I want to commend Cullen Roche’s post on the good, the bad, and the ugly of modern monetary theory to your attention. You will be hearing a lot more about MMT in the coming year or so, since it’s being espoused by people who want to spend a lot more than they can within present constraints, and you may find it informative. I suspect that most of them will ignore this key passage from his post:
Importantly, MMT does not say deficits don’t matter or that the government has NO constraint. While the government has no nominal budget constraint it does have a real budget constraint (ie, inflation).
and, importantly, real productive capacity. Our present problem is that we’re already issuing ourselves credit faster than inflation and faster than we’re increasing what we’re producing. Therefore, if you want to consume more you should want us to produce more. There are fundamentally two ways that more can be made available to consume:
- We can import less.
- We can produce more.
In theory we could also export more but other countries want to consume more, too, and are in a position to block that strategy.
In my view if we elect to do none of those things and instead issue ourselves credit so we can buy whatever we want, untethered to the underlying economy, it’s risky.
A few more things to keep in mind: very few Keynesians actually believe in what Keynes taught, very few free marketeers actually believe in free markets, and very few of those who claim to support MMT actually do. There will never, however, be a lack of people longing for perpetual motion.
Also I remember very clearly Paul Krugman’s curt assessment of MMT (“it’s just wrong”). As those espousing what could best be thought of us “folk MMT” gain more influence in the Democratic Party, I expect that to disappear into the memory hole.
Update
There’s another good explainer on MMT at The Macro Tourist.
No one “adopts” MMT as a way of doing things. We already operate this way, it’s just that it only applies to tax cuts and military spending. Anything else is considered financially constrained as though it exists in an entirely different monetary system.
Ben,
I think it’s actually 100% the opposite. Defense spending requires annual appropriations. “Mandatory” spending – the vast majority of spending by the federal government – does not. It has no financial constraints except occasional executive-level rule-changes. There’s no upper-bound on it while there is, every year, an upper bound on what can be spent on defense. The value of MMT will be tested there, not on defense and other discretionary spending.
So the 2020 Democratic Platform will consist of Medicare for all paid for by a wealth tax, a 70% income tax, and money printing? And this is just for starters? Where’s the main course?
Andy, Republicans and Democrats never ask how military spending is paid for. Ever. Republicans never ask how we pay for a tax cut. Only affordability of social programs is subjected to sound finance logic.
Ben,
Republicans and Democrats say a lot of things that don’t comport with reality and are blatant hypocrites.
In the real world, the growth of entitlement spending has far outstripped defense which has trended down over the last 6 years or been mostly flat (depending on your metric) and is WAY lower than at any time during the Cold War period.
So when you say that “We already operate this way (MMT)” when it comes to defense I don’t think the data supports your argument (tax cuts is another story).
I will try to keep this short.
MMT describes an accounting tautology because the monetary system is based upon an accounting tautology, but what it creates is credit. Properly understood, debt is on the minus side of a balance sheet, and debt is extended not credit. Credit is on the plus side, but it is not the only thing on the plus side.
Money (M1 or M2, take your pick), actual assets, and credit (financial derivatives) are on the plus side. “Money” is created through lending, and by repaying a debt obligation, “money” is destroyed.
The monetary system is based upon fractional reserve lending, and the entire monetary system is technically bankrupt at all times. Monetary transactions are transfers of the plus side of one balance sheet to another the plus side of another, and as long as all balance sheets are balanced, the system can be considered solvent.
When there is no money (M1/M2) for a monetary transaction, it must be borrowed, and one financial entity lends it to another for the duration of the transaction. Monetary transactions that occur on a single balance sheet are transfers from one account to another, and they do not require money( M1/M2).
The government can create money (M1/M2), but it is also done through credit creation. Money (M1/M2) is the residual from credit destruction. When the government “borrows money”, it creates credit, and this credit is subject to the same “Laws of Financing”. (To my knowledge, I just created this term.) The credit created is destroyed through debt repayment, but because the government is borrowing from itself, the interest is not destroyed. It becomes money (M1/M2).
(The Laws of Financing are accounting tautologies applied to fractional reserve lending. “Money” created through lending will be destroyed through debt repayment. As long as an equilibrium is maintained, the balance sheet size does not matter. Simply, “money” is credit, and credit is “money”. It is the Theory of Financial Relativity.)
When the government uses a balanced balance sheet, inflation is not a big problem. The increase in actual money (M1/M2) is miniscule when compared with credit creation.
Hyperinflation occurs when the government does not use a balance sheet. In this case, the government would add to the plus side with no counterbalance on the minus side.
Asset inflation is the problem, and there is no objective way to determine if an asset price is increasing because of added value or credit. (The Relativity problem of determining which train is moving.) The entire monetary/financial system is based upon asset value, but there is no natural way to determine the actual value. Fiat money creates fiat value.
The Great Depression and Recession were caused by the same phenomenon – hyperdeflation of fiat value. Fiat value is supported only by faith that the asset is priced correctly, and this pricing is based upon the pricing of similar assets. If one is mispriced, most likely all others are mispriced, and any derivatives of those assets are most likely mispriced.
Monetary flows are a phenomenon based upon hard(ish) money (M1/M2). In a credit backed monetary system, the system is based upon credit flows, and these occur as the credit is created and destroyed. Monetary flows in a credit backed monetary system are transfers from one balance sheet to another, and only fiat value is created.
MMT assumes that inflation can be used to regulate the system. In this system, asset inflation occurs when fiat value increases, and by definition, fiat value cannot be measured.
Since the 2008 Financial Collapse was caused by the inability of sub-prime borrowers to make payments, the simple solution would have been a guaranteed second job or guaranteed minimum income that would have allowed the borrowers to make their payments.
MMT is based upon the theory that fiat money can create fiat value in perpetuity, but much like perpetual motion is impossible, perpetual fiat value creation is also impossible.
I tried to keep it short.