I cannot resist responding to a recent article by Stephanie Kelton, explaining the MMT view of public debt:
Since the government’s budget deficit is, by definition, the difference between what it spends and what it collects in the form of taxes and other payments to itself, it may seem reasonable to call it “overspending” when the government spends more than it takes in. But it’s not.
As every economist knows, inflation — not a budget deficit — is the tell-tale sign of an economy that is under pressure from excessive spending. If prices aren’t accelerating, you don’t have an inflation problem. And if you don’t have an inflation problem, you don’t have a spending problem.
It’s rare to see such a classic example of a non sequitur. Yes, inflation is a sign of overspending, in the sense of excessive aggregate demand. But in context, the second paragraph makes no sense at all. The previous paragraph was not about aggregate spending, it was about federal spending and the budget deficit. Indeed the entire article up until that point is discussing budget deficits, and nothing else. For instance, here’s the first paragraph:
When I was the chief economist to the Democrats on the Senate Budget Committee in 2015-2016, I attended a number of hearings, all called by its chairman, Republican Senator Mike Enzi of Wyoming. He would invariably open with prepared remarks that included his observation that deficits are evidence of “chronic overspending.”
So then what are we to make of the paragraph that begins “As every economist knows”? There are two possibilities here:
1. Kelton is referring to excessive federal spending. But in that case, the claim is completely false. Economists do not generally believe that inflation is a tell tale sign of excessive federal spending, mostly because it obviously is not. Deficits tended to be low during the Great Inflation, and then rose sharply in the 1980s, as inflation fell sharply. Deficits again soared over the last few years, again without high inflation. So it’s certainly not true that “every” economist regards inflation as a sign of excessive federal spending, rather economists view it as a sign of excessive aggregate spending.
2. OK, so perhaps that’s what Kelton meant. But then the entire article makes no sense. She had been trying to push back against the view that excessive federal spending and large budget deficits are a problem when inflation is low. If the paragraph about what “every economist knows” is referring to aggregate spending, then it has no bearing on her claims. In that case, the entire article literally makes no sense at all. Her “proof” has no bearing on the claim she is disputing.
This is also puzzling:
Depressed conditions meant that the government could have spent a trillion dollars without raising a single tax. It would not have been inflationary. But as things tighten up, and the slack dissipates, the economy moves to a fuller utilization of its resources.
We almost never make it all the way to maximum velocity — we did during the mobilization for World War II — and we’re almost surely not there now. That day could come. And when it does, you don’t get to spend so freely.
Put aside the odd comment about “velocity”, which was actually relatively low during WWII (albeit slightly higher than in 1940). She’s right that excessive (aggregate) spending did cause substantial inflation during the war. But the suggestion that inflation is only a problem when we reach full utilization of resources makes no sense. Yes, the unemployment rate fell to barely over 1% during WWII, and we were certainly operating at capacity. But we also had double-digit inflation during 1980 and 1981, a time of 7% to 8% unemployment. In other countries you can find even more extreme examples of stagflation. Excessive spending can occur when the economy is far from capacity.
Just to be clear, I don’t expect the current federal deficits to lead to high inflation, due to monetary offset. So it is reasonable for MMTers to predict low inflation for the foreseeable future. The financial markets also predict low inflation, as do most mainstream economists. But that’s not the point. While big budget deficits lead to hyperinflation in places like Zimbabwe and Venezuela, in the US the deficits are likely to place a burden on future taxpayers, slowing growth. Sharp future tax increases are the actual risk, not high inflation.
PS. I’m expecting commenters to tell me that MMTers use terms like ‘velocity’ and ‘spending’ in a way that’s radically different from how mainstream economists use these term. They seem to have their own private language.
Here’s velocity:
HT: Dilip
READER COMMENTS
Ahmed Fares
Mar 9 2019 at 6:53pm
Hyper-inflation causes money-printing and not the other way around.
Yes, that is true; Henwood adopts the Monetarist explanation that “too much money” causes inflation. He confuses causation and correlation. Severe supply constraints can push up prices, increasing the amount of money that needs to be created both publicly and privately to finance purchases. Tax revenues fall behind spending so a deficit opens up as spending tries to keep pace with inflation. The money stock is a residual and it will grow rapidly with hyperinflation. That does not mean it is the cause. Mitchell has closely examined the hyperinflation cases from the MMT perspective; the argument is not at all odd and has the advantage that it is fact-based, unlike Henwood’s Monetarist linking of money and inflation that has been so thoroughly discredited that even central bankers have dropped it. —L. Randall Wray
Lorenzo from Oz
Mar 9 2019 at 7:55pm
Hard to argue with folk using a Humpty-Dumpty approach to language.
They are also hardly the only ones to use the motte-and-bailey style of argument, but it does not make it any less frustrating, as Cameron Harwick points out.
https://cameronharwick.com/blog/whats-radical-about-mmt/
Lorenzo from Oz
Mar 9 2019 at 7:58pm
Philosopher Nicholas Shackel, who identified and named the motte-and-bailey style of argument sets out what it is nicely here:
http://blog.practicalethics.ox.ac.uk/2014/09/motte-and-bailey-doctrines/
Benjamin Cole
Mar 9 2019 at 8:13pm
Curiously, the MMT’ers may be right when inflation and interest rates hit zero.
If a government can borrow at negative interest rates, as sometimes happens for Switzerland Austria or Japan, the situation becomes even more curious.
There is every probability in the next recession that interest rates and inflation will hit zero zero or even go lower.
In such an environment, will the monetary tools of interest rates and QE work? Even if QE eventually works, is not speed of the essence when people are unemployed?
Given that capital markets are global, if only one central bank goes to QE is that effective?
But I think that MMT’ers do have a blind spot. They are trapped within the conventional mode of thinking that a government can only borrow or tax. As was illustrated in Japan during the Great Depression, the government can also print money with very successful results in terms of macroeconomics.
It seems to me that both conventional macroeconomists and the MMT’ers want to place macroeconomic policy into a straitjacket. They then devise extreme contortions to get their arm-less policies to work.
Dudes, have the federal government print money and spend it. A recession is no time to dilly-dally around.
Matthias Goergens
Mar 10 2019 at 12:56am
QE as in buying assets with fresh money will work regardless of interest rates. Targeting interest rates might just not work.
Eg Singapore targets the exchange rate, but they do that by buying and selling assets. In their case, I think they are buying foreign exchange, but it doesn’t matter too much. Eg the Fed could target the exchange rate or the NGDP level, and still buy and sell American federal government bonds as the policy tool to reach that target.
(In practice, we might see a change to price level targeting instead of NGDP targeting first. Or equivalently, average inflation rate targeting that makes up for past misses. I think those were in the discussion at the Fed?)
Yes, one central bank doing QE is effective for their currency.
Because of rational expectations, the speed that matters is the speed at which people start believing that QE works. And that can be fairly quick, basically as soon as they announce a credible policy or even before.
Benjamin Cole
Mar 10 2019 at 5:12am
“Because of rational expectations, the speed that matters is the speed at which people start believing that QE works. And that can be fairly quick, basically as soon as they announce a credible policy or even beforeMG
Egads, do people even know what is QE, let alone do they think it will work? What minute percent of the population are you discussing?
Besides that, there are Phd. economists, such as John Cochrane, who insist QE is ineffective entirely, and then there are published studies by the Federal Reserve Bank of St. Louis that said QE would have to be four times larger than it was to be effective.
So even “experts” who understand QE argue about its merits.
Some people say QE just “swapped reserves for Treasury bonds.” If that is true, we are dependent on commercial banks and endogenous money-creation creation to get us out of a recession. Except, banks do not want to lend into a recession, and no one wants to borrow. Yikes!
Can we just open up the heavy artillery in the next recession?
Rajat
Mar 9 2019 at 10:30pm
In fairness to Kelton, I’m pretty she meant ‘maximum velocity’ to mean full employment or a FE level of spending/output.
But the comment that the US only reached FE in WW2 is puzzling. The Fed more or less hit its implicit or explicit inflation target from the early 90s to 2007, and is not far away from it now. Is she saying that US spending can be significantly higher without causing the target to be exceeded or does she have a problem with the target? Presumably the former. Unfortunately, the Fed’s timidity over the last decade has not just given Trump a spending-based platform for election and re-election, but brought undeserved attention to MMT.
Scott Sumner
Mar 10 2019 at 1:32am
Ahmed, Yes, and rising orange prices cause crop failures in Florida. (I’m joking)
Ben, You don’t understand MMT. MMTers understand that governments can print money to pay for stuff.
Rajat, You said:
“In fairness to Kelton, I’m pretty she meant ‘maximum velocity’ to mean full employment or a FE level of spending/output.”
Perhaps, but why say “in fairness to Kelton”. If you are right that she is making up new meanings for words in ways that no one else understands, that’s a pretty serious problem, isn’t it?
We have terms for “full employment”, such as “capacity” and “the natural rate of output”. Unfortunately, “maximum velocity” means something very different. (I’m not saying that’s what she meant, BTW, just responding to your hypothesis. I don’t know what she meant.)
It would really help if MMTers used economic terminology the way the rest of us do, and make their arguments using terms we can all understand.
Rajat
Mar 10 2019 at 1:43am
Scott, I don’t disagree about the MMTers’ use of terminology, but even if they don’t argue in good faith, it doesn’t mean the rest of us shouldn’t. The link she provided in the same sentence of that passage is to an article entitled, “Full employment: Are we there yet?”, so I think her intended meaning is clear enough.
But in general, I think I’ve read enough from the MMTers to believe that it raises nothing new or interesting other than that it makes a song and dance of the fact that previous views on the sensitivity of real interest rates to the size of national debt were – in hindsight – overblown. I don’t think MMT offers anything useful for future economic policy development.
Benjamin Cole
Mar 10 2019 at 5:17am
Ben, You don’t understand MMT. MMTers understand that governments can print money to pay for stuff.
Ha, perhaps guilty as charged on the first declaration.
On your second declaration, MMT’ers may understand government can go to money-financed fiscal programs, but they seem to respect the taboo that governments should not print money. They keep talking about Uncle Sam borrowing more and more money, mountains of it though all time, to fund huge social welfare programs, or a Green New Deal. That is about the worst possible face one can put on fiscal stimulus.
BTW, check out Larry Summers March 4 paper at Brookings. Without big government deficits, he says neutral interest rates would be seriously negative already.
Hey, Summers said it, not me.
Scott Sumner
Mar 10 2019 at 3:02pm
Ben, You said:
“but they seem to respect the taboo that governments should not print money.”
No they don’t.
Benjamin Cole
Mar 10 2019 at 8:05pm
Okay MMT, schemMMT.
More important is Larry Summers March 4 paper at Brookings on the need for large and chronic federal deficits.
Egads this is Larry Summers talking, not some lulus from MMT land.
Aleksander
Mar 10 2019 at 10:05pm
I really like this passage:
Of course directing economic activity is hard. That’s why we normally outsource it to the markets by using money. Then we only have to finance it (through taxation or money creation), which is much easier.
I mean, we don’t even have to finance it if we don’t want to; the government could just order individuals to work for free on public works, and to give away all their things. But coordinating all these orders in a socially optimal way is really really hard, so instead we just tax everyone and outsource the coordination to the markets.
If you tax everyone so much that the government has to manually steer the economy to “manage the inevitable upheaval”, then financing was only “easy” in the sense that it was literally easy to pass those tax laws (which is also not true in the current political climate). But I guess that’s what she means when she talks about budget deficits as well; it is technically easy to spend more than you collect, regardless of future consequences to the economy.
Thaomas
Mar 11 2019 at 6:57am
Public sector deficits are are negative savings and unless they are being used to finance activities that have future benefits and present costs that pass an NPV test, will slow growth relative to not running the deficits [assuming that the Fed is doing its job of minimizing unemployment with a constant increase in the price level]. Such a regime would produce approximately “Keynesian” counter-cyclical movements in deficits.
There is a possible role for fiscal policy — departures from the NPV rule — if monetary policy is systematically perusing policies that are not consistent with full employment of resources and a stable increase in the price level, but exactly what it would look like would depend on the specific kind of mistaken use of monetary instruments and how the Fed would react to the policy.
Benjamin Cole
Mar 11 2019 at 8:08am
On falling neutral real rates, fiscal policy, and the risk of secular stagnation
Lukasz Rachel and Lawrence H. SummersThursday, March 7, 2019
This paper is an A-bomb.
Summers says monetary policy won’t work in the modern world, and negative interest rates very risky.
Gotta go fiscal, but can’t build up debts to high. Yeah, both options bad.
It looks like Summer is leading up to money-financed fiscal programs, but then he doesn’t pull the trigger.
Cody Allen Christianson
Mar 11 2019 at 10:38am
You’re misunderstanding what Kelton is arguing. The goal of the Fed is to manage inflation and employment. They currently print and destroy money to control Bank reserves which theoretically should ripple through the real economy. But why limit money creation into the financial sector? The Fed can give the Treasury as much money as was politically determined which would be spent directly into government programs. Public debt doesn’t need to be paid back by raising taxes, it can be paid back by printing money. Then inflation is the only issue that the Fed and Politicians would need to worry about. Public spending should be set to provide as much as the public wants without creating too much inflation. For example, if we wanted to fully fund Social Security, we would have to ensure the extra demand was followed by appropriate supply for which those funds would purchase.
Starting with no government taxes or debt being issued, the government could fully fund every program the public desires. How much inflation would this create? Where would the inflation be? Lets add some taxation to remove some of the inflation (private demand) and government bonds to do the same while creating a savings vehicle for the public. This is the premise of MMT. There is no reason why we couldn’t do this if inflation and employment is maintained at a desired rate.
Scott Sumner
Mar 11 2019 at 3:53pm
Cody, I’ve discussed that exact point in many previous posts. The governmentn can raise about 0.3% of GDP by printing money to finance spending (without high inflation). That’s pretty small.
Thomas Sewell
Mar 13 2019 at 11:22pm
I think combining your response with Cody’s description of MMT creates a great plan. Let’s limit Federal government regular spending to a maximum deficit of 0.3% of GDP. 😉
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