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Modern Monetary Theory (MMT) is an oddball macroeconomic framework that provides the theoretical structure that underlies the wishlist of progressive massive government spending proposals like universal basic income, free child care, free college, and universal healthcare. Where does the money come from to pay for these lavish giveaways? Government prints it. Just like that.
Crazy, right? Not according to MMT. MMT holds that monetarily sovereign countries like the US, UK, Japan, and Canada, which spend, tax, and borrow in a fiat currency that they fully control, are not constrained by revenues or ability to borrow when it comes to federal government spending. Their budgets are not like that of a household. And it is a mistake to think that their policies should be shaped by the same budgetary limitations. Put simply…debt doesn’t matter. Money supply doesn’t matter. Tax revenue doesn’t matter. Want money? Print as much as you want.
But what about inflation? Surely unlimited money creation leads to rampant inflation. No? No. MMT contends that the only limit on government spending is the availability of real resources, like workers and raw materials. When government spending is too great with respect to the resources available, inflation can surge if decision-makers are not careful. ( side note – this explains the progressive impetus for unconstrained immigration. ) Taxes and bond sales do not raise revenue to fund spending but rather are tools to drain money out of an overheating economy. See, you’ve had it all backward. MMT is not naive and irresponsible. MMT unlocks the true potential of government to do good.
That is the argument. And you’d think that it flies in the face of conventional, neoclassical economics. But you might be wrong. Buried deep in the foundations of economic theory is a loophole where MMT is confirmed by the mathematics of neoclassical orthodoxy. Let me explain …
In its simplest form, orthodox macro theory models the economic output as the sum of Consumption, Investment, and Government. C + I + G. If you took Econ 101 you might recall that formulation. Economists have elaborate mathematical depictions of each of these pieces and the result is a dense thicket. Not all of the mathematical descriptions are the same. It’s possible to build in or leave out different bits and opinions vary on what should be included. But one of the variables that is always present in every formulation is the money supply. Two standard bits that are options are The Natural Rate of Unemployment, and Rational Expectations.
Without getting into a debate about angels dancing on economic pins, both these pieces of thought are rock solid, gold plated orthodoxy.
The Natural Rate hypothesis contends that there is some level of unemployment in every economy below which it is impossible to go for long. We don’t need to specify what that number is, just recognize that it exists and it’s not zero. There will always be people who are between jobs. Maybe they are moving. Maybe they have voluntarily changed jobs. Whatever. There will always be some unemployment from these causes. There can be structural rigidity as well. Regardless, The Natural Rate says that unemployment can’t be zero. Friedman and Phelps won the Nobel for the Natural Rate.
Lucas won the Nobel for Rational Expectations. Lucas observed that people tend to anticipate the consequences of any change in policy: they “behave rationally” by adjusting their actions to take advantage of new laws or regulations, inevitably weakening or undermining them. In some cases, these actions are significant enough to offset completely the outcome the government had hoped to achieve.
So we have two pieces of economic thought that have been blessed with Nobel Prizes. That’s as orthodox as it gets.
If one builds both Rational Expectations and The Natural Rate into a macro model, and then does a little algebra … bada bing, bada bang, bada boom … all the variables that relate to the money supply cancel each other out. They are simply gone. A money supply of Zero is allowed. A money supply of Infinity is allowed. The money supply just ceases to matter. And this result is not unique to a particular macro model. ANY model containing both The Natural Rate and Rational Expectations produces this result.
“Isn’t this interesting!” That’s what the esteemed professor of Macro Theory said as he demonstrated this to our Ph.D. class. Interesting? WTF? It’s not interesting. It’s horrifying. We did something completely orthodox and got a nonsense answer. This is the economic equivalent of Galileo going to the top of the Tower of Pisa, dropping two balls, and one falling up. Somewhere, somehow, we economists have done something very, very wrong. Nobody in the class cared but me. “There are lots of other interesting results.” I vividly recall this as the day I knew I’d never finish my doctorate. But the point here is that this “interesting result” is precisely MMT. Money supply being irrelevant is the central MMT message.
I’m not arguing that MMT is correct. Far from it. It’s intuitively obvious to even the casual observer that MMT is ludicrous. But if there are conditions where MMT is allowed by orthodox economics then there is a genuine problem somewhere that needs to be found and addressed. Maybe it’s as simple as either Natural Rate or Rational Expectations being incorrect. But that’s not obvious. Certainly, the Nobel committees didn’t think so.
I don’t have the answer. But I do believe this highlights a legitimate area of inquiry. Where have we gone wrong?Published in