MMTers would fight inflation with fiscal austerity

Not long ago, policymakers like Rep. Alexandria Ocasio-Cortez were enamored of something called  Modern Monetary Theory (MMT). This theory starts with a banal observation — that a government that issues the currency its debts are denominated in need never (technically) go bankrupt — and, on that basis, argues that we don’t need to worry about the budget deficit. As a leading MMTer, economist Stephanie Kelton, argued in her 2020 book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy:

Uncle Sam has something the rest of us don’t—the power to issue the US dollar. Uncle Sam doesn’t need to come up with dollars before he can spend. The rest of us do. Uncle Sam can’t face mounting bills he can’t afford to pay. The rest of us might. Uncle Sam will never go broke.

MMT appealed to many, like AOC, because it seemed to offer the Philosopher’s Stone of economics, the fabled free lunch. But it didn’t.

As Kelton wrote:

Just because there are no financial constraints on the federal budget doesn’t mean there aren’t real limits to what the government can (and should) do. Every economy has its own internal speed limit, regulated by the availability of our real productive resources— the state of technology and the quantity and quality of its land, workers, factories, machine, and other materials. If the government tries to spend too much into an economy that’s already running at full speed, inflation will accelerate. There are limits. [Emphasis added]

Policymakers, then, ought not be looking at the deficit when setting fiscal policy, but at the overall economy – “…the government’s budget isn’t supposed to balance. Our economy is,” Kelton wrote – and to find balance or imbalance in the economy we had to look at the rate of inflation. Kelton explained that:

A deficit is only evidence of overspending if it sparks inflation.

Finally, the federal government has historically almost always kept its deficit too small. Yes, too small! Evidence of a deficit that is too small is unemployment. Of course, MMT recognizes that deficits can also be too big. But Senator Enzi had it all wrong. A fiscal deficit isn’t evidence of overspending. For evidence of overspending, we must think of inflation.

But we didn’t need to worry about this. This was, MMTers told us, “the prevailing era of too-low inflation”.

That era is now over. Briefly put, when COVID-19 hit, the federal government borrowed big and the Federal Reserve printed big, using the new money to buy government debt and keep the government’s borrowing costs down. This money was spent into an economy whose capacity to produce the goods and services to spend it on was constrained by shutdowns and other anti-COVID-19 measures. We hit those limits.

Given MMTers had recognized inflation as a problem to be remedied, what did they suggest as the remedy? What would MMTers have been doing these last couple of years if they had been in charge?

Because they thought that we were in an “era of too-low inflation”, MMTers like Kelton spent much more time telling us about all the spending they would do than about how they would deal with the inflation that might arise as a result. But they weren’t silent on the matter. Kelton draws on the work of economist Abba P. Lerner:

To maintain full employment and keep inflation low, Lerner wanted the government to keep constant watch on the economy. If something happened to move the economy out of balance, Lerner wanted to the government to respond with a fiscal adjustment, either changing taxes or altering government spending.

If inflation began to creep up, Lerner believed that Congress could respond by raising taxes or cutting back its own expenditures.

In other words, MMTers would fight inflation with fiscal austerity and, presumably, they would deal with high inflation such as we have had recently with particularly strict fiscal austerity.

The Federal budget could certainly use a bit of austerity, but it isn’t clear that it would do very much to fight inflation: how would you get measures like that through Congress? How would fiscal measures fix a monetary problem? Governments in the 1960s and 1970s, when Lerner’s influence was at its peak, did, in fact, use taxes as a tool to fight inflation and with little success because they kept on printing money.

Either way, the free lunch that attracted so many to MMT was never really there. MMTers, in fairness to them, never entirely pretended that it was. One wonders whether AOC still supports MMT now that it dictates fiscal austerity?



Apr 23 2023 at 4:02pm

Governments in the 1960s and 1970s, when Lerner’s influence was at its peak, did, in fact, use taxes as a tool to fight inflation

Could you explain that statement. The US ran a deficit most of the 60s and 70s.

a government that issues the currency its debts are denominated in need never (technically) go bankrupt

How about when it gets to the point that foreign lenders and exporters devalue dollars?

Incidentally, Kelton was in the transitory inflation camp in mid 2021.

Jon Murphy
Apr 23 2023 at 5:42pm

Could you explain that statement. The US ran a deficit most of the 60s and 70s.

Deficits exist whenever spending exceeds tax revenue.  If spending is greater than tax revenue, even if tax revenue is rising, then deficits will persist.

Apr 23 2023 at 7:52pm


Wrong antecedent, Jon.  The statement to be explained is the one that I quoted.  The context is a period of budget deficits.

Jon Murphy
Apr 23 2023 at 8:29pm

Yes, I know.  I was responding to that antecedent.  Deficits and using fiscal policy to attack inflation are not mutually exclusive.

Apr 23 2023 at 9:05pm


Are you suggesting deficits are a way to reduce inflation?

Jon Murphy
Apr 23 2023 at 9:39pm

I don’t think you understand the quote you quoted.

Apr 24 2023 at 11:27am


Could that be why I questioned it?  Your posts indicate that you don’t either.

Richard W Fulmer
Apr 24 2023 at 9:03pm

I think that the way you worded the following sentence is the reason for the confusion:
“Deficits and using fiscal policy to attack inflation are not mutually exclusive.”

I think that Vince took it to mean that two ways in which to fight inflation are to run deficits and to use fiscal policy. I took the sentence that way at first. Now I suspect that what you meant was:

Government can try to deal with inflation via fiscal policy while simultaneously making inflation worse by running deficits.

Apr 25 2023 at 1:14pm


Richard, do you agree that deficits generally make inflation worse?  I’m not sure what Jon was trying to say.  Fiscal policy is govt spending and taxing.  Deficits are a direct result.

Michael Graves
Apr 24 2023 at 4:23pm

You cite such limited MMT references. MMT never proposes to fight inflation with austerity. It provides a view that real resources are the actual constraint.

As JM Keynes once offered, “Anything we can do, we can afford.”

Policy should implemented to address resource constraints in the economy. That is, grow the productive capacity.


Neil Wilson
Apr 25 2023 at 1:43am

Yet another article on MMT that doesn’t mention the Job Guarantee and how that *replaces* interest rate adjustment as the stabilisation policy.

Government spending then drops as people get jobs – which is how you break the Gordian knot of politicians, and central bankers, failing to operate counter cyclically.

The way MMT recommends managing stabilisation is via strong and effective automatic stabilisers coupled with a floating exchange rate that is left to float.

No discretionary policy change should then be required over the business cycle, whether that is by politicians *or* unelected wonks in central bank ivory towers.

Beyond that MMT is strictly tax and spend – but in the actual underlying numeraire – labour hours. If government wants to do more it needs to shift the correct number of labour hours from the private to the public sector. If it wants to do less it does the opposite.

That way we don’t damage and destroy the finance and construction sectors with artificial interventions in the market for money. Instead money can be left to find its own market-driven limit at the bounds of ‘creditworthiness’.

The ‘monetary problem’ we have is this needless and fruitless obsession with base interest rates – the failed belief that the system can be controlled with that one lever. It can’t.

Apr 25 2023 at 3:25pm


If government wants to do more it needs to shift the correct number of labour hours from the private to the public sector. If it wants to do less it does the opposite.


How does the government shift labor to the private sector?  Will it force a government employee off of its payroll?

Sanjiv Sharma
Apr 25 2023 at 7:31pm

Excess fiscal spending could lead to demand-based inflation as Kelton suggests. What we recently experienced was essentially supply-driven inflation, Yes, Covid pushed up demand for goods vs. services, just when the supply chain bottlenecks were disrupted. Recall shipping cost rising over 5 fold.

The Ukraine war exasperated fuel and food costs (again supply).

Corporations increased profits along with prices (taxes on excess profits?).

Not all inflation can be fought with taxes, other policy measures need to be introduced, as Kelton recognizes.

Given the structure of congress automatic stabilizers like the Job Guarantee should be implemented.

Also raising interest rates does not unambiguously reduce inflation.

As Volker admitted, monetary policy works one bankruptcy at a time.

Firms also price in interest costs along with futures price which are unambiguously higher.

With Debt to GDP above 100%, a 5% increase in interest rates raises interest expense and therefore the deficit by over 5% (albeit non-immediately but quickly given the amount of excess reserves) all else being equal (which they are not as tax collection decreases in a recession).

Derek McDaniel
Apr 25 2023 at 10:05pm

“argues that we don’t need to worry about the budget deficit”

budget deficits do not create insolvency. They matter in many other respects.

Currency financing is very similar to equity financing. Neither can create insolvency. Both have limits. Equity issuers operate with a profit motive, so they naturally don’t want to dilute share values, they raise capital when they see an opportunity, where additional spending can increase share value.

Governments do not have a profit motive, unlike shareholder issuer, they aren’t trying to increase or maximize the value of their currencies. So there is a degree of flexibility there, that one would not want for a company.  Some dilution of currency value is not a bad thing.

The governments “borrowing” is inseparable from people who are willing to accept the currency selling goods, services or labor. Government “borrowing” is not about collecting money, but about people accepting currency as payment, and then saving. Both people who save money matter, as well as people who earn the money.  You can compare the market valuation of a national debt to a market cap. When the debt is too big, you get inflation, the value of currency and debt both go down.

All of this, helps to understand, what is in essence described as neofisherism.

Higher interest rates cannot reduce inflation, as interest is a measure of the appreciation of debt or some financial asset. As prices are relative, interest rates are the measure of money’s depreciation.

Higher (nominal) rates cannot reduce inflation, because a higher rate implies more cash relative to a financial asset or debt. But higher rates CAN stabilize bond values.

In the worst case, an overnight rate, a yield that is universal and risk free, becomes a simple stock split.  Stocks can be split 1 into 2 or 3, at one point of time, but an interest rate can do the same thing continuously over time. $1 today, buys $1.05 in 1 year, which buys 1.00 + 2*0.05 + 0.0025 = 1.1025 in 2 years. This is just a fractional stock split.

The logic of the fisher equation is simple, increase the nominal rate, and either the real rate, or inflation must increase, the difference being split in some proportion. For a nominal rate increase to decrease inflation, the real rate must increase by MORE than the amount of the nominal rate increase.

It is not plausible that real rate increases exceed nominal rate increases, unless there is some other, more direct mechanism for increasing the real rate of interest. Fortunately, there is. That method is defaults. The more defaults the fed forces, the higher the real rate. If everyone had infinite credit limits it would not matter how high the nominal rate were.  But the fed increases nominal rates, and then they increase real rates.

Only there is no need to increase the nominal rate to increase the real rate, and the nominal rate increase actual moderates and blunts the affect of the real rate increase, and furthermore, requires the aggregate market valuation of the national debt to increase, in other words, the market cap–

A higher nominal rate, devalues cash in relative terms (precisely by the yield offered on bonds), thus creating a possibility to increase “real borrowing”, but like any real borrowing, it must be matched by an expenditure with positive benefit, and furthermore, it is not until that debt comes round, that we know if it was worth it. A higher nominal rate can only allow a country to borrow more money in real terms, ie, delay the effects of inflation(ie dollar milkshake).

No one knows to what extent, a nominal rate increase, will be split between a real rate increase, and an inflation increase(per the fisher equation), or if, as economists like to suggest, the real rate increase will exceed the nominal rate increase, and inflation will be suppressed by expanded “real borrowing”. But it is a dangerous and unnecessary game.

Permanent zero rate policies, are in effect, treating currency like an equity instrument. They do not have a definitive inflationary bias, but they do increase the volatility of currency value on markets. This may be considered good or bad. With increased currency volatility, things like trade balance and investments, current accounts, tend to rebalance much more quickly, reducing the potential for large imbalance build ups. But increased currency volatility can also make it more difficult to finance normal operations in a smooth and continuous manner. Thus some yield curve, although a very dovish one, may be prudent. As you are only offering a way for people to swap today’s dollars for more future dollars, much like staking a cryptocurrency. So on this, at least, I disagree with warren mosler, not descriptively, only prescriptively, that despite the tendency to cause more inflation(very modest) rate increases, can spread that inflation out over time in a very smooth and continuous fashion, and furthermore decrease the volatility and uncertainty of inflation.  Smooth inflation of 3%, may be more desireable than inflation that fluctuates wildly, but averages 2%, say between -8% and +10%.

That is the nature of the financial tradeoffs involved, but the taylor rule is an idiocratic ponzi-esque solution, believing that arbitrary nominal rate increases create arbitrary deflationary force, when nothing could be further from the truth. As such I recommend, increasing rates in response to inflation, although in a much more modest fashion. “Set the nominal rate as if it were the real rate”, is the rule I would use. The nominal rate is set beforehand, but the real rate is measured post-hoc, so if you try to use the nominal rate to compensate for the real rate, you will just always be missing the mark.  Furthermore, the real rate can be affected directly, by disciplining bank credit creation and the pricing of bank collateral, or limiting the price level bid offered in fiscal spending. “The price level is a function of prices paid by government when it spends, or collateral demanded when it lends” as mosler says in 7 deadly innocent frauds.

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