value says inflation is the constraint, but it has no sensible definition of what that is that doesn’t involve political/bureaucratic micromanagement of the economy. MMT largely focuses on the vertical monetary system when all recent economic crisis were the result of mismanagement of the horizontal monetary systems.

    • There’s an operational indicator. When a government finds it can’t buy enough of the things it needs to buy at current market prices — when it has to out-bid the private sector — then it can guess that inflation is on the way.


Sorry, the comment form is closed at this time.

Blog at WordPress.com.
Entries and Comments feeds.