It was interesting to spend a few weeks in London recently and catch up with…
Last week, Thomas Fazi and I had a response to a recent British attack on Modern Monetary Theory (MMT) published in The Tribune magazine (June 5, 2019) – For MMT. The article we were responding to – Against MMT – written by a former British Labour Party advisor, was not really about MMT at all, as you will see. Instead, it appeared to be an attempt to defend the Labour Party’s Fiscal Credibility Rule, that has been criticised for being a neoliberal concoction. Whenever, progressives use neoliberal frames, language or concepts, it turns out badly for them. In effect, there were two quite separate topics that needed to be discussed: (a) the misrepresentation of MMT; and (b) the issues pertaining to British Labour Party policy proposals. And, the Tribune only allowed 3,000 words, which made it difficult to cover the two topics in any depth. In this three-part series, you can read a longer version of our reply to the ‘Against MMT’ article, and, criticisms from the elements on the Left, generally, who think it is a smart tactic to talk like neoliberals and express fear of global capital markets. I split the parts up into more or less (but not quite) three equal chunks and will publish the remaining parts over the rest of this week.
The Tribune recently published the unequivocally titled Against MMT (June 3, 2019) – written by James Meadway, former advisor to shadow chancellor John McDonnell.
The sub-heading of his article was:
Modern Monetary Theory disorients the Left by peddling simplistic monetary solutions to complex problems of political power.
He joins a swathe of mainstream economists and policymakers – Kenneth Rogoff, Larry Summers, Paul Krugman and others – who have viscerally attacked Modern Monetary Theory (MMT).
Incredibly, Republican Senators have even proposed a resolution in Congress denouncing MMT – the first-ever resolution proposed against an economic theory.
More surprising is the fact that MMT has also been the subject of fierce criticism by left-wing economists and commentators such as Doug Henwood and Paul Mason.
In common with these other ‘critiques’, Meadway’s article is really not about the core body of work known as MMT at all.
Rather he seeks to defend the credibility of the neoliberal-inspired Labour Fiscal Credibility Rule by setting out a ‘straw person’ version of MMT and then rehearsing the standard accusations that MMT proponents are naive about inflation, exchange rate collapse and the might of global capital.
In doing so, Meadway demonstrates that he has not grasped (or refuses to grasp) the subtleties of MMT.
In a political sense, his arguments repeat those that Chancellor Dennis Healey used when he lied to the British people in the mid-1970s about the Government running out of money.
These falsehoods eased the path for Margaret Thatcher, created the space within Labour for the highly damaging Blairite years, and constrain the current British Labour leadership’s conception of what is possible in terms of economic policy formation.
In the last year or so, the critiques of MMT have accelerated as its public profile has risen, partly due to Alexandria Ocasio-Cortez’s promotion of the ideas in relation to her endorsement of a ‘Green New Deal’ (GND) proposal.
Here is AOC receiving her copy of our (Mitchell, Wray and Watts) new MMT textbook – Macroeconomics – from her advisor Andrés Bernal.
There was also a bit of coverage about the book in this recent Bloomberg article (May 31, 2019) – A 600-Page Textbook About Modern Monetary Theory Has Sold Out.
MMT not only threatens vested neoliberal interests in politics but also challenges the hegemony of mainstream macroeconomists who have been able to dominate the policy debate for decades using a series of linked myths about how the fiat monetary system operates and the capacities of currency-issuing governments within such a system. MMT exposes these myths.
An MMT understanding allows us to break out of the illusory financial constraints that for too long have hindered our ability to imagine radical alternatives and to envision truly transformational policies, such as the Green New Deal, in the knowledge the issue is not whether we can afford a certain policy in financial terms but only whether we have enough available resources – and political will – to implement it.
This is massive paradigm shift. It’s no surprise that the establishment’s reaction has been so vicious.
Our response here is to Meadway’s Tribune article, but it applies equally to other recent attacks published elsewhere.
To set the record straight we start by providing a straightforward understanding of what MMT actually is – rather than what its critics often accuse it of being.
What is MMT?
At the outset, it is important to note that MMT should not been seen as a regime that you ‘apply’ or ‘switch to’ or ‘introduce’.
Rather, it is a lens which allows us to see the true (intrinsic) workings of the fiat monetary system.
It helps us better understand the choices available to a currency-issuing government and the consequences of surrendering that currency-issuing capacity (as in the Eurozone).
It lifts the veil imposed by neoliberal ideology and forces the real questions and political choices out in the open.
An MMT understanding means that statements such as the ‘government cannot provide better services because it will run out of money’ are immediately known to be false.
Such an understanding will change the questions we ask of our politicians and the range of acceptable answers that they will be able to give. In this sense, an MMT understanding enhances the quality of our democracies.
MMT is agnostic about policy. bar its preference for an employment buffer rather than an unemployment buffer to discipline inflation.
In general, it makes no sense to talk about an “MMT-type prescription” or an “MMT solution” as Meadway does.
To make that MMT understanding operational in a policy context, a value system or ideology must be introduced. MMT is not intrinsically ‘Left-leaning’.
A Right-leaning person would advocate quite different policy prescriptions to a Left-leaning person even though they both shared the understanding of how the monetary system operates.
We can see that in the recent debates in the Japanese Parliament where conservative politicians and Communist party members have invoked MMT understandings to argue against sales tax hikes designed to reduce the fiscal deficit.
In the simplest possible terms, MMT describes and analyses the way in which ‘fiat monetary systems’ operate and the capacities that a government has within that system.
Currency sovereignty requires a government to issue its own currency, floats it on international markets, and only issue liabilities in that currency.
Such a government has a monopoly over currency issuance. Here it is important to note that MMT distinguishes between ‘currency’ and ‘money’, a nuance that escapes Meadway – viz his accusation that MMT is wrong to assert that government is a monopoly issuer of currency because “most money is created by private banks when people take out loans”.
Banks cannot create currency. But the implications of this takes us beyond the remit of this response.
The task of such a government is to provision itself with real resources to deliver its socio-economic program.
It creates a demand for its otherwise worthless currency by requiring all tax liabilities to be extinguished in that currency.
The government spends its currency into existence through the purchase of goods and services from the non-government sector (so-called government spending) which provides the non-sector with the funds necessary to pay its tax obligations.
The consequence of this logical ordering of events (spending to fund taxation) is that currency-issuing governments do not have to ‘fund’ their spending and can never run out of currency.
Saying otherwise is as stupid as saying that a football game has to stop 3 minutes into the second-half because the scoreboard has run out of points to post!
It also means that a currency-issuing government can purchase whatever is available for sale in that currency, including all idle labour.
The appearance of idle labour, for example, is evidence that the government has not spent enough relative to its tax take – so taxes are too high and/or spending is too low.
In turn, this means that the unemployment rate is not a ‘market’ phenomenon or a choice of individuals (the mainstream dogma) but a political choice of government. The ideology of mass unemployment is thus exposed by an MMT understanding.
Further, a currency-issuing government is not like a household, which uses the currency and faces intrinsic and binding financial constraints on its spending.
The household analogy is popular in mainstream macroeconomics but provides us with zero understanding of what the capacities of the issuing government are. Unlike a household, the constraints on government spending are not financial but real – limited by the goods and services that are available for sale.
The core MMT developers do not, as Meadway claims, consider a “hierarchy of currencies” with the US dollar at the top nor do they assume that non-dollar currencies have only limited currency sovereignty.
All currency-issuing governments enjoy monetary sovereignty as outlined above.
We should not conflate the capacity to purchase available goods and services with some ability to provision an economy with adequate real resources, as Meadway seems to do.
Issuing one’s own currency doesn’t make a nation ‘rich’. A nation with limited access to real resources either locally or through trade will still remain materially poor.
Sovereignty, though, means the government can use its currency capacity to ensure the resources that are available are always fully employed in one way or another.
In this way, Meadway is wrong when he claims “If you can’t issue the dollar, MMT isn’t going to work.” That is a fundamental misunderstanding.
MMT also doesn’t assume that a nation, as Meadway claims:
… can choose to run enormous deficits, and the whole economy can sustain extraordinary trade deficits …
Typically, the non-government sector (households, firms and ‘rest of the world’) desires to spend less than its flow of income – that is, there is an overall desire to save.
If unchecked, such a leakage from the income-spending stream will cause firms to reduce production and lay off workers.
The role of government net spending in this context is to fill that savings gap to avoid recession.
In normal times for any nation running an external deficit, the government has to run fiscal deficits up to size necessary to maintain spending sufficient to keep all resources fully employed.
A nation such as Norway, with strong export revenue, can still provide first-class public services and infrastructure while its private domestic sector achieves its desired saving, while its government runs a fiscal surplus. But that situation is rare.
In general, MMT uses the sectoral balances (or flow of funds) approach, which tells us that the government sector’s deficit (surplus) is always equal to the non-government sector’s surplus (deficit).
Further, if there is an external deficit (exports less than imports plus net financial flows), then the government balance necessarily has to be in deficit for the private domestic sector to be in surplus – that is, for the private domestic sector to be able to save overall.
If this condition is not met, growth will necessarily have to be sustained by an expansion in private domestic debt, which is an unsustainable basis for growth.
Since Britain is not likely to generate large external surpluses in the foreseeable future, it follows that the only way private debt – and the power of financial institutions over society – can be brought under control without driving the economy into recession is for the government to run persistent and substantial fiscal deficits.
This reminds us that steering the economy towards full employment, something socialists should arguably aim for, doesn’t just require ‘fine-tuning’ – some extra spending when the economy slumps – and public investment.
It requires constant control of its movement through fiscal policy.
Fiscal deficits ‘in themselves are neither good nor bad’, as the economist Abba Lerner, one of the precursors of MMT, wrote in the 1940s.
Any assessment of the fiscal position of a nation must be taken in the light of the usefulness of the government’s spending program in achieving its national socio-economic goals and the savings desires of the non-government sector.
This is what Lerner called the ‘functional finance’ approach.
Rather than adopting some target fiscal outcome defined in financial terms (for example, some deficit as a percentage of GDP), governments should spend and tax with a view to achieving ‘functionally’ defined outcomes, such as full employment.
Fiscal policy positions thus can only be reasonably assessed in the context of these macroeconomic policy goals. So the real limit to government deficit spending is therefore the capacity of the economy to absorb it without generating runaway inflation.
But it should be emphasised that all spending carries an inflation risk if it outstrips the capacity of the economy to respond to it by producing goods and services. Government spending is not unique in that respect.
Now, governments voluntarily impose accounting rules on themselves, which might require them to have sufficient funds in their account at the central bank where ‘tax’ revenue is recorded, before they can spend.
If they desire to spend more than the ‘available’ funds, a rule may require them to ‘cover’ the deficit through debt issuance.
While these accounting smokescreens elicit the impression that the taxes and borrowing fund the spending, nothing could be further from the truth.
As noted above, the ability to pay taxes come after spending.
The etymology of the term ‘revenue’ is outlined in the following graphic:
Taxes are thus government spending that is returned to the government!
Further, the funds that the government ‘borrows’ are, in an accounting sense, just the prior spending that has not been previously taxed.
And, if the non-government sector didn’t want to hold any of their wealth portfolio in the form of government bonds (debt), the government’s central bank always has the option of stepping in and buying either new or existing bonds by crediting relevant bank accounts.
There is no financial constraint on this activity. And most central banks around the world have purchased huge quantities of government debt in the context of quantitative easing. The Bank of Japan is continuing to do this on a massive scale.
While mainstream macroeconomists (like Meadway) try to link ‘monetary operations’ (taxes, bond sales) with ‘funding operations’, the reality is that government spending occurs in the same way irrespective of the accompanying transactions (such as bond issuance).
Governments just instruct their central banks to credit bank accounts (MMT calls this adding reserves) via the digital system.
Invoking terms such as “government-printed money”, as Meadway does, to describe this process is fundamentally wrong.
There is no ‘printing’ going on.
The ‘printing’ term is, of course loaded, and creates a frame that ‘mad’ government officials are cranking up printing presses and pumping the notes into the economy willy nilly.
Further, while taxation is just the ‘debiting’ of bank accounts, it would be nonsensical to think of taxation as ‘unprinting’ money.
Does this mean that taxes are not necessary?
… to be continued.
We will return to the issue of taxes and inflation in Part 2 tomorrow.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.