In an op-ed in the Washington Post Lawrence Summers expresses his worries about American politicians embracing Modern Monetary Theory:
First, it holds out the prospect that somehow by printing money, the government can finance its deficits at zero cost. In fact, in today’s economy, the government pays interest on any new money it creates, which takes the form of its reserves held by banks at the Federal Reserve. Yes, there is outstanding currency in circulation, but because that can always be deposited in a bank, its quantity is not controlled by the government. Even money-financed deficits cause the government to incur debt.
Second, contrary to the claims of modern monetary theorists, it is not true that governments can simply create new money to pay all liabilities coming due and avoid default. As the experience of any number of emerging markets demonstrates, past a certain point, this approach leads to hyperinflation. Indeed, in emerging markets that have practiced modern monetary theory, situations could arise where people could buy two drinks at bars at once to avoid the hourly price increases. As with any tax, there is a limit to the amount of revenue that can be raised via such an inflation tax. If this limit is exceeded, hyperinflation will result.
Third, modern monetary theorists typically reason in terms of a closed economy. But a policy of relying on central bank finance of government deficits, as suggested by modern monetary theorists, would likely result in a collapsing exchange rate. This would in turn lead to increased inflation, increased long-term interest rates (because of inflation), risk premiums, capital fleeing the country, and lower real wages as the exchange rate collapsed and the price of imports soared.
I think that Dr. Summers is missing a number of the subtleties in the idea. Because the dollar remains the world’s primary reserve currency there’s a lot more demand for dollars than there is for, say, the Venezuelan bolivar. That provides more leeway for U. S. spending than would otherwise be the case.
Also, as long as production outstrips spending I think it’s true that we can spend more than we take in.
Where MMTers and I disagree is that I think there’s more risk than many of them do, the risk may emerge suddenly and without warning, and the consequences would be catastrophic.
Where serious, sensible modern monetary theorists and I agree is that I don’t think we need to balance running a deficit in one year with running a surplus in some other year. As long as our deficits are relatively small we can run them indefinitely. However, talk of running deficits in the tens of trillions (without commensurate expansion of production) worries me, too.
To me, the problem is with economics more broadly. It seems economists – writ large- are wrong. I don’t believe any of them have been able to predict the tipping point for excessive debt/deficits.
My usual response to this, which I presume would be bitterly contradicted by worthies like Drs. Summers and Krugman, is that economics is a descriptive science like anthropology not a predictive one like physics.
It is also what I mean when I say that fine-tuning is not possible. IMO economics is just observation and common sense. People respond to incentives. That they do not respond perfectly and deterministically to incentives makes people say that it doesn’t work.
‘That they do not respond perfectly and deterministically to incentives makes people say that it doesn’t work.”
Or uniformly. All of the vagaries ultimately end up in price. Every scheme to distort price deteriorates market signaling and efficient function. MMT is just another of those schemes.