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A monetary theory more Aristotle than Copernicus.
In February, the Congressional Budget Office (CBO) reported that the federal deficit is projected to total $2.3 trillion in the 2021 fiscal year. That total does not include the $1.9 trillion in so-called COVID-19 relief spending signed into law by President Biden in March. The public share of the national debt currently stands at a little above 100 percent of GDP — the CBO forecasts that this will hit 107 percent of GDP by 2031, the highest debt-to-GDP ratio in U.S. history.
Many see this as a problem, with increased government borrowing pushing up interest rates. But others view all this red ink with equanimity. As economist Stephanie Kelton argues in her new book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, in almost all instances federal deficits are good for the economy. “They are necessary.” Phew!
Kelton arrives at this reassuring conclusion via Modern Monetary Theory (MMT), which she claims could revolutionize economics in the same way that Copernicus revolutionized astronomy. MMT starts with the observation that a monetary sovereign like the federal government — a body that issues the currency its liabilities are denominated in — need never go bankrupt. It can meet whatever liabilities it incurs simply by issuing a sufficient nominal amount of currency. This is a truism, but MMTers argue that it frees the monetary sovereign from worrying about things like debt crises because you can always print the money you need to pay your debts.
So, MMT amounts to this: You don’t have to worry about turning into Greece if you can turn into Zimbabwe instead.
If a monetary sovereign expands the money supply when output is depressed, say when unemployment is high, many macroeconomists would agree that it is output rather than prices that would increase. This is hardly revolutionary. Monetarists and New Keynesians would agree on this. Both, however, would also agree that when the monetary sovereign expands the money supply when output is close to capacity, say when unemployment is low, it is prices rather than output that would rise — otherwise known as inflation.
In other words, there is a point at which further money creation only generates inflation, not increases in output and higher standards of living. Indeed, Kelton admits this:
“Just because there are no financial constraints on the federal budget doesn’t mean there aren’t real limits to what the government can (and should) do. Every economy has its own internal speed limit, regulated by the availability of our real productive resources— the state of technology and the quantity and quality of its land, workers, factories, machine, and other materials. If the government tries to spend too much into an economy that’s already running at full speed, inflation will accelerate. There are limits.”
This belated acknowledgment of economic reality is fatal to Kelton’s claim for any great novelty for MMT. She writes: “There is absolutely no good reason for Social Security benefits, for example, to ever face cuts. Our government will always be able to meet future obligations because it can never run out of money.” This is technically correct, but only in nominal terms. With inflation, that money might not get you much, and the effect will be a real cut in the purchasing power of your Social Security check.
Kelton raises this — “The question is, ‘What will that money buy?’” — but she instantly dismisses it with boilerplate about how, “We need to make sure that we’re doing everything we can to manage our real resources and develop more sustainable methods of production as the babyboom generation ages out of the workforce.” You don’t say?
So, what’s the point of MMT? Where is the Copernican revolution? There isn’t one. Instead we have rebadged monetarist/New Keynesianism for when unemployment is high and rebadged Mugabeism for when it is low.
Kelton offers examples in support of MMT, but where her theory is just underwhelming, her history is actively bad:
“As a share of gross domestic product (GDP), the national debt was at its highest — 120 percent — in the period immediately following the Second World War. Yet, this was the same period during which the middle class was built, real median family income soared, and the next generation enjoyed a higher standard of living without the added burden of higher tax rates.”
Yes, the federal government ran up a considerable debt defeating Nazi Germany and Imperial Japan. But with victory over Japan in 1945, spending fell sharply: by 73 percent in real terms between 1945 and 1948. In seven of the 15 years to 1960, the government ran a budget surplus. And deficits were never large, averaging one percent of GDP. The economy grew faster than government, so federal spending fell as a share of GDP from 41 percent in 1945 to 17 percent in 1960. That Golden Age Kelton references was one of mostly sound government financial management.
We also are told that deficits “didn’t dissuade John F. Kennedy from landing a man on the moon.” Again, this is true, but with these deficits came inflation, which rose from 1.4 percent in 1960 to 12.3 percent in 1974. These examples hardly support Kelton’s case for vast deficits and their essential harmlessness.
There is an old joke: What does a parrot have in common with the Holy Roman Empire? The parrot isn’t holy, Roman, or an empire. Modern Monetary Theory is much the same. It isn’t very modern. Throughout history people have been saying that we would be rich if only we had more of the medium of exchange. It isn’t monetary policy so much as a way of escaping the inevitabilities of fiscal policy. And its theoretical basis is a banal truism. It is simply the latest in a long line of claims to have found a Magic Money Tree for government.
John Phelan is an economist at Center of the American Experiment.