MMT: not so modern

Followers of Modern Monetary Theory (MMT) often comment on my posts. I had never heard of MMT before I started this blog. From what I could gather from comments

1. MMT seems obsessed with the accounting detail of government transactions
2. This seemed to lead to ideas that I thought were standard bits of macroeconomics

Occasionally I would out of curiosity try and read something by MMT’s leading lights, which reinforced these impressions. For example MMTers seemed to think that they had discovered that a government with its own central bank need never default on its debt, but as far as I was concerned that was a standard and rather trivial implication of the government’s consolidated budget constraint. MMTers also seem curiously averse to equations.

Lately these MMT comments have been getting rather annoying, so I thought I would write all this down. Luckily I do not have to, as Thomas Palley has already done it for me (here and here). I have absolutely nothing to add, except to note that the upshot is not that what MMT says about this budget constraint is wrong, but that it was well known long before MMT and that it is hardly a complete macro theory.

Let me give an illustration of this last point. Some have commented that my recent discussion of fiscal rules ignores the fact that governments can finance investment, or anything else, by creating money. What would happen if the government started doing exactly that: stopped issuing debt and just created money. Let’s assume that real output is at its ‘full employment’ level. That would force interest rates down, which in turn would raise demand and create inflationary pressure, which is not really desirable. MMTers tend to ignore this, and it is not at all clear why. Of course in a recession with interest rates at their zero lower bound (ZLB) things are different, but MMT does not pretend to be just ZLB macro.

This raises the question of why MMT seems to have quite a following. Perhaps it is a reaction to mediamacro’s often implicit assumption that a country like the UK or US could go bust through a forced default. And, to be fair, some mainstream economists seem to want to keep that misapprehension alive, while others take the existence of independent central banks as a binding constraint. It is suggested too often that the government cannot create money in reaction to a funding crisis because this would cause inflation, even when we are at the ZLB, inflation is well below target and the central bank is creating huge amounts of money.

Finally a request. I am bound to get comments on this post disputing what I say, which is fine. But please, for the sake of those people who may still have an open mind, keep these short and to the point. If you accept that a government’s deficit must equal new borrowing plus the creation of new (base) money, there is no need to go into the accounting or transaction details therein.

Looking for the flimflam

According to Thomas Palley, Paul Krugman and my defence of mainstream economics is “pure flimflam”. The definition of flimflam is ‘nonsensical or insincere talk’ or ‘a confidence trick’. Nonsensical I guess is possible, but insincere or a confidence trick it most definitely is not. But I guess this no worse than ‘pure drivel’, which is how Lars Syll once described one of my posts.

Despite all this, I would like to have a debate about macroeconomics with heterodox economists, and have tried to initiate one in the past. A debate that gets beyond generalities (and name calling), and talks about actual macroeconomic mechanisms and what policy makers should do. This is because I’m genuinely puzzled about what I am doing that heterodox economists find so wrong.

According to Thomas Palley, New Keynesian economics “retained the nonsense of marginal productivity distribution theory while discarding the foundations of Keynesian economics”. We “use price and nominal wage rigidity to explain cyclical unemployment”. Now I admit to not being terribly concerned about what Keynes really meant, but I’m at a loss to see marginal productivity distribution theory at the centre of New Keynesian theory. What New Keynesian theory does need is that falls in real interest rates stimulate aggregate demand (i.e. some form of IS curve), and in the basic model this comes from changing the intertemporal pattern of consumption. Is that wrong? What explains cyclical unemployment is real interest rates being at the wrong level. Movements in wages and prices get us out of a recession because they lead the central bank to reduce real interest rates. At the zero bound they cannot do that, and in those circumstances wage and price flexibility could make things worse. Is that wrong?

Now it is true that the standard New Keynesian model assumes a labour market that clears, but a model that replaces this with labour market imperfect competition would not behave very differently. That is what I actually teach. Equally the basic New Keynesian model assumes rational expectations, but if we want to change this to a case where agents make predictable errors that is easy enough to do. I also teach this to undergraduates. (For a pretty good guide to what I teach, see this paper by Carlin and Soskice. I use their textbook.)

Which brings us back to teaching. As I said in my original post, I would like to make students aware of heterodox critiques, but I want to point out where in my mainstream account that critique would enter. (I think what I teach is pretty close to how many central bankers think, if not the rest of 'my tribe'!)  I believe I can do that for what I call anti-Keynesians (freshwater or whatever), although I remain at a loss as to how flexible prices can get us out of a liquidity trap when central banks target inflation (see here and here). So where (in terms of macroeconomic mechanisms) do I locate the heterodox (post-Keynesian or whatever) critique of New Keynesian analysis? This is not an insincere or trick (flimflam) question.