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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
“As late as a week ago, such a phrase as ‘hopefully awaiting the gradual convergence of the physical sciences and the social sciences’ would have provoked no more than an ironic tingle or two in the back of my neck. Now it howls through the Ponchatoula Swamp, the very sound and soul of despair.” –Walker Percy, The Moviegoer
MMT is essentially a political get-rich-quick scam. Like all such con jobs, it depends on the triumph of wishful thinking over reason.
I haven’t looked at all the comments yet, but I need to get something out. I have been studying this for a long time.
It’s a very weird concept, but you can pay for everything with the Federal Reserve and control inflation with the IRS. That’s what they are talking about. Then basically, they assume that the government is going to do productive things with the printed money.
What happens in reality is, people lose agency because everything comes from government contracts and it’s really a bitch to control inflation with the tax system. Democracies is just inflate because people want free stuff. Then the problem is the government requires inflation. So does the financial system. Since progress is better living through purchasing power otherwise known as deflation, and people are having fewer and fewer kids, the whole system blows up eventually.
I think you basically have two choices: go full Austrian or do with a guy says in those Mike Green interviews that I post here that nobody watches. If you go for Austrian, the United States stops policing trade routes, which is obviously a big problem. That’s why the migraine concept is better, but he even admits that nobody is going to do this until everything blows up. Even then I kind of doubt that we are smart enough and honest enough to pull it off.
This is called legal tender laws. There may have been a time when legal tender laws expanded human flourishing. Not anymore.
Thanks. Wish I could take credit. There is an acronym our IT folks use – IOTTMCO – Intuitively obvious to the most casual observer. I hear it all the time. It’s usually directed at me or used about me when I have computer or network problems. I suspect it’s not complimentary.
MMT advocates are like alcoholics who refuse treatment because “I can quit drinking whenever I want to.” Technically, that statement is true. But relying on it is simply a way of avoiding dealing with a habit that will inevitably end in disaster.
I’ve thought that maybe it had its origins here, as I first heard it in an econometrics class where this paper, A First Lesson in Econometrics, was on the syllabus. (The readings went downhill from there.)
I watch videos about this stuff all of the time. Some of it is behind pay walls. One of the things these guys are saying is the whole separation between the treasury and the Fed has been bogus for a long time. They are just buying too much government debt. Even if they are buying other stuff that holds the interest-rate down for the government.
The thing that blows my mind is, the federal reserve owns 20% of the TIPS market. These are bonds that are supposed to reflect market expectations of inflation. There is something seriously screwed up about that.
https://www.city-journal.org/high-taxes-do-not-mean-great-public-services?utm_source=Twitter&wallit_nosession=1
Too funny!!!!! It does seem like that at times. At least Siegfried can laugh at himself and the discipline. He probably couldn’t write that today.
“MMT contends that the only limit on government spending is the availability of real resources, like workers and raw materials.”
…But there seems to be an implicit assumption that “the availability of real resources” is far above the level of real resources (which, properly understood, includes things like capital assets and worker skills, rather than just raw numbers of workers and raw tons of raw materials) which are currently being drawn on. I don’t think that’s true.
If I might take the other side. Not that MMT is correct, but that MMT does fit within the standard neoclassical framework under the conditions you outline, then we have found another of the paradoxes that need to be resolved by a new theory than can remove the paradox. MMT might be the issue that brings around another round of methodology in economics—a serious study of the philosophy of science and its methods. I think the last round was in the late ‘70s early ‘80s after the stagflation of the 70s proved, or should have proved, the failure of the standard Keynesian model. I had been expecting the Great Recession to usher in another round of the study of methods. Keynes made a comeback of sorts, as it gave the political class a handy policy prescription to justify doing what they wanted to do anyway. But common sense and Stein’s Law says that deficit spending cannot increase forever. So in any scientific community, researchers will try to demonstrate that it can, given the current theory, and others will try to find a way to explain all the facts and perhaps create a new theory. Hopefully before we create a natural experiment for MMT.
I’ve thought for some time that the problem with macroeconomics was that it wasn’t built up from micro principles. We have micro theory, and can demonstrate much micro experimentally, but when we try to aggregate up from individuals to a “market,” something gets lost. Somewhere in the story Monetary theory is added to solve some problem or another in the aggregation story, but to me it never made the problem go away. My suspicion has been that we do not possess a correct understanding of money. We describe its uses and functions but never get to what it is.
That’s my two cents and defense of economics.
I hate to say it’s like physics … but it’s like physics. In physics there is the micro equivalent – quantum theory. It ought to be possible to arrive at cosmology by simply taking quantum theory and summing over all the particles in the universe.
But you can’t.
Or, you can, but you don’t get cosmology if you do.
Same with economics. Microeconomics seems to be on solid footing. But you ought to be able to derive Macro Theory by simply taking Micro and summing over all the consumers and all the producers and all the government entities.
But you don’t.
Economics, like Physics, needs a Grand Unifying Theory.
Spot on!
Memory may be a little fuzzy but didn’t we go through this exercise in 1978-1979? Hey, if it will bring us another Reagan in 2024 I am all for it.
I do believe you are correct. But it may have started as far back as under Nixon. Wasn’t it Nixon with the WIN buttons.? (WIN – Whip inflation now)
The following from the late, great, Jude Wanniski…
Man, that is really interesting. Incredible.
For those interested, Wanniski’s wife gathered his writings here
No that was Ford. Nixon’s wage and price controls didn’t work. So Ford tried to rally the nation to do the same voluntarily. As I recall, a lot of what Ford proposed were things that sounded just as foolish as they did a few years later when Carter said the same things—wear sweaters, turn down the heat, carpool, save more, etc. But the campaign also hinted at things like turning down wage increases, or not raising prices for your goods when input prices were rising. Fiscal policy—tax increases—might have worked, along with monetary policy—raising interest rates, but Ford was looking for a voluntary solution to undo what the government had wrought. It [raising taxes] would have been painful, just maybe not as painful as when Reagan let the Fed try to solve the problem a few years later.