By Scott Sumner
Modern Monetary Theory is a term that one encounters with increasing frequency. It is often applied to a specific policy, such as advocacy of expansionary fiscal policy. But that’s not a very useful definition. Lots of economists now advocate expansionary fiscal policy in the current environment of very low interest rates and high unemployment.
MMT is more than fiscal stimulus; it is a model of the macroeconomy. In order to better understand the MMT model I’ve been reading “Macroeconomics”, an undergraduate textbook written by William Mitchell, Randall Wray and Martin Watts. You probably won’t be surprised to learn that it’s not my cup of tea. But I don’t want to be unfair in my appraisal, so I’ll discuss a point of confusion here (and another today over at MoneyIllusion), and try to elicit feedback from those better schooled in the model. Am I being unfair? If so, what’s the intuition that I’m missing?
On page 85 they present a national income account equation (which is accurate), and then provide a peculiar interpretation:
(6.4) (GNP – C – T) – I ≡ (G – T) + (X – M + FNI)
The terms in Equation (6.4) are relatively easy to understand now. The term (GNP – C – T) represents total income less the amount consumed by households less the amount paid by households to government in taxes net of transfers. Thus it represents household saving.
The left-hand side of Equation (6.4), (GNP – C – T) – I, thus is the overall net saving of the private domestic sector, which is distinct from total household saving (S) denoted by the term (GNP – C – T).
Everything is correct until the final sentence. It does not represent net saving. Once you subtract investment from household saving you end up with the sum of the government deficit (defined as a positive number) and the current account balance (the net inflow of foreign saving.) That’s not net saving as conventionally defined, which is equal to net investment is a simple economy with no government or trade.
Because this might be confusing to readers, let’s consider their model in a closed economy context, for instance, how would it apply to the global economy as a whole? In that case, you could drop the current account balance (zero for the globe by definition) and you’d end up with:
(GNP – C – T) – I ≡ (G – T)
The claim is that net saving equals the budget deficit in a closed economy. Unless I’m missing something, that’s a really weird definition of net saving, completely unrelated to how mainstream economists (of all stripes) define saving.
And it’s not just me; Robert Blumen reaches a similar conclusion:
Modern monetary theory, which is now experiencing its fifteen minutes of fame, contains a number of strange and counterintuitive propositions.1 Proponents claim that these propositions are not an economic theory, only an accounting identity. One of these is that the private sector can save only if the government runs a deficit.
Within the self-consistent, tail-chasing world of MMT, these statements are true by definition. However, when MMT aphorisms are interpreted using their normal meaning in the English language, their conclusions are not only false, but foolish.
Now you might argue that it’s a free country and people are entitled to define terms in unconventional ways. Nonetheless, I have two objections to the way they define net saving.
1. This is an introductory economics textbook. Students that learn this definition of saving would be utterly confused by the way the term ‘saving’ is used in any other economics class, or in the broader society. Thus by their definition, net saving would always be exactly zero in any closed economy with no government, or any closed economy where the budget was always balanced. And yet people would still be saving in that situation (in the conventional sense), as net saving would equal net investment. To give you a sense of the magnitudes involved, suppose that the global budget deficit is 3% of global GDP and global net investment is 20% of global GDP. Then net household saving would be 3% of GDP as defined by MMTers, and 23% of GDP as defined by other economists. That’s a radically different definition.
2. My bigger objection is that they seem to draw meaningful causal implications from this peculiar definition of saving. This isn’t just a typo, one minor glitch in an otherwise straightforward textbook, this definition informs much of the subsequent analysis. Thus on page 96 we see the following:
Since the accumulation of a stock of financial wealth results from a surplus, that is, from a flow of saving, we can also conclude that causation tends to run from deficit spending to saving.
This is actually correct if you define “saving” according to the second equation above, but it’s an utterly meaningless statement. After all, in a closed economy context, “net saving” is just another term for “budget deficit”. In an open economy context, “net saving” is just another term for “budget deficit plus current account balance”. In plain English, students are being informed that causation tends to run from deficit spending to deficit spending! True, but utterly without significance.
Identities like C+I+G = GDP or M*V = GDP can be useful if used correctly, as a foundation for a behavioral model that tries to compare a policy related term (M or G) with an interesting goal variable (GDP). However both sides of the closed economy equation above are the budget deficit; there is no goal-related variable.
Now it’s possible that I’m missing something very basic here. But reread Robert Blumen’s appraisal; he’s saying the same thing.
I’ll reserve final judgment until I hear back from MMT commenters; perhaps I’m misinterpreting the textbook. My initial appraisal, however, is quite negative. Over at TheMoneyIllusion I ask for help in understanding their view of open market operations.