Explaining persistently low interest rates despite large deficits and rising debt has been one of the central challenges of macroeconomists since the end of the Great Recession. This dynamic has led to increasing attention to Modern Monetary Theory (MMT), presented as an alternative to the mainstream macroeconomic way of thinking, in some fiscal policy discussions. Such discussions are at times restricted by a difficulty, expressed by policymakers and economists alike, in understanding MMT’s core principles and how they inform MMT’s views on fiscal policy. MMT suggests that deficit financing can be used without harmful economic effects in circumstances of low inflation rates and low interest rates, conditions that currently exist despite indications that the country is at full employment.
This report surveys the available MMT literature in order to provide a basic understanding of the differences (or lack thereof) between the defining relationships established in MMT and mainstream economics. It then explores how such distinctions may inform policy prescriptions for addressing short- and long-run economic issues, including approaches to federal deficit outcomes and debt management. Included in this analysis are observations of how policy recommendations from MMT and mainstream economics align with current U.S. economic and governance systems.
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From the introduction:
Unlike mainstream macroeconomic theory, where consensus has been reached on how core relationships translate into mathematical equations, there is no comparative mathematical statement of MMT. Some academic economists have translated MMT into a mathematical framework, and the explanation of the differences between mainstream and MMT theory are based on those discussions.3 Proponents of MMT do not necessarily accept that framework, however.
Footnote 3 refers to Menzie D. Chinn, Notes on Modern Monetary Theory for Paleo-Keynesians, Spring 2019; and Nick Rowe, “Reverse-Engineering the MMT Model,” A Worthwhile Canadian Initiative (blog), 2011.
The link below did not work for me.
“Footnote 3 refers to Menzie D. Chinn, Notes on Modern Monetary Theory for Paleo-Keynesians, Spring 2019;”
AS: Thanks – link fixed.
Have you read this critique of MMT? https://thenextrecession.wordpress.com/2019/01/28/modern-monetary-theory-part-1-chartalism-and-marx/ (there are 3 parts)
The Congressional Research Service has produced a lot of interesting discussions. Usually CRS focuses on some policy debate so this commentary on what is seen by many as an academic debate begs the question. Does CRS think we are about to have a President guided by the MMT crowd? As is President Bernie Sanders?
This link also seems to have issues.
” Nick Rowe, “Reverse-Engineering the MMT Model,” A Worthwhile Canadian Initiative (blog), 2011.”
I think I would need to be sitting in your class to fully follow the material.
By “mainstream macroeconomic theory” is CRS referring to classical Keynesian theory as expressed in The General Theory of Employment, Interest, and Money?
If so, the differences from MMT are quite insignificant. It is also true that Keynes did not put much faith in mathematical models even though he was a professional mathematician:
“It is a great fault of symbolic pseudo-mathematical methods of formalising a system of economic analysis . . . that they expressly assume strict independence between the factors involved and lose all their cogency and authority if this hypothesis is disallowed; whereas, in ordinary discourse, where we are not blindly manipulating but know all the time what we are doing and what the words mean, we can keep “at the back of our heads” the necessary reserves and qualifications and the adjustments which we shall have to make later on, in a way in which we cannot keep complicated partial differentials “at the back” of several pages of algebra which assume that they all vanish.
“Too large a proportion of recent “mathematical” economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.” The General Theory, pp. 297-98.
Keeping the boom going, instead of accepting the slump as normal, is the essence of Keynesian theory. Deficit spending, especially on infrastructure, education, healthcare and other beneficial programs, has been the driving force of our economy for over 8 decades. With inflation and interest rates low, there is simply no reason not to keep the boom going with deficit spending. The Phillips Curve has flatlined and should be relegated to the dustbin of history along with the gold standard.
Hello Professor Chinn,
I am just a life-long learner with no experience with economics above the Principles of Economics level.
Several years ago, I realized I needed to educate myself on important economic concepts: health economics, economic inequality, and basic/principles of economics.
A few years ago, I was searching the economics forums on Reddit for info on MMT. Is it worth my time to learn something about MMT?
I know I should have saved it and I cannot find it now, but one of the economists on Reddit wrote (as I recall):
(total economics faculty at UMKC) divided by (total economics faculty at all universities) = acceptance of MMT among knowledgeable economists.
Until MMT gains acceptance among knowledgeable flagship university economists, I’ve got more pressing basic economics to learn.
Cheers,
Frank
Dear Folks,
A few notes. These are mostly directed to AS, and others interested in a theoretical discussion, and not policy as their primary interest.
1) MMT has a lot of similarities with the work of Abba Lerner on Functional Finance. People who are interested can see this at
https://www.gc.cuny.edu/CUNY_GC/media/LISCenter/pkrugman/lerner-function-finance.pdf
2) The link to Menzie’s work is fixed, and is valuable. Menzie’s take is a little more closely connected to the AD-AS extension of IS-LM than is the work of the CRS authors. (I think this is valuable; others might not.) The link to Nick Rowe’s work has not been fixed.
3) Keynes was critical of Functional Finance. A detailed examination of Keynes’s views is at
http://www.ie.ufrj.br/intranet/ie/userintranet/hpp/arquivos/100320175924_aspromourgos_2014_keynes_lerner.pdf
4) My own personal view is a bit stronger than that of Keynes, and may be worth consideration. Public debt implies the government that issues it will be able to pay it back. We can ask if private borrowers really do have an infinite demand for such debt, regardless of the price level. It is not just countries such as Zimbabwe which have this problem; it was a fear for Israel in the 1980s. Between the investments governments make – which lead to increased private output or decreased private spending, if they are sensible capital or regulatory changes – and the taxes the governments collect, and the property governments take by duress, such as eminent domain, which can only go so far – the governments have to give serious promises of obtaining enough revenue to pay the private investors back. Moreover, the governments are in competition with each other; if we do not want to buy bonds from Indonesia, and we have capital mobility, we can buy bonds from Australia instead. This is not to say that governments should not do public works, far from it. It is also not to say that governments should not use deficts to fight unemployment. But a government that spends its money on hiring militias to collect money or property, as in Zimbabwe, is not on a stable course. Even for more sensible and stable countries, debt is a serious matter. It is seriously constraining Japan now, which has led to the consumption tax increase. It is one possible avenue to reduce this problem to raise taxes in good economic eras, so as to pay the debt back, and not rely on supply-side nostrums which have not proved out. MMT doesn’t seem to have an inherent mechanism that constrains governments to do this, in and of itself – it is an auxiliary assumption.
The classic article which suggest skepticism on debt growth, especially debt growth greater than the growth rate of the economy, is Thomas Sargent and Neil Wallace, “Some Unpleasant Monetarist Arithmetic”, published by the Federal Reserve Bank of Minneapolis, and available at
https://www.minneapolisfed.org/research/qr/qr531.pdf
Martin Uribe is the most sensible critic of their argument, but we can debate whether the conditions he requires would or could hold. His work is at
http://www.columbia.edu/~mu2166/qf/slides_uribe_monetarist.pdf
Julian
P.S. To be more, I should have stated “decreased private costs”.
Julian Silk: Thanks – link to Rowe’s blogpost fixed.
Keynes’ criticism of Lerner’s thinking on deficit spending was political: the common man would not accept a constantly rising debt and therefore it was not practical to propose. Supposedly, Keynes also said that the government debt could not keep on growing indefinitely.
That was in 1943 when the federal debt was $136B. Today, the debt is $23T and rising by a trillion dollars annually. So Keynes was clearly wrong: not only has the federal debt grown by several orders of magnitude, the common man has come to accept the growing debt as normal and nothing to fear.
In The General Theory, Keynes develops the theory of effective demand as the driving force of economic growth: if demand becomes deficient, the economy will collapse into recession or depression. Maintaining demand is essential and federal deficit spending is the only means to directly increase demand. The federal budget deficit is fuel for the economy and using it for infrastructure investment multiplies the beneficial economic effects. As former Fed chairman Alan Greenspan said: “The U.S. can pay any debt it has because we can always print money to do that. So there is zero probability of default.”
Increasing the federal debt has NOT raised inflation or interest rates. In 2000 when we had the largest ever budget surplus of $236 Billion, the 10yr Treasury bond rate was 6.03%. But now, with a deficit of $1 Trillion, the 10yr Treasury bond rate is 1.8% (3Q2019). With a trillion $ deficit, the interest rate is one third what it was when we had the largest surplus in history. Likewise, in 4Q1997 inflation was less than 2%, but after 3 years of budget surpluses, inflation increased to 3.4% in 4Q2000.
Julian,
Thanks. I read the Lerner paper from 1943.
My impression is that Learner seems to be talking about an economy that is machine-like, finely adjustable and deterministic.
Best I can tell, MMT is little more than Argentine-style money printing. If you’re worried about the moral hazard of a budget deficit currently running at $1 trillion, then you’ll be mightily worried about the implications of MMT (and the two topics are related — both are about free money, damn the future).
If you put as much effort into building a model of inflation, interest rates and unemployment using the data on tab ‘Figure 1.5’ of the CBO long term projections as you did modeling MMT, you’d have something pretty impressive, I think.
But how does it address your favorite – DEMOGRAPHICS! After all mainstream macro NEVER mentions DEMOGRAPHICS!
“If you put as much effort into building a model of inflation, interest rates and unemployment”.
Excuse me? Oh host does not bother to model out the basics of macroeconomics? Lord Stevie – this crap of yours needs to stop.
P.P.S. An even more restrictive version on the “Unpleasant Monetarist Arithmetic” is from the Canadian Journal of Economics for 1998, and is provided here
https://www.jstor.org/stable/136204?seq=1#page_scan_tab_contents
Julian
“We develop a model similar to that of Sargent and Wallace and modify it to allow for financial intermediation. In the presence of reserve requirements, unpleasant arithmetic arises even when the real rate of growth exceeds the real return on bonds.”
The Sargent and Wallace paper assume that the real interest rate > the real growth rate. Their insight was that when the long-run government budget constraint holds any attempt to lower taxes permanently lower than government spending would lead to an exploding debt/GDP ratio unless the FED decided to run a massive inflation rate. Before the 1981 tax cut – we did not experience such long-run fiscal folly. But then Reagan replaced tax&tax and spend& spend with spend&spend and borrow&borrow. Sargent and Wallace were worried that the FED could not keep inflation low long under such fiscal dominance.
Hey dominance is something Trump likes. No wonder he wants fiscal irresponsibility and easy money!
GDP growth has been falling since 2Q2018 and is now half the rate it was back then. Should we just sit back and wait for the economy to fall into recession?
What should we do then? Balance the budget?
To escape the last recession required a deficit of 10% of GDP which was the highest since WWII. Does anyone want to do that again?
Dear Folks,
BEA has just put out the advance estimates for the 3rd quarter U.S. GDP, and it shows growth to be continuing, at a 1.9% pace. Consumption is increasing and the real problem is investment, which is basically constant. Those who think significant increases in the deficit or negative interest rates or some other fiscal or monetary policy that requires drama are required (independent of any desire to support the Administration politically) might explain how their preferred measures will increase investment significantly, and show some evidence for it.
J.
Monetary policy in the form of reducing interest rates directly influences investment levels, as Keynes said:
“The significant conclusion is that the output of new investment will be pushed to the point at which the marginal efficiency of capital becomes equal to the rate of interest; and what the schedule of the marginal efficiency of capital tells us, is, not what the rate of interest is, but the point to which the output of new investment will be pushed, given the rate of interest.” The General Theory, p. 184.
Fiscal policy in the form of increased government deficit spending on consumption directly causes increased investment, which Keynes referred to as “capital”.
“capital is brought into existence not by the propensity to save but in response to the demand resulting from actual and prospective consumption.” The General Theory, p. 368.
That reducing interest rates should promote increases in business investment seems self evident, as the lower cost of borrowing results in increased profits.
Likewise, it should be obvious that increasing consumption demand via deficit spending, will cause businesses to increase investment to meet that demand. This is particularly necessary since growth rate of personal consumption expenditures (PCE) decreased to 2.9% annualized in Q3, from 4.6% in Q2. Slowing personal consumption growth must be offset with higher government deficit spending on consumption.
The principles of economics, as Keynes remarked, are simple and obvious.
MMT in a nutshell:
GDP is the measure of our productive economy. GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because ALL spending is someone else’s income). Our economy depends on household spending (2/3 of GDP). That spending is limited by household income (which comes only from those three sectors). Business provides that income to the extent demand (business opportunity) exists, and government provides the rest (by way of bookkeeping entries to household bank accounts). All that’s important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends ONLY on currency-users perception), there are no limits other than that perception.
This says that a monetary sovereign can maintain a healthy economy for its populace just by circulating tokens (so long as they don’t promote disbelief among its users – which promotion of disbelief seems to be the main contribution of neoliberal economists).
MMT in a nutshell:
GDP is the measure of our productive economy. GDP is the sum of household, business and government spending (and likewise the income of those sectors equals that spending, because ALL spending is someone else’s income). Our economy depends on household spending (2/3 of GDP). That spending is limited by household income (which comes only from those three sectors). Business provides that income to the extent demand (business opportunity) exists, and government provides the rest (by way of bookkeeping entries to household bank accounts). All that’s important to the economy is maintaining this flow, and with a fiat currency (whose value, by definition, depends ONLY on currency-users perception), there are no limits other than that perception.
This says that a monetary sovereign can maintain a healthy economy for its populace just by circulating tokens (so long as it maintains belief among its users).
Part of the problem with people not understanding MMT is they keep trying to state it “in a nutshell” when like many economics ideas, it cannot be stated/explained in a nutshell. It really wouldn’t be worth a damn if it could be. Intelligent people do not try to state Keynesianism in a nutshell, and when they attempt it (always in vain) it’s largely to boost their own ego and give themselves a false sense that their brevity in explanation exhibits some kind of sharpness of mind.
Related to Japan and MMT, I thought this was an interesting blog post.
http://www.bondeconomics.com/2019/10/quick-comment-on-takeda-article.html
I can’t say whether Romanchuk’s statement is 100% accurate, however I think i can state he presents a strong argument.