Why is MMT so popular?

I think, as a result of earlier posts, that I can be pretty confident that I can answer this question. But first some background. Although MMT has been around for some time, it recently held its first international conference and has in the last few years attracted a devoted band of followers online. According to this article, it has ‘rock star appeal’. In this post I just want to concentrate on the core of MMT which involves fiscal policy, and not talk about other ideas like job guarantees.

There are short and simple explainers around (e.g. here), but what these and MMT followers are typically not so good at is in explaining exactly why and how they differ from mainstream macroeconomics. To understand this, we need to go back to the 1960s and 70s. Then there was a debate between two groups in macro over whether it was better to use monetary policy or fiscal policy as an instrument for stabilising the economy. I prefer to call these two groups Monetarists and Fiscalists, because both sides used the same theoretical framework, which was Keynesian.

To cut a long story short the monetarist won that argument, although not quite in the way they intended. Instead of central banks controlling the economy in a hands off way using the money supply, they instead actively used interest rate changes to control output and inflation. Fiscal policy was increasingly seen as about controlling the level of government debt. I have called this the Consensus Assignment, because it became a consensus and because I don’t think there is another name for it.

The one or two decades before the financial crisis were the golden years for the Consensus Assignment, in the sense that monetary policy did seem to be relatively successful at controlling inflation and dampening the business cycle. However many governments were less successful at controlling government debt, and this failure was termed ‘deficit bias’.

MMT is essentially different because it rejects the Consensus Assignment. It regards monetary policy as an unreliable instrument for controlling the economy, and MMT prefers to use fiscal policy instead. They are, to use my previous terminology, fiscalists.

If you are always using government spending or taxes to control the economy, you are right not to worry about the budget deficit: it is whatever it needs to be to get inflation to target. Whether you finance those deficits by creating money or selling bonds is also a secondary concern - it just influences what the interest rate is, which has an uncertain impact on activity. For this reason you do not need to worry about who will buy your debt, because you can create money instead.

The GFC exposed the Achilles Heel in the Consensus Assignment, because interest rates hit their lower bound and could no longer be moved to stimulate demand. Alternative measures like QE really were as unreliable as MMT thinks all monetary policy is. What governments started to do was use fiscal policy instead of monetary policy to support the economy, but then austerity happened in 2010 for all the reasons I explore at length here.

Now we can see why MMT is so popular. Austerity is about governments pretending the Consensus Assignment still works when it does not, because interest rates are at their lower bound. We are in an MMT world, where we should be using fiscal policy and not worrying about the deficit, but policymakers don’t understand that. I think most mainstream macroeconomists do understand this, but we are not often heard. The ground was therefore ripe for MMT.

Policymakers following austerity when they clearly should not annoys me a great deal, and I am very happy to join common cause with MMT on this. By comparison, the things that annoy me about MMT are trivial, like a failure to use equations and their wordplay. You will hear from MMTers that taxes do not finance government spending, or that spending comes first, but you will hardly ever see the government’s budget constraint which makes all such semantics seem silly.

MMT is particularly attractive because it does away with the perennial ‘where is the money going to come from’ question. Instead it replaces this question with another: ‘will this extra spending raise inflation above target’. As long as inflation is below target that does not appear to be a constraint. In the US right now interest rates are no longer at their lower bound, but inflation is below target, so it appears to MMTers that the government should not worry about how extra spending is paid for.

Of course having a fiscal authority following MMT and a central bank following the Consensus Assignment once rates are above their lower bound could be a recipe for confusion, unless you believe what happens to interest rates is unimportant. I personally think we have strong econometric evidence that changes in interest rates do matter, so once we are off the lower bound should we be fiscalists like MMT or should we return to the Consensus Assignment? That is a question for another day.