Leftist Monetary Theory
‘Modern Monetary Theory’ Is a Joke That’s Not Funny
Yes, a government that issues its own currency can pay its bills. But piling up debt for no urgent reason is lunacy.
By Michael R. Strain January 17, 2019,
There’s a theory behind it.
If you follow the debates over U.S. economic policy, you had probably heard of modern monetary theory well before freshman Democratic Representative Alexandria Ocasio-Cortez spoke favorably about it earlier this month.
If you thought from the start that the whole idea sounded like lunacy, you were right, even if it’s possible to admit some sliver of sympathy for it. So why is MMT, as it is known for short, generating such intense interest now?
First, let’s start with the confusion over what it is. The answer seems to depend on which advocate of MMT is being asked. It is sometimes a theory of money. MMT is also being discussed in the context of a political program to justify huge increases in social spending. Finally, there is its role as a prescription for macroeconomic policy.
Even as just an economic theory, it is not settled or fully developed. This makes engaging with it challenging — even, at times, frustrating.
The bedrock observation of MMT is correct: Any government that issues its own currency can always pay its bills. This observation allows policy makers to show less concern about the budget deficit than is typically the case.
In fact, MMT is growing in prominence precisely because of its relative lack of concern about the size of the deficit. In the years immediately after the Great Recession, which started in December 2007, this aspect of MMT stood in favorable contrast to the position of fiscal-policy centrists and many Republican politicians who called for significant reductions in the deficit at a time of very high unemployment.
Today, when some are continuing to question commonly held views about fiscal policy, the thrust of MMT — the deficits matter a lot less than its critics would have you believe — is attractive to many solid economists. (Though I am not yet sold on their arguments.)
In my reading, this is about all that can be said favorably regarding modern monetary theory. As a political program, the observation that a government issuing its own fiat currency can’t involuntarily default — an observation with which mainstream economists largely agree — has been used to advocate for extremely expensive spending policies, including a universal jobs guarantee and single-payer health care. There’s no need, some MMT advocates argue, to let paying for these proposals through tax increases get in the way of enacting them; government can just increase the deficit.
In a short review of MMT, the economist Stan Veuger (my colleague at the American Enterprise Institute) notes that on its face this is not all that different from current policies that deliver benefits today and costs tomorrow, including the deficit-financed 2017 tax cuts. But that’s more of a criticism of this approach to legislating than a justification for MMT.
Political progressives like Ocasio-Cortez who are showing sympathy for MMT are also being short-sighted. If we further loosen the shackles tax revenue has placed on federal spending, then Democrats may get Medicare for All the next time they control the government. But, in turn, when the GOP is next in the White House, what might it do with its newfound fiscal freedom?
Both parties claim to care about the deficit, but once in power they often act as if they care more about putting their preferred policies in place, whether these are tax cuts in the case of conservatives or new spending programs in the case of liberals. Further loosening political constraints on deficits is reckless, no matter which party is doing it.
But it is in its ideas about macroeconomic policy that MMT fully earns its place on the fringe.
The theory understands that the economy is constrained by real limits on its inputs to production. If you push its advocates hard enough they will admit that at some point all that spending could send the economy into a bout of damaging inflation.
But they quickly dismiss that risk, in part by pointing to the lack of inflation in advanced economies in the recent past and by appeals to vague thought experiments.
So what does MMT have to say about inflation when it does materialize? Since under MMT the central bank is responsible for financing government programs through printing money, it falls to the institution with authority over tax and budget policy — the U.S. Congress — to make sure prices are stable by raising taxes and moving the budget deficit into surplus. As part of a series of columns last year for Bloomberg Opinion, leading MMT exponent Stephanie Kelton called on fiscal policy, not the Federal Reserve, to manage the business cycle.
But it is extremely difficult to imagine Congress responding to an overheating economy by legislating tax increases. If anything, the opposite is easier to imagine: When households are being hit with price increases, the natural inclination of an elected representative might be to increase their disposable income by lowering taxes, not raising them.
It is precisely this dynamic — the occasional need for the institution in charge of price stability to inflict short-term pain for long-term benefit — that justifies in large part the political independence of central banks.
Veuger, who is largely critical of MMT, points out that its advocates may envision an independent fiscal authority, though even on this their views are hard to decipher.
But tax policy changes the way income is distributed across households — the after-tax income of high-earning households is reduced, and households to which income is redistributed see increases — and Veuger argues that for this reason it should not be conducted by an agency that is independent of politics.
Monetary policy also has distributional implications. For example, low interest rates are good for borrowers but bad for savers. But given that the U.S. already heavily redistributes income through the tax code, Veuger is right that we should avoid the turmoil that would be created by handing tax policy over to a new, independent agency.
We typically think of inflation as being generated from an overheating economy with excess demand. But prices can also rise because it has become more expensive for businesses to produce goods and services. For example, this situation could occur if the price of oil were to increase rapidly — the economy could experience stagnation and inflation at the same time.
In this scenario, MMT seems to call for tax increases in order to restrain inflation. But the economy is already slowing. Raising taxes
would only make a downturn worse, increasing unemployment and further slowing the economy.
Modern monetary theory is seductive in its promises and, occasionally, in its observations. But if enacted it could cause great harm to the U.S. economy. Like Medusa, it may seem beautiful. But if you look it in the eye you will turn to stone.
Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”