Sebastian Edwards is perhaps the world’s leading expert on populist policies in Latin America. He has an excellent new paper discussing the lessons of Latin American populism for the debate over MMT. Here’s the abstract:
According to Modern Monetary Theory (MMT) it is possible to use expansive monetary policy – money creation by the central bank (i.e. the Federal Reserve) – to finance large fiscal deficits that will ensure full employment and good jobs for everyone, through a “jobs guarantee” program. In this paper I analyze some of Latin America’s historical episodes with MMT-type policies (Chile, Peru. Argentina, and Venezuela). The analysis uses the framework developed by Dornbusch and Edwards (1990, 1991) for studying macroeconomic populism. The four experiments studied in this paper ended up badly, with runaway inflation, huge currency devaluations, and precipitous real wage declines. These experiences offer a cautionary tale for MMT enthusiasts
There’s a lot of debate about what MMT is actually saying, and what sort of data we can use to evaluate its claims. In support of MMT, some point to the fact that the US can seemingly run large deficits without triggering a fiscal crisis and/or much higher interest rates. That may be inconsistent with some alternative models, but it’s no surprise to market monetarists who understand the link between interest rates and NGDP growth.
Since the early 1980s, there has been a major downward shift in the trend rate of real interest rates, which seems likely to persist for some period of time. This new reality leads to various one-time adjustments. Stock and real estate prices are higher than otherwise, for instance. And now politicians have discovered that with lower real interest rates, old rules of thumb about maximum sustainable deficits are no longer valid. But the underlying models are still appropriate; there is no free lunch in fiscal policy. The only thing new is that the interest cost of maintaining a debt ratio of 100% of GDP is roughly equal to the cost of maintaining a debt ratio of 50% of GDP back when real interest rates were twice as high. And it’s still true that large budget deficits today are not a good idea because of the advantages of smoothing tax rates over time, combined with the looming demographic challenges to the entitlement programs.
PS. At MoneyIllusion I have a follow-up on last year’s post discussing the link between fracking and manufacturing jobs growth. The punch line is that my hypothesis looks even better today.
READER COMMENTS
Michael Clifford
May 3 2019 at 5:59pm
You and I both know that MMT proponents will respond to this indignantly – saying Venezuela, Argentina and Chile don’t have monetary independence and thus don’t fall under the MMT model.
It may be that they think their model is the only one that recognizes the value of monetary sovereignty, or that they think it is somehow different from central bank independence – which, IIRC, was also a defining feature of most historical hyperinflations. It may be none of those. I’ll never get to know if they refuse to answer my questions, which has been their modus operandi on Twitter lately.
The major substantive differences between monetarism and MMT ultimately come down to understanding monetary disequilibrium and the Fisher Effect.
Benjamin Cole
May 3 2019 at 7:34pm
Yes, and Japan too.
The Bank of Japan has bought back about 45% of Japanese government bonds outstanding. The Japanese national debt is somewhere around 230% of Japanese GDP.
Michael Woodford says that quantitative easing in conjunction with national deficits is just a helicopter drop. Or MMT?
Japan=Argentina?
In conclusion, I would like to say that no one in macroeconomics is ever wrong. Even Sebastian Edwards.
Thaomas
May 4 2019 at 8:22am
Basically, “debt” is not the right policy indicator to look at and “deficits” are not much better. Every deficit us the difference between the consumption, investment and taxation decisions. If those decisions are correct the resulting deficit is correct. Of course levels of debt influence borrowing rates and borrowing rates are an input to correct investment decisions. “Good” outcomes like small full employment surpluses or stable Debt to GDP are the result of good spending and taxing decisions but focusing on deficits or debt can distract attention from the fundamental policy variables.
Theodore Lopez
May 5 2019 at 9:06am
MMT is essentially the discovery that you can get businesses to produce goods and services they otherwise would not want to produce and workers to perform jobs they otherwise wouldn’t want to perform by threatening to throw them in jail for tax evasion. Basically it is a vision of a command economy with the underlying threat of state violence obscured by rhetoric about inside money and taxation.
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