MMT is wrong
I have a new piece in The Hill, discussing the increasingly popular “Modern Monetary Theory”:
The basic problem is that MMT proponents mix up the roles of fiscal and monetary policy. They argue that monetary policy should play a supporting role, holding down interest rates to reduce the cost of public borrowing.
Meanwhile, the thinking goes, fiscal austerity should be the tool used to hold down inflation when aggregate spending begins to exceed the productive capacity of the economy.
Unfortunately, there is a long history suggesting that this approach will not work. In 1968, President Johnson raised taxes and balanced the budget, in the hope and expectation that this would hold down inflation. Instead, inflation got even worse, as monetary policy was still highly expansionary. It is monetary policy that determines the price level, not fiscal policy. . . .
Unfortunately, the underlying model used in MMT is based on false assumptions about the inflation process. If you start to rely on a flawed theory as a guide to policy, there will eventually come a time when it will lead policymakers astray, as happened when President Johnson relied on an MMT-type theory and accidentally triggered the greatest peacetime inflation in American history.
Please read the whole thing.
PS. Here’s LBJ and Fed Chair William Martin:
Jan 25 2019 at 8:32pm
Very good piece. You explained the relevant tenets of MMT very concisely, along with it’s problems.
Jan 26 2019 at 10:20am
Sarcasm is funny.
Jan 25 2019 at 11:29pm
I do not genuflect to the MMT totem inside the Temple of Macroeconomics.
On the other hand, I find there is no conventional macroeconomist who can explain why Japan does not have inflation. When a central bank buys back 45% of national debt, and national debt is 225% of GDP, but no inflation ensues, one begins to wonder about everything. There are more job openings than people looking for work in Japan ( and now the United States as well ).
Perhaps the right course is to become an inflation agnostic.
Jan 26 2019 at 1:24am
We were on the gold standard in 1968. Now we’re not. One of the central tenets of MMT is that our economic policies are still based on experiences with the gold standard, but that fiat currency requires a rethink of all monetary policy’s relationship to fiscal policy.
Jan 26 2019 at 5:48am
Most of the money creation in economy is done by commecial banks. While the total credit of private non financial sector is about 30 trillion US dollars, broad money M3 is 14 trillion. M1 the immediately disposable money is about 3.7 trillion, up from 1.5 trillion since 2008. Yet the M1 velocity decreased from 10.5 to 5.5 in the same period, when the interest rates were close to zero. How can it be? The answer lays to my opinion in price decrease in consumers merchandise due to technological developments, that reduces the measured nominal GDP. The inflation was tuneled to value holding assets like cryptocurrencies, real estate, shares, bonds, etc. The price increase in most of the value holding assets is not measured in the price indexes.
Jan 26 2019 at 10:40am
In 1968 the Fed was raising the Fed Funds rate. This is not expansionary. In 1969 the Federal budget showed a small surplus, and the result was a recession. Inflation increased through the late 1960’s as the government took young men out of the work force and sent them to VietNam, reducing the supply of labor and causing inflationary shortages.
Jan 26 2019 at 11:52am
You wrote, “Unfortunately, there is a long history suggesting that this approach will not work.” MMT proposes a Job Guarantee to regulate inflation, which uses employment as a buffer stock to set the price of wages. It does not rely on tax increases.
Jan 26 2019 at 2:32pm
Isn’t that formulation of “MMT” pretty outdated? I have not heard anyone argue that fiscal policy could be used to manage inflation up or down in a long time. (I think it was in my undergraduate public finance course ~ 1962)
There is an argument for “fiscal policy” if the Fed were reluctant to engage in sufficient QE to keep price level and/or NGDP on its target growth trajectory. Basically, fiscal policy should just stick to taxing and spending according to an NPV rule, which will, of course produce a “counter-cyclical” pattern of deficits as the cost of borrowing falls and prices of activity inputs fall below marginal cost during recession.
Jan 27 2019 at 12:52pm
Thaomas, You said:
“I have not heard anyone argue that fiscal policy could be used to manage inflation up or down in a long time.”
MMTers make that argument, and their theory is increasingly popular.
Jan 26 2019 at 3:44pm
I’m sure I would not have to ask this question if I paid more attention to your posts on monetary policy. It is not clear to me from your column why anyone accepts MMT, and I assume that if a number of economists believe in some economic theory there is some colorable basis for the belief. What is the basic causal mechanism that proponents of MMT believe in and you deny, and what ever led anyone to believe it?
Jan 26 2019 at 9:23pm
it’s all in Scott’s essay, did you even read it? Let’s see if I get it right:
MMT is not widely believed amongst economists but more and more Democrats (Sanders, AOC) seem to believe in it, that’s why it might become relevant.
Let’s start what MMT gets right. Number one: Money is really important. What else? Maybe #2: A country with its own currency can never run out of money, it can always print new money.
The problem of course is inflation. They want to fight inflation by raising taxes. They say inflation is a problem of fiscal deficits but Scott says this was wrongly believed long time ago, in the 1960s by LBJ, which led to the highest peacetime inflation in US history – and his story looks pretty convincing.
Jan 28 2019 at 10:30am
I think there are two other things MMT gets right (though it then goes very wrong with them):
(1) Fiscal stimulus is a poor tool to combat recessions. Besides the oft-cited problems that (a) Congress showers money on favored constituencies rather than ostensibly more stimulatory types of spending, and (b) the money multiplies slowly, the deeper problem is that the multiplier seems to be very small in recessions. At least, that’s my reading of the Romers’ and others work.
(2) Monetary stimulus is a more powerful tool to combat recessions–especially if they have a monetary cause (e.g., pre-Depression Fed and Bank of France policy, runs on the repo market in last decade’s financial crisis). Again, this is my reading of work like the Romers’, as well as Friedman & Schwartz.
(I suppose this is just an expansive way of agreeing that “Money is very important.”)
However, though monetary policy is a better tool at fighting recessions than fiscal policy, that doesn’t mean that fiscal policy is an effective way to fight inflation (the Fed has shown it has pretty good tools for that, too). The U.S. had inflation of 6.2% in 1969 despite a budget surplus, for instance.
Jan 27 2019 at 12:54pm
Frank, It’s been a while since I read their stuff, but I recall two mistakes. Confusing tautologies with causal relationships. And not understanding the implications of “endogenous money.”
Jan 26 2019 at 3:50pm
It seems like you have found the Achilles heel of MMT.
A dagger right into its heart.
Jan 28 2019 at 9:07am
Hmmm. I thought the extreme taxers historically (e.g., Johnson) and now (Sanders and AOC) promote it not so much to reduce excess deficits but to pay for their extreme entitlement spending—Johnson’s “Great Society” Medicare and Medicaid and now proposed ”free” sick care, education, etc.
Jan 28 2019 at 11:03am
MMTers, it seems to me, have merely “discovered” that the government can successfully, (up to a point), coerce it’s citizens into going to work at a specified wage, paid in currency at a specified value, under penalty of arrest for tax evasion. But they forget the (up to a point part). If you substitute the phrase “voucher to not be arrested by internal security forces” for “money” in their pronouncements it makes a whole lot more sense. When they argue that a sovereign government has no budget constraint, the more scrupulous ones add “fiscal” or “financial”. But democratic governments face a political constraint on spending and taxation and all governments face a “torches and pitch forks” constraint at some level of repression.
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