Modern Monetary Theory – what is new about it?

In a few weeks I am off to the US to present a keynote talk at the – International Post Keynesian Conference – which will be held at the University of Missouri – Kansas City between September 15-18, 2016. I will also be giving some additional talks in Kansas City during that week if you are around and interested. The keynote presentation is scheduled for Friday, September 16 at 17:00. The topic of my keynote presentation will ‘What is new about MMT?’ and will challenge several critics from both the neo-liberal mainstream and from within the Post Keynesian family that, indeed, there is nothing new about MMT – they knew it all along! Well the truth of it is that these characters clearly didn’t previously know or understand a lot of key insights that MMT now offers. No matter how hard they try to reinvent what they knew, the facts are obvious. MMT makes some novel contributions to our knowledge base and shows why a lot of so-called mainstream macroeconomic theory that parades as ‘knowledge’ is, in fact, non-knowledge. This blog and the second-part will provide some notes on the paper I am writing (with my colleague Martin Watts) on this topic.

1. Introduction

Over the last several years, after an even longer period of being ignored, the ideas attributed to Modern Monetary Theory (MMT) have entered the popular discourse.

While many commentators are viewing the core ideas as a progressive answer to fill the void created by a mainstream macroeconomics that has lost credibility, an increasing number of economists have attempted to discredit MMT.

Interestingly, the economists seeking to discredit MMT have not been confined to those working within the mainstream tradition (New Keynesian or otherwise). Indeed, considerable hostility has emerged from those who identify as working within the so-called Post Keynesian tradition, even if that cohort is difficult to define clearly.

Earlier criticisms by so-called Post Keynesian economists, specifically targetted at their disdain for the Job Guarantee policy advocated by Modern Monetary Theory (MMT) proponents (see Aspromourgos 2000, Kadmos and O’Hara 2000, King 2001, Kriesler and Halevi 2001, Mehrling 2000 and Sawyer, 2003). These specific issues were dealt with in Mitchell and Wray (2005).

The more recent criticisms have become more general in scope and can be split into two different strands. It is these more recent criticisms that we address in this paper, given that we identify that they are directed at the overall credibility of the MMT approach, as an alternative to the mainstream macroeconomic approach.

At the outset, we consider mainstream macroeconomics to be the type of economics that is almost universally taught in undergraduate courses in universities around the world and represents the usual dialogue in the financial press.

The first line of attack comes from those who claim ‘we knew it all along’ – that MMT offers nothing new (for example, Palley, 2013, 2014; Wren-Lewis, 2016a).

Since the onset of the Global Financial Crisis, which exposed the inadequacies of mainstream macroeconomic theory and practice, many economists operating in the mainstream tradition have attempted to distance themselves from this failure.

This attempt at re-establising credibility is a common tactic for a degenerative paradigm in science. Economists operating in the New Keynesian tradition, for example, which in their standard models did not even have a financial sector, now claim that the crisis – cause and solution – was entirely comprehensible within a ‘modified’ New Keynesian approach.

Krugman (2009) attempted to deal with this by accusing the so-called “freshwater economists” who think that Keynesian economics were “fairy tales that have been proved to be false” of failure and suggesting that the “saltwater economists” (which he identifies with) were pragmatists who considered “that Keynesian economics remains the best framework we have for making sense of recessions and depressions”.

Tied up in this attempt to resurrect the credibility of elements of mainstream theory were the strident criticisms from MMT proponents, who had unambiguously foreshadowed the likely implications of the private debt buildup as early as the 1990s while the mainstream economists were declaring that “central problem of depression-prevention has been solved” (Lucas, 2003: 1), effectively asserting that the business cycle was dead and waxing lyrical about the ‘Great Moderation’ (Bernanke, 2004).

These criticisms and growing interest in MMT ideas among academics and the broader community also challenged Post Keynesian economists, who also had not fully appreciated the dangerous financial trends in the 1990s and were increasingly being diverted into post modernist ventures focusing on gender, race, metholodology etc.

Initially, MMT was considered to be too marginal to pose any threat.

But in the last five years or so, it has attracted more attention from both mainstream and Post Keynesian economists, as more people become attracted to the capacity of MMT ideas to embrace the reality of the situation – a major weakness of existing mainstream, and, it has to be said, Post Keynesian economics.

In a this vein, the New Keynesian economist Simon Wren-Lewis (2016) attacked MMT on two grounds. He wrote:

1. MMT seems obsessed with the accounting detail of government transactions

2. This seemed to lead to ideas that I thought were standard bits of macroeconomics

In a similar vein, the self-described Post Keynesian economist, Thomas Palley (2013: 2) wrote that:

… the macroeconomics of MMT is a restatement of elementary well-understood Keynesian macroeconomics. There is nothing new in MMT’s construction of monetary macroeconomics that warrants the distinct nomenclature of MMT.

Palley gets more strident in his claim (2013: 7) that “There is nothing new about its theory, and the theory it uses is simplistic and inadequate for the task. Furthermore, MMT-ers have failed to provide a formal model that explicates their claims.”

Palley concluded that (2013: 14):

In fact, MMT is an inferior rendition of the analysis of money-financed fiscal policy contained in the stock-flow consistent ISLM analysis of Blinder and Solow (1973) and Tobin and Buiter (1976).

We should immediately be suscipicious of such claims given that MMT proponents would not consider ISLM analysis to be remotely cognate to their understanding of the way the monetary system functions.

The ‘nothing new’ criticism is sometimes accompanied by the put-down that “MMTers also seem curiously averse to equations” (Wren-Lewis, 2016a). Palley’s reference to a “formal model” repeats the claim that an economic proposition that is not backed up by some mathematical expressions is clearly deficient.

We do not deal with that criticism here. Suffice to say that the great works of Marx and Keynes, among others would be disregarded if the inclusion of mathematical squiggles was the demarcation criteria between deficient and sound analysis. But it is also not correct that MMT economists have avoided formal expressions when they consider them to be useful in advancing comprehension (see Mitchell and Muysken, 2008).

The second line of attack has come from Post Keynesian economists, who have claimed MMT presents a fictional account of the world that we live in and in that sense fails to advance our understanding of how the modern monetary system operates (Lavoie, 2011; Fiebiger 2012a, 2012b).

A corollary of the ‘fictional world of MMT’ attack is that “MMT policy recommendations take little account of political economy difficulties” (Palley, 2013: 2) – in other words, there is a dysfunctional naivety in MMT.

Their main concerns appear to be focused on the way MMT ‘consolidates’ the central bank and treasury functions into the ‘government sector’ and juxtaposes this with the non-government sector.

Specific claims focus on balance sheet analysis and the varying implications of the treasury selling debt to the central bank or to the non-government sector bond dealers.

Fiebiger (2012a), for example, takes exception to the statements made by MMT author Randy Wray (1998: 78) along the lines that the “Treasury spends before and without regard to either previous receipt of taxes or prior bond sales”. In his view these class of statements are wrong because they ignore the institutional reality that governs the separation of the central bank and the treasury and financially constrains the latter.

Accordingly, he asserts that this ignorance of the contraints on the treasury “defines MMT and is defective” (Fiebiger, 2012: 2).

Marc Lavoie (2014) seems to think this criticism is important enough to devote a whole section in his book to repeating it.

The problem is that these critics have failed to understand the intent of the MMT consolidation of the central bank and treasury functions into a whole government sector.

Long before Fiebiger or Lavoie had entered the debate, Mitchell (2009) has observed that governments had erected elaborate voluntary contraints on their operational freedom to obscure the intrinsic capacities that the monopoly issuer of the fiat currency possessed.

In the same way that Marx considered the exchange relations to be an ideological veil obscuring the intrinsic value relations in capitalist production and the creation of surplus value, MMT identifies two levels of reality.

The first level defines the intrinsic characteristics of the the monopoly fiat currency issuer which clearly lead us to understand that such a government can never run out of the currency it issues and has to first spend that currency into existence before it can ever raise taxes or sell bonds to the users of the currency – the non-government sector.

There should be no question about that.

Once that level of understanding is achieved then MMT recognises the second level of reality – the voluntary institutional framework that governments have put in place to regulate their own behaviour.

These accounting frameworks and fiscal rules are designed to give the (false) impression that the government is financially constrained like a household – that is, in context, has to either raise taxes to spend or issue debt to spend more than it raises in taxes.

Fiebiger claims MMT ignores these constraints. But Mitchell (2009) wrote extensively about their existence and their functions within the neo-liberal approach to government policy.

Importantly, by introducing the consolidated government sector, MMT strips way the veil of neo-liberal ideology that mainstream macroeconomists use to restrict government spending.

We learn that these contraints are purely voluntary and have no intrinsic status. This allows us to understand that governments lie when they claim they have run out of money and therefore are justified in cutting programs that advance the well-being of the general population.

By exposing the voluntary nature of these constraints, MMT pushes these austerity-type statements back into the ideological and political level and rejects them as financial verities.

The Post Keynesian critics appear to be oblivious to this veil of ideology and the purpose it serves.

New Keynesians also attack MMT in this vein.

It is clear that several of these commentators have chosen this ‘shoot-from-the-hip’ approach, and in doing so, have grossly misrepresented what can be found in the primary academic MMT literature (published by the original academic developers of that literature).

Paul Krugman (2011) reasserting the central conclusions that the mainstream IS-LM macroeconomic framework, wrote:

I’m not clear on whether they … [MMT proponents] … realize that a deficit financed by money issue is more inflationary than a deficit financed by bond issue.

Krugman seems to misunderstand the banking operations that occur when governments spend and issues debt. A fiscal deficit not matched by debt issuance to the non-government sector shows up as excess reserves in the banking system once all transactions are completed.

The central bank can then maintain its (positive) target interest rate by either draining the reserves via an open market operation (that is, sell debt) or pay a return on the excess reserves sufficient to placate the banks’ desire for competitive return.

If the fiscal deficit is matched by debt issuance to the non-government sector, the bank reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.

The only difference between the Treasury ‘borrowing from the central bank’ and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target.

A simple way of understanding this is that the funds used by the non-government sector to purchase the debt represented a part of its saving and was therefore not being spent anyway.

Further, the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.

All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity. It is totally fallacious to think that private placement of public debt reduces the inflation risk

Wren-Lewis (2016) provides a further example of this ‘shoot-from-the-hip’ approach.

He writes that if governments stopped issuing debt and “just created money” and we “assume that real output is at its ‘full employment’ level” then:

That would force interest rates down, which in turn would raise demand and create inflationary pressure, which is not really desirable. MMTers tend to ignore this, and it is not at all clear why. Of course in a recession with interest rates at their zero lower bound (ZLB) things are different, but MMT does not pretend to be just ZLB macro.

One will struggle to find an MMT account in the primary literature that would replicate Wren-Lewis’s representation of it.

Government deficits, in general, put downward pressure on the overnight interest rate because they influence the reserve balances held by banks at the central bank. But the central bank has a number of operating strategies (for example, paying interest on excess reserves), which allow it to maintain control over the short-term interest rate.

Note also that Wren-Lewis invokes the Classical assumption of ‘full employment’. Of course, any increase in aggregate spending beyond the capacity of the economy to respond with increased production will be inflationary. That observation is central to MMT’s understanding of inflation.

But Wren-Lewis’s claim is also static in nature, a common problem in New Keynesian-type models which ignore real world dynamics.

Even at full employment, as long as the government increased spending commensureate with the growth in the productive capacity of the economy (which increases with capital investment, productivity growth and population growth), then Wren-Lewis’s conclusion is errant. A growing ‘money supply’ is not inevitably inflationary, in a dynamic world.

In this paper, to negate the claim that there is nothing new in MMT, we discuss three areas where MMT has clearly made original contributions.

The fact that the critics ignore these contributions reflects a combination of ignorance and/or denial – which we suggest results from a desperation that follows being confronted with the reality that the paradigm one has been working in for years has failed to provide a coherent understanding of the way the fiat monetary system actually operates.

The four areas we focus on here are:

1. The introduction of buffer stocks into a theory of inflation and the juxtaposition between employment guarantees and unemployment.

In this section we will show that while the mainstream theory of inflation and the extant Post Keynesian approach has been constructed within the Phillips curve framework, where the debate centres on the existence (and the nature) or otherwise of the trade-off between inflation and unemployment.

By constructing the understanding of inflation within a buffer stock theory, MMT reduces the Phillips curve to a single dot or point within the unemployment-inflation space.

In other words, it shows that through the use of employment buffer stocks, a government can maintain what MMT calls ‘loose’ full employment with price stability.

In other words, the trade-off disappears.

That insight is a clear advance on the previous ways of dealing with the relationship between unemployment and inflation in the literature – mainstream or Post Keynesian.

2. The importance of the consolidation of the treasury and the central bank and the emphasis on banking arrangements. A thorough understanding of the way the banking system operates within the macroeconomic flow of funds has largely been ignored by mainstream macroeconomics and Post Keynesian economists.

MMT has provided new insights into the way these arrangements influence the impact of fiscal deficits on bank reserves and interest rates and the role played by the central bank.

While Post Keynesians rejected the so-called mainstream ‘crowding out’ theories (where fiscal deficits are alleged to push up interest rates and stifle private investment), MMT provides new ways of understanding why crowding out cannot occur in a modern (fiat) monetary system.

3. The explication of the dynamics of fiscal deficits and public debt. We consider the difference between deficit doves, who consider fiscal deficits are appropriate under some conditions but should be balanced over some definable economic cycle, which we argue has been the standard Post Keynesian position, and the MMT approach to deficits, which considers the desirable deficit outcome at any point in time to be a function of the state of non-government spending and the utilisation of the productive capacity of the economy.

Fiscal rules in MMT are only meaningful if related to the state of non-government spending and the utilisation of the productive capacity of the economy. They are never meaningful if expressed as some target percentage of GDP or some balance over a cycle.

4. The importance of language and its relation to ideology. MMT authors have also incorporated developments from cognitive linguistics and social psychology into their work to emphasise the role that metaphors play in reinforcing perceptions.

While the MMT authors did not develop these understandings they were the first to apply them to macroeconmomics.

We contend that the extant mainstream and Post Keynesian Theory, despite protests to the contrary, have not considered these significant aspects of the fiat monetary system and, as such, MMT provides important new perspectives that should be incorporated into a unified macroeconomic theory.

2. MMT and the Phillips Curve

One of the central macroeconomic areas where MMT has clearly made an original contribution has been in terms of inflation theory, and, more specifically, the discussion of a the trade-off between inflation and unemployment (that is, the Phillips curve debate).

First, public sector job creation has a long tradition in policy thinking even if it is now largely discredited by the mainstream economists, who, if they advocate any demand-side measures at all, prefer to promote ineffective solutions such as private wage subsidies.

Clearly, there is no claim that MMT invented the concept of public sector job creation as a solution to unemployment or as a path to full employment, even though the use of employment guarantees is a centrepiece of MMT’s macroeconomic policy approach.

Importantly, public sector job creation is seen by MMT as a macroeconomic rather than a microeconomic strategy – part of an overall macroeconomic stability approach. We will come back to that presently.

Second, the idea of using employment guarantees is also not exclusive to MMT and in fact has a long history. The debates surrounding the ‘right to work’ and the responsibilities of the state in ensuring everyone who wants to work has an opportunity go back hundreds of years.

More recently, Hyman Minsky (1965: 196) wrote:

Work should be available to all who want work at the national minimum wage. This would be a wage support law, analogous to the price supports for agricultural products. It would replace the minimum wage law; for, if work is available to all at the minimum wage, no labor will be available to private employers at a wage lower than this minimum. That is, the problem of covereage of occupations disappear. To qualify for employment at these terms, all that would be necessary would be to register at the local public employment office.

This description by Minsky clearly overlaps with the MMT construction of the Job Guarantee (Mitchell, 1998; Mosler, 1997-98), who independently conceived of a employment buffer stock being a superior way of introducing full employment and price stability in a fiat monetary system.

The use of buffer stocks to condition prices is also not exclusive to MMT. Indeed, Benjamin Graham (1937) discussed the idea of stabilising prices and standards of living by surplus storage. He documented the ways in which the government might deal with surplus production in the economy.

Graham (1937: 18) said:

The State may deal with actual or threatened surplus in one of four ways: (a) by preventing it; (b) by destroying it; (c) by ‘dumping’ it; or (d) by conserving it.

In the context of an excess supply of labour, governments in the neo-liberal era adopted the “dumping” strategy via the so-called Non-Accelerating Inflation Rate of Unemployment (NAIRU) approach, which used buffer stocks of unemployed to condition the inflationary process.

It made much better sense to use the conservation approach.

Graham (1937: 34) notes that

The first conclusion is that wherever surplus has been conserved primarily for future use the plan has been sensible and successful, unless marred by glaring errors of administration. The second conclusion is that when the surplus has been acquired and held primarily for future sale the plan has been vulnerable to adverse developments …

In the above quote from Minsky (1965) you also see a reference to agricultural price support schemes akin to the work of Benjamin Graham.

Graham’s distinction was important in the MMT development of the Job Guarantee. Mitchell (1998b) writes that the motivation for his work on the buffer stock employment model began when he was a fourth-year economics student at the University of Melbourne in 1978.

The basis of the Job Guarantee idea came during a series of lectures he attended on the Wool Floor Price Scheme introduced by the Commonwealth Government of Australia in November 1970.

The scheme was relatively simple and worked by the Government establishing a floor price for wool after hearing submissions from the Wool Council of Australia and the Australian Wool Corporation (AWC). The Government then guaranteed that the price would not fall below that level by the AWC purchasing stocks of wool in the auction markets if there were excess supplies and storing the wool in large stores. When the wool clip was deficient in any year, the AWC would sell stock from the store to stabilise the price.

In effect, the Wool Floor Price Scheme generated ‘full employment’ for wool production. Clearly, there was an issue in the wool situation of what constituted a reasonable level of output in a time of declining demand. The argument is not relevant when applied to available labour.

Application of the principle to labour is clear. If there was a price guarantee below the ‘prevailing market price’ and a buffer stock of working hours constructed to absorb the excess supply at the current market price, then the Government could generate full employment without encountering the problems of price tinkering.

At the time (and before the ‘mad cow’ disease), Mitchell (1998a, 1998b) called this approach the Buffer Stock Employment (BSE) model. Around the same time and independently, Mosler (1997-98) had outlined what he termed an Employer of Last Resort (ELR) approach, which replicated the characteristics of the BSE model.

In the context of Benjamin Graham’s work, the Wool Floor Price Scheme was an example of storage for future sale and was not motivated to help the consumer of wool but the producer. The BSE policy is an example of storage for use where the “reserve is established to meet a future need which experience has taught us is likely to develop” (Graham, 1937: 35).

Graham also analysed and proposed a solution to the problem of interfering with the relative price structure when the government built up the surplus. In the context of the BSE policy, this meant setting a buffer stock wage below the private market wage structure, unless strategic policy in addition to the meagre elimination of the surplus was being pursued.

For example, the government may wish to combine the BSE policy with an industry policy designed to raise productivity. In that sense, it may buy surplus labour at a wage above the current private market minimum.

Graham (1937: 42) considered that the surplus should “not be pressed for sale until an effective demand develops for it.” In the context of the BSE policy, this translated into the provision of a government job for all labour, which was surplus to private demand until such time as private demand increases.

On the financing issue, Graham was particularly insightful.

Once again the distinction between conservation for future use (the BSE) and conservation for future sale (Wool Floor Price Scheme) is important. Graham (1937: 43) said that the latter

… suffered from the fundamental weakness that they depended for their success upon advancing market prices … A price-maintenance venture is inherently unsound must in all probability … result in serious financial loss … But a rational plan for conserving surplus … should not involve the State in financial difficulties. The state can always afford to finance what its citizens can soundly produce. (emphasis in original)

It is clear that a fiat currency-issuing government always has the financial capacity to purchase the idle labour for sale in that currency. In other words, to eliminate cyclical unemployment through job creation.

The various proponents of MMT agreed to use the Job Guarantee terminology to aid clarity in exposition (thus embracing the various terms that had emerged in the increasingly consolidated literature (for example, BSE, ELR, Public Service Employment).

So what is so special about the Job Guarantee? Isn’t it just another public sector job creation scheme?

The stimulus to the development of the Job Guarantee as a response to mass unemployment reflects, among MMT authors are growing dissatisfaction with the extant Post Keynesian solutions to unemployment.

While those solutions clearly advocate public sector job creation supported by infrastructure investment spending stimulus they have historically relied heavily on income policy guidelines to suppress supply-side (cost) inflation. In other words, they bought into the Phillips curve trade-off argument.

These ‘generalised’ expansions clearly had difficulties with spatial targetting and enforcing an inflation anchor, not to mention the problems that income policies had historically encountered (design, enforcement, etc) (see Mitchell and Juniper, 2006).

The use of employment buffer stocks seemed to be the way to bypass the Phillips curve issue altogether while still maintaining high levels of employment.

The presence of a Phillips curve (stable or otherwise) then becomes an artifact of the way in which governments conduct their fiscal and monetary policy.

This work was clearly an advance (new) in terms of existing Post Keynesian and mainstream macroeconomics.

Conclusion

In Part 2, I will complete this section of the discussion

References:

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That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved.