Ricochet is the best place on the internet to discuss the issues of the day, either through commenting on posts or writing your own for our active and dynamic community in a fully moderated environment. In addition, the Ricochet Audio Network offers over 50 original podcasts with new episodes released every day.
Modern Monetary Theory: Wishful Thinking or Exposing a Fatal Flaw at the Heart of Neoclassical Economics?
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.
But…
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 General
If Democrats believe this, why do they keep raising taxes? Why do we collect taxes at all? Why do we need an IRS?
Want money? Print as much as you want. Tax revenue doesn’t matter.
I think Democrats really do believe that. I think. But then I don’t understand their tax policy.
This is the sort of thinking that Thomas Sowell would describe as so absurd that only a PhD would believe it.
You just found the basis for a ground-breaking PhD and you quit?
The problem is that people take a static formula like GDP= C+I+G and attempt to apply it to a dynamic situation and assume that changing one of the numbers, that two of the other numbers will be constant. Sorry, the dynamic world is much more complicated.
MMT is like extrapolating that since a person can skip a meal without dying, that they can skip unlimited meals. I challenge all the MMT folks to try it.
Because under MMT taxation is the key to fiat currency value. What prevents a barter economy? Taxation. The IRS says goods are taxable income and they demand dollars in payment.
You could doctor in exchange for, say, chickens but the IRS doesn’t want 30% of your poultry. You deal in dollars because THEY deal ONLY in dollars. Otherwise, those green pieces of paper are useless.
I have a problem with squaring belief in MMT with any sort of “rational expectation.”
I don’t know what macroeconomic theory is for – telling Santa Claus what we want but feeling some obligation to at least state reasons? If in any case its output makes no mention at all of money supply, I am not totally surprised. I remember spending million-dollar bills in Bolivia. I mean they actually said $1,000,000 on them. True, there was a small b before the dollar sign, indicating they were in fact Bolivian pesos. Once upon a time, and probably for just 5 minutes, 1 Bolivian peso was worth what a million of them were when I got there. Still, the country ran. That may be all a macroeconomist expects.
Thank you for what is the first post on economics I ever read in full. Such posts generally turn me off because every single one I’ve ever looked at conveys exasperation. Yours does too, but not as much, and is far more graceful and instructive. Than economics, no scholarly field radiates more impatience verging on hostility. Although we shall see what Latin American Studies has in store. It may be the only scholarly field where there forever hangs in the air the question Well what if YOU were Bolivian?
I know…Strange but true.
You have to get a doctoral advisor to agree to your project. They wanted doctoral students to safely mortar another brick in the wall of orthodoxy. I wanted to go rooting around under the foundations. Nobody, and I mean no-bod-y was interested…not even the department’s pet Marxist.
Our educational system is so screwed up on so many levels. Lordy.
It’s not that new ideas don’t occur to them. It’s that they actively avoid new ideas.
In institutions of higher learning, devoted to research.
This is nuts.
“Isn’t this an interesting result.”
It’s been a mantra in my house for the 40 years since, used to cover all manner of unbelievable situations.
Simple, (1). their tax policy is to punish the opposition Party’s donors while leaving safe havens for their own.
(2). The non partisan answer is that they try to purposely overstimulate the economy to benefit of the 80% while using taxes on the 20% to blow off the froth of the overheating.
Thanks for the kind words. Surely this is the only time an essay containing “badda bing, badda bang, badda boom” has been described as graceful.
I can only speak to the situation in Economics. If you look at the educational background of many in the profession, their undergrad work was in physics and applied math. They genuinely want economics to look like physics, but without that messy and annoying experimental branch where your beautiful mathematics can be destroyed by an ugly fact.
I have never taken economics with anything other than a HUGE grain of salt. When you prefix everything with ceteris paribus, but it never is, it’s hard to take it too seriously.
This is just another brick in that wall.
If econ were real science, you’d have funding for a very long time.
Thanks for the very interesting (!) and accessible post.
Any chance of un-members-onlying it?
Don’t let @kentforrester see this comment. He just posted an article about grammar, and I doubt he’d approve of your converting “only” into a present participle verb. You know how those grammar people are. I’ll just keep this between us, Charlotte.
How many economists does it take to change a lightbulb?
None. Assume it is light…
Done as requested.
Now this is an interesting conversation.
It seems to me that fiat money has imputed value, and commodities have intrinsic value. Gold has both imputed and intrinsic value.
It reminds me of Mansa Musa who is reputed to be the richest man who ever lived. Whether or not, one year on his hajj to Mecca, he was so lavish and liberal in handing out gold that he reportedly “crashed” Egypt’s economy and it took 12 years to recover. One estimate I’ve read is that gold lost 25% of it’s value; I suppose that estimate referred to it’s buying power. And depending on the story, on his return passage Musa had to take back, or borrow back, much of the gold he had originally given out.
When I think of this kind of inflation, to work in a free market (where greed is controlled and not a variable…), there’d have to be a resultant supply and demand issue, wouldn’t there?
Suddenly, more people can afford to demand a good or service and those offering the good or service see dwindling supply or less availability, so they increase prices until demand and supply are balanced again…
Is that how we see inflation working in our economy?
That’s how understand the process of arriving at an equilibrium. Additional income – the MMT created money – pushes everybody’s demand curve to the right. Assuming that (at least initially) that the supply curves are unchanged, that raises prices across the board. That’s period 1. In period 2 there are several competing effects. Higher prices should call forth additional supply. Cetreis paribus, the additional supply drives down prices. (This is why the MMT fans need continual increases in all factors of production.). But Ceteris is never paribus and among the prices driven up are the prices for supplier’s inputs. This means that they cannot produce as much as they had planned because they have budget constraints or they have to raise prices. You can see the inflationary spiral developing.
But at some point, you’d think supplier(0) would attempt to increase supply, as well, right? I’d expect supplier(0) to roughly have the same product:cost ratio that scales better than supplier(n) in the chain. Is that too diverse to make such a generalized assumption? I’m admittedly applying what I know of the supply chain in the industry I know. For instance, supplier(0) in textiles is fiber farming and thread production. To increase the supply, you plant/husband more, hire a hand or two where new product more than covers the new costs. And now supply increases and supply(0) can start lowering prices commensurate to the new product:cost ratio.
Is the assumption that the product:cost ratio drastically alters with scale?
Right, but if all suppliers are trying bid for additional inputs that raises the prices of the inputs. It’s the same argument we just made about goods prices. So for a fixed input budget a producer can’t get as many inputs as they thought. Supply doesn’t increase enough to drop prices back to where they were initially. And now we start period three with higher goods prices and higher input prices. This is why the MMT folks need ever increasing inputs…to keep supplier’s prices down. But as a supply chain aficionado you know that these lag.
I don’t understand what you mean by the free market controlling greed. But I get the feeling you are more informed on economics than I am. I would say that in Musa’s story, it appears that gold became the commodity in great supply and the bread became the payment that was in short supply for the abundant gold. So in effect, gold lost value as a commodity regardless of it being a currency.
I basically look at the economy as supply and demand, and all that governments do is functionally alter one or the other. So, MMT increasing supply of dollars still would, similar to Musa’s abundance of gold, seem to me to make dollars less valuable. And the only way to cure the economy was to take gold out of circulation. But I get the impression that inflation is not simply static supply and demand but an upward-spiraling feed-back loop.
There’s also a psychological factor. This would play out over time, and increase the speed of inflation and slow the recovery.
Oh don’t make that assumption. I’m a novice. I largely checked out far too early because the subject in its current practice is so unintuitive, I didn’t think I could ever get it. The fact those more knowledgeable have been saying that something is screwy gave me more confidence to test the waters and learn. I find I like the intro to the subject, at least.
As to greed, some aspect of price reflects how much someone can get away with asking even above market value and depends on a consumer that is either limited by available suppliers or not knowledgeable in cost (not a good bargainer). Economists assume that into the market price. And I suppose in a truly free market, greed is minimized. But greedy people always seem to figure out a way to turn it not into a free market.
Thanks
That’s one of my favorites.
I suppose if you don’t have any laws requiring the conservation of
matter and energyincome and utility, you can get about anything. Stick with micro.Yeah, I thought about it and it comes down to debt and productivity, which I think conforms pretty much to income and utility. The last three or four national hyperinflations off the top of my head were Venezuela, Zimbabwe, I’ll include Greece here even though it wasn’t hyper-, and Weimar Germany.
Venezuela was caused by breaking the rule of law, destroying production, and printing more money to maintain an artificially high lifestyle.
Zimbabwe was caused by breaking the rule of law, destroying production, and and printing more money to maintain its lifestyle.
Greece was caused by limiting production, and borrowing money to maintain an artificially high lifestyle.
And Weimar Germany it was going off the gold standard, borrowing money to wage a war it couldn’t afford, borrowing money and printing more money to repay your way out of the loans.
Each situation is is simply spending more than you make by producing. The three true hyperinflations included trying to print your way out.
The bottom line is living high and not producing, and resorting to printing more money.