I read an article in the Financial Times earlier this week (September 23, 2023) -…
Many people have drawn to my attention in recent weeks the evolution of the Modern Monetary Theory (MMT) Wikipedia entry and raised concern about the criticisms that are now on that site. I thought I better go and read the entry. I certainly have not added material to the site. Having said that I am happy that there is a page available. It seems that the criticisms cited are sourced to blogs by an Austrian Schooler, a graduate student blogger, and Brad DeLong. There does not appear to be an sound academic citation. The critics actually admit to basing their views on a cursory reading of the MMT literature and then only on the blogs that are out there now (including this one). The major claim is that MMT is just an accounting tautology. That just means they have read the first of hundreds of pages of MMT and then probably haven’t really grasped its significance. MMT is in fact an accounting-consistent, operationally-sound theoretical approach to understanding the way fiat monetary systems work and how policy changes are likely to play out.
The Austrian critique is based on this blog entry – The Upside-Down World of MMT – and no academic work is provided to back it up.
Mr Murphy began his critique with the follow “Krugmanesque myth”:
According to many proponents of MMT, “deficits don’t matter” when a sovereign government can issue its own fiat currency, and all the hand wringing over the government’s solvency is absurd.
Which proponents say “deficits don’t matter”? Answer: None that I know and I am close to all the major developers of the “school of thought”.
Please read my blog – To challenge something you have to represent it correctly – for more discussion on this point.
That inauspicious opening is a clue to what follows. I suspect Mr Murphy hasn’t read any of the definitive primary source material.
Which is evident in this admission by Mr. Murphy:
After my admittedly brief exploration, I have concluded that the MMT worldview doesn’t live up to its promises.
So no deep analysis. Let me say that I took two full courses in Austrian economics during my studies – 1 at undergraduate level and 1 at postgraduate level and have studied in depth the main academic texts. I have also read all the major contributions by Austrian economists since my student days.
But Mr Murphy, our Austrian School blogger, reads a few blogs – “briefly” – and then decides MMT is just tautology.
You will note that the example used by Mr Murphy to refute the ineluctable MMT accounting logic that government deficit (surplus) = non government surplus (deficit) is a non-monetary barter economy where Robinson Crusoe collects coconuts and eats less than he collects and so saves (in real terms). He then gets a stick to allow him to collect more coconuts.
He says that:
This is an admittedly simple story, but it gets across the basic concepts of income, consumption, saving, investment, and economic growth. Now in this tale, I never had to posit a government running a budget deficit to make the story “work.”
It is a very simple story.
It fails to get across any information about income, consumption, saving, investment and economic growth in a monetary economy.
It is not a monetary economy using a fiat currency issued under monopoly conditions by the national government. There is no unemployment in a barter economy. With no trade (another assumption of Murphy) and “own-production” then saving is always at the same time investment and there can never be a deficiency of aggregate demand.
Barter economics provides no insights into what happens in an monetary economy where consumers and producers are not the same entity, transactions cross borders, and, crucially, you cannot go on paying taxes unless the government spends first (in macro context).
Murphy also claims that the standard national income-expenditure statement which most macroeconomists (not just MMT proponents) would accept is flawed. He uses this to say that there is “something is very fishy with the MMT conclusions regarding private saving and government budget deficits”:
The error crept in at step one, with the equation GDP = C + I + G + (X – M). The only justification for measuring “output” (left-hand side) by the summation of spending (on the right-hand side) is that in a market exchange, the “value” of something is whatever the buyer spends on it. However, if the government can raise revenues through present taxation or by borrowing now and paying back with future taxes, then this justification falls away. It’s simply not true that $1,000 in private consumption or investment spending is an equivalent amount of “real output” to $1,000 spent by bureaucrats who raised the money without the consent of their “customers” and who may very operate under a “use it or lose it” appropriations process.
So cutting through the ideological hype (about consent and inefficient “use it or lose it” government spending etc), you realise that Mr Murphy does not understand basic macroeconomics.
If consumers or firms order $1000 worth of shirts from a clothing manufacturer and prices do not change then real output goes up by $1000. GDP rises by $1000 and National income rises by $1000.
If the same order is received from a government department – exactly the same result occurs. The National Accounting framework does not have in-built paranoia about “crowding out” effects or the primacy of private free market exchanges which are implicit in Mr. Murphy’s (false) claim.
Moreover, Mr. Murphy doesn’t appreciate how interest rates are set in a modern monetary economy. He claims that a “fundamental problem with relying on macro-accounting tautologies” (which he considers is the basic flaw of MMT) is that “people often bring in causal arguments from economic theories without realizing they are doing so”.
Then he provides this example whic his derived from the sectoral balances (in his case he ignores the external sector):
G – T = S – I
As a free-market economist, I don’t need to run from this tautology. I can use it to underscore the familiar “crowding out” critique of government deficit spending. Specifically, if government spending (G) goes up while tax revenue (T) remains the same, then the left-hand side of the equation gets bigger as the government budget deficit grows. So the accounting tells us that the right-hand side must get bigger too. It may happen partially because people cut down on consumption and save more (due to higher interest rates and their expectation of higher tax burdens in the future), but it may also happen because private-sector investment goes down. In other words, as the government borrows and spends more, the equation tells us we might see lower private consumption, rising interest rates, and real resources being siphoned out of private investment into pork-barrel spending projects. I can tell my “story” of the dangers of government deficit spending with that equation just fine.
First, whereas his Robinson Crusoe example was meant to “prove” that government deficits (G > T) are not required for the non-government sector surplus (in this case, the private domestic sector surplus because he assumes away the external sector), this example, clearly refutes that once a government sector is introduced (which issues the currency).
Consider the sources of spending in a closed economy, Household Consumption (C), Private Investment (I), and Government spending (G). Together they equal total aggregate demand and national income (GDP):
GDP = C + I + G
The uses of GDP (National Income) in a closed economy are, Consumption (C), Saving (S) and Taxes (T). So from that perspective:
GDP = C + S + T
In other words:
C + I + G = GDP = C + S + T
Re-arranging that a bit:
C + (G – T) = C + (S – I)
Which you can interpret to mean that in an accounting sense (theories come later), total private consumption (C) plus the budget deficit (G – T) equals total private consumption (C) plus the private sector surplus (S – I).
Assume C = 100 and G = T = 0 and so if I is equal to 100 then GDP must be equal to 200.
Then 100 + 0 = 100 + (S – I). So S = 100 and (S – I) = 0.
In other words the private domestic sector’s total spending is 200 and its total income is 200, which means they spend exactly what they earn and cannot accumulate financial assets via saving overall. In this case, the private sector overall cannot reduce debt levels.
Now imagine if G was 100 and Taxes 50 in the previous example.
Then C + (G – T) = C + (S – I) = 100 + (100 – 50) = 100 + (S – 100). In this case, GDP would be 300, and S would be 150 and the private domestic sector spends less than they earn by 50 (S – I = 50). The only way that the private domestic sector could spend less than they earn in these circumstances would be if the government provided the demand boost to permit higher saving.
A way of understanding this is that the leakages from the spending stream (in this case, S + T) must equal to the injections into the spending stream (in this case, G + I) for GDP to remain unchanged. Otherwise, GDP adjusts and so would S and T until the equality was reached. So S = 150, T = 50, and G and I are 100 satisfies that “equilibrium condition”.
Mr Murphy imposes his skewed theories and suggest that the rise in (S – I) is because consumption falls (Ricardian agents fearing tax rises or reacting against interest rate rises) and/or investment falls (due presumably to higher interest rates). That is, public spending crowds out private spending.
Then we enter the theoretical and empirical dimensions. Why do interest rates rise when governments net spend? In a modern monetary economy, the central bank sets the interest rates and governments spend without recourse to “funding”.
To understand the causality – start of at Day 1 of a new monetary system. How do the private sector pay their taxes or buy government bonds in the new currency which they do not issue? The answer is incredibly simple. The government has to spend first and put the currency into the hands of the non-government sector.
The government doesn’t need to draw on any non-government saving in order to spend. And when it spends it boosts income and private saving is always a function of national income.
Ask yourself which conceptual view (theory) accords with the data? MMT or crowding out? If you think crowding out then please explain Japan for the last 20 or more years – rising deficits, rising saving, zero interest rates, positive investment (with cyclical fluctuations).
Also explain why the US doesn’t have crippling interest rates right now and why rate pressure is downwards?
For those who do update the Wikipedia page perhaps you can now amend the text pointing to Murphy’s blog accordingly.
Then there was the blog by the postgraduate student mentioned in the Wikipedia article as constituting an authoritative reference. This person said:
Bob Murphy has a post up debunking Modern Monetary Theory … His reaction is essentially the right one: it’s bad economics to confuse accounting identities with behavioral laws.
This student also says “I haven’t put all that much time into learning about it” (it being MMT) but has the temerity to pronounce MMT “debunked”.
I don’t really think a two paragraph blog which says that “economics is not accounting” is an academic way to proceed.
Where for example, does any MMT proponent (the main proponents) say that “accounting is economics”? Answer: no where. So just as “economics is not accounting” this criticism has nothing to do with MMT.
The confusion lies in those who want to represent MMT by the sectoral balances framework – as if that is the extent of it. In this blog – Stock-flow consistent macro models – I explain why accounting is important for a macroeconomist.
Flows add to stocks and you have to track those relationships consistently over time. One still has to theorise about what determines the flows and their inter-relationships but if you try to make statements that do not add up then you are lost in ad hocery and nonsense.
What is a good example of that? Take the proposition that is prominent in the current debate and perpetuated as much by conservatives as progressives. That there is too much debt (public and private) at present and both sectors have to endure a period of deleveraging. Governments pursuing fiscal austerity programs have stated exactly that and also in the same breath claim it will be good for jobs and growth.
Simple accounting tells you that the proposition that both the private domestic and public sectors can reduce debt will only be possible under special conditions. I exclude the sensible option that governments stop issuing debt to match their deficits. The deficits are the Flow (of net spending) and the rise in public debt is the Stock response (given current institutional arrangements).
Take the sectoral balances:
(S – I) = (G – T) + (X – M)
Please read my blog – Saturday Quiz – August 27, 2011 – answers and discussion – for a full derivation (see answer to Question 3).
Private domestic deleveraging requires (S > I). A government surplus (G < T) is required to reduce public debt (in levels not as a percentage of GDP). To be possible, this would require the external surplus to be greater than the sum of the private domestic and government surpluses. For most nations that is a very unlikely occurence. But if the external account is in deficit, then it is impossible for both sectors to reduce their debt levels simultaneously.
You can make that sort of “reality check” conclusion by understanding the stock-flow relations embedded in the National Accounts. In that sense, MMT is stock-flow consistent and is based firmly on the constraints imposed by our national accounting structures. But if that is all there is to it then we would not have gone very far.
Brad DeLong wrote a blog (April 15, 2011) – Is “Modern Monetary Theory” Modern or Monetary or a Theory? which is also cited as a critique of MMT in the Wikipedia article.
I wrote a blog about Brad DeLong’s analytical position – There is no credit risk for a sovereign government – about this time last year (August 17, 2010). While DeLong likes to think of himself alongside Paul Krugman as part of the “Keynesian” army against all the neo-liberals they are both New Keynesians. In that sense, they are not very dissimilar to the current dominant orthodoxy (Greg Mankiw and co).
In that blog I noted that DeLong teaches his students that:
As the late Milton Friedman put it, for the government to spend is for the government to tax. Whenever the government spends, it is also promising explicitly or implicitly to tax somebody, either in the present or the future, either directly or indirectly, to pay for that purchase.
I wondered how he then explains the decades of consistent budget deficits that the US government (and most other governments ran in the Post Second World War period? Implicit in this citation of Friedman is the Barro Ricardian Equivalence nonsense. Accordingly, students are told that governments can net spend now if they issue debt but because the debt has to be paid back there is an implied tax rise which is known by households and firms and they accommodate that into their present spending decisions.
The reality is that governments do not usually retire their outstanding debt obligations (other than the trivial situation of paying back maturing obligations as new obligations are issued). There is also no empirical evidence to support Ricardian Equivalence. Why aren’t UK consumers rushing out to spend? Why are they saying their major concern is job insecurity exacerbated by the Government’s attack on the deficit?
Anyway, DeLong stated in his April 15, 2011 blog that:
I think I am beginning to understand what had confused me: MMT is not M, or M, or T … unless the proponents of a point of view admit that it is a set of guesses about the world that is potentially falsifiable, you don’t have a theory–rather you have a tautology … Issuing money in exchange for goods or services is called “spending”. Issuing bonds in exchange for goods or services is called “borrowing.” Destroying private-sector assets via taxation is called “taxing.” The government’s spending, borrowing, and taxing together make up not its monetary policy but its fiscal policy.
There is no reference to the primary MMT academic literature in DeLong’s attack. Instead he quotes from a blog that is itself an attempted critique of MMT. Sound academic practice, not!
But once again we meet this claim that MMT is just a tautology. And I can only assume that the critique comes from not understanding the depth of the MMT framework. I suggest that is implied when Brad DeLong thinks that issuing debt is a fiscal policy act – which is the mainstream textbook position.
First, MMT is about monetary economies (that is the _M_) part. It is not about barter economies which a major part of mainstream theory is built upon (such as the Corn Models). If you read New Keynesian theory you will find that they introduce “money” into their models in a way that fails to remotely correspond to the dynamics and operational realities of a modern monetary economy based around a fiat currency with a central bank setting interest rates.
Further, without attempting to understand how central banks actually operate, New Keynesians derive their monetary rule (which is just an interest rate setting reaction function) by assuming that the central bank minimises a loss function in which both deviations of inflation from its target value and deviations of output from its natural level play a role, subject to the Phillips curve they impose (with natural rate properties enforced despite empirical rejection).
They also assume that the central bank can control aggregate demand using the interest rate. So they have a sort of Taylor rule such as the real interest rate set equals the natural interest rate plus some function of the inflation gap plus some function of the output gap (output out of sync with the potential).
The models are thus always represented in real terms, whereas the central bank can only set the nominal interest rate. To get around that problem they presume that the central bank can observe both the natural output level and the natural rate of interest correctly. That is, of-course impossible in reality and defies the operational realities in which central banks operate.
Please read my blog – Mainstream macroeconomic fads – just a waste of time – for more discussion on this point.
Monetary economies are quite special – for example, it is only the introduction of state money that generates the possibility of unemployment.
Second, MMT is about fiat monetary systems which are “modern” given the collapse of Bretton Woods was in 1971. The flexible exchange rate period is the most recent organisational framework for exchange rates. So that is the M__ part. It is true that the concepts used in MMT derive back to an older literature – Marx, Kalecki, Keynes, Knapp, Lerner etc. But in understanding the operational realities that confront governments now MMT is explicating choices and implications in a non-convertible monetary system.
Third, MMT is also ground in operational realities that pertain to the modern fiat monetary system. MMT provides unique insights by detailing the way the system actually functions rather than an ideological wash of how we might like it be (which is essentially the mainstream textbook approach).
For example, a national government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored).
Once we realise that government spending is not revenue-constrained then we have to analyse the functions of taxation in a different light. Taxation functions to promote offers from private individuals to government of goods and services in return for the necessary funds to extinguish the tax liabilities.
The orthodox conception is that taxation provides revenue to the government which it requires in order to spend. In fact, the reverse is the truth. Government spending provides revenue to the non-government sector which then allows them to extinguish their taxation liabilities. So the funds necessary to pay the tax liabilities are provided to the non-government sector by government spending. It follows that the imposition of the taxation liability creates a demand for the government currency in the non-government sector which allows the government to pursue its economic and social policy program.
This insight allows us to see another dimension of taxation which is lost in mainstream analysis. Given that the non-government sector requires fiat currency to pay its taxation liabilities, in the first instance, the imposition of taxes (without a concomitant injection of spending) by design creates unemployment (people seeking paid work) in the non-government sector. The unemployed or idle non-government resources can then be utilised through demand injections via government spending which amounts to a transfer of real goods and services from the non-government to the government sector. In turn, this transfer facilitates the government’s socio-economics program. While real resources are transferred from the non-government sector in the form of goods and services that are purchased by government, the motivation to supply these resources is sourced back to the need to acquire fiat currency to extinguish the tax liabilities.
Further, while real resources are transferred, the taxation provides no additional financial capacity to the government of issue. Conceptualising the relationship between the government and non-government sectors in this way makes it clear that it is government spending that provides the paid work which eliminates the unemployment created by the taxes.
So it is now possible to see why mass unemployment arises. It is the introduction of State Money (which we define as government taxing and spending) into a non-monetary economics that raises the spectre of involuntary unemployment. For aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period). Involuntary unemployment is idle labour offered for sale with no buyers at current prices (wages). Unemployment occurs when the private sector, in aggregate, desires to earn the monetary unit of account through the offer of labour but doesn’t desire to spend all it earns, other things equal. As a result, involuntary inventory accumulation among sellers of goods and services translates into decreased output and employment. In this situation, nominal (or real) wage cuts per se do not clear the labour market, unless those cuts somehow eliminate the private sector desire to net save, and thereby increase spending.
So the purpose of State Money is to facilitate the movement of real goods and services from the non-government (largely private) sector to the government (public) domain. Government achieves this transfer by first levying a tax, which creates a notional demand for its currency of issue. To obtain funds needed to pay taxes and net save, non-government agents offer real goods and services for sale in exchange for the needed units of the currency. This includes, of-course, the offer of labour by the unemployed. The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.
You will not understand these aspects of the modern fiat monetary system by reading a macroeconomics textbook (written by Brad DeLong or Paul Krugman or any other mainstream economist).
To understand how taxes are used to attenuate demand please read this blog – Functional finance and modern monetary theory.
So here we have some essential insights from MMT which combine a detailed scrutiny of how monetary systems operate with theoretical notions linking spending to income generation. It is true that these “theories” are not new and Marx, Kalecki, Keynes and others clearly understood the fact that aggregate demand drives income and output.
After all they were variously fighting the mainstream claims that aggregate demand could never be deficient and that all unemployment was a voluntary preference for leisure – which is the underlying theme of mainstream macroeconomics.
But then MMT proponents have never claimed to have invented a new theory. What we have done is to take theories of spending and income determination that have stood the test of time and embedded them in a very concise stock-flow consistent framework which is grounded in the operational realities of the fiat monetary system.
In doing that MMT can also see why a non-fiat monetary system (such as the Eurozone) fails.
Fourth, is public borrowing a part of monetary or fiscal policy? Brad DeLong claims it to be exclusively a fiscal act. To some extent the distinction between the two arms of aggregate policy is indistinct although mainstream economists consider the boundaries to be clear – which is a reflection of the shortcoming of their approach.
The fundamental principles that arise in a fiat monetary system (to repeat) are as follows.
- The central bank sets the short-term interest rate based on its policy aspirations.
- Government spending is independent of borrowing which the latter best thought of as coming after spending.
- Government spending provides the net financial assets (bank reserves) which ultimately represent the funds used by the non-government agents to purchase the debt.
- Budget deficits put downward pressure on interest rates contrary to the myths that appear in macroeconomic textbooks about ‘crowding out’.
- The “penalty for not borrowing” is that the interest rate will fall to the bottom of the “corridor” prevailing in the country which may be zero if the central bank does not offer a return on reserves.
- Government debt-issuance is a “monetary policy” operation rather than being intrinsic to fiscal policy, although in a modern monetary paradigm the distinctions between monetary and fiscal policy as traditionally defined are moot.
If governments spend by crediting bank accounts and operationally do not need revenue to spend (given they issue the currency) then borrowing is not undertaken to facilitate spending.
Accordingly, debt is issued as an interest-maintenance strategy by the central bank. It has no correspondence with any need to fund government spending. Debt might also be issued if the government wants the private sector to have less purchasing power.
So borrowing is a monetary policy action and part of the central bank’s liquidity management strategies. It is not part of fiscal policy because in a fiat monetary system there is no imperative to borrow.
The central bank may agree to pay the short-term interest rate to banks who hold excess overnight reserves. This would eliminate the need by the commercial banks to access the interbank market to get rid of any excess reserves and would allow the central bank to maintain its target interest rate without issuing debt.
DeLong fails to explore the deeper operational realities that are characteristic of a fiat monetary system. MMT provides that depth of reasoning which goes well beyond the realm of tautology and definitional truths.
I clearly have a theoretical model that I use to make sense of the operational realities of the system. I often make predictions based on that theoretical framework and then trace through the stock-flow implications in a consistent way. If I start to chalk up consistent forecast errors based on my application of theory to reality then I will wonder about the approach I take.
Anyway this brings me to the final point – having an academic debate without any academics being involved – which seems to be a common theme running through the “critiques” of MMT on Wikipedia.
Just this week I noticed Paul Krugman continued to act as the MMT marketing manager in his blog (August 26, 2011) – Academic Debate, Real Consequences (Wonkish). The topic is irrelevant really for the point I am making here.
Notice the title – Academic debate – and in the body of the text he cites a number of articles from his New Keynesian academic mates. Then he says:
Meanwhile, Cullen Roche makes much the same argument, although he insists that you need MMT to make it, which would be news to Woodford (and me).
The “much the same argument” is linked to a blog site that Cullen Roche runs which is sympathetic to MMT and was founded in 2008. As his bio tells you Cullen Roche is involved in the financial markets as an investment adviser.
In Paul Krugman’s recent attack on MMT he also cited Cullen Roche’s blog as the authority. Please read my blog – To challenge something you have to represent it correctly – for more discussion on this point.
And with all due respect to Cullen, he is not an academic and is a relative newcomer to MMT.
The point: how can you have an “academic debate” if you do not cite the primary sources of the literature? Answer: You cannot.
It is like having a conference about Keynes with no scholars of Keynes in attendance. But then Paul Krugman participates in those events too. Please read my blog – A celebration of 75 years since Keynes turns into a farce – for more discussion on this point.
This is not an exhaustive treatment of the topic. But it does expose the fact that those who have sought to “debunk” MMT have barely even read the main academic literature and have clearly misunderstood or misrepresented what limited amount they have read.
This quote comes from the 1989 book (page 79) – The Tao of Health, Sex & Longevity written by American Daniel P. Reid (who now lives in Australia).
The pain of a new idea is one of the greatest pains in human nature … Your favorite notion may be wrong, your firmest beliefs ill founded. And your favorite foods may be the root cause of your greatest pains! It’s a fact of life that people find it much easier to believe a lie they’ve heard a thousand times than a fact they’ve never heard before.
There was a line I read the other day from Nicholas Klein who was addressing the Amalgamated Clothing Workers of America in 1914. He said:
And, my friends, in this story you have a history of this entire movement. First they ignore you. Then they ridicule you. And then they attack you and want to burn you. And then they build monuments to you. And that, is what is going to happen to the Amalgamated Clothing Workers of America.
I don’t think MMT proponents want any monuments. Just some sensible policy aimed at reducing unemployment and restoring dignity in the lives of those who have borne the brunt of the neo-liberal onslaught.
The quote resonates with a quote Warren Mosler used to use in his slides (which is attributed – with some dispute – to German philosopher Arthur Schopenhauer):
All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.
The fact that the MMT critics are starting to come out is a good thing. We are past the stage of being ignored and moving into the ridicule stage.
Next step we get our flame suits out (although I must say I have worn one most of my career such has been the attacks).
That is enough for today!