Last Wednesday (November 22, 2023), the Tory government in Britain released their fiscal update known…
My office was subject to a random power failure for most of today because some greedy developer broke power lines in our area. So I am way behind and what was to be a two-part blog series will now have to extend into Wednesday (as a three-part series). That allows me more time today to catch up on other writing commitments. The three-part series will consider a recent intervention that was posted on the iNET site (September 6, 2018) – Mainstream Macroeconomics and Modern Monetary Theory: What Really Divides Them?. At the outset, the iNET project has been very disappointing. Very little ‘new’ economic thinking comes from it – its offerings are virtually indistinguishable from the New Keynesian consensus that dominates my profession. The GFC revealed how impoverished that consensus is. It has also given space for Modern Monetary Theory (MMT) to establish itself as a credible alternative body of theory (and practice). The problem is that the iNET initiative has been captured by the mainstream. And so the Groupthink continues. The article I refer to above is very disappointing. It claims to offer a synthesis between Modern Monetary Theory (MMT) and mainstream macroeconomics by way of highlighting “what really divides” the two schools of thought. You might be surprised to know that according to these authors there is not much difference – only that mainstream economists think that monetary policy should be privileged to look after full employment and price stability and MMT economists (apparently) think fiscal policy should have that role. The authors claim that for the on-looker these minor differences are opaque in terms of outcomes (if the policies are applied properly) and suggest that there is really no reason for any debate at all. Accordingly, the New Keynesian consensus is just fine and the mainstream economists knew all the MMT stuff all along. It is an extraordinary exercise in sleight of hand engineered by constructing the comparison in terms of two ‘approaches’ that cull the main aspects of each. The real issue is why would they waste their time. Degenerative paradigms (or research programs in Imre Lakatos’ terminology) typically try to absorb challenging paradigms that, increasingly have more credibility and appeal, back into the mainstream through various dodges – ‘special case’, ‘we knew it all before’, ‘really nothing new’, etc. This is Part 1 of my response. It won’t be an easy three-part series but stick with it and I hope it gives you a lot of insights into the abysmal state of the mainstream macroeconomics profession.
I wasn’t surprised by the discussion. Resistance from the dominant paradigm is part of the evolution of a new idea.
There is the famous construction (sometimes attributed to German philosopher Arthur Schopenhauer, sometimes to Gandhi) that “All truth passes through three stages: First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.”
I actually think there are four stages – the first being that new ideas tend to be ignored initially.
In terms of what I might call the intrusion (or challenge) of MMT to the mainstream orthodoxy in macroeconomics, we are now well into the ridicule, opposition phase, which means we are making progress.
And a derivative of the ridicule/opposition phase is what I call the ‘absorption’ phase or the ‘we knew it all before’.
It goes like this – okay guys this MMT thing, there really isn’t much about it, nothing new, and …. and when we apply some of the policies we get inflation, rising interest rates, transfers of tax burdens to the future generations, insolvency, etc
These predictions come straight out of the mainstream macroeconomics model (see below). To compare MMT with the mainstream macroeconomics we have to consider the building blocks of each. Otherwise, the comparison will be fraught.
I considered this issue, in part, in this suite of blog posts:
1. Modern Monetary Theory – what is new about it? (August 22, 2016).
2. Modern Monetary Theory – what is new about it? – Part 2 (long) (August 23, 2016).
3. Modern Monetary Theory – what is new about it? – Part 3 (long) (August 25, 2016).
Over the 24 or so years that we have been working on the MMT project together (the core team, that is) – I have observed the process through which MMT ideas have entered the economic debate, first at conferences and in the scholastic literature, and more recently, through various Op Ed, Social Media type avenues.
At first, there was no engagement from the mainstream economists, apart from some isolated hostility, usually the manifestation of previous personal disputes anyway.
Then, over the last several years, after that even longer period of being ignored, MMT ideas have entered the popular discourse.
While many commentators are increasingly viewing the core MMT ideas as a progressive answer to fill the void created by a discredited mainstream macroeconomics, an increasing number of economists have attempted to disabuse people of the validity of MMT ideas.
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 were specifically targetted at their disdain for the Job Guarantee concept and open economy issues.
Randy Wray and I wrote an article in 2005 addressing those criticisms.
[Reference: Mitchell, W.F. and Wray, L.R. (2005) ‘In Defense of Employer of Last Resort: a response to Malcolm Sawyer’, Journal of Economic Issues, XXXIX(1), 235-244].
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.
As you will see, the iNET article has a rather bizarre redefinition of mainstream macroeconomics, which in no small part, they require to blur the differences between what they call ‘mainstream’ macroeconomics and what they, in turn, call MMT.
Neither version they present is particularly credible.
In the first blog post cited above (August 22, 2018) I document the evolution of the more recent criticisms.
They fall into two broad camps:
1. The ‘we knew it all along’, ‘there is nothing new’ in MMT camp – this is tied in with the mainstream macroeconomists trying to regain credibility after their core analytical framework (New Keynesian approach) failed dramatically in the wake of the GFC.
So, while MMT is now seen as a major challenger to the mainstream macroeconomics narrative, the ‘we knew it all along’ gang try to claim that MMT only presents, in the words of Simon Wren-Lewis what “I thought were standard bits of macroeconomics” (Source and (Source)).
2. The ‘MMT presents a fictional world’ camp – this is a more nuanced argument about whether central banks and treasuries work closely together and whether ‘taxes and bond issuance’ fund government spending.
The pedants in the second camp ignore the fact that long before they entered the fray I (for one) had written that that governments create institutional structures that impose voluntary constraints on their operational freedom and obscure the intrinsic capacities that the monopoly issuer of the fiat currency possesses.
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.
MMT strips way these veils of neo-liberal ideology that mainstream macroeconomists use to restrict government spending.
We learn that these constraints 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.
Mainstream macroeconomics does no such thing. It holds these voluntary institutional structures out as intrinsic financial constraints.
The whole ‘government budget constraint’ literature which emerged in the 1960s (beginning with Carl Christ etc) was tied up in the mainstream view that macroeconomics had to recognise that just as an individual consumer makes spending choices to maximise utility (in their theory) subject to budget constraints (income and other endowments), the government must be considered to face the same spending environment.
The iNET article claims that:
Functional finance is widely understood, by both supporters and opponents, as a departure from orthodox macroeconomics. We argue that this perception is mistaken: While MMT’s policy proposals are unorthodox, the analysis underlying them is entirely orthodox. A central bank able to control domestic interest rates is a sufficient condition to allow a government to freely pursue countercyclical fiscal policy with no danger of a runaway increase in the debt ratio. The difference between MMT and orthodox policy can be thought of as a different assignment of the two instruments of fiscal position and interest rate to the two targets of price stability and debt stability. As such, the debate between them hinges not on any fundamental difference of analysis, but rather on different practical judgements-in particular what kinds of errors are most likely from policymakers.
So, this is more or less the ‘we knew it all along’ defense of mainstream macroeconomics.
To which I respond, no you didn’t know it all along. And, you still don’t know it. And, you still teach ‘fake’ knowledge – it is in your textbooks, your PowerPoint slide shows that you use to indoctrinate your students, your academic papers, your Op Ed articles and your media interviews.
Within that literature and then, later, in the textbook treatment of it, students learn the following:
1. Governments are financially constrained.
2. That means to spend the government must tax, which have negative consequences on work and investment incentives.
3. Spending more than it taxes (deficits) leads to a new ‘funding’ decision.
4. They recognise that the deficit could be funded by ‘money printing’ but claim this would be inflationary.
5. So the best option (among the two evils) is to issue debt, which pushes up interest rates and crowds out private spending.
6. There is a very real possibility that any stimulus from the deficit spending will be wiped out by the crowding out.
That is mainstream macroeconomics and it is not possible to spin it any other way.
To give you are guide, the best-selling macroeconomics textbook is Macroeconomics (currently 9th edition) by Greg Mankiw.
It is hard to argue that the body of theory and policy practice that is laid out in that book does not represent what we consider to be mainstream thinking and pedagogy.
Here are some core quotes (from the 7th Edition):
1. “When a government spends more than it collects in taxes, it has a budget deficit, which it finances by borrowing from the private sector. The accumulation of past borrowing is the government debt.”
2. “government borrowing reduces national saving and crowds out capital accumulation. This view is held by most economists and has been implicit in the discussion of fiscal policy throughout this book.”
3. “When these economists conduct long-term projections of U.S. fiscal policy, they paint a troubling picture … One reason is demographic … A second, related reason for the troubling fiscal picture is the rising cost of health care … Simply increasing the budget deficit is not feasible. A budget deficit just pushes the cost of government spending onto a future generation of taxpayers. In the long run, the government needs to raise tax revenue to pay for the benefits it provides.”
4. “Some economists believe that to pay for these commitments, we will need to raise taxes substantially as a percentage of GDP … Other economists believe that such high tax rates would impose too great a cost on younger workers. They believe that policymakers should reduce the promises now being made to the elderly of the future and that, at the same time, people should be encouraged to take a greater role in providing for themselves as they age.”
5. “In this case, the “good” is loanable funds, and its ‘price’ is the interest rate. Saving is the supply of loanable funds – households lend their saving to investors or deposit their saving in a bank that then loans the funds out. Investment is the demand for loanable funds – investors borrow from the public directly by selling bonds or indirectly by borrowing from banks … The interest rate adjusts until the amount that firms want to invest equals the amount that households want to save.”
6. “Consider first the effects of an increase in government purchases … the increase in government purchases must be met by an equal decrease in investment … To induce investment to fall, the interest rate must rise. Hence, the increase in government purchases causes the interest rate to increase and investment to decrease. Government purchases are said to crowd out investment.”
7. “The government’s control over the money supply is called monetary policy … The primary way in which the Fed controls the supply of money is through open-market operations-the purchase and sale of government bonds.”
8. “the quantity theory of money states that the central bank, which controls the money supply, has ultimate control over the rate of inflation. If the central bank keeps the money supply stable, the price level will be stable. If the central bank increases the money supply rapidly, the price level will rise rapidly.”
9. “When the government prints money to finance expenditure, it increases the money supply. The increase in the money supply, in turn, causes inflation. Printing money to raise revenue is like imposing an inflation tax.”
10. “unemployment results when the real wage remains above the level that equilibrates labor supply and labor demand. Minimum-wage legislation is one cause of wage rigidity. Unions and the threat of unionization are another.”
11. “Over long periods of time, prices are flexible, the aggregate supply curve is vertical, and changes in aggregate demand affect the price level but not output. Over short periods of time, prices are sticky, the aggregate supply curve is flat, and changes in aggregate demand do affect the economy’s output of goods and services.”
12. “Large government debt or budget deficits may encourage excessive monetary expansion and, therefore, lead to greater inflation. The possibility of running budget deficits may encourage politicians to unduly burden future generations when setting government spending and taxes. A high level of government debt may increase the risk of capital flight and diminish a nation’s influence around the world.”
13. “Each dollar of the monetary base produces m dollars of money. Because the monetary base has a multiplied effect on the money supply, the monetary base is sometimes called high-powered money.”
And so on.
This is core mainstream macroeconomics and is fed into the policy-making process on a daily basis.
It drives narratives, policy choices, how government departments and central banks are run (at least at the political level) and it is fed continuously, albeit in different (more simpler) language to the general population on a daily basis.
A journey through my 14 years of blog posts will leave you with no doubt that MMT as a body of work doesn’t accept any of those propositions that are fed into the minds of economics students around the world every day.
I won’t critique each one. Go back to the – Debriefing 101 – category and trace through the blog posts there.
You will see that:
1. MMT rejects the claim that currency-issuing governments fund their spending via taxation and bond-issuance.
2. MMT rejects the claim that deficits reduce national saving – it makes no sense to think of a fiscal surplus as ‘saving’. Saving is the act of foregoing current spending to increase future spending. A currency-issuing government never needs to do that. Fiscal surpluses are better seen as destroying non-government wealth.
3. The intergenerational challenge (ageing society) is not a financial one but, rather, a productivity challenge. The government will always be able to fund pensions and first-class health care providing there are adequate real resources available.
4. Current deficits carry no implications for future taxes. Every generation chooses, through the political process, the tax structure that is in place.
5. The ‘loanable funds doctrine’ has no application to a modern monetary and banking system. Investment brings forth its own saving. There is no finite level of saving that constrains investment. Banks will extend loans to any credit-worthy customer.
6. Increased government deficits do not put upward pressure on interest rates and do not starve the non-government of funds. There is no financial crowding out arising from fiscal policy in a modern monetary economy.
7. The central bank cannot control the money supply.
8. Government spending is not facilitate by ‘printing money’. And expanding the monetary base (say via QE) does not induce inflation as a matter of course.
9. Unemployment is not due to real wage rigidity but rather arises from a systemic failure to provide enough jobs. That failure arises due to inadequate spending in the economy. When the non-government sector’s spending and saving decisions are made and executed, if there is a deficiency then it means the fiscal deficit is too low. Entrenched mass unemployment is a political choice made by governments.
10. There is no short-run/long-run dichotomy. The long-run is just a series of linked short-run situations and fiscal policy is effective in each.
11. Issuing government debt does not reduce the inflation risk of spending. All spending (government or non-government) carries that risk. Issuing debt just alters the wealth portfolio of the non-government sector.
12. There is no money multiplier.
So you see that the core mainstream concepts are rejected outright by MMT.
How then could someone conclude that there is really no difference between mainstream macroeconomics and MMT?
Answer: by conducting a false comparison.
We will continue exploring that by analysing the iNET argument specifically in Part 2 tomorrow.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.