Policy advice
It’s also important to recognise that monetary and fiscal policy are linked.
According to Peter Boettke we can summarize the history of government intervention in the macroeconomy with a simple flow chart. It explains periods of hyperinflation and the causes of sovereign debt crises. It is relevant for Weimar Germany, Mugabe’s Zimbabwe and most of the Western world as of today. The “old adage” of macroeconomics is as follows:
- Governments run permanent budget deficit, which leads to a steadily increasing debt burden.
- Unable to fund this through taxation or borrowing, ultimately the government seek to monetize the debt. The inflation that results creates an artificial boom, by pushing interest rates below their natural rate.
- When the malinvestment made during the boom becomes evident, there is a bust, and the economy enters a recession.
What about MMT?
According to Modern Monetary Theory (MMT), it’s fashionable to claim that a country that issues their own currency cannot default on its debt. But as Stephen Kirchner points out, they can and they have.
MMT is also invoked to claim that governments can make spending commitments (such as welfare spending) without having to raise taxes. Recollect the three main forms of government finance: (1) taxes; (2) borrowing; and (3) inflation. MMT essentially says that 1 & 2 are only necessary to prevent inflation, and therefore at full employment (i.e. with stable inflation) taxes or borrowing aren’t acting as a constraint on spending. Technically this is true, but I believe that it is an exercise in semantic word games to distinguish between their claim – that “taxes don’t fund the welfare state” – and the fact that taxes are required to offset the inflation that would otherwise be caused by the money printing used to fund the welfare state. (see here).
Ultimately the achilles heel of MMT is real resource constraints. The problem with public finance has never been a shortage of cash, but the scarcity of the real factors of production. Printing money can bid those resources away from the private sector, but cannot create more of them.
Martin Wolf (2023, p. 244) points out three principle dangers of MMT:
1. We can’t expect policymakers to know in advance when inflation will “bite” – it’s naive to expect them to understand the size of the output gap
2. Risk of losing control over the monetary system – the creation of money will have increased reserves which are likely to enter the real economy during any boom phase
3. Flight of money into goods, services and assets will generate bubbles
In 2022 the New York Times wrote an article about MMT called “Time for a Victory Lap*“. Many reputable economic policymakers expressed frustration for taking those ideas so seriously (e.g. Larry Summers) but I’d recommend Noah Smith’s article, “The NYT article on MMT is really bad“. An important point that he makes is that the piece is really a profile of Stephanie Kelton, demonstrating the link between appeals to authority rather than analytical precision. Having attempted to take MMT seriously, my conclusion is that it’s a movement, not a meaningful economic concept.
There is increased attention by economists to supply side factors. See these articles for more:
- It’s time for a new, progressive supply-side economics, by Eli Dourado, Center for Growth and Opportunity (January 2021)
- Bring Back Supply-Side Economics, by Tyler Cowen, Bloomberg (March 2021)