Further thoughts on MMT and net saving
By Scott Sumner
In a recent post I raised two objections to the MMT description of “net saving”, which is the following for a closed economy:
(GNP – C – T) – I ≡ (G – T)
This equation basically says that the government budget deficit equals the government budget deficit. But on the left side of the equation the budget deficit is redefined as “net saving”.
Let me try to present a case in favor of this approach, before criticizing it. Suppose I said total wealth minus non-monetary wealth equals the money supply:
Wt – Wnm ≡ M
Obviously, the left side of the equation is also the money stock, but does describing it this way help? You could argue that this identity shows that a rush for liquidity at a given income level (i.e. a desire to hold more of one’s wealth in the form of money), is potentially destabilizing. If there is an increased demand for money, then the government should boost the money supply (right side of the equation) to prevent the identity from being maintained by a fall in national income. When there’s a rush for liquidity, printing more money would meet the extra demand for money at full employment.
As far as I can tell from the commenters, MMTers are making a sort of analogous claim for the budget deficit. Thus, if at current interest rates and the full employment level of GDP there is more desire to (privately) save than to invest, then the government should accommodate that increased desire to save by running a budget deficit, which represents negative saving for the government sector.
Lurking in the background is the simple Keynesian cross model, with no role for monetary policy. (The “paradox of thrift” is another way of describing this concept.) This model is sometimes called “vulgar Keynesianism”, because it is considered less sophisticated than New Keynesian (IS-LM) models where monetary policy determines national income at positive interest rates, and fiscal policy is only needed at the zero lower bound for interest rates.
If I’m correct in my interpretation, then I still have the same two complaints about the model:
1. It’s confusing to students to call the left side of the equation “net saving”. Some other term should be used.
2. I don’t believe the identity is useful, because the underlying model that it’s being used to illustrate is wrong. I’ll illustrate this objection by discussing recent trends in the US budget deficit.
Everyone agrees that the 2020 spike in the budget deficit is a response to Covid, but there are other recent changes in the deficit that seem more “exogenous” in some sense. For instance, in calendar 2013 the deficit plunged from $1,060 billion to $560 billion, reflecting the desire for austerity among Republican members of Congress. After staying low for a few years, the deficit soared to more than a trillion dollars between 2016 and 2019, despite a booming economy. This reflected both increased spending and the Trump tax cuts.
Neither change was in response to a public “wanting” more or less “net saving”. Neither change was aimed at stabilizing aggregate demand. Instead, both changes reflected the political situation. In the Keynesian model, the 2013 austerity should have had a contractionary effect, but it did not due to offsetting monetary stimulus. The more recent increase in the deficit might have had a mild expansionary effect, but the Fed tried to offset that effect by raising interest rates multiple times. At the very least, this offsetting action by the Fed prevented inflation from rising to even their 2% target in 2019.
I can’t imagine how it could be useful to consider these fiscal policy changes from the perspective of how much net saving the public “wants” to do. Congress acts, interest rates move, and the public willingly buys up the newly issued Treasury debt at the new interest rate. The same thing occurs when IBM issues bonds. If the fiscal policy is seen (correctly or not) as threatening to destabilize the economy, as in 2013 and 2017-18, then the Fed acts to offset the effect. Keynesian economists predicted a slowdown when austerity was announced in late 2012, but by the fourth quarter of 2013 the year-over-year growth rate was considerably higher than 12 months earlier.
The budget deficit is one among many factors that the Fed needs to offset when targeting inflation at 2%, much like housing, exports, business investment, and other volatile sectors that might impact aggregate demand. If the budget deficit did determine aggregate demand, then we would have given Congress the duty to target inflation at 2%. Thank God we did not! As the 2013 and 2019 examples demonstrate, our fiscal policy is recklessly procyclical, and if Congress were determining inflation then we’d be back in the 1970s (or 1917-51) with inflation rates gyrating wildly up and down.
And it’s not just the US; other developed countries also give their central banks the responsibility for targeting inflation. There is no plausible alternative. A model that suggests that the budget deficit determines aggregate demand, even at positive interest rates, is simply wrong.