DAVIS KEDROSKY – SEPTEMBER 29TH, 2020
EDITOR: LUCIA DARDIS
History is eerily symmetrical. Another recession is looming, and, as in 2009, the government is meeting it with a fiscal spending package—an unprecedented $2.2 trillion initially flowing into American households and businesses via the March 25 CARES Act, with more following throughout the summer and fall. But the symmetry is dwarfed by sheer scale. The response more than doubles the $800 billion levied against the Great Recession, and passed in record time without a down vote. Where will this money come from? Owing to Modern Monetary Theory, the idea that deficits do not matter, no one cares. While proponents of stimulus a decade ago argued that borrowing to revive demand would be well worth the costs, a new generation of academics would ignore the tab altogether. Furthermore, they want the outlays to continue long after the crisis has passed.
Professors and politicians fought throughout 2009 over when to return federal spending to normal, but the consensus today appears to be that global policymakers at the time retrenched too soon, cutting spending and hiking interest rates before the recovery had begun. Advocates of Modern Monetary Theory (MMT) certainly agree. Led by the ever-vocal Stephanie Kelton, William Mitchell, and Randall Wray, these hitherto fringe academics have argued that common solvency-based assessments of government finance are inapplicable and misleading. Their core tenet is that a government whose debt is denominated in its own fiat currency cannot go bankrupt, as any obligations can be fulfilled by printing more money. Wray has said this repeatedly and explicitly, writing that “[t]here is no chance of involuntary default so long as the state only promises to accept its currency in payment.” While differences among proponents are ubiquitous, most accept this as a central premise.
Kelton and Wray founded their analysis on a philosophical claim about the nature of money, that bills are actually “socially-sanctioned” IOUs—that is, money has always been debt. Conventional economists usually ground money as a “store of value,” as was the case when currencies were either hard (gold, silver, or other metals) or hard-backed. Paper currencies merely replaced the older, spontaneous forms that had inherent value with symbolic notes. But if governments and institutions made currencies, addition to the existing money supply would be a normal function, not the distortion of a natural equilibrium. Policymakers are not competing for a scarce resource on the money market, but rather participating in a process of arbitrary creation that happens daily at private banks.
A litany of disconnected policy prescriptions follows. Not only would governments have the power to issue debt at will, certain that the funds can be procured, future taxation would not need to account for present spending. Consequently, the supposed law of Ricardian Equivalence, which argues that consumers will save in the face of expansionary policies in expectation of future tightening, would not apply, and boosts in demand could be achieved regardless of economic circumstances. Not only does this permit fiscal authorities to attempt colossal projects (such as the CARES Act) with impunity, it also entails that “monetary and fiscal policy should be formulated to achieve full employment with price stability.” One method of doing so, apart from setting the interest rate at a level compatible with the requisite spending, would be the introduction of a federal jobs guarantee as an automatic stabilizer. In a downturn, unemployed workers would simply get paychecks and labor hours from the public sector, keeping demand elevated until the economy rebounds. There’s a sinister downside, however: the guarantee aims to tamp down wages, not raise them, by creating a surplus pool of cheap labor. In turn, guaranteed jobs can only be of the hardly-appetizing minimum wage variety.
Though increasingly popular in liberal policy circles and explicitly touted by Bernie Sanders and Alexandria Ocasio-Cortez as a way to pay for expensive progressive projects, prominent economists question MMT’s basic tenets. Paul Krugman, a noted liberal and Keynesian, offers a concise critique. Linking MMT with the Depression-era “functional finance” doctrine of Abba P. Lerner, a talented heterodox colleague of Keynes and Hayek, Krugman stresses that debt could “snowball” if interest rates exceed the rate of GDP growth—a scenario made far more likely by excessive borrowing and the abrupt expansion of the money supply. Eventually, stabilization would require a large primary surplus, which would in turn necessitate either elevated taxes or spending cuts. That might be “possible,” Krugman writes, “but you do have to wonder whether the temptation to engage in some form of financial repression/debt restructuring/inflation would prevail. And more to the point, investors would wonder about that, pushing r-g (the spread between interest and GDP growth rates) even higher.” Thus MMT threatens to create the very conditions for its own unsustainability. Harvard professor N. Gregory Mankiw agreed: “a government may decide that defaulting on its debts is the best option, despite its ability to create more money. That is, government default may occur not because it is inevitable but because it is preferable to hyperinflation.” Assuming that the stability required to support federal profligacy would persist is an unwarranted analytical leap.
But much of the debate over MMT is irrelevant at present. Coronavirus is in large part a supply shock, and consequently, stimulating demand is a question for the future. The task facing Congress is getting the American economy to the end of the crisis intact—with as many bills paid, workers retained, and businesses afloat as possible. Even once the pandemic abates and escaping the recession becomes the primary focus, there’s already a heavily-thumbed response playbook, and most pages call for Keynesian fiscal stimulus. The basic conditions (approaching 25% unemployment) for a gigantic bout of government spending, coupled with continued monetary easing, have been met and surpassed. Short-run real output has dropped and unemployment has skyrocketed. Because of this, capacity underutilization is rampant and the multiplier effect (the additional boost to GDP from increased spending) will be large. There’s plenty of room for economic expansion, so the solution—while exceptional in size—can be fairly conventional in form. Greg Mankiw’s Principles of Economics textbook claims 90% of economists agree that fiscal policy has a “significant stimulative impact” on an underemployed economy. That’s the fourth least controversial axiom in the discipline.
An interview in the Financial Times portrays a vindicated Kelton. The new spending influx, she says, proves that “you’ve always had the power, you know?” Well, no, we don’t know. Emergency conditions, as noted, cannot be used to justify standard economic protocol. A confluence of historical circumstances—already-low interest rates, the “exorbitant privilege” of the dollar as the global reserve currency, and the pandemic—have made a one-time surge of deficit spending both feasible and necessary. These conditions will not last forever. There is a level of borrowing that will terrify foreign investors, cause interest rates to leap above the slow pace of growth, and produce other distortionary effects. Giving spendthrift politicians the license to find that limit by explaining that the only barrier (easily mitigable) to their action is profiteers generating inflation is, on this flimsy basis, misguided. So is the fallacy, cherished by generations of Keynesian scholars, that technocratic policy management can be used to fine-tune the business cycle. Keynes himself ridiculed this hubris, remarking to his over-eager disciples that “you can promise to be good, but you cannot promise to be clever.”
Ultimately, MMT may not be all that different from standard economics. Scorn for public debt costs has long since entered the disciplinary mainstream, as have a renewed openness to discretionary fiscal policy and skepticism about monetary tools. Where it deviates from consensus, however, is also where it errs. One Citibank report sums up MMT’s conclusions as follows: “what’s right is not new, what’s new is not right, and what’s left is too simple.” Drawing inferences about the potential for unprecedented infrastructure plans, universal healthcare, and constant full employment from the necessary response to the current recession is disingenuous. That the US could spend more without increasing taxes is true and banal. One cannot therefore conclude, however, that spending does not need to be “paid for.” Logic and reality resist such simplicity.
Modern Monetary Theory sounds confusingly similar to regular economics because it is. MMT isn’t analysis at all: it’s an attitude.
Featured Image Source: ResearchGate
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