Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 4 September 2016

Fiscal rules and MMT

What I call the ‘consensus assignment’ in modern macroeconomics is that monetary policy keeps output stable at a level that leaves inflation at target over the medium term, and fiscal policy stabilises the ratio of government debt to GDP. Most mainstream macroeconomists understand that assignment does not work at the Zero Lower Bound (ZLB), but a few disagree. To those that follow MMT fiscal rules that target the deficit are wrong because they think fiscal policy should do the job monetary policy is supposed to do in the consensus assignment, even outside the ZLB. They do not think monetary policy is predictable or reliable enough to do the job the consensus assignment gives it. That is a perfectly legitimate view, but one I and mainstream macro do not agree with. I discussed all this here in March.

Contrast this simple one paragraph explanation to this post, which takes 14 paragraphs to miss this basic point. Instead it says
  1. I assume that output is constant (my italics)

  2. I prefer models about how the world should work rather than how it works

  3. I am “a static kind of man living in a dynamic world”

  4. I am “a proponent of waste”

  5. People should question my veracity when I make my arguments
The first three are mistakes I can understand, because for some reason he has failed to grasp the point about monetary policy and has tried to come up with other rationalisations. But the final mistake is going too far: just because you cannot understand another point of view does not mean the other person must be lying. Is this acceptable discourse within MMT?


  1. MMTers understand that monetary policy "works" in the complete opposite way the mainstream thinks. That is, higher rates actively cause higher prices (inflation) via multiple channels.

    First and foremost, banks lend based on income. Interest rates are not as big a consideration as the mainstream makes them out to be.

    Second, lower rates directly reduce government spending and the budget deficit. The central bank cutting interest rates *is* fiscal consolidation.

    Third, the propensity of savers to spend their interest income is greater than borrowers borrowing to spend. And on top of that, the economy as a whole is a large net saver holding lots of government bonds.

    Fourth, lower rates imply lower storage costs for businesses, dragging down inflation. Higher rates directly increase costs which are then reflected in prices on a constant basis, the textbook definition of inflation!

    As a result of these reasons, lower interest rates directly reduce demand and total spending in the economy, and are categorically not inflationary in any sense.

    The natural rate of interest is zero, and it should be left there forever. Without central bank manipulation of the interest rate market, the base "interest rate" will always drift back to 0%. Fiscal policy should be, and is, the only game in town. The deficit has been far too small for far too long now.

    1. "the propensity of savers to spend their interest income is greater than borrowers borrowing to spend" - could you point me to the empirical evidence that supports this?

  2. "I assume that output is constant (my italics)"

    Where on earth did he get this idea from? People need to do basic research into their opponents - this guy is clearly regurgitating lazy strawmen talking points about "mainstream" economics, he clearly made no actual effort to understand your position.

  3. Apart from the “unpredictability” and “unreliability” of monetary policy, I suggest it has an absolutely fundamental theoretical flaw, though I’m not sure how many MMTers share this view.

    The main monetary policy tool is interest rate adjustments, though obviously QE can be added to that. And those two tools are supposed to adjust borrowing and lending. But there is no particular reason to assume it’s inadequate borrowing and lending that is the cause of a recession. Indeed, making that assumption lead to an absurdity in the recent recession, as follows.

    The recession was sparked off by excessive and irresponsible borrowing. So what do the authorities do to rectify the situation? They cut interest rates and implement QE so as to encourage more private sector borrowing, lending and debt!

    Moreover, we have the absurd spectacle of politicians and senior policy wonks saying in one breath that we need more borrowing, lending and debt, while in the next, they deplore the total amount of debt.

  4. For my part, I don't think you're being in any way dishonest, and I found your summary of your disagreements with MMT very clear and helpful.

    I also think it's admirable how you engage with a wide range of people on social media rather than only discussing these things with other professional economists - or only other mainstream economists.

    Back in March you gave a nice summary of one of my blog posts where I presented Mosler's argument that unemployment is created by the state and wrote: "I can unpick what I agree with and what I do not using perfectly standard economic ideas". I didn't ask at the time what you do and don't agree with in that account and why, but I would like to know your thoughts on it.

  5. You say you still support the consensus assignment, but haven't the past 8 years shown how dangerous it can be to put such emphasis on govt responsibility to control it's debt and deficits? I'm not sure the public and the media will ever understand the difference the ZLB makes.

  6. I am not an economist though I did a bit of economics many years ago and remember the stress laid on the multiplier which was thought likely to be something like 4.

    Are you saying that the fashionable anti-austerity policy of fiscal expansion only works to increase growth when interest rates have reached their lower bound ?

    When you say that monetary policy keeps output stable at a target level of inflation I take it you mean that monetary policy is targeted on inflation and if it is correct will automatically keep output growing at trend , perhaps related to productivity. I do not have access to the article in Economic Journal you referenced .

    1. 1) Those multiplier effects could be offset by monetary policy, yes
      2) Yes

  7. Simon, I think MMT-ERS would say that even if we are relying on monetary policy to stabilise the economy a rule that targets govt debt is wrong, because if for example a country has a high trade deficit, a govt deficit is not necessarily indicative of an expansionary fiscal stance, it's just a reflection of the sectoral balances. This makes sense to me as a layman, do you think it is wrong?

    1. They might, but mainstream macro would say that - ZLB apart - monetary policy stabilises output/inflation, fiscal policy stabilises debt and the trade balance is whatever it is.

    2. A minor point: when you write that "monetary policy stabilises output/inflation...." I assume you meant that it should be used to stabilise output/inflation....

      A more important point. The comment of Anonymous at 4 September 13:28 nicely illustrates one of the issues in your previous blog on the stress on accounting relations rather than theory in some Stock-flow consistent models. The fact that a country has a high trade deficit and a govt. deficit tells us nothing at all about desirable policy. The accounting relationships have to hold by definition. On their own they say nothing about what has caused changes in any of the componenets of the balances nor what policies might be sensibly used to change them.

      Some of the previous blogs and comments on them have decried the dropping of discussions of methodology and on history of economics from university economics courses. I am old enough to remember from my undergraduate days at LSE 50 years ago, that Lipsey and others constantly dinned into us that identities and equilibrium equations are not the same thing, nor are behavioural relations, even though all of them are commonly written with an equals symbol [ = ].


  8. Who is Ellis Winningham? I have been following MMT for several years now and this is the first I have heard of him. A search at Levy Institute where the MMT economists post working papers turns up nothing by Ellis Winningham. A Google search suggests he is chiefly a blogger advocating MMT.

    For an accurate view of MMT I would suggest looking at the work of MMT economists that recognize one another as speaking for the MMT school of economic thought and critiquing this rather than relying on second-hand sources.

    The founders of MMT are Warren Mosler, L. Randall (Randy) Wray and William F. (Bill) Mitchell. There are only a handful other economists that have joined them — Stephanie Bell Kelton, Pavlina Tcherneva, Scott Fullwiler, Eric Tymoigne, Andrea Terzi, for example. All are academic economists other than Warren Mosler, who was a fixed income fund manager. They generally post working papers at Levy Institute and also blog at well-known MMT venues, particularly New Economic Perspectives and billy blog. MMT teaching is centered at Levy Institute's Bard College and University of Missouri at Kansas City (UMKC).

    There are other economists writing about MMT that worth reading, too. Peter Cooper (Australia) and Dirk Ehnts (Bard in Berlin) come to mind. There are some blogging on MMT who understand it well also, in particular Neil Wilson (UK).

    Bill Mitchell has recently posted a three part series on the contributions of MMT entitled, Modern Monetary Theory – what is new about it? It's a draft of a paper that will be presented as the keynote address at the International Post Keynesian Conference in mid-September at UMKC. Part 1 in the blog series mentions SWL as an MMT critic.

    1. To be fair to Ellis, there is a tendency in MMT to avoid talking about how they relate to the mainstream. I had to write 2 posts to work it out.

  9. Never heard of Ellis (the guy you link to in the post.) You would be far better off interacting with Bill Mitchell and Randy Wray as they have a better understanding of the theory imo.

    "To those that follow MMT fiscal rules that target the deficit are wrong because they think fiscal policy should do the job monetary policy is supposed to do"

    But in particular auto stabilisers, which immediately offset changes in demand in real time with no need for major political decisions.

    So what the MMT people, or myself at least, have been arguing for is *advocacy* for better auto stabilisers, in particular the Job Guarantee from economists such as yourself. To give such ideas "credibility."

    1. If a mainstream economist in my area wrote a post that I knew to be rubbish I would say so. Look forward to MMT economists doing same on this occasion.

    2. Do you expect Bill Mitchell to rewrite a rebuttal of every MMT-related blog post he doesn't agree with? I am sure there is quite a lot that gets written by mainstream economists that you yourself don't agree with. Do you go around correcting each and everyone of those?

    3. No, but someone would. Anyone who was a mainstream economist and wrote an attack on someone else that was completely misguided would be called out by others.

    4. That's not really fair. There are thousands of mainstream economists, literally. As Tom said above, there are probably less than 10 MMT economists. Expecting them to be watching out for every unfair attack in their name is not reasonable. They have jobs, families, etc., and they don't even blog that much anymore except for Bill. If there were thousands of them like the mainstream, then OK, but it's not even close.

  10. This looks very much like you have read Bill's draft paper that will be presented as the keynote address at the International Post Keynesian Conference in mid-September at UMKC.

    But instead of replying directly to Bill you've used Ellis as a strawman?

    Or as your own ways and means account.

    1. Why does it very much look like that?!

    2. Because it looks like another drive by another hit and run.

      All we want is for you to stand still and debate with Bill or is that too much to ask ?

      He is there every day you could have posted on his blog the parts you disagree with. Phillips curve just as an example and the NAIRU.

      It comes across as the economics profession is very political never mind fiscal policy or monetarism.

      You try and break down politics within economics. We are trying to break down politics between economists.

      So everyone can move forward.

      Is that too much to ask ?

      Krugman is the same he uses his New York Times blog to perform hit and runs and drive by's but won't stand still and talk.

      So how on earth is everyone going to move on ?

      Why are you not going to the conference ?

  11. Simon, I hope you eventually "come round." The more the merrier.

    I would just like you and other economists to read the stuff directly from the horse's mouth.

    I think if you interact with the MMT economists you'll come around gradually. You are already familiar with Godley SFC modeling, and you have worked at HM Treasury, so it is not that big a jump for you. But blogs are not going to do it. You needs to read some books and papers that lay out theory. Then we can intelligently debate it.

  12. Professor, if you want to discredit MMT by attacking a particular writer on the subject, why don't you just go for the gold- Bill Mitchell, author of billy blog, indisputably one of the founders of MMT, who has written (and I am not kidding) millions of words on the subject. I am sure that somewhere there he has made some typo that you could attack to make just as bad a point as you did with this post.

    And if you do happen to find an actual flaw in the theory and explain it, then thousands of people really would appreciate it, including me. But your article today is just very suspect. You pick on one MMT advocate (who is probably a very fine individual but unknown to me) and then jump your assumptions to an entire group. You know that is wrong.

    1. I don't want to discredit MMT as a point of view. As I've said before, its just standard Keynesian macro plus an unconventional belief that monetary policy does not work. But this blog made a very personal attack on me. It would be nice to hear other MMT people say that was wrong.

    2. Professor,

      I agree with Jerry Brown and others. If you want to engage MMT, please pick up the gauntlet thrown by e.g. Bill Mitchell in a recent 3-part series of blog posts entitled 'Modern Monetary Theory - what is new about it?' If, for whatever reason, you have neither the time nor the inclination to spar with the heavy-weights - which is your prerogative of course - then just say so, and stop pretending that you do.

    3. I have engaged with MMT - see my earlier posts. "Pretending that I do" - what the hell does that mean?

    4. Precisely what it says in the comment. There is a lot of material out there that has been written by the 'founding fathers' of MMT, yet you seem to have a preference for defending mainstream macro from the writings of lesser-known bloggers.

    5. "it's just standard Keynesian macro plus an unconventional belief that monetary policy does not work."


      I would suggest that is an inadequate summary that misses the bulk of MMT's unique contributions:

  13. Naive question - why is the objective of fiscal policy to stabilise the ratio of government debt to GDP, rather than to stabilise debt service costs as a percentage of GDP ?

    1. Its a good question. One point is that the idea that debt crowds out private investment relates to its level, not its service cost.

    2. "One point is that the idea that debt crowds out private investment relates to its level, not its service cost."

      Savings can't crowd out private investment?


    3. Not sure that I really understand Simon's overall stance with respect to the macro-economic need for, or benefit of, public infrastructural investment on, say, transport connectivity (e.g trans_Pennine link?), or expanding new annual housing supply to c250,000 dwellings (due to market failure, not possible without planned public intervention).

      Such increases, all other things being equal, will increase the debt ratio if funded by conventional gilts, but not, if funded directly by some variant of 'helicopter money'. Neither,in current conditions, at a constrained additional level would be likely to increase inflation by a monetary transmission, but could well bid up labour and material costs in the short term (as would a private-financed construction stimulus); their introduction should therefore be combined with improved supply side targeted interventions, namely, more effective apprentice policy and the related reform of other casualised construction industry practices, which have bedevilled the industry for decades, and which need occur in any case.

  14. "its just standard Keynesian macro plus an unconventional belief that monetary policy does not work."

    But Simon as Bill is going to point out as the keynote address at the International Post Keynesian Conference in mid-September at UMKC.

    It is a lot more than that. He has clearly laid out areas that the mainstream said they knew all along but it is very clear they didn't.

    He has also laid out very clearly areas that you agree on. Something you say never happens.

  15. "its just standard Keynesian macro plus ... "

    I doubt that.

    It is EXTREMELY banking-system-operational centric from the get go - a very different starting point for their "paradigm"

    And the importance of that is the contrast with the generally laggard approach of "mainstream" when it comes to the incorporation of banking into the subject matter

    I'm no MMT advocate, but would suggest like others that Bill Mitchell's blog is the place to go to get a more comprehensive and consistent overview

  16. This is Mosler's seminal work

    Worth having a look at to see just how banking system centric MMT is:

  17. I read the usage of veracity as 'Conformity to facts; accuracy' rather than 'Habitual truthfulness'. I do not think Ellis Winningham was questioning your truthfulness but was claiming that any the further arguments against Post Keynesian MMT, especially the Job Guarantee proposal would not be correct.
    The use of the term hypocritical was unacceptable however, even if he believed you had contradicted yourself by claim prior knowledge of something he is convinced you did not understand.

  18. I sometimes disagree with Simon, sometimes defer, sometimes fail to grasp, and often agree, but I never seen any reason to doubt the honesty of his arguments

  19. Thanks SWL. I don't have much to say about your today's post but I looked up your March post.

    "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."

    Yes, we are fiscalists.

    "What about a world where monetary policy did successfully control demand and inflation, which is the world I’m writing about?"

    To an MMTer you sound like: "let's dream we live in the space and not on earth".

    That's not to say that lower interest rates cannot bring more aggregate demand but fiscal policy is more effective. I guess you've heard It all before but you disagree.

    Let me ask you something else: do you belive in "hot potato" also? Nick Rowe does. Best.

  20. Vassilis Serafimakis5 September 2016 at 18:57

    This is only about the accusation of lying. Disputing the veracity of any of your statements or your line of argument is certainly not in the same as claiming you are lying. My English is not prefect but it is sufficient for me to understand this.

  21. I just can't see how we need any models to describe how fiscal and monetary policy interact. It's trivial.

    Fiscal policy is the creation or destruction of government financial assets by treasury.

    Monetary policy determines how much interest is paid on those financial assets. Increased interest payments results in an increase in financial assets.

    The only thing that actually matters, though, is spending. All the money in the world can exist but until they are spent it's a moot point.

    Fiscal policy is the only method by which a government can directly influence spending.

    End of story. There is nothing else to this. You don't need models or diagrams or anything.

  22. The “fiscal rules and MMT” debate is conducted at too high a level of abstraction to be useful as a guide to policy. MMT supporters often refer to Lerner’s functional finance, which proposes that government should manage levels of taxation and spending to achieve a level of demand that avoids excessive unemployment or inflation. This can be seen as a guideline for appropriate fiscal rules targeting public debt or deficits, where political debate or the budget process is framed in those terms. The real question over any specific rule is not “is it a rule” but “does this rule facilitate or constrain achieving a reasonable level of demand”, which requires examination of the details of the rule and the economic circumstances in which it is applied.

    We also need to recognise that financing a public investment programme, whether through long-term low interest loans or monetary creation, is just one issue in implementing this. To take an example, the financing of large-scale public housing is the easy part, given political will. The real constraints are around resources. Skill bottlenecks could be cleared within a couple of years but issues around land use and planning will be harder. Macroeconomic theory is not much help here.

    Similarly, the usefulness of monetary policy has to be assessed against specific economic or institutional features. It cannot be asserted or denied without reference to time and place. I would argue that monetary policy, particularly interest rates, has been declining in effectiveness in recent decades, but such an assessment is based on how the global economy and finance has evolved, not on an ahistorical comparison of Keynesianism and MMT.

    1. MMT is miles ahead on this

      Smart People talk about Government Buying

    2. Lyn's points make sense to me in their entirety.

      Just one observation; a sustained 'steady state' housing programme of c250,000 dwellings annually should itself generate positive supply side impacts on the construction industry in particular and the wider economy in general over time, and other other things equal, push up the sustainable long term growth rate.

  23. I confess that I don't always understand everything you write Simon, so as a non expert, I won't comment on the substance of his argument. However I would note that on the "about this blog" page Mr Winningham says his site, like yours is addressed to interested layman like myself. However even in attempting to express this simple aim, he manages to waffle, repeat himself, and be hugely condescending all at the same time. In my experience clarity of thought seldom accompanies flabby language, so I don't think I'll be lapping up his aperçus


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