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By Gerald Epstein,
Modern Money Theory (MMT) has recently gained a remarkable amount of attention. This has stemmed largely from the “shout-outs” it has received from prominent progressive politicians such as Alexandria Ocasio-Cortez. Its recent appearances in the news and social media have also drawn a variety of criticisms from economists of different stripes. Though much of the previous debate about MMT has concentrated on theoretical and doctrinal issues, less seriously discussed have been those MMT monetary and fiscal policy proposals that have attracted the attention of progressive politicians and activists. I recently presented a paper at the Economic Association Conference in New York in early March in order to engage in a constructive debate of MMT monetary and fiscal policy ideas. Here are the main points from that presentation and paper.
Roughly speaking, as developed by Randall Wray, Stephanie Kelton and others, MMT’s macroeconomic approach amounts to Abba Lerner’s “functional finance” approach with several twists: “sovereign money” and “debt monetization.” For them, the main goal of fiscal and monetary policy is to maintain full employment without (excessive) inflation. Their point about sovereign money is that governments do not need to save or levy taxes to “pay for” goods and services because all they need to do is print their sovereign currencies and use this money to acquire them. In fact, when the central bank and the treasury are institutionally connected, this money payment happens automatically, according to MMT. But, in the case of the U.S., as Marc Lavoie points out, these policies amount to deliberate decisions by the Federal Reserve to monetize Treasury debt since the Federal Reserve charter prohibits the Fed from directly lending to the U.S. government.
What then is the role of monetary and fiscal policy? The “functional finance” claim is that the role of “taxes” and “borrowing” should be to drain spending from the economy when necessary to prevent excessive inflation, not to “finance” spending, per se. MMT advocates add that the proper target of monetary policy should be to keep interest rates very low in the long run, while fiscal policy should be adjusted when necessary to maintain full employment and moderate inflation. According to MMT, any level of sovereign debt is sustainable in the narrow sense that the issuers of sovereign money will never need to default on its debt; it just needs to print more money to service and even repay the debt if necessary.
There are obvious questions about the viability of MMT macro policies: what would be their impacts on inflation, exchange rate instability, interest rates, financial instability, investment and economic growth? What, ultimately, are the limits and constraints on MMT macro policy?
Wray and other MMT analysts have recognized many of these issues, and have discussed them in various writings, including Wray’s 2012 MMT Primer. But, in my view, MMT advocates have not sufficiently addressed the institutional, empirical, and policy realities of the modern international financial system and their implications for the limitations on MMT policy. My conclusion is that, when one takes these into account the substantial empirical and institutional literature that has studied these issues, the applicability of MMT policy proposals, appears to be, at best, extremely limited.
To start, even though MMT advocates claim that its macroeconomic framework applies to all countries with “sovereign currencies,” there is significant evidence that it does not apply to the vast majority of such countries in the developing world that are integrated into global financial markets. As is well-known, these countries are subject to the vagaries of international capital flows, sometimes called “sudden-stops.” The problem is that in light of these flows, these countries have limited fiscal and monetary policy space, surely insufficient to conduct MMT-prescribed monetary and fiscal policies for full employment. Wray argues that that flexible exchange rates are sufficient to provide sufficient policy space for these countries to undertake MMT macro-policies. Occasionally the issue of capital controls is briefly mentioned but not seriously discussed as a complementary policy. But a careful survey of the empirical evidence casts grave doubts on the effectiveness of flexible rates for giving policy autonomy or insulating these countries from the vagaries of global financial flows. This problem is worse for countries that cannot borrow in their own currencies, but also applies to small, open countries that are able to borrow in their own currencies. The upshot is that only countries that issue their own internationally accepted currency might have the policy space to conduct MMT policies.
Even for those countries that issue their own international currencies, the sustainability and “exploitability” of the international role is not absolute. The country that has the greatest fiscal and monetary space is the United States, which issues the predominant key currency, the US dollar. Whereas Wray has written that the predominance of the dollar is not something we will need to worry about in our lifetime, historical and empirical evidence suggests that even considerable forces for persistence of key currency positions can weaken over time, perhaps even rapidly and dramatically. This is especially true when there are competing currencies with both a “will” and a “way” to achieve key currency status. China (and to a lesser extent, the Euro zone) are competitors in this sense. There is significant evidence of a move to a multi-currency system in which dollar holders can more easily switch out of the dollar if significant, perceived problems arise, such as high exchange rate instability, or excessive inflation. In such a world, the ability of the US government to exploit the dollar’s “exorbitant privilege” to sustain very large debt levels or sustained low interest rates will have limits. To be sure, these limits are uncertain but history suggests that the US cannot completely ignore them.
But even if the dollar’s role continues indefinitely to create space to implement MMT macro-policies, that doesn’t mean that the US should actually do so. MMT proposed policy amounts to an “America First” macroeconomic policy. While it is traditional for the US (and other countries) to ignore the impacts of their macroeconomic policies on the rest of the world, presumably a progressive approach to policy would adopt a more internationalist perspective. There is significant evidence that there are substantial spillover effects of US monetary policy on emerging market and developing countries that are transmitted largely through the dollar’s predominant international role. These spillover effects can be highly destabilizing if the Federal Reserve pursues excessively loose or tight monetary policy without any consideration of their impacts on developing countries. For example, as Jane D’Arista shows, the low interest rates of the Greenspan era helped to generate dangerous levels of dollar denominated leverage in emerging markets which contributed to the spread of financial crisis in 2007-2008. A more internationalist, progressive approach to macroeconomic would take these impacts into account. At a minimum, to address these impacts, MMT analysts would have to evaluate institutional arrangements such as capital controls, and financial regulations to mitigate these negative impacts. These receive at most only a cursory mention in their work.
MMT advocates might argue that their proposed low US interest rates would facilitate growth in developing countries by reducing the cost of capital for these countries, so that the spill-overs would be good, not bad. But by itself, this claim ignores the highly speculative nature of modern international financial markets. A careful analysis of the impact of low, long term interest rates shows that in the absence of strong financial regulations domestically and internationally, the impact is likely to be the accumulation of high leverage, asset bubbles, and financial instability. Yet MMT theorists talk very little in the context of their proposed macroeconomic policies about the necessary role of financial regulations and capital account regulations in channeling funds productively and limiting financial crises. This is puzzling in view of their long association with the work of Hyman Minsky, but it is true nonetheless. In short, this relative lack of attention to financial instability and financial regulation in the context of their proposed monetary and fiscal policy is a key example of their inattention to institutional and empirical constraints on the policies they propose.
As I mentioned earlier, much of MMT’s policy appeal stems from the perception that the theory implies that progressives with programmatic plans do not need to say or worry about the costs of these programs or how they are going to be “paid for.” But even within the framework of MMT itself, this claim of a free lunch is incorrect. Recall that MMT theorists recognize that at or around full employment, further economic expansion could lead to an increase in inflation and if this fiscal and monetary expansion were pushed too far, inflation could accelerate. In this world, at full employment, the government would have to raise taxes or cut private or other public spending in order to make room for new fiscal initiatives. This is no free lunch.
While Stephanie Kelton, a key point person on policy issues, has occasionally indicated in interviews that at full employment, such trade-offs need to be considered, the thrust of the MMT argument sits elsewhere. The point made over and over is that the US can “afford” any policy by simply printing money and that any level of debt is “sustainable”. But the MMT proponents do not emphasize sufficiently in policy arenas that they use the terms “affordable” and “sustainable” in narrow, technical ways that are not all that economically meaningful. In Wray’s text referenced earlier, “afford” means that the Fed can simply print the money; and “sustainable” simply means that since the Fed can print the money, the US never has to formally default. It does not speak to the macroeconomic impacts of these policies. Given the MMT emphasis on this point, progressive policy activists can be forgiven for missing the occasional qualifications in interviews and footnotes scattered around.
To see how dangerous this illusion is, consider this example: let’s say there is a coalition of progressive groups want passed into law the following set of policies:
1. Employer of Last Resort Policy to guarantee full employment (a favorite policy of MMT advocates)
2. A Green New Deal
3. Medicare for All
4. Free (or debt free) college education
5. Universal Child Care
The illusion of empowerment that MMT brings is that the coalition of forces that promotes these plans don’t have to discuss who is going to pay for these programs. But going through a simple exercise shows that this is inconsistent with MMT theory itself.
If we implemented all these policies, then we would have “over” full employment. This is true by definition, in fact, because the ELR policy creates full employment. (The Green New Deal plan itself has a public job guarantee program.) So, this set of programs would generate full employment and full capacity utilization. Even if these are envisioned as “buffer” programs, implementing the remaining programs, at some point, would generate “over” full employment. If the coalition does not find a way to “pay for” the group of programs as a whole, those that come up above the full employment line will have to be abandoned. Whose policy gets to be implemented first is therefore crucial. So the question is, whose plan should be on the chopping block? In this world, the different members of the coalition will simply have to fight it out amongst themselves.
It would be better to recognize at the outset that there is no free lunch as the economy moves toward full employment. It would be better to engage in the old-fashioned exercise of determining national priorities. To free up production capacity in a progressive way, rather than cut one of the progressive policies, it would be better, for example, to cut excessive government military expenditures, and raise taxes on the wealthy. This means that policy advocates do have to discuss from the beginning national priorities, taxes, and means to “pay for programs”, even within the narrow confines of MMT. The failure to do so leads to a completely perverse situation that spares the progressive’s enemies and gores their allies.
A better alternative macroeconomic policy framework to guide progressive programs can in fact be built on the principles long annunciated by heterodox economists and increasingly, even some newly enlightened “Keynesian” economists: Analyze the costs and employment implications of various policies. Of course, in a recession and with high unemployment, these opportunity costs are much less, even, perhaps, close to zero. Understand the long-term investment aspects of the policy and the social returns to those investments. Insist that increasing the debt to finance productive investments is sensible. Understand the externality-solving and social wealth creation that programs implement. Assess the superiority of these proposed policies relative to other uses of our resources, and cut back on those uses that are found inferior. We already largely know what those are: military spending, fossil fuel production, and consumption financial speculation that threatens our financial stability; and the accumulation of excessive wealth that destroys our democracy.
In this conceptualization, “functional finance” might have some important perspectives to offer to be sure; but the theory and logistics of sovereign money and MMT, I would argue, offer very little of use to any progressive policy revolution.
originally posted here