Sebastian Edwards on MMT and Latin American populism
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have discovered that with lower real interest rates, old rules of thumb about maximum sustainable deficits are no longer valid.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.