A(nother) critique of ‘Modern Monetary Theory’

Imagine that the government could simply print whatever amount of money it needed to guarantee everyone a decent income, fantastic public services, and a secure job if they wanted one – with enough left over to save the planet too. That, for many, is the promise of a new economic paradigm known as “Modern Monetary Theory” (MMT).

If you’re already thinking that this sounds too good to be true, you are probably right, and certainly not alone. Indeed, I’ve been struck by three things about the more fervent supporters of MMT.

First, they rarely have any academic or professional background in economics. Of course, this is not necessarily a bad thing. However, most people who have actually studied economics at university, or worked in a finance ministry or central bank, are likely to agree that the correct parts of MMT are nothing new and that the new parts are often wrong.

Second, MMTers are almost always on the political left, or extreme left, and strong believers in big government. Again, that is not necessarily a bad thing. But it is often impossible to escape the conclusion that they are looking for some intellectual backing for a predetermined agenda of heavy state intervention, high public spending and high taxes.

Third, many of the more cultish MMTers are convinced that they are right and that it is only a matter of time before everyone else recognises this. Anyone who disagrees with them must, therefore, have some ulterior motive in doing so, or is just plain stupid.

For example, an MMTer recently tweeted that it must be “scary” for me and others “to see a new, obviously true, paradigm emerging and strengthening, and trying to inoculate the dying one by reiterating customary gibberish whilst fearing for the future of neoliberalism-based careers and reputations”. Er, what?

It is even more bizarre when the same treatment is handed out to left-leaning Keynesian economists, including strong opponents of “austerity”.

To be fair, there are some perfectly reasonable and polite advocates of MMT. It also has a respectable academic pedigree, helpfully summarised here, which some trace all the way back to Keynes himself. People such as Professor Stephanie Kelton, author of The Deficit Myth and a sometime advisor to the US Democrats, deserve to be taken seriously. So let me explain why I remain a sceptic.

The central proposition of MMT is that a sovereign country with its own fiat currency can always print more money to pay its bills and service its debts. So far, so good. The UK, for example, is clearly in a better position here than members of the euro, such as Italy and Greece. However, this is neither a new idea nor does it give the government a free hand to spend and borrow as much as it likes.

The US economist Larry Summers has compared MMTers to believers in an extreme interpretation of the “Laffer curve”. It is obviously true that there is a level beyond which high tax rates become such a disincentive to work that tax revenues actually fall. But some people have been known to exaggerate this fact to claim that tax cuts will always pay for themselves.

Similarly, many followers of MMT have looked at the recent surge in government borrowing and concluded that there never has been – and never can be – a lack of money to pay for better healthcare, education, welfare or a Green New Deal. Sadly, this is baloney.

Money itself may not be a “scarce resource”, but the same cannot be said of the goods and services that it is expected to buy. Otherwise, any country with its own currency could use its “magic money tree” to pay for world-leading healthcare, education and so on.

Indeed, these constraints are recognised by the more sensible MMTers. They accept that if the government spends so much that the total demand for goods and services exceeds the capacity of the economy to supply them, the result will be higher inflation. But again, this is pretty standard stuff. Where MMTers differ from the pack is on the appropriate policy response.

More orthodox economists would see this kind of overheating as something to be tackled by monetary policy. But most MMTers would argue that the natural rate of interest is zero.

Instead, in the topsy-turvy world of MMT, it is the government that should control inflation, using “well-targeted taxes” to manage private demand. Many MMTers are also keen on wage and price controls, and even rationing, despite the miserable track record of all these forms of state intervention in the past.

The whole approach to taxation is odd. Most people would naturally think of taxation as what pays for spending. But in the world of MMT, spending comes first, financed by money created by the government. The main purpose of taxation is simply to take some of this money back again in order to manage inflation and incentivise work.

MMTers insist that this strange way of looking at the public finances is a more accurate description of how the system operates in practice. But it will leave most people who’ve actually worked in government scratching their heads.

MMTers also argue that government deficits play a crucial role in balancing the economy and are therefore essential, rather than something to fear. The key point here is that deficits and surpluses have to offset each other. (Actually, this is just an accounting identity, rather than a behavioural or causal relationship, but I’ll let that go.) If the private sector needs to run a surplus to repay debts that have become unsustainably high, then the government has to run a deficit. Some go even further and argue that government deficits provide the additional money required to support economic growth.

However, it is simply not right to claim that government deficits are necessary for a successful economy. Many countries, notably in Scandinavia, have run budget surpluses for long periods in the past and still enjoyed sustained increases in living standards.

In addition, deficits are usually financed by conventional borrowing, not money printing. This is true even now during the pandemic. In the UK, for example, the government has significantly increased its sales of gilts to private investors. Some of these new government bonds have subsequently been bought by the Bank of England, but not all.

If what MMTers are saying is that governments should be willing to run bigger deficits to stimulate demand during recessions, and especially when interest rates are already close to zero, that’s hardly new or controversial either. Nor do you have to be an MMTer to recognise what Keynes called the “paradox of thrift”, which is that if everyone tries to repair their finances at the same time the result is likely to be an even longer depression.

MMT comes with a lot of unhelpful baggage too. If MMTers had their way, central banks would lose what independence they have, risking higher inflation and a complete loss of monetary credibility and fiscal discipline. It is also unclear what people working on government-guaranteed jobs would actually be doing, or what would happen when they move on.

Above all, MMT is being used to support a “big state” agenda where the government plays a much larger role in the economy, for good or ill, and in good times as well as bad. Higher public spending would also still mean higher taxes, even if the rationale for a larger tax burden is to prevent overheating and “incentivise work” rather than to balance the books.

In short, MMT is simply a repackaging of some old ideas to appeal to a new audience. There really is no such thing as a free lunch – even from a magic money tree.

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