Rarely does an economic theory get so much attention in the media. But MMT is currently in the spotlight. ‘Modern Monetary Theory’ (MMT) is, however, not exactly modern. Its principles can be traced at least as far back as the 1940s or possibly even to Ricardian times.
The main conclusion of MMT is that a sovereign state can concentrate on the desired outcomes of policy, like achieving full employment and need not worry about deficits. As it issues its own currency, it can never be forced into default. It can always print additional money to pay off its debts. Interest rates can be kept low and taxes can eventually be used to curb inflationary pressures.
When asked by a US senator what he thought about MMT, Fed Chair Jay Powell answered: “The idea that deficits don’t matter for countries that can borrow in their own currency, I think is just wrong. US debt is fairly high to the level of GDP − and much more importantly − it’s growing faster than GDP, really significantly faster.
We are going to have to spend less or raise more revenue.” The irony of this is that this senator’s question was probably provoked by the fact that MMT has been embraced by the left wing in the US, for instance by US Congresswoman Alexandria Ocasio-Cortez, a rising political star on the left. She sees MMT as a way to pay for her proposed New Green Deal.
But it could be argued that the US president is himself a practitioner of MMT, albeit a silent one (though it’s probably the only thing he’s silent about), having fired up growth with unfunded tax cuts and attempting to bully the Fed into implementing a low interest rate policy, which is exactly what the proponents of MMT would advise. But they would advise the government to scale back its efforts once full employment has been reached. It can be argued the US has reached this point, or is at least close to it. So perhaps Trump is already overdoing it.
It is also understandable that the political opponents of the Republicans would have little desire to start calling for strict budgetary discipline. That would represent a strange role-reversal in US politics and probably generate little political dividend. I hasten to add that while it is short, the post-war track record of Democrats is actually better than that of the Republicans when it comes to budgets.
MMT has been ridiculed of late by prominent mainstream US economists, and a bit excessively, I might add. It has clearly hit a nerve. Paul Krugman, who is not conservative in the least, complained that MMT adherents were playing a game of ‘Calvinball’, a reference to the ingenious comics by Bill Watterson, in which the main character keeps changing the rules.
Larry Summers calls it the new ‘voodoo economics’, a reference to Bush’s initial criticism of Reagan’s tax cut plans, which were supposed to pay for themselves. These ideas originally came from Laffer, the inventor of the famous Laffer Curve. Reaganomics turned out to be anything but an illustration of MMT, as the Fed kept money tight, initially.
It would now be unthinkable for the Fed to do the same. Therefore, MMT probably has further to run, though the US president currently seems to be picking the wrong battles: take his border wall, for instance. That said, he seems conciliatory towards China. A more fruitful battle in a pre-election year would be trying to implement additional fiscal stimulus in the form of tax cuts, but this time for the middle class, or maybe infrastructure projects other than the wall.
The Fed will remain accommodative as long as long-term inflation expectations stay subdued, which is likely to be the case for the foreseeable future. In the meantime, I see little reason to believe prices for risky assets won’t continue to drift upwards.
This article was first published in Robeco Quarterly, March 2019
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