It is getting to the stage that one gets bored reading critiques of Modern Monetary Theory (MMT) by leading mainstream economists. As the critiques have escalated over the last few years, I can safely say that not one has really said anything: (a) that the core body of work we have developed hasn’t already considered and dealt with – about 20 years ago!; (b) which means, none of the long line of the would be demolition team has achieved their aim. And when they write Op Ed articles that basically just say – oh, MMT economists ignore “the demand for money” and “MMT falls flat on its face” when inflation emerges as part of the emergence out of this crisis, I get bored. Really, is that the best they can come up with. The latest entreaty in the boring stakes comes from Willem Buiter, who seems to have left the commercial banking sector and gone back into academic life. His latest Op Ed – The Problem With MMT (May 4, 2020) – is not his best work. Boring is the best descriptor. Why did he bother? Did he think he had to establish his relevance. He would have been better concentrating on the archaic mess that his mainstream framework is in. Anyway, sorry to end the week like this.
Let me state clearly, at the outset, there may be an inflationary spike coming out of this diabolical mess.
If so, it will be accompanied by hideous unemployment rates.
So we will have what economists call ‘stagflation’ – the combination of accelerating prices and mass unemployment.
And it may come when fiscal deficits remain at elevated levels as governments provide in various ways and to various degrees to support income growth and stop the world sinking into a deep Depression and who knows what.
But be careful of causality and to be sure you put the pieces together properly.
When I provided by criteria for assessing various fiscal policy options recently, regular readers will recall I included an option – Supply Chain.
See my blog posts:
2. The advanced nations should take the lead of Pakistan in job creation (May 4, 2020).
I explicitly emphasised that this particular crisis was rather special in several ways. One way was that it was not just a ‘demand phenomenon’ – a lack of spending causing output and employment to fall.
Clearly, there was a significant ‘supply-side’ aspect to the crisis – factories being forced to shut, production constrained by lockdowns, global supply chains being interrupted.
We don’t know yet how disrupted the supply-side of the world economy has been and what the implications for delivery of goods and services into various markets will be.
But inasmuch as there are significant disruptions occurring, while at the same time governments are stabilising (to some extent) income levels, there will be a break in the expenditure-income-output cycle, which may trigger inflationary impulses.
Remember the basic rule of macroeconomics – Spending equals income equals output, which drives employment growth.
In this crisis, fiscal intervention is aiming to reduce the fall in income arising from the enforced lockdown.
But if the income from one period is cycled into the system next period but output has fallen in that next period then where does the spending go?
Into accelerating prices is where!
If that was to happen, then it says nothing about MMT’s relevance or validity. My face will be intact (not having fallen flat on it!).
But Willem Buiter thinks otherwise.
He starts with an error by referring to the “policy agenda implied by Modern Monetary Theory has become all the more appealing”.
He hasn’t read much I suspect to construct his opening salvo in this way.
What is the “policy agenda implied by Modern Monetary Theory”?
Here we get two tensions.
1. There is no policy agenda implied by MMT – there are principles established, causalities that deliver consequence, descriptive components – but what MMT delivers is an understanding of these things. To operationalise that understanding you have to impose a set of values (an ideology).
A person who has a deep understanding of MMT but who has a Right-wing type ideology will apply that understanding to come up with a totally different policy set than I would come up with.
What is implied there? Nothing.
2. In their haste to trip over themselves to make the point, many mainstream macroeconomists have written Op Eds about MMT saying there is nothing new and that they knew it all along.
They write things like ‘everyone knows that you have to increase fiscal deficits when there is a serious shortfall of private spending’.
What is implied there? Well, that they have only said that when it became obvious to all that their beloved monetary policy bias hasn’t done the trick and the only way to save economies has been through fiscal policy – GFC and now!
But, moreover, if all these characters are jumping on the fiscal deficit train as they are then Buiter is really having a go at all them as well.
He talks about MMT offering “a dangerous half-truth” – and refers to an MMT economist writing in the FT recently, whom he quotes:
They’re going to have massive deficits. And it’s fine.
Apparently, that is a “half-truth” because “while this assessment is correct for now, it won’t necessarily be correct in the future”.
So it is fully true now and if circumstances change then what? Our assessment might change based on our understanding of the role of fiscal deficits – which means it would be fully true then.
Two fully trues struggles to make one half-truth!
Here is a little interview I did with myself just now.
Question: Does the core body of MMT work care about fiscal deficits?
Answer: Definitely – they are central to our thinking.
Question: Does the core body of MMT work say that deficits are ‘fine’?
Answer: Sometimes. It all depends on context. How many times have I written that over the last 16 years of writing blog posts and articles and books, and, before that, in academic publications?
I posed a question within my answer, which has the answer: lots!
Question: Does the core body of MMT work say that deficits can always be large relative to GDP and be that way forever?
Answer: Definitely not.
Please read this blog post – The full employment fiscal deficit condition (April 11, 2011) – which specifies the exact condition that fiscal policy has to match.
And the inference to be drawn is if non-government spending accelerates after a lull, then the larger than normal fiscal deficit will have to be lower and will fall somewhat anyway via the automatical stabilisers.
So when you go through that routine it is hard to know what the ‘half-truth’ is.
Yes, at present, fiscal deficits have to be much larger than in more usual times.
Should they remain that way if things settle down again?
Definitely not – then they would risk driving inflationary pressures from the demand-side.
But Willem Buiter clearly hasn’t taken any of that nuance into account and thinks that:
… we should anticipate that the year following the end of the COVID-19 lockdown could be when MMT falls flat on its face – starting, perhaps, with a burst of inflation in the UK.
Whenever there have been substantial supply-side constraints in history we see inflationary pressures rising.
As I noted above, we don’t know yet how deep the supply constraints will impact. But if they do, there might be some price spikes. Whether they shift into an inflationary spiral is also uncertain.
There is no reason they should if factories restore the supply chain relatively quickly.
And while we are not spending in cafes and restaurants at present we are redirecting that demand to supermarkets, and apart from the irrational run on toilet paper and flour at the outset of the crisis, my local supermarket seems to be getting back to normal and I haven’t observed any flagrant inflationary pressures.
Yesterday, the Australian Bureau of Statistics published the latest – Retail Trade, Australia, Mar 2020 – and it showed that turnover:
1. Cafes, restaurants and takeaway food services fell 22.9 per cent in March 2020 with “Cafes, restaurants and catering services (-30.3%), and Takeaway food services (-13.0%)”.
2. Food retailing rose 24.1 per cent in March 2020.
Substitution in action.
And further households that have maintained their incomes and not travelling as much or buying this or that are diverting that income into saving and reducing their debt.
Remember that households around the world have variously built up massive debt levels and a period of constrained spending is allowing them to restore some safety into their balance sheets. While the source of this motivation is bad, the outcome, in this particular instance is good.
But, Willem Buiter then thinks he is on a roll and tries to get pithy:
… policymakers are flirting with disaster if they accept MMT’s main message, which can be paraphrased as: “Deficit, schmeficit. Just boost public spending or cut taxes, then monetize the resulting imbalance.”
Depending on which style manual one uses “” infer a quotation.
In this instance, Buiter is not quoting from anything that has ever been written by any credible MMT writer.
MMT’s main message is nothing like that.
Refer to my discussion above about CONTEXT!
But let’s focus a little on the ‘monetisation’ angle.
I wrote about these issues in this blog post (among many others) – Building bank reserves is not inflationary (December 14, 2009).
First, central banks are crediting bank accounts on behalf of treasuries every day. That is how government spending occurs – some central bank official types some numbers into relevant accounts – and zap! – government spending occurs.
Second, the mainstream narrative (within which Willem Buiter’s story line site) create a fictional account of this process.
The mainstream macroeconomic textbooks all have a chapter on fiscal policy, where the so-called ‘Government Budget Constraint’ (GBC), begins with the construction that governments have to ‘finance’ all spending either through taxation; debt-issuance; or central bank money creation.
But, as noted above government spending is performed in the same way irrespective of the accompanying monetary operations.
The textbook argument claims that money creation or in Buiter’s words “monetisation” (borrowing from central bank) is inflationary while the latter (private bond sales) is less so.
These conclusions are based on their erroneous claim that ‘monetisation’ adds more to aggregate demand than bond sales, because the latter forces up interest rates which crowd out some private spending.
All these claims are without foundation in a fiat monetary system and an understanding of the banking operations that occur when governments spend and issue debt helps to show why.
What would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a fiscal deficit without issuing debt to the non-government sector?
Like all government spending, the Treasury would instruct its central bank to credit relevant commercial bank accounts.
The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made.
Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet).
Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.
What happens next depends on how the central bank manages the extra reserves in the system.
When there are excess reserves, there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities).
The central bank has three options:
1. Do nothing and allow the overnight interest rate to fall Japan-style to zero – that is, leave the excess reserves in the banking system.
2. Conduct open-market-operations (OMO) by exchanging government debt for bank reserves – thereby draining the reserves. It will do this if the central bank desires a non-zero (positive) target short-term policy interest rate to be the expression of its monetary policy.
Note that if this option is pursued, the public debt sold to the non-government has no correspondence with any need to fund government spending.
The debt serves an interest-maintenance strategy by the central bank when used for this purpose.
And note further that as long as the central bank has a mandate to maintain a target short-term interest rate, the size of its purchases and sales of government debt are not discretionary if only open market operations are relied on to manage liquidity.
Once the central bank sets a short-term interest rate target, its portfolio of government securities changes only because of the transactions that are required to support the target interest rate.
The central bank’s lack of control over the quantity of reserves underscores the impossibility of debt monetisation when only OMO are deployed.
The central bank would be unable to monetise the federal debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to the support rate.
However, if the central bank purchased securities directly from the treasury and the treasury then spent the money, its expenditures would show up as excess reserves in the banking system.
Under the exclusive OMO option, the central bank would be forced to sell an equal amount of securities to support the target interest rate.
In that case, the central bank would act only as an intermediary. The central bank would be buying securities from the treasury and selling them to the public. No monetisation would occur.
3. The central bank, as is the norm these days, may agree to pay the short-term interest rate to banks who hold excess overnight reserves.
This eliminates the need by the commercial banks to access the interbank market to get rid of any excess reserves and would allow the central bank to maintain its target interest rate without issuing debt.
With that background (core MMT) it is then hard to make sense of Buiter’s argument about monetisation.
The point is that the only difference between the Treasury ‘borrowing from the central bank’ and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target.
If it debt is not issued to match the fiscal deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the Japan solution).
There is no difference to the impact of the deficits on net worth in the non-government sector.
Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.
However, the reality is that:
1. Building bank reserves will not expand credit (December 13, 2009).
2. Building bank reserves is not inflationary (December 14, 2009).
3. The money multiplier process so loved by the mainstream does not describe the way in which banks make loans.
4. Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.
So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.
This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and productive capacity.
It is totally fallacious to think that private placement of debt reduces the inflation risk. It does not.
Willem Buiter then allows some faint praise enters the picture.
To be sure, some parts of MMT make sense. The theory views the treasury (or finance ministry) and the central bank as components of a single unit called the state. The treasury is the beneficial owner of the central bank (or, put another way, the central bank is the treasury’s liquidity window), which implies that central-bank independence is an illusion, especially when it comes to its fiscal and quasi-fiscal operations. MMT holds, correctly, that because the state can print currency or create commercial bank deposits with the central bank, it can issue base money at will.
All this is obvious.
And if we accept that then significant aspects of mainstream macroeconomics is then to be dispensed with.
His language suggests he has not really read much of the MMT literature because we never use the term “print currency” and actively disabuse that connotation.
He continues making the most obvious point that he assumes we haven’t thought about. To make that assumption he would have had to also consider that we were deeply incompetent as professional economists, and, more pertinent, not very bright.
Apparently, a currency-issuing government can get itself in a bad situation that goes like this:
1. The government services its outstanding debt (pays interest) by the central bank crediting bank accounts, which Buiter calls “monetization”.
2. Then it gets confusing because we shift from “debt servicing” to the overall “deficit” and back again.
3. But his point is that if the central bank is crediting reserve accounts on behalf of the treasury, it is possible that it creates inflation.
4. Why? Just assertion.
5. But this leads to his conclusion that the government may default on the debt if it requires public ‘spending’ that might provoke inflationary pressures.
So all we learn from that interchange is nothing more than if spending from any source (household consumption, business investment, export revenue, and/or government spending) might drive total nominal expenditure ahead of the real capacity of the economy to absorb it via increased output.
And he knows that because he says “To get to the heart of the matter, forget about issues such as bond financing” – that is, let’s move on because there was nothing to gain from going down that path anyway but I did because it sounded erudite!
The point he wants to make is this:
Assume that public spending and tax revenues are fixed in real (inflation-adjusted) terms. The resulting real deficit will be equal to the increment in the real stock of base money that the private sector must be willing to absorb each period.
In English, he is trying to get to a point where he concludes that spending will be so strong relative to the productive capacity of the economy to absorb it that the only result will be “upward pressure on inflation”.
Yes, this is his “Problem with MMT”.
After some jargon-ridden gymnastics about “real-money balances”, “monetized increases in public spending”, etc and a claim that we might “quickly” shift from low interest rates to “a normal monetary regime”, although the fact that with “Japan stuck at or near the ELB for the past 20 years, the concept of “normal” may require some rethinking”, Willem Buiter writes, after inferring MMT is “reckless” for assuming large deficits are no problem ever (we do not assume that):
… there still would be no inflationary threat so long as the economy has excess capacity (idle resources). But when … the unbridled monetization of state deficits eventually would eventually exhaust what slack there is, putting upward pressure on the rate of inflation.
That’s really the article.
That if spending growth is excessive, nations achieve full employment and then inflation.
MMT 101 really.
MMT doesn’t ‘ignore’ this “at its peril”.
It is core MMT.
I don’t know why Project Syndicate continues to publish this sort of misinformation.
In the blog post I cited above – Building bank reserves is not inflationary (December 14, 2009), I wrote the following.
It is clear, however, that if interest rate changes do impact on spending such that low interest rates are more expansionary than higher interest rates, then a fiscal expansion and a zero interest rate policy will be stimulatory. The issue is not that this will be intrinsically inflationary as is asserted by the mainstream.
It just means that the extent of the fiscal injection that is required to achieve full capacity utilisation is reduced. The government always has the capacity to balance aggregate spending to match the capacity of the economy to absorb it.
11 years ago approximately.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.