Modern Monetary Theory: A Valid Proposal Or Voodoo Economics?

Apr 27th, 2019 | By | Category: Featured Issues, Politics & Current Events

Modern Monetary Theory (MMT) is a macroeconomic theory that has won recent converts, especially presidential candidate, Bernie Sanders, and Congresswoman Alexandria Ocasio-Cortez (AOC), who argues that this is how she would finance her radical Green New Deal.  Paul Krugman, Pulitzer prize-winning columnist calls MMT “Calvinball” (a game played in the comic strip “Calvin and Hobbes).”  Former Treasury Secretary, Larry Summers refers to MMT as the new “Voodoo economics.”  Laurence D. Fink and Bill Gates call MMT “garbage” and “crazy talk.”  When the University of Chicago’s Booth Business School polled economists on MMT ideas, only 28% agreed with MMT, while 72% strongly disagreed.  Nonetheless, some Progressive Democrats are embracing MMT as a way to finance a vastly expanded “Medicare-for-All,” ambitious infrastructure projects and other government programs.  What is MMT and why are more people paying attention to it?  Is it “magic” as an economic plan or is it a proposal that could bankrupt the United States?

As The Economist recently put it, “MMT has its roots in deep doctrinal fissures.  In the decades after the Depression economists argued, sometimes bitterly, over how to build on the ideas of John Maynard Keynes, macroeconomics’ founding intellect.  [The inflation of the 1970s killed classic Keynesian economics, which was replaced by a monetary policy led by central banks.]  In the end, a “Post-Keynesianism” [emerged]: an eclectic mix of ideas consigned to the heterodox fringe.  In the 1990s a number of like-minded thinkers drew on post-Keynesian ideas in fleshing out the perspective embodied in MMT.”  There is no “canonical MMT” model but there are several central ideas.  If there is a guru of MMT, it is economics professor Stephanie Kelton of Stony Brook University on Long Island.  [Other academic strongholds for MMT are the University of Missouri—Kansas City and the Levy Economics Institute at Bard College.]  Her central argument:  “The government doesn’t need to worry so much about how much it borrows to pay for spending programs.  Unlike a household or business, it can never run out of money.  The government can always print money to pay for debts.  The constraint, according to MMT, isn’t the deficit, but whether the borrowing and spending spurs inflation and disrupts economic activity.”  In effect, MMT “debunks 40 years of misassumptions of how markets and public credit work.”  But the entire appeal of MMT rests on two foundational assumptions:  Fiscal deficits are irrelevant as long as unemployment is low and prices are stable.  “Raising spending when the economy is already at capacity can lead to rapid inflation.  The purpose of taxes, then,  is to keep inflation in check.  Spending is the accelerator, taxation the brakes.”

The Republican Party has historically been the Party most concerned about the deficit spending of the US government.  But both the White House and the Congress in 2017 and 2018 generated annual deficits of nearly $1 trillion.  The annual deficits will continue to grow due to the massive tax cuts of the Trump era and the increase in military spending.  The Wall Street Journal reports that “The [US] deficit totaled 4.5% of economic output last year, compared with an average of 2.9% over the previous 50 years.  Debt-to-GDP has more than doubled, from 35% at the end of 2007 to 78% by the end of 2018 and is on track to hit 93% by 2029.”  Anyone who is not concerned with these figures is foolish and deceitful.  That the Republican Party under Donald Trump is advocating and implementing such increases in deficit-spending is shameful and unprincipled.  The Party did not justify such deficits on the basis of MMT; it was an act of political expediency.

But why have Progressives found MMT appealing?  Sanders and AOC, for example, counter that established assumptions about deficits are not true.  Big government deficits were supposed to mop up available pools of capital and drive up interest rates, which would, in turn, elbow out private investors, damage growth and feed inflation.

  • In their view the reason this has not happened is that the federal deficit is too small, “depriving the economy of critical investments. The best way to stabilize the economy and ensure full employment and a humming economy . . . is to have the federal government guarantee everyone a job.”
  • Giant private-sector deficits are much more alarming than public-sector ones because households and companies are at much greater risk of losing access to credit in a downturn. Unlike the US treasury, they cannot print money or issue bonds.
  • MMT also hints that taxes will not increase because governments have an almost unlimited ability to print money and issues bonds; hence, major tax increases are not necessary.

As several economists have observed, MMT gives every evidence of being “free-lunchonomics.”  No matter how one views MMT, its basic premise means that some future generation will pay for our immediate profligacy.  And at some point in time, the idea of government simply printing money to finance its programs will produce hyperinflation.  As Federal Reserve Chairman, Jerome H. Powell, has argued, “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong.”  Both common sense and classical economics indicate the real dangers with the MMT model—surging inflation and ever higher interest rates.  Additionally, rising government spending will crowd out more productive private investment.  And, a rather haunting question persists:  “How much more debt can you have on the US balance sheet and not have global financial markets react?”  The current US national debt is over $22 trillion, an unimaginable figure.  MMT advocates basically argue that this figure is not important.  The only factor that is important is the ability of the national government to print money and issue bonds.  Geopolitical factors such as who owns the US debt are also important and largely ignored by progressives who advocate for MMT.  That China holds such a large portion of our debt does seem to be important.  To argue, as MMT advocates often do, that to service the US debt, all the Treasury needs to do is print more money is not only counterintuitive when it comes to normal economic thinking, but also seems to ignore the consequences of such practices when one examines history.  Michel Bloomberg, former New York mayor, when asked about MMT and its major tenet of government’s singular ability to print money, declared, “This is the path to making America the next Venezuela.”  Although hyperbolic and filled with political nuance, Bloomberg raises a major point—how does government guarantee that its unique ability to simply print money to meet its obligations not produce hyperinflation quite rapidly?

In the final analysis, MMT seems to me to be a panacea that a few Progressive politicians are embracing to explain their extraordinary claim that they can finance the Green New Deal and Medicare-for All, without significant increases in taxes and without the genuine threat of real inflation.  MMT seems too risky and too unproven to adopt as a national economic policy of the United States.

See “Free Exchange,” in The Economist (16 March 2019), p. 67; Kate Davidson in the Wall Street Journal (1 April 2019); and Patricia Cohen in the New York Times (7 April 2019).

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