In 200 Years When Economics Is A Science….
March 30, 2022
Life will be much easier when economics is a science and we have proof of what policies work and which don’t. Do deficits matter? Does supply side economics work as advertised? Is the only purpose of a corporation to maximize shareholder value? So many questions. And today so many of the answers we hear sound intuitively correct but are they really?
Anyway, an interesting article from Forbes in 2019 about “modern monetary policy.”
Policy and business circles these days buzz about something called modern monetary theory (MMT). Many claim it explains why budget deficits do not matter and why monetary ease, “printing money,” can cover the difference between spending and taxes and never produce inflation. It has allowed Bernie Sanders and other politicians on the progressive left to dismiss establishment concerns about Medicare for all or the Green New Deal or other proposals that would involve vast expansions of federal spending.
Whatever politicians and some in the media claim for this theory, it does have rigorous foundations. These, as described by MMT’s leading proponent, Prof. Stephanie Kelton, economic advisor to Bernie Sanders in his 2016 campaign and presently the focus of much media attention, show a more nuanced and less radical picture than many claim. Neither are the tenets of MMT new. On the contrary, Prof. Kelton’s work draws heavily on the theory carefully expounded over 90 years ago by the great economist John Maynard Keynes. Nor is MMT as left leaning, as some seem to think , though Prof. Kelton clearly has a political if not economic bias in favor of progressive causes.
On the question of budget deficits, Prof. Kelton, like Keynes, most emphatically contends that they do matter. Debt, in and of itself, can do considerable harm. But also like Keynes, her MMT theory adds an important nuance. Not all deficits, she points out, are alike. If the deficit results from spending on things like infrastructure or education or, perhaps, research and development (R&D), it can foster an acceleration in economic growth that pays an ample return on the outlays and the debt incurred to finance these policies, enough return to ease the burden of debt. The deficits and debt will, however, cause harm if they result from unproductive spending. Because of this well-grounded and important distinction, Kelton has argued that the Congressional Budget Office would do more good if it focused less on accounting and more on weighing the economic benefits of policies. In this regard, she and MMT seem to support the very Republican push for what Washington refers to as dynamic accounting, an accounting of ultimate budget effects after assessing the economic response to policy. More generally, MMT also bears a strong similarity to Ronald Reagan’s “supply-side economies.” Reagan, of course, stressed tax cuts and tax reform, but as with MMT, his claim was that these policies would foster economic growth that would pay handsome returns on the debt incurred to finance the tax polices.
Though these arguments fit well with much earlier thinking, they do stand in sharp contrast to the economic model commonly applied in Washington today and championed by Paul Krugman. He argues that federal budget deficits always cause harm. They increase the demand for borrowing and so cause interest rates to rise, crowding out private investment in the economy and so slowing growth regardless of the sorts of policies that caused them. In contrast, MMT argues, and Keynes would have argued, that such interest rate affects are “weak tea,” in Kelton’s, not Keynes’ words. More important are levels of optimism and pessimism. When business people are optimistic about the future, when their “animal spirits,” to use Keynes’ words, are high, they will borrow and expand regardless of higher rates. If, however, those “spirits” are low, it hardly matters how low interest rates fall. People will not invest. Kelton quotes Keynes on the matter.
On monetary policy, Kelton’s MMT does claim that sometimes increasing the flow of money can support deficits without harm. But the theoretical position includes two provisos: first the deficits must support productive fiscal policy (spending in Kelton’s world but also perhaps tax relief) and second the economy must have the capacity to grow in response to the added demand created by the increased money flows. In this respect, MMT is not dissimilar to the old monetarist attitude propounded by Milton Friedman, which held that money growth creates inflation only when it outpaces the economy’s capacity for real growth.
Up to this point, MMT grounds itself on much solid thinking about economics, “stands on the shoulders of giants,” to quote Isaac Newton on his discoveries in physics. But MMT becomes less substantial when Kelton, speaking for it, draws spurious distinctions between what economists call “cost push” and “demand pull” inflation. In this always dubious approach to the subject, the former sort of inflation occurs when costs rise and the latter sort occurs when demand outstrips the economy’s ability to produce. But the distinction dissipates once it become clear that without the demand, no one could push through a general rise in costs. Take her example of the great inflation of the 1970s and early 1980s. She says it was due to a rise in oil prices engineered by the Organization of Petroleum Exporting Countries (OPEC). This particular set of price increases only became generalized because the Federal Reserve (Fed), in an effort to blunt the real economic pain of a rise in fuel costs, increased money flows more rapidly than the economy’s ability to increase production. Perhaps the Fed had no choice. Had it held the line on money growth, the rising relative price of fuel would have slowed real growth by drawing more of what people had in spending power and sending it to OPEC. Whatever outcome was preferable, it was the general rise in demand that caused the inflation.
All this theory, interesting as it is and useful to analysts and policy makers, matters little to politicians. They, as they always have, will use what elements of this or any other economic thinking support their agenda. They never feel a need for coherence or further justification. Kelton, who politically must have considerable sympathy with Bernie Sanders, all but admitted this in a recent interview. When asked how much she influenced him when she advised his 2016 campaign, she said that he pretty much had his agenda set before she joined. She just helped as she could. This story should warn that when politicians and their allies in the media refer to MMT or any economic view, they do little to offer a comprehensive understanding of its implications, and care even less about such things.