Why Modern Monetary Theory is a Serious Idea for a Serious Time: A Response to James Pethokoukis
Big ideas. I never understood why many people have a problem with them. A group of colonies declaring independence from the most powerful nation on earth, and setting up a democratic government was a big idea. Putting a man on the moon was also a pretty big idea. Developing vaccines against the scourge of disease was no small concept.
We even managed to provide a couple of generations of Americans with low or no cost higher education after a devastating economic depression followed by a horrific world war; at the same time, we provided aid and military security to other nations devastated by that war, allies and foes alike. This was a really big deal. And to top it off, we managed to provide the highest standard of living in history to our citizens, and established, for a time, an example of how well a country can serve its citizens (though clearly not all members of that society were well served). These were big ideas. And we pulled them off.
But how? Can we do it again now that we are again at a crisis point in our history?
Yes, we can, and understanding how our economic system really operates can give us insight into how we turned big ideas into a prosperous reality in that past, and how we can do so again in the future.
Which is where we come to Modern Monetary Theory or MMT.
MMT is an area of economic study, more specifically macroeconomics, which looks at the overall economy rather than particular segments of the economy, which is classified as economics. MMT has been in the news lately, due to a whirlpool of economic stagnation since the financial crisis of 2007-2008, significantly increasing economic inequality throughout the industrialized world and the rise of populist politics. It was thrust into the limelight with the appointment of Stephanie Kelton, a vocal proponent of MMT, to the position of economic advisor to the 2016 U.S. Presidential candidate, Bernie Sanders.
As MMT theorist Bill Mitchell often says, after a groundbreaking idea is ignored, then laughed at, it is attacked and finally accepted. MMT is now in the third stage, criticism. So we now see articles like the piece in “The Week” by James Pethokoukis, titled “Why Modern Monetary Theory is an unserious idea for an unserious time”. Mr. Pethokoukis is an economist at the very serious American Enterprise Institute, a right-wing “think tank”, set up in 1943 with serious money from business people opposed to the New Deal. The AEI, Cato Institute, and Heritage Foundation are but three of the many organizations established to help bring the big ideas of the one percent to fruition.
Mr. Pethokoukis asserts that the big ideas of the U.S. left, including Medicare for All, free state and community colleges, a Green New Deal and a federal jobs guarantee are all unaffordable through mere taxation. In realization of this, the left, according to Pethokoukis, has come up with the convenient, if less than magical, MMT. This “sort-of fiscal cheat code” would enable us to fully realize our big ideas by using the modern-day equivalent of printing money—keystroke entries to the balance sheets of those providing the dreamed about goodies. MMT would allow this simply by the realization that the U.S. Congress is the only constitutionally authorized entity allowed to create dollars. And since those dollars are no longer tethered to any commodity, such as gold (aka “fiat” money), there is no limit to the number of dollars we can create. This, in turn, means there is no reason the U.S. government would ever be forced to default on any monetary obligation.
Pethokoukis correctly states that MMT does not support perpetual and infinite creation of dollars. While there is no limit to the amount of money we can create, there will always be a limit to the amount of money we should create. That limit is determined by the availability of productive capacity and resources. Therefore, if people want to work, and are capable of working, we can create the dollars to put them to work.
To a non-economist, this may seem a pretty simple idea. To an economist, this is hard to conceive. For one thing, the study of economics is about limitations, or at least it tends to be taught that way. Because we live in a world of limited resources, we are always faced with choices between alternatives. This is true; however, we tend to forget that it is the resources, that are limited, not the numeraires placed on those resources. Dollars, or any unit of currency, are simply numeraires. MMT acknowledges this fact. MMT calls out the nakedness of the emperor. And this is what is frightening to those who advise the emperor on fashion.
You see, MMT, while using the term “theory” in its name, is not simply an idea to be tested for validity, MMT is actually an explanation of how we are and have been, operating as the economic system since the collapse of the Bretton Woods Agreement in 1971. We simply have not recognized it as such.
But some have. Why do we never have discussions of how to pay for military escalations that bomb poor countries back to the Stone Age? How can we afford the escalation of the security state to the point where we are perpetually watched, overheard and recorded?
The truth is that the federal government does not operate like a household or a business. The federal government does not use tax dollars to fund spending. Taxes are a mechanism for providing authority to our monetary system. We must have dollars because by law we may only pay taxes in terms of dollars. So must everyone else subject to the U.S. tax system, meaning all the economic activity occurring in the U.S. is potentially subject to taxation in U.S. dollars. Taxes drive our need for that particular currency. And in order to obtain taxes in dollars, the U.S. government must initially provide them by spending into the economy.
Ignoring the effects of international trade, a balanced budget would require that all the money spent by the federal government over a given time period would need to be taxed out again. There would be no net gain of money to the economy and no net wealth increase. Any wealth increase by one party would have to be offset by a decrease in wealth of another party.
Pethokoukis incorrectly compares MMT to the Laffer Curve, which provided a rationale for the Reagan-era tax cuts, and set the stage for every round of federal income tax cuts since then. Arthur Laffer is the right-wing darling economist who wrongly took it on faith that federal income tax rates were so high that merely cutting them for the highest income brackets would stimulate the economy sufficiently that the resulting burst of activity would easily refill public coffers with the income tax revenues from the winners of the newly attained bounty. The comparison fails for those who understand that concerns about the level of tax revenues are not a focus of MMT policy analysis. What is an important focus for MMT policy is the strength of consumer demand in the economy, rather than the supply side emphasis of the Laffer Curve.
Instead of the federal budget, sectoral balances are an essential analytical and policy tool for measuring the condition of the economy under an MMT regime. In the broadest sense, every economy can be seen, and measured, as the summation of three sectors: The private sector, the public sector, and the foreign sector.
The private sector would include all economic transactions in a given time period by private businesses and individuals, the public sector would be all the economic transactions done by all levels of government, and the foreign sector represents what we sell to other nations less what we import from other nations. For any given time period, say a month, a quarter or a year, the total of these sectors is the total economic activity or gross national product.
A balanced federal government means whatever is spent into the economy by the federal government is subsequently taxed away, leaving the total economic system being primarily composed of the private sector and the foreign sector. Now, what if your nation is a net importer, meaning you buy more from other countries than you sell to them? This means that the private sector is being drained of wealth. If you are a net exporting country, your wealth will increase by an amount equal to the value of your exports, and no more.
While it sounds like a good idea to be a net exporter, the fact is that for every net exporting country, there must be at least one net importing country, because the world total of exports and imports must balance each other out. Besides this act, there may be other economic or geopolitical reasons a country sees an advantage in being a net importer. For these countries, the only way to add wealth to the private sector, i.e. savings, is to have a public sector budget deficit. The U.S. is, and has been a net importer for many years, and will continue to be for the foreseeable future. As a result, balancing the federal government budget means a loss in wealth to the private sector, over and above the loss due to international trade. For economic growth in the private sector, we must have a federal government budget deficit.
Next, we must address the issue of government bonds raised by Pethokoukis and other critics. Typically, a bond is a debt instrument which pays a return over a specified period of time. As such, it is easy to see government bonds being issued as a form of borrowing. That is true for states and localities, which often use bond issues to fund infrastructure projects.
However, for the U.S. federal government, there is never a need to borrow dollars. If you think about it, it makes no sense to have to borrow something only you can create, and which you can nearly always create.
Instead, the U.S. government uses bonds to adjust interest rates, and as a source of secure savings for citizens and foreign entities. They trust the U.S., as an issuer of a sovereign fiat currency for a wealthy nation, will never be forced to default. It is essentially a governmental counterpart to a certificate of deposit you obtain from a commercial bank.
Finally, as Pethokoukis correctly points out, there is the issue of inflation. We tend to think of inflation in a simplistic way, as “too many dollars chasing too few goods.” This can be true, but demand and supply variables add significant complexity to the issue. As quantitative easing has shown, a lot of cash in the monetary system will not necessarily cause inflation if consumers are not inclined to spend money on goods and services for various other reasons. When consumers increase savings or pay down debt, additional money is less likely to actually circulate through the economy as purchasing power, and less likely to be inflationary.
A new field of economic study, Behavioral Economics, is increasingly showing how the realities of our thinking processes clash with assumptions economists have made for years. Economists, even the best ones, are not immune to the very human habits of viewing nonpersonal issues through a personal lens, overcoming ingrained knowledge even when it is shown to be false, and allowing themselves to be influenced by monetary concerns, including protecting a source of income.
MMT must overcome these and other hurdles, but the advocates for sharing this knowledge understand the seriousness of their charge. Lives are in danger when austerity is imposed on any complex economy. When people have few options, they may be faced with nothing but options they feel are bad, like not having a job or going into the military. Unemployment and underemployment not only prevent people from enjoying a decent life, but they also deprive society of the contributions those people can make. And with climate change, we face the monumental problem of reducing our destructive impact on the environment if we want to maintain a civilized society.
Proponents of MMT recognize the seriousness of our predicament, and they see a serious approach to help the people of this country in a dangerous time. We should accept that MMT is how our system is already working, and we must harness this knowledge to advocate for all members of society, not just a few. In addition to this idea, we need all the big ideas we can think of.