How Modern Monetary Theory Can Enable Liberals

And it has the virtue of being an accurate description of reality too. Bill Mitchell has a great interview in Harvard International Review about debt, deficits, and modern monetary theory. Mitchell contrasts the dominant New Keynesian paradigm with MMT:

Well, the New Keynesian paradigm is built upon a series of false premises that affect policy prescriptions. False premise number 1: government has to borrow to fund spending. False premise number 2: there’s a fixed supply of savings available at any point in time. False premise number 3: the government, by borrowing from that fixed supply of savings, denies private sector borrowers those funds, and competition for those funds drives up interest rates.

MMT says the following:

There is no finite pool of savings in the economy. Savings is a function of national income. When you have rising national income, you have rising savings. So if government spending stimulates economic activity, and thereby GDP and national income, savings will rise simultaneously. That’s the first part of the story.

The second part of the story is that private sector borrowing is not dependent upon a fixed supply of savings. The concept of a bank in the New Keynesian model is that the bank sits there waiting for depositors to come with their savings, and only once the bank attracts those deposits is it in a position to lend. In other words, the New Keynesian conception is that banks are constrained by their existing reserves. In reality, however, banks always have the capacity to create loans for credit-worthy borrowers because they can always get more reserves. Banks can get reserves from a number of sources, but at the end of the evening the banks know they can cover their reserves by borrowing from the central bank. So the conception of banking in MMT is much different from the stylized treatment in New Keynesian economics.

The third story is what happens when the government runs a budget deficit. What happens in the money market is as follows: the US government buys something from the private sector. They pay the manufacturer, who then pays the workers. A whole range of transactions follows from that initial government purchase. All of those transactions work their way through the system and find their way to the reserves of the banks each day. Typically—though not at the present because we are in an extraordinary situation where the central bank is paying interest on reserves—those reserves would just sit there and earn zero interest for the banks. And so typically, as I’ve explained before, banks try to get rid of those reserves, driving down the interest rate in the interbank market in the process. What you can understand from that is that budget deficits, independent of any monetary operations, drive interest rates down, not up. This is the complete opposite of what orthodox economists claim is the case, and it’s confirmed by the present combination of record low interest rates and very large budget deficits.

This, to me, is the key point (boldface mine):

In MMT, we see public debt as private wealth and the interest payments as private income. The outstanding public debt is really just an expression of the accumulated budget deficits that have been run in the past. These budget deficits have added financial assets to the private sector, providing the demand for goods and services that have allowed us to maintain income growth. And that income growth has allowed us to save and accumulate financial assets at a far greater rate than we would have been able to without the deficits.

The only issues a progressive person might have with public debt would be the equity considerations of who owns the debt and whether there an equitable provision of private wealth coming from the deficits. There is a debate to be had about that, but there is no reason to obsess over the level of outstanding public debt. The government can always honor its debt; it can never go bankrupt. There’s no question that the debt obligations will be met. There’s no risk. What’s more, this debt provides firms, households, and others in the private sector a vehicle to park their saved wealth in a risk-free form…

Particular budget outcomes should never be a policy target. What the government should be targeting is real goals, by which I mean a sustainable growth rate buoyed by full employment.

Why do we want governments? We want them because they can do things that improve our welfare that we can’t do individually. In that context, it becomes clear that public policy should be devoted wholly to making sure that there are enough jobs, that poverty is eliminated, that the public health and public education systems are first class, that people who are less well off are able to become better off, etc.

As long as the Left continues to frame arguments in terms of deficits, we will lose–and there’s no need to do so. Of course, we do have to realize that the Left can no longer argue that we can’t afford defense spending either. That, however, is an instructive case. We could oppose defense spending for several reasons:

1) We don’t like a particular war.
2) We are allocating too much manpower to military needs, and not enough to domestic ones.
3) We are misallocating too many resources to military needs.
4) Wages and profits in the military sector are spiraling out of control.

All of those could be legitimate reasons to reduce defense spending (or not). But saying we can’t afford defense spending isn’t legitimate; we can always spend the money. Once we understand that, it’s incredibly liberating.

Of course, the majority of the U.S. public hasn’t wrapped its head around the theories of natural selection and common descent or the implications of four dimensions of space-time, so it will probably take a while….

An aside: For those of you worried about deficits:

From a macroeconomic point of view, the spending and tax decisions of government should be such that total spending in the economy is sufficient to produce the level of real output at which firms will employ the available labor force. This is the goal, and the particular budget outcomes must serve this goal.

None of this is to say that budget deficits don’t matter at all. The fundamental point that the original developers of MMT would make—myself or Randall Wray or Warren Mosler— is that the risk of budget deficits is not insolvency but inflation. In saying that, however, we would also stress that inflation is the risk of any kind of overspending, whether investment, consumption, export, or government spending. Any component of aggregate demand could push the economy to that point where we get inflation. Excessive government spending is not always to blame.

In sum, we’re quite categorical that we believe that budget deficits can be excessive and can be deficient as well. Deficits can be too large, just as they can be too small, and the aim of government is to make sure that they’re just right to employ all available productive capacity.

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1 Response to How Modern Monetary Theory Can Enable Liberals

  1. Detroit Dan says:

    Well said! Long live Mike the Mad Biologist!

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