MMT and mainstream macro

There were a lot of interesting and useful comments on my last post on MMT, plus helpful (for me) follow-up conversations. Many thanks to everyone concerned for taking the time. Before I say anything more let me make it clear where I am coming from. I’m on the same page as far as policy’s current obsession with debt is concerned. Where I seem to differ from some who comment on my blog, people who say they are following MMT, is whether you need to be concerned about debt when monetary policy is not constrained by the Zero Lower Bound. I say yes, they say no, but for reasons I could not easily understand.

This was the point of the ‘nothing new’ comment. It was not meant to be a put down. It was meant to suggest that a mainstream economist like myself could come to some of the same conclusions as MMT writers, and more to the point, just because I was a mainstream economist does not mean I misunderstood how government financing works. It was because I was getting comments from MMT followers that seemed nonsensical to me, but which should not have been nonsensical because the basics of MMT are understandable using mainstream theory.

One comment on that earlier post provided a link to a very useful Nick Rowe post, who as ever has been there before me. This suggested that MMT assumed a vertical IS curve (there is no impact of interest rates on aggregate demand). If the IS curve is vertical, then it explains the puzzle I have. In the thought experiment I outlined in my previous post, if the government started swapping debt for money the decline in interest rates that would follow [1] would have no impact on demand, so there would be no rise in inflation. Indeed what else could it be besides an assumption of a vertical IS curve, as MMT does not deny that excess demand would lead to inflation at full employment.

I now think that is putting it too strongly. The view that many MMT writers have is that interest rates have an unreliable impact on demand relative to fiscal instruments. In that case of course you would have to use fiscal policy to control demand and inflation. That would be the focus of the fiscal rule. It is a similar regime to one I suggest would be appropriate for individual Eurozone countries. Inflation would be a discipline on deficit bias. [2]

What about a world where monetary policy did successfully control demand and inflation, which is the world I’m writing about? Evidence suggests you then need a fiscal rule stopping deficit bias (a gradual rise in the debt to GDP ratio over successive cycles). In a country with its own central bank (so no concern about forced default) and where all debt is owned domestically, the standard reasons why you would be concerned about deficit bias are intergenerational equity, crowding out of capital, and having to raise distortionary taxes to pay the higher debt interest bill.

There is a lot you can say on all three, but the point I want to make is simple. Being in that world means you do not need to worry about other sector balances because of their impact on demand. By being in that world at no point am I misunderstanding how government financing works, or ignoring the role of money. It does not mean I read the government budget constraint from left to right or vice versa! Yet I still get comments like this one left on a more recent post.

“Your political yourself Simon. One thing more than anything really annoys me. Why do you never announce or go public and say that taxes do not fund government spending?”

Comments like the one above, taken without context from some MMT paper, just appear stupid. By all means criticise my view that monetary policy is effective, or that rising debt has costs, but in future comments like that will just be ignored.

Let me make the same point using another example. Alex Douglas in a post argues that MMT does make an original contribution to political economy. He looks at a Warren Mosler claim that the state creates unemployment, and this is the only reason unemployment exists. It seems to me (with some additional help from Alex) that this involves two elements. The first sounds like a combination of points that mainstream economists might make: deficient demand exists because we are in a monetary economy, and some combination of monetary and fiscal policy can always get rid of deficient demand. The second is that money exists because the state requires taxes to be paid with it. Now I’m less sure about that second argument, but the point is that I can unpick what I agree with and what I do not using perfectly standard economic ideas. Yet if he had simply sent me a comment which said “the state currency is fundamentally a device for coercing labour” I wouldn’t have had a clue what he was talking about.

Now you might ask at this point why is it so important to be able to put MMT arguments in the language of standard macro. MMT is a coherent school of thought, using a language that those who have read the important texts understand. [3] Someone like me should just take the time out to read those texts. Well I have read some MMT papers, but I can assure you I have read many more than pretty well every mainstream macroeconomist I know. So what you may say. But it is a fact, and you may think it is an unfortunate fact, that mainstream macroeconomics is pretty dominant in both academic and policy circles. And it will stay that way: heterodox economists have been predicting the downfall of mainstream economics for longer than I have been an economist. [4] So if MMT is to have any influence, it will be through changing how mainstream macroeconomists think.

You gain that influence by properly understanding the mainstream. Bill Mitchell, writing in 2013, lambasts economists like me who try to suggest that the fixation with debt since 2010 does not come from mainstream macro. He does not believe it, and writes

“Why is there mass unemployment if government officials understood all our claims? It would be the ultimate example of venal dysfunctional politics to hold that that everybody knows all this stuff but are deliberately disregarding it – for what?”

But that is the tragedy of what has happened since 2010. Politicians, either out of panic or with ulterior motives, decided in countries with their own currencies that we should start worrying about the market no longer buying government debt, and austerity was the result. In this they were supported by a media that thought the government was like a household, and economists from the financial sector who had their own reasons for promulgating this myth. True, they did find support from some mainstream academic macroeconomists, but that support was never based on mainstream theory.

What mainstream theory says is that some combination of monetary and fiscal policy can always end a recession caused by demand deficiency. Full stop: no ifs or buts. That is why we had fiscal expansion in 2009 in the US, UK, Germany, China and elsewhere. The contribution of some influential mainstream economists to this switch from fiscal stimulus to austerity in 2010 was minor at most, and to imagine otherwise does nobody any favours. The fact that policymakers went against basic macro theory tells us important things about the transmission mechanism of economic knowledge, which all economists have to address.

[1] Bill Mitchell appears to suggest that in this case the central bank could maintain its interest rate by selling its stock of government debt. However pretty soon it would run out of assets to sell. This is exactly why some central bankers are reluctant to undertake helicopter money. One solution with helicopter money is to get the government to recapitalise the central bank, but of course to do that would involve creating more government debt. The central bank could start creating its own debt, but if governments stopped creating their own debt and asked the central bank to do it for them, nothing has really changed. 

[2] It is not clear to me that in such a world debt would always be tied down. A government that used an effective (in multiplier terms) fiscal instrument in booms (e.g. government spending) but an ineffective one in depressions (tax breaks for the wealthy) might experience an upward drift in debt. But what is clear is that in such a regime, concern about the debt stock should never justify significant departures from demand and inflation stabilisation.

[3] Although, as the range of comments to my earlier posts showed, what people understand MMT to mean varies quite a lot.

[4] I personally would not welcome the disintegration of macro back into separate schools of thought. Economists should be like doctors, and I do not want to have to ask my doctor what medical school of thought they belong to. I have relied on doctors using the same language and being able to understand each other. However I also realise that the unwise fixation of the current mainstream with microfoundations methodology can act as an exclusion mechanism, which encourages the formation of alternative schools of thought. This is yet another reason to be very critical of this methodological hegemony.