Governments across the world have dramatically increased their spending in an effort to prevent economic collapse. So how will they pay for it all?
The traditional economic answer to that question is that governments should run large budget deficits, issue new debt today and service that debt over time as the economy rebounds.
That conventional view has come under attack by the proponents of so-called Modern Monetary Theory (MMT), whose most visible advocate is former Bernie Sanders adviser Stephanie Kelton.
The argument behind this theory is that, actually, we shouldn’t worry about budget deficits at all. In doing so, MMT makes two claims: one weak and one strong.
The weak claim is that a country that can issue debt denominated in its own currency, say dollars, can always finance a shortfall between its spending and its revenues. The central bank can, at the press of a button, create unlimited new dollars.
Because of this, a government can never fail to make payment on dollar-denominated liabilities. In this sense, there can never be a problem financing government deficits. In Kelton’s words, the deficit is a “myth”.
This is neither a new nor a controversial idea. It is well accepted by central bankers, treasury officials, academic economists, and other experts — even if it’s not well understood by various politicians and commentators who are all too quick to talk as if the government budget is just like a household budget. It is not.
But if this view is so well accepted, why don’t countries usually finance budget deficits this way?
The answer is because the strong claims of MMT do not follow from this weak claim. The important constraint facing a government is not how to cover liabilities denominated in its own currency. The important constraint is how to pay for real goods and services. After all, no one cares about currency for its own sake. They care about what they can buy with that currency.
In this sense, the real constraint is inflation. Indeed, the more sophisticated MMT proponents like Kelton agree with conventional economics on this point.
So the real question is: when and under what circumstances is a government likely to run into the inflation constraint?
Conventional economics offers a comprehensive analysis of the circumstances under which different monetary and fiscal policy settings and different economic shocks lead to inflation — or deflation for that matter.
Although policy makers all know that a country can never run out of its own currency, they nonetheless use conventional economic analysis to guide policy. That’s because the weak MMT claim is largely irrelevant for thinking about how to respond to a crisis.
By contrast, proponents of MMT don’t have much to say about when the inflation constraint will bind or what consequences follow if it does.
Some proponents of MMT suggest that the inflation constraint cannot bind if the economy is at substantially less than full employment, as it is right now. According to this view, absence of inflation is a sign the economy is below full capacity and the presence of inflation is a sign that it is hitting capacity.
But this simplistic thinking provides no guide as to how inflation interacts with the real economy when the economy is at less than full capacity. Can inflation bring down the real debt burdens of households and firms? Can inflation bring about changes in real wages even when nominal wages don’t change? And if so is that a good thing?
Perhaps more importantly, can inflation spiral out of control even when an economy is below capacity? Even well-functioning economies can experience large increases in inflation when there is a structural deterioration of underlying fiscal capacity (e.g capacity to raise taxes,
or to cut spending) — as in France in the early 1980s, New Zealand in the mid 1980s, and South Korea in the early 1990s.
All that said, inflation is not the problem we’re dealing with now. We are in the midst of what is likely to be the largest recession since the Great Depression.
With private demand weak and monetary policy options limited, the need for ongoing fiscal stimulus is very compelling. Alarmism about deficits and an embrace of austerity is counterproductive.
By focusing on the trivial issue of how a government mechanically supplies enough currency to cover liabilities denominated in its own currency, supporters of MMT do a profound disservice to their larger policy goals. If you believe in a “Green New Deal” or a larger social safety net, then those goals should be argued for on their own terms. They don’t suddenly become good ideas just because the government can print money.
Keynes didn’t need MMT to argue for fiscal stimulus in a severe recession. We don’t either.
Chris Edmond, Richard Holden and Bruce Preston are professors of economics at the University of Melbourne, UNSW Business School and the University of Melbourne, respectively.
Get more Crikey, for less
It’s more than a newsletter. It’s where readers expect more – fearless journalism from a truly independent perspective. We don’t pander to anyone’s party biases. We question everything, explore the uncomfortable and dig deeper.
Join us this week for 50% off a year of Crikey.
Editor-in-chief of Crikey
Leave a comment
MMT sounds fine but how does it affect the value of our currency with regard to other economies; what happens to the purchasing power of the A$ as we import much of what we consume?
If there was a correlation between the size of the government deficit/non government surplus and the exchange rate, you’d expect it to be the absolute go-to graph for anyone attempting to debunk MMT.
So why isn’t it? Because there is no such relationship.
veritas: presumably all governments are in the same boat. Some *once-off* devaluations might occur, but so what?
Export derived foreign “money”.
I assume Crikey has sought an MMT economist for a response to this disingenuous description of MMT? Sadly this is what is expected of Holden and co, trying to hold up an economic theory that repeatedly makes incorrect predictions about the inflationary impacts of monetary and financial policies. Their argument is either ‘MMT is nothing new’ or strawmen arguments, willfully or ignorantly misrepresenting MMT.
Fortunately there is a far superior article to this one – recent and close to home. I’d never paid much attention to MMT until recently. As the linked article below points out though MMT is actually Modern Monetary Practice as it’s what good modern central actually do now.
https://www.michaelwest.com.au/do-the-grandchildren-really-pay-the-debt-the-problem-with-scott-morrisons-plan-for-recovery-and-mmt/
That is quite a good article (and followed up by another yesterday about purple houses). The description contains a logical step that I don’t follow though:
“The Government has raised $5 billion worth of funds from the banks for its infrastructure project and the RBA has created another $5 billion which the banks can now lend to the private sector, perhaps to finance their contribution to the railway PPP.”
But banks don’t lend money that they have. They lend money that they think they’ll be able to get back, give or take the risk premium. It is the banks that “print money” in the primary instance. There isn’t any obvious need for the RBA’s part in the current mode of currency creation. They aren’t alone in being able to print money: the explanation of the RBA’s interaction with government bonds holds too.
And yet there’s a global economy on top of all of that, and our dollar only gets what it’s worth, in international trade.
How long can you shift inflation from consumables into assets before someone notices?
The real question is why should govt pay interest to banks/middlemen for loans when the RBA can lend instead and then cancel that debt? The LNP’s key base is the private financial sector ( sadly, the “big 4” Australian oligopoly of banks – which are on average 70% foreign owned) who donate to the LNP and the ALP to maintain their key role of retail/domestic credit creation and lending to govts.
What don’t you like about this explanation? Do you have a link to a more accurate one? I’ve come across a few, but none that go past “it’s OK as long as the economy is operating under capacity”. Many of the early ones I’ve read were clearly fairy stories when taken outside the context of the USA, as they didn’t take other economies or other currencies into account at all.
Having seen the byline, I guess I shouldn’t be surprised at the bad faith argument being espoused here.
The rebuttal of green new deals or larger social safety net proposals is always that “we can’t afford it”, or “where’s the money coming from?”, or “what will you cut back to pay for that?”
The insight of MMT is that everything is affordable in purely monetary terms, so the debate should indeed be focused on the effects of the spending rather than the spending itself, and the relative merits of consumption of real resources for this purpose or that purpose.
The authors are being thoroughly disingenuous by suggesting that the fact that the government has the power of the purse should be disqualified from the discussion, in effect ensuring that opponents of neoliberal dogma always have one hand tied behind their back.
‘Everybody knows’ a Government can always pay its debts – oh except the vast majority of politicians and commentators, and apparently their economic advisors, many of whom would be … economists?
Where has been the steady chorus of economics professors decrying most governments’ obsession with balancing budgets? (And where, for another example, is the chorus of economics professors decrying the use of GDP as an indicator of general welfare?)
Stephanie Kelton stands up and says it and you say ‘Oh, we all know that, that’s a weak claim’. Bruised egos? Seems to me if the claim is true that makes it a strong claim.
It is not ‘the more sophisticated MMT proponents’ who say inflation is the real constraint, that has been a central claim of the founders of MMT. Perhaps you have been reading ill-informed and garbled versions? Perhaps you need to be better-read?
You don’t seem to disagree that an economy operating below full capacity is less likely to suffer inflation, you just claim more sophisticated understanding of when inflation might occur – so where is the chorus of professors decrying the very frequent cries of ‘Zimbabwe’ any time someone mentions MMT.
Anyway, ‘inflation’ does not seem to be a well-understood phenomenon in mainstream economics circles. The oil embargoes of the 70s were claimed to have caused inflation, but that was a real rise in the cost of operating, not merely a devaluation of currency caused by excessive issuing.
So Keynes advocated a version of deficit spending. So what? A stronger argument can be made in this era of floating, non-gold-standard currencies, especially with the obsession for balanced budgets. You’re so smart, why weren’t you saying what she’s saying?
Oh, now you’re saying it’s a ‘trivial’ issue that the government supplies its own money. So what about all the claims of ‘burdening our grandchildren’?
And if the government can issue its own currency, why does it use it to buy interest-bearing bonds (even as it is selling other bonds), rather than directly spending, at zero interest, to support the floundering economy?
Someone (not Gandhi) allegedly said
First they ignore you, then they laugh at you, then they fight you, then you win.
Congratulations, you’ve reached stage three, on the wrong side.
Thank you, nice response!
Well said Geoff. I find it curious that many economists, such as these three, tie themselves in knots arguing against MMT, given that even they have come around to accepting that a government with a fiat and floating currency can spend new money into existence. Surely they also accept that Government surpluses result in deficits in the non government sector. And the hoary old arguments about money printing leading necessarily to inflation are clearly contrary to experience, as in Japan for example.
Most of the diatribes directed at MMT seem to boil down to statements that Governments can’t be trusted with the knowledge, and so are encouraged to believe that Governments are like households, and that spending decisions should be left to the market. This argument carries some weight, given the performance of many of our politicians. However, it is the behaviour of the private banking system that worries me most, as they also have been given the mandate to lend money they don’t have, and they often tend to fund enterprises that exacerbate inequality (such as property speculators and other forms of gambling) . In doing so, of course, they increase their own power and wealth.
Yes, private banks in fact create far more money than the government. It generates inflation too – inflation of property and stock prices. Strangely, these apparently are not counted in official inflation statistics.
Yep, banks decide how much property developers charge buyers for say a unit or new house, because the majority of developers borrow from the banks.
Nicely put. Cogent & comprehensive.
“Bruised egos” indeed!
Excellent stuff Geoff. Saves me a long diatribe, just a shorter one at the end required.
typical bullshit from the economist, lets understand one thing, these idiot economists are responsible for every recession Depression in world history, the fact is sovereign nations cannot print currency in a high inflation period but dont have to because the economy is strong, they must print money in recessionary times and we have zero inflation/interest rates at the moment and going into stagflation, the problem is how the printed money is spent, if it is given as subsidies and tax cuts to the rich it makes the economy worse because those greedy bastards dont need to spend, they stack it in their Cayman tax free accounts, if i`st given to ordinary people they spend it immediately and stimulate the economy, when inflation rises again the extra currency can then be slowly withdrawn, these economists know this but the average dumbed down citizen does not ,so these economist grubs frighten the public with their economic bullshit and voodoo economics into accepting their ever decreasing incomes and lifestyle. .
my previous article is being moderated probably because it is too true and would upset the establishment that ultimately controls all media and the drones are only allowed to hear or read what their masters want.
Braddy , all good points, although I would say the best bang for your government created bucks is quality infrastructure. A proper NBN anyone? How about an electricity grid that is an electricity web, connecting all states and allowing solar and wind farms and strategically placed batteries all over the vast countryside. Maybe then a serious go at super fast rail (though not sure whether that adds up, but planes are never going to be fossil fuel free).
Public housing maybe, why is any Australian sleeping in the streets.
Free electricity for households, cheap electricity for business, a revived manufacturing sector and transforming raw materials to iron and aluminium here because its the cheapest place in the world!
Didn’t someone important write about that, oh yeah, Garnaut.