What Is “Modern Monetary Theory”?
Ever since the Great Depression it has been settled doctrine in the nations of the North Atlantic that the government has a responsibility to keep the macroeconomy in balance: The circular flow of spending, production, and incomes should be high enough to keep there from being unnecessary unemployment while also being low enough so that prices and inflation are not surprisingly and distressingly high.
To accomplish this, governments use fiscal policy—the purchase of goods and services, the imposition of taxes, and the provision of transfer payments—and monetary policy—the provision by the central bank to the system of those liquid assets called “money” and its consequent nudging up and down of interest rates and asset prices—to attempt to keep the circular flow of spending, etc., in balance with the economy‘s sustainable productive potential at the expected rate of inflation .
Modern Monetary Theory says (1) that that is all there is to worry about, and (2) that fiscal policy should play the principal role in this balancing process.
Is there excessive unemployment? Then the government should boost its purchases and cut its taxes. How will we know that we have gone too far in doing this? Rising inflation will tell us—when we see the whites of rising inflation‘s eyes, Then will be the time to cut purchases and raise taxes.
Are there rational worries that the interest payments on the outstanding national debt are too high? Then, Modern Monetary Theory says, expand the money supply to push down interest rates and so make it possible for the government to refinance its debt on sustainable terms.
Does that monetary expansion threaten to cause excess inflation? Then deal with that stress the normal way a government following Modern Monetary Theory deals with incipient inflation: cut government purchases and raise taxes until the macroeconomy is back in balance.
This is the macroeconomic policy management gospel that Abba Lerner preached during and after World War II under the name of “Functional Finance“. It is a good gospel—much better than the ravings of those yahoos who nearly a decade ago denounced Ben Bernanke for debauching the currency and risking an explosion of inflation via quantitative easing. It is a good gospel—much better than the ravings of those yahoos, including President Obama, who said nearly a decade ago that the United States government needed to freeze spending because it needed to tighten its belt just as American households had been forced tighten theirs.
In most ways, Modern Monetary Theory—Functional Finance—is just macroeconomic common sense:
- We do not like high unemployment.
- We do not like excessive inflation.
- Thus the government should make it its first priority to use its tools of economic management so that we do not experience either.
- And maybe the government needs to be a little bit clever in how it uses fiscal and when and how it uses monetary policy to keep the task of financing the national debt from becoming an undue or even an unsustainable burden.
So what can go wrong with MMT?
Three things can go wrong:
MMT implicitly assumes that the debt market is efficient—that if the government debt gets on an unduly burdensome and unsustainable path, we will see that immediately in high interest rates. If that is not true, the government and the economy can face one hell of a mess should a bubble in government bond prices develop and then collapse. Cf. Greece.
MMT implicitly assumes that wealth-owners react rapidly when they see trouble ahead—that when investors conclude that the government cannot or will not balance its books without ultimate high inflation, inflation will jump immediately.
MMT implicitly assumes that extra financial leverage generated by the high values of collateral assets does not serve as a significant source of risk—that it is only on a small scale that investors will borrow foolishly just because they can.
If any of these three implicit assumptions are false, then policies that are good according to MMT can be bad in reality: Interest rates low enough to make financing government debt easy may generate an economy prone to financial collapse and disaster. Today’s inflation may not be a good enough warning sign of long run fiscal policy unsustainability. Collapses in government bond bubbles may generate “sudden stops” that require extremely rapid fiscal adjustment that the political system cannot face.
Nevertheless, if one must choose between MMT on the one hand and the yahoos of either monetary stringency or fiscal austerity on the other, choose MMT. It is closer to being an accurate view. We do seek a circular flow of spending, production, and incomes both high enough to keep us from unnecessary unemployment and also from surprisingly and distressingly high prices and inflation.
This is a modest goal. It is not something pushed out of reach by some malign and austere economic or budgetary accounting logic.
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