Modern Monetary Theory is On the March

By William K. Black
February 18, 2019     Bloomington, MN

Modern Monetary Theory (MMT) continues to advance rapidly.  We are past the first phase of reaction (first they ignore you), deeply into the second phase (then they attack you), and expanding the ranks of the third phase (then you win).  We are very early in the third phase, winning with increasing numbers of people, but still a minority view.

One of the proofs of MMT’s advances is a nearly respectable treatment by the Wall Street Journal as the feature of a news article.  The other major proof is the pathetic efforts of MMT critics quoted in the article to attack MMT.  The article, implicitly, admits that MMT scholars have repeatedly proved correct in their predictions that the existing and projected U.S. fiscal budget deficits would not trigger damaging shortages of real resources that will cause damaging levels of inflation.  The article, implicitly, admits that nations with fully sovereign currencies are vastly less vulnerable to economic injury from budget deficits.

The article implicitly admits that MMT opponents’ predictions have failed and that reality has repeatedly falsified their archaic monetary theories that described nations living under the gold standard and therefore lacked a fully sovereign currency.

In theory, high debt levels should cause interest rates to rise. That’s because investors will demand higher returns to compensate for the risk they take on when the government borrows at unsustainable levels or because they worry that so much debt could trigger inflation. The need to finance such high levels of debt also makes less money available for other investments.

In practice, investors are happy to keep lending to the U.S. in good times and bad, regardless of how much it borrows. In 2009, for instance, when the Obama administration’s stimulus efforts sent federal deficits rising to almost 10% of GDP, the highest since World War II, the interest on 10-year Treasury securities remained below where it had been before the recession.

Many Republicans warned the U.S. was pushing itself to the brink of a fiscal crisis and pressed Mr. Obama to rein in spending. Economists debated how much debt a nation could hold before it crimped growth. In one paper, Harvard University economics professor Carmen Reinhart and Kenneth Rogoff, a former chief economist at the International Monetary Fund, found that countries with debt loads greater than 90% of GDP tended to have slower growth rates.

Those three paragraphs demonstrate the falsification of archaic monetary theory.  First, in the most important policy predictions in the lifetime of virtually all living economists, the archaic theory failed every predictive test and led to policy proposals that were spectacularly harmful.  Second, and even more implicitly, MMT’s predictions proved correct and MMT scholars’ policy advice proved accurate and exceptionally helpful in reducing the severity and length of the Great Recession.  The article reports as if there were only one monetary theory – the archaic one.

Third, the article does not explain that Reinhart and Rogoff’s ‘finding,’ as MMT scholars predicted and demonstrated was false.  The journalists should have given special kudos to graduate economic students at U. Mass for demonstrating the falsity of what Reinhart and Rogoff “found.”  Their data also showed, consistent with MMT and contrary to Reinhart and Rogoff, that nations with fully sovereign currencies showed far greater resilience.

Fourth, the first paragraph of the article quoted above inadvertently demonstrates the key weakness of archaic monetary theory substituting conclusory adjectives to ‘prove’ the point that their theory asserts.  What are “high debt levels?”  How much “higher” interest rates do government bond investors supposedly demand in response to “high debt levels?”  (Note that the archaic model piles undefined adjective upon adjective to build their strawman arguments.) What supposedly represents “unsustainable levels” of government debt?  Again, the one effort to convert these vague adjectives into a real standard produced Reinhart and Rogoff’s embarrassing fake fiscal cliff.

Fifth, the last sentence of the first paragraph quoted above wins the prize for piling on vague adjectival ipse dixits as a substitute for any evidence.

The need to finance such high levels of debt also makes less money available for other investments.

One, MMT shows that governments with fully sovereign currencies do not “need” to “finance” their debt.  Two, what does the phrase “such high levels of debt” mean?  Three, how much “less money” is “available.”  Four, what “other investments” supposedly will lack “money?”  MMT makes clear that a nation with a fully sovereign currency cannot lack “money” to undertake “investments.”  MMT makes clear that real resource constraints can actually serve as constraints.  Scholars, and finance professionals, overwhelming agree with MMT on the issue of real constraints.  Five, the journalists did not inform their readers that MMT scholars correctly predicted that the fiscal stimulus program responding to the Great Recession would not “crowd out” access to finance.  The reality is that corporations are sitting on unprecedented amounts of cash and engaging in record stock “buybacks” – so the “crowding out” prediction of archaic monetary theorists was, again, falsified.

The journalists then create two false contrasts – status and ideology.  They note that “prominent” economists agree that MMT scholars’ predictions proved correct.

Now, some prominent economists say U.S. deficits don’t matter so much after all, and it might not hurt to expand them in return for beneficial programs such as an infrastructure project.

“The levels of debt we have in the U.S. are not catastrophic,” said Olivier Blanchard, an economist at the Peterson Institute for International Economics.

The journalists implicitly contrast Blanchard with Stephanie Kelton.

Some left-wing economists go even further by arguing for a new way of thinking about fiscal policy, known as Modern Monetary Theory.

Note that MMT scholars are not “prominent,” even if like Kelton they have held high positions of authority and even if like Kelton, Randy Wray, Mat Forstater, and Scott Fullwiler they have predictive records, demonstrated for two decades; that are the envy of the most “prominent” economists in the world.  It is no insult to Blanchard to point out that each of the four MMT scholars that did key work at UMKC got the most important macroeconomic issues of our lives correct, while the IMF leadership largely got those issues wrong.

Note that Blanchard is at the Peterson Institute.  Pete Peterson is a Wall Street plutocrat who created an institute to push his ultra-right wing deficit hysteria and odes to austerity in order to push for the privatization of Social Security – Wall Street’s greatest dream.  Blanchard’s macroeconomic conversion based on reality falsifying Peterson’s worship of austerity speaks well of Blanchard.  The journalists treat Blanchard as free of any ideology, while defining Kelton as exemplifying “left-wing economists.”  Ideology does not define MMT or the scholars who identify with MMT.  MMT began as an accurate description of how fully sovereign, partially sovereign, and non-sovereign currencies actually operate and the implications of those differences for proper policy.  MMT does not answer whether we should fund particular government projects – it addresses the capacity and results of funding such projects.  These are common, but unworthy journalistic tactics.

Here is the journalists’ response to Kelton’s explanation of MMT.  The response grudgingly admits that MMT scholars’ predictions about the most important macroeconomic issue of all living economists’ lives proved correct.

So far the runup in government debt has not led to steep price increases. Inflation has stayed at or below the Federal Reserve’s target for most of the past quarter century.

Yes, “so far” (over a decade), but hyper-inflation might be right around the corner!  Of course, interest rates on U.S. debt and inflation are both low and the Fed has been consistently unable to meet its (very low) inflation target goal because inflation and interest rates have been exceptionally low for over a decade despite increased federal debt.  Notice that the journalists revert to misleading adjectives – “the runup in government debt has not led to steep price increases.”  It has not led to any meaningful “price increases.”  Indeed, inflation, for a decade after stimulus, remains so miniscule that the Fed views the inflation rate as too low – not too high.  The Fed, despite aggressive monetary policies designed to increase inflation to the Fed’s target rates, has consistently failed to do so.

The best part of the article, however, was its implicit demonstration that MMT’s severest critics have nothing.  Ad hominem attacks demonstrate that economists follow lawyers’ guidance – when the facts are strongly in my favor I pound the facts, when the law is strongly in my favor I pound the law, and when the facts and law are against me, I pound the table.

Alan Auerbach, an economist at the University of California at Berkeley, says the MMT view “is just silly” and could lead to unwanted or unexpected inflation.

Here is the great thing about attacking scholars’ theories that are “just silly” – it is simple to point out the theoretical and recurrent predictive failures that a “silly” theory inevitably produces.  Auerbach had his chance, but he pounded the table because he has nothing.  The truth is that Auerbach has never read the MMT scholarly literature.  We know this because Auerbach, like Blanchard, has moved increasingly into greater agreement with MMT’s precepts and policies.  Auerbach’s attacks on MMT are purely ad hominem because they are based on a strawman view of MMT of his own creation not informed by reading the scholarly MMT literature.

Next, the WSJ article went to the laziest critique – one that ignores MMT precepts to attack MMT.

Meantime, Greece and Italy are two recent examples of countries that appear to have hit thresholds where high debt loads lead to higher interest rates and economic pain. The U.S. may have such a threshold too, just not yet seen.

Greece and Italy do not have sovereign currencies.  MMT scholars, particularly Kelton, predicted that the creation of the euro would cause great harm to European nations with weaker economies such as Greece and Italy.  Japan, which has had debt levels nearly three times recent U.S. debt ratios, cannot produce even modest inflation despite stringent efforts.  The WSJ reduces itself to the equivalent of warning that there “may” be dragons beyond some point on the map!

The journalists end with a ‘parade of horribles.’  If the dragons were they real, they would falsify ‘modern macro’ rather than MMT.

By continuing to run large deficits, says Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget, the U.S. is slowing wage growth by crowding out private investment, increasing the amount of the budget dedicated to financing the past and putting the country at a small but increased risk of a future fiscal crisis.

Market interest rate signals can be misleading and dangerous. By blessing the U.S. with such low rates now, he says, financial markets just might be “giving us the rope with which to hang ourselves.”

Goldwein has no known relevant scholarly record.  He is a minor Pete Peterson operative.  His “crowding out” assertion is bunk in general and his compounding assertion that it explains weak wage growth compounds its baseless nature.  Nothing has crowded out private investment.  Despite record low interest rates for over a decade, deliberate management choices not to invest in new plant and equipment and R&D and instead to do unprecedented levels of stock buybacks designed to raise the value of corporate CEOs’ shares have limited private investment.  Goldwein does not even attempt to support his assertions with data or logic.

Instead, the facts force Goldwein into a startling charge that falsifies all of his neoclassical economic nostrums, not simply his Pete Peterson debt hysteria.  Neoclassical economics and finance predicts that creditors’ anticipation of future inflation largely drive present longer-term interest rates.  This is essential for modern macro’s bedrock rational expectations theory.  In his desperate effort to resurrect the validity of his debt hysteria in the face of supposedly catastrophic debt levels producing exceptionally low long-term interest rates, Goldwein tosses neoclassical economics’ most sacred cows (efficient markets and rational expectations) into the trash by pronouncing that “market interest rate signals can be misleading and dangerous.”

Put aside for the moment the hypocrisy of the fact that debt hawks have proclaimed for decades that nearly every small increase in interest rates is a clarion signal that the markets believe that government debt has reached such high levels that severe inflation is imminent.  In every modern case, reality has falsified these myths.

My colleagues and I have been making the point for decades that “market interest rate signals can be misleading and dangerous.”  Interest rates for extremely risky and fraudulent loans are, prior to financial crises, frequently glaringly too low.  First, the overall level of interest rates for lending becomes too low when an asset-pricing crisis is growing.  Second, the risk ‘spread’ between highly risky and low risk assets typically falls to ludicrously low levels as an asset-pricing crisis nears the “Minsky moment.”  The problem is not the capital markets’ inability to take into appropriate account future inflation, but the fact that markets encourage asset-pricing bubbles that render “interest rate signals … misleading and dangerous.”  Markets are frequently grotesquely inefficient and rational expectations theory is irrational.

It would be wonderful if Pete Peterson’s operatives joined us in fighting neoclassical fictions that Peterson has long spread.  It would be wonderful if Pete Peterson’s operatives joined us in fighting epidemics of “control fraud and predation” and warning against the bubbles that those pathologies hyper-inflate.  It is these fraud epidemics that hyper-inflate bubbles that are the Achilles’ “heel” of capital markets, core neoclassical theories, and financial crises.  The firms that finance the fraud-inflated asset bubbles fit the metaphor about giving the private sector the “rope” with which they will hang the economy.

Capital markets have not displayed recurrent critical failures in modern times about anticipated inflation.  The opposite is true.  One of the best predictors of serious recessions are inverted yield curves.  Yield curves invert overwhelmingly based on future expectations of overall interest rate movements, rather than asset-specific credit risks.

8 responses to “Modern Monetary Theory is On the March

  1. Andrew Anderson

    The article, implicitly, admits that nations with fully sovereign currencies are vastly less vulnerable to economic injury from budget deficits. Bill Black

    Then please note that the US economy runs off bank deposits, not its fully sovereign currency*, and while Federal deficit spending creates bank deposits, so do the banks themselves when they “lend” (“Bank loans create bank deposits”).

    Then what’s so “sovereign” about deficit spending for the common welfare having to compete for real resources with the ability of the heavily privileged banking cartel to safely create similar amounts of bank deposits, not for the common welfare but for the private welfare of the banks themselves and for the welfare of the so-called “credit worthy” of what is, in essence, the public’s credit but private gain?

    Also, it should be noted that the current banking model, whereby sovereign currency use is largely limited to banks and other depository institutions, with the non-bank private sector limited to private bank deposits and mere physical sovereign currency (bills and coins), is a relic of the archaic Gold Standard when sovereign currency was too expensive or scarce for the entire economy to use but only depository institutions and the National Government. So our current banking model is also archaic and should be replaced with a money system that is designed from the ground up to take full advantage of inexpensive sovereign currency to create an ethical, stable money system whose conceptual simplicity would preclude the misunderstanding so prevalent today.

    *One might think that physical currency, bills and coins, is an (small) exception to this rule but how likely is it that, for a given bill or coin, its origin is a cashed Federal check as opposed to a redeemed bank, credit union, etc. deposit?

  2. Bill Black, always a great read.

    “One of the best predictors of serious recessions are…” lending standards being flagrantly lax (especially in conjunction with loan fraud/control fraud). + too much bad debt getting rolled over. The “a rolling loan gathers no loss” phenomenon, with a large growing bubble of bad debt. This sets the stage for the Minsky moment.

    Characteristically, Peterson/neoliberals misdirect attention, pointing at public finances, rather than what’s going in private sector finances.

    And then there’s the thing about the Smoot-Hawley remake. MMTers would never make such a mistake.

  3. Thanks for the article Mr. Black. I am a supporter, but I’m curious as to your response to criticisms such as this from Cullen Roshe:
    “The US Treasury is legally required to obtain funds before it spends. When you incur a tax liability your tax dollars actually go to the Treasury and credit its General Account which gives it the legal ability to then credit someone else’s bank account. This is an undeniable legal requirement that immediately disproves the MMT position.”
    I am sure that this is not a new one to you – what are your thoughts?

    • huh? wouldn’t that mean deficits are illegal?

    • When Mr. Roche says “The Treasury is legally required to obtain funds before it spends” he is missing the point that the Treasury meets that requirement by creating the “funds” out of thin air in the form of bonds.

      As I see it, the US Government issues money in three forms: paper notes and coins (“walking around money); deposits at the Federal Reserve Bank, aka reserves (“checking account money”) and Treasury bonds (“savings account money”). All three are dollar-denominated liabilities created out of thin air by the Government, and all three are dollar-denominated financial assets of the private sector. Although there are limitations on conversion of bonds, as a practical matter any of the three can easily be swapped for either of the other types. When Mr. Roche refers to “funds” I believe he is only thinking of reserves.

      Through open market operations, the Treasury swaps securities it creates out of thin air for reserves held by the private sector, and the Fed swaps reserves it creates out of thin air for Treasury securities held by the private sector. Thus, the Treasury comes to hold reserve deposits at the Fed and the Fed comes to hold Treasury securities. The “why” of these operations is partly historical but also has legal causes and functional effects.

      Historically, bond sales were one way that the Treasury protected its gold supply. This reason has been obsolete since we abandoned the gold standard.

      Legally, the Treasury is required to have positive balances in its reserve accounts at the Fed before it can spend. It credits tax receipts to those accounts, but tax receipts generally don’t cover all the spending that Congress has authorized. The Treasury makes up the difference by creating bonds out of thin air and selling them to the private sector, accepting reserves as payment which it then adds to its reserve accounts at the Fed.

      Functionally, bond sales drain reserves out of the private sector. As reserves are drained out of the private sector the interest rate that banks must offer to get what they need to meet reserve requirements increases. The Fed for its part enters the bond markets as a buyer or seller, adding reserves to or draining reserves from the private sector. It uses these operations to fine tune the interbank interest rates on reserves to its monetary policy target.

  4. Scott Pressman

    @Patrick Dore
    While I’m no academic, I know that when you pay taxes, it doesnt go to some mythical account that allows others to borrow. It is currency simply removed from circulation (think dollars shoveled into a furnace). When someone wants to borrow the bank simply creates it out of thin air…the Fractional Banking System.
    It seems many people cant let go of the fact that there is no gold backing the dollar since that statement would imply “something” of value “must ” be doing so.

  5. A minor note; Pete Peterson died in March, 2018.