Beware the Deceptive Allure of Modern Monetary Theory

At the height of policymakers’ interest in ‘monetaryism’, I worked at the UK Treasury, helping to prepare short-term forecasts of the money supply. The practice did not use the Treasury’s economic forecasting model, but projected financial flows using regional balance sheets, money flows and accounting identities. added everything; The surplus of each sector was the deficit of the other. It was like doing MMT. This flow-of-funds perspective juxtaposes with the standard textbook treatment. Our tables made it clear that the monetary base (money plus central bank reserves) was not a policy variable; It moved around to reflect, among other things, the deficit of the public sector. And the data showed how government spending can be self-financing, which is the central claim of the MMT. Together with the central bank, the Treasury can create new money by spending it.

Why, MMT asks, is borrowing from the public a problem? If a currency issuer can issue as much as it wants, why does the government need to borrow? It says that the only constraint is the economy’s ability to meet demand. If too much money is spent, excess demand will cause inflation. So there is no limit on how much the state can spend. It could be inflationary, that is the only concern.

Up to this point, it’s not really contrary to conservative macroeconomics. Nevertheless, economists also talk about the stability of government finances. MMTers make fun of this sort of thing, but they’re wrong for two reasons. The first is that inflation risk is itself a constraint on government spending. The second is that one of the main objectives of the central bank is to control inflation. MMTers fail to understand its implications.

The US Fed is about to raise interest rates to curb inflation, which continues to rise. Using monetary policy to rein in demand means the Fed cannot monetize government spending permanently. This puts fiscal stability back on the table. Policy makers now have to ask: What is the outlook for growth, interest rates, deficit and debt? Suppose the Fed succeeds in controlling inflation but the government maintains its spending. Will higher interest rates cause the public debt to grow faster than the economy can be sustainable? Granted, for MMT, this question does not arise—but not because of the cryptic truth encoded in the accounting identity. This is because the MMT believes the Fed will play no role in fighting inflation. The MMT’s recipe for monetary policy is to “leave the policy rate at zero and release money as needed.” So fiscal policy should do everything. It must realize broader ambitions for public spending—job guarantees, a green new deal, universal health care, retirement security, tuition-free colleges, student-loan forgiveness, etc.—and result in inflationary pressures.

How does MMT propose to do this? Perhaps by raising taxes, though MMTers have mixed feelings about this (to accept this requirement is to admit that not everything can be afforded). Perhaps with direct control over prices, wages, profits and credit. Perhaps by examining spending closely, plan by plan, in favor of outlays that reduce inflationary pressures (such as by boosting the labor supply) and to avoid those that worsen it (for example in overcrowded areas). adding to the demand). That’s a tall order for a US Congress that generally struggles to do anything, no matter what, with the foresight and technical precision to demand a new fiscal policy.

Most economists have long called for a division of labor between fiscal policy (subject to twirling political pressures, biased short-term calculations toward excess of inflation) and monetary policy (delegated to independent central banks, charged with anchoring anticipated inflation) advocated. He had reason. In removing the Fed from the picture, MMT ignores lessons learned over the course of decades.

One more thing: MMTers are right to say that they are proposing a radical change in governance. The MMT impotent the inflation-controlling institution, demanded unimaginable levels of knowledge and competence in Congress, advocated greater state spending, lowered the cost of inflation, and saw talk of fiscal discipline as rubbish. .

If MMT advocates are put in charge, inflation expectations will rise even before a single policy announcement is made. Thus they accept the only constraint of spending would be to stifle their ambitions and stop their program from the very beginning.

But, as I said earlier, his ideas are really interesting.

Clive Crookes is a Bloomberg Opinion columnist and editorial board member covering economics, finance and politics.