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NOTE: THIS IS A POST ABOUT ECONOMICS
MMT is more keynesian than the [mainstream] Keynesians
When John Maynard Keynes published his General Theory of Employment, Interest, and Money in 1936, he hit the current Zeitgeist. In the 1930s, classical and neoclassical economics were in trouble and under fire from both sides of the political spectrum.
The allegedly revolutionary approach of Keynes was that he criticized (neo)classical, supply-side economics and pledged to think about economics from a demand perspective. He offered a different solution, some that were quickly championed by journalists and young economists, namely, that the government should step in during a crisis and fight it by strengthening demand.
Put short, Keynes proposed that governments should stabilize demand via additional government spending to bring the economy back to a course of growth. Although his ideas were not new, Keynes put the theses of John Law, Thomas Malthus, and the Birmingham School of Thomas Attwood in a General Theory.
Although Keynes's critics found many flaws, fallacies, and mistakes in his theory, the triumph of Keynesian economics could not be stopped. In times when economies all around the world suffered from the consequences of the Great Depression from 1929, the proposals were a welcomed, different view on the economy and undoubtedly had a significant influence on the further course of economic theories.
Even though the ideas of Keynes lost influence in the economic mainstream in the 1970s, they were never gone at all. Governments and central banks have favored Keynesian monetary and fiscal policy throughout this day, or at least something pretty close to Keynesian ideas. Yet, especially governments mostly forget the second part of Keynes’s theory because he at least pointed to the fact that governments should run surpluses when times are good and lower their involvement in the economy. This shows that Milton Friedman was right when saying nothing is as permanent as a temporary government program.
Although most proponents of Keynesian economic policies and greater involvement of governments in the economy come mostly from rightwing or leftwing populist parties, the developments since 1980 brought up other proponents of monetary expansion. Some, one would not have expected to be in that camp: people from the financial industry.
However, at second sight, the reason why they are proposing it becomes evident if we take into account that their wealth had increased enormously since the 1980s when Alan Greenspan introduced financial markets to the Greenspan Put. Since then, they could benefit from indefinitely rising asset prices.
When central banks reacted to rising rates of consumer price inflation that was caused by the monetary and fiscal expansion in 2020 and 2021, it did not take long for advocates (and some who were critical of ZIRP and NIRP) to warn that the rate hikes might be too extreme. Yet, I was slightly surprised to read in recent weeks that many decision-makers in the financial sector started to claim that Modern Monetary Theory was correct.
At its core, Modern Monetary Theory still invokes Keynes and his General Theory. However, with a crucial difference: while Keynes still pointed to the importance of deficits and tax revenues, proponents of MMT claim that deficits do not matter. Governments of monetary sovereigns should never ask how to finance a particular public policy. The most well-known book in MMT is probably The Deficit Myth by Stephanie Kelton. Portfolio manager Mike Green recently stated on Twitter that MMT is descriptive, not prescriptive. The question, however, is whether the theory is correct. After the theory has become quite popular in some political circles, it is worth having a closer look at the theses and claims of MMT.
In my view, the linchpin of MMT is their theory of currency value, which is probably why it is called the Modern Monetary Theory. While the name suggests that it is some new theory, the idea is, in fact, more than 100 years old. In contrast to classical economics, where the value of money derives from the value of the good that was used as money, the German economist Georg Friedrich Knapp (1842-1926) formulated the thesis that money has value because it is issued by the state (=Chartalism).
As the state has a money monopoly, it can issue as much currency through credit as it wants. The value of money is justified by the fact that it is redeemed in tax payments. Money is demanded from users because they have to pay taxes for it.
The proponents of MMT explain this with simple book-keeping arguments: If the state (the government AND the central bank) spends money into existence, it raises the government’s deficit and ends up in additional surpluses for the receivers (the private sector, or the owner of resources). Because of that, MMTers claim, the government can never repay all of its debt because all the money would be sucked out of the economy.
For MMTers, interest rates do not have a crucial influence on investment decisions. According to them, investments are based on potential future growth potentials. Therefore, they argue, interest rates should be held at zero, at least for the state.
Taxes are not seen as a form of income for the government, as neoclassical theory assumes, but as a tool to redistribute wealth and fight inflation. With taxation, the state should ensure that spending does not get excessive in an economy or, put differently, that more money is circulating than resources are available. MMT is no free lunch, Stephanie Kelton said in 2021. However, the argument is not that taxes should be raised when inflation has already picked up but immediately after the government raises expenditures:
If the government wants to boost spending on health care and education, it may need to remove some spending power from the rest of us to prevent its own more generous outlays from pushing up prices. One way to do this is by coordinating higher government spending with higher taxes so that the rest of us are forced to cut back a little to create room for additional government spending….MMT emphasizes the importance of deciding when tax increases should accompany new spending and which taxes will be most effective at restraining inflationary pressures.
Stephanie Kelton - The Deficit Myth
According to Kelton, Warren Mosler, and other MMTers, inflation is simply a supply-side phenomenon that emerges because of monopolistic pricing power. As a result, so they say the government should fight monopolies and hinder the banks from issuing too many loans. After all, even MMT acknowledges that resources are finite.
Another thesis I want to mention is one I recently heard in the Forward Guidance Podcast, where Warren Mosler was invited. In the podcast, Mosler claims economists have it all backward regarding interest rates and inflation.
According to Mosler, the following is true: at high debt levels, rate hikes result in higher costs to refinance the debt while the economy is simultaneously shrinking. However, higher refinancing costs also mean that the private sector surplus is increasing (his words, not mine) because bondholders get higher interest payments to spend.
Then, Mosler refers to Argentina, where the central bank has recently raised interest rates to 97 %, and inflation continues to accelerate. Currently, annual inflation is about 110 % year-over-year. For him, Argentina proves that rising rates fuel inflation because higher interest payments cause private-sector surpluses to increase. As crazy as his proposal sounds (at least for classical and neoclassical economists), he said that the central bank needs to cut interest rates to get inflation back under control because it leads to falling incomes.
Now, as I have laid out the theses of the proponents of Modern Monetary Theory, let us examine if the claims are correct. Firstly, let me point out the things that MMT actually gets right before I move on to discuss its fallacies. After all, there are a few things where MMT is correct, but to paraphrase Hazlitt: Whatever is original in MMT is not true, and whatever is true is not original.
For example, it is correct that deficits alone do not cause consumer price inflation. The relationship between government deficits and consumer prices is strong in some periods but weak in others. However, that notion is not new. Since Richard Cantillon’s Essay on the Nature of Trade in General was published in 1755 (probably even since the Spanish scholastics), it is well known that it depends on where the money is spent.
Also, the description of how money is created in a fiat money system is correct. The old assumption that banks lend out deposits is not valid anymore, as the Bank of England and the German Bundesbank also found. Central banks create base money out of thin air, and banks can multiply it to a certain extent. As a result, the relationship between savers and borrowers is wholly repealed. Modern Monetary Theory perceived this correctly, although it is not originally from it.
But let us go on to the main chore of MMT, which claims that money has value because you have to pay taxes with it. It is crucial to note that MMTers make no extinction whether the money is specie or paper money. Money has value because it is redeemable in tax payments.
Economist Per Bylund (Oklahoma State University) recently published a significant paper examining this claim further. He did this because Stephanie Kelton asked him to do so during a discussion on Twitter. Within the debate, Kelton referred to an article by Randall Wray, Taxes Are for Redemption, Not Spending.
In his article, Wray tries to explain why taxes are not needed before the government spends, but that the government spends it at first, creates private sector surpluses, which creates demand, and then the private sector pays taxes.
Wray refers to an example from Georg Friedrich Knapp, where Knapp compares government money with coatroom tokens, with a slight change, namely that the coats are homogenous. As Bylund correctly notes, the example does not explain why anyone would exchange his coat for a token in the first place, although his supposition is the following:
The point of Wray’s adapted cloakroom example is to illustrate that government currency is not a good, as it is in traditional monetary theory (Menger 1892; Mises 1953), but merely a claim. It is… a ‘token’ which can be ‘redeemed’ for a coat. (Bylund, p. 154)
In order to prove that the analogy shows how government-issued money works, Wray refers to historical examples from tally sticks to paper money in colonial America.
In these cases, the government issued tokens that could then be used by taxpayers to ‘redeem’ their tax liabilities. Also, the tokens were often discarded and destroyed rather than reused by the government after taxes were paid, which Wray suggests further supports the thesis that they were in fact ‘redeemed’ for tax liabilities (p. 154)
According to this theory, government expenditures (MMTers include the central bank in government) raise the money supply, while taxes decrease it. Bylund even agrees that the argument would be valid if the government destroyed its collected tax revenues.
Yet, the historical facts are chosen selectively on the one hand, and on the other, they are no proof that state-issued currency is indeed money. The first question that must be raised (which Bylund does) is that even if tokens are obligated to pay taxes, there is no reason to use the state-issued token for barter between individuals.
The step from specific use to general use that Tomin and Golub as well as Kelton assert without explanation. (p. 156)
Even in the historical example that Wray uses, it is not that the tokens alone had to be used to pay taxes. Still, the government also accepted the common, already circulating currency (real money).
The argument becomes even more absurd if one spins it further and thinks about a music festival, where chips are issued to pay for all the goods and services offered at the festival sight. Those chips have no value because the organizer issues them but because they can either be exchanged for goods and services or back into real money. No one would have the idea of taking the chips back home from the festival and paying with them at the local grocery store.
As Bylund correctly reasons, the theory is completely unsuitable to explain what money is. The claim of MMT merely shows that there is demand for a good the government chooses (paper money) if it obligates you to pay taxes with it. A possible explanation is Greshhams Law, where the tokens are used for barter while one holds the real money.
Yet, it is no explanation why owners of resources would accept the token from the government to sell them to it. According to Bylund, political reasons might exist (p. 158).
Furthermore, people use a certain form of money because it has had value in the past, has value today, and is expected to have value in the future. In the past, money had value because it could be redeemed in gold or another commodity before the link was capped. General acceptance is a reason why people continue to use the currency even in times of high inflation, at least up to a certain point.
But if the chore claim of Modern Monetary Theory is flawed, as Bylund shows, it quickly becomes apparent that most of the claims that MMTers make are wrong.
At this point, I want to discuss another thesis: that interest rate increases fuel inflation further because it translates into higher income for bondholders.
Firstly, one should note that there is indeed a scenario where inflation is accelerating despite rising interest rates. That would be the case when governments (and consumers) do not cut back on spending but keep it constant or even increase it. Yet, this only holds in that specific case: higher interest rate payments increase the number of issued government bonds. If the government continues spending more money can be described as fiscally driven inflation.
In such a scenario, consumer price inflation accelerates if supply falls faster than demand. However, if it is true that money has value because it is redeemable in tax payments, as MMT claims, then prices could only stay high if the state continues to spend money into existence, pays higher prices, and does not cut back on spending to lower demand.
At this point, the thesis completely collapses, as MMTers would argue that the state could simply lower inflation if it forces producers to sell resources at lower prices. However, a history recap shows that government-implemented price controls only result in economic imbalances and shortages. If price controls were ever lifted, they would quickly adjust to higher levels, like in 1973 when Richard Nixon lifted his induced price controls.
Additionally, MMTers forget that currency units are already circulating in such a scenario, and the producer might choose to sell the resources to other currency holders who want to buy what the government did before. The assumption that the money supply does not influence prices is also questionable under these circumstances.
Just as Bylund showed in his piece, MMT is highly selective when choosing historical evidence that supports its claims. Warren Mosler’s example of Argentina of why rising interest rates fuel inflation makes that evident as well.
If someone brings up Argentina to point out it shows that MMT does not work, the usual answer you get from MMT is Argentina is not MMT because it is no currency sovereign. But, strangely, if Argentina is not proof that MMT does not work but simultaneously is evidence why the MMT claim that rising interest rates fuel inflation is accurate.
Argentina suffers from high inflation despite rising interest rates because it has to issue dollar-denominated debt to borrow money. Additionally, the domestic demand for pesos also collapses as people try to flip over their pesos immediately to exchange them either for goods and services or to buy things like dollars, gold, or bitcoin because they expect that the peso will be less valuable in the future. As a result, import prices are rising as no one wants to hold the Argentinan peso, which shows what happens if a country goes full MMT.
If one looks at the United States (allegedly a place where MMT works), Mosler’s claim is also not supported. If neoclassical economics is putting the cart before the horse, as he argues, then rising interest rates would lead to increasing interest rate expenditures and higher inflation. However, since the 1980s, interest rates followed inflation, and then interest rate expenditures followed, so this theory does not only not fit in Argentina, but it also does not fit in the US.
As a result, one can say that there is not much left from MMT that is true, except for some banal factual statements. In fact, MMT just looks like a fabricated thesis to support the claim that the state has to steer the economy centrally and that deficits do not matter, which is hitting the current Zeitgeist of populists all over the political spectrum.
Like Keynes, who offered a theoretical foundation for why governments need to spend in times of crisis and run deficits, MMT just pours a (given) solution to a problem into a theory.
For MMT, the government is the archetype of a hero who looks after all of us and creates a better world, strikingly reminiscent of Marx.
Look into my eyes
And tell me what you see,
Some real, this is real,
What you wish to be
Fear Factory - Archetype
I wish you a splendid weekend!
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(All posts are my personal opinion only and do not represent those of people, institutions, or organizations that the owner may or may not be associated with in a professional or personal capacity and are no investment advice. I may change my view the next day if the facts change)