09/07/2019 Modern Monetary Disagreement - Project Syndicate

Skip to main content The Big Picture

Modern Monetary Disagreement

In an economic climate of persistently low real long-term interest rates and rising public demand for social and environmental programs, Modern Monetary Theory has been gaining momentum on the left. But it remains to be seen if MMT’s approach to government spending, central banking, and debt can win over a wider range of economic policymakers.

In this Big Picture, Harvard’s Kenneth Rogoff expresses doubts that MMT’s prescriptions would prove either safe or effective, and worries about the long- term fiscal and monetary implications. But James K. Galbraith of the University of Texas at Austin counters that MMT has a sound footing in Keynesian economics, and may be the only way to achieve both full employment and price stability.

Sebastián Edwards of UCLA, however, warns that in countries where some version of MMT has been tried, it has never ended well. But Robert H. Dugger of Hanover Provident Capital disputes that, and argues that the debate will be rendered moot by the next major debt crisis, which will make some form of MMT inevitable. Featured in this Big Picture

ROBERT DUGGER

SEBASTIÁN EDWARDS

JAMES K. GALBRAITH

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 1/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

KENNETH ROGOFF

Modern Monetary Nonsense Kenneth Rogoff

Modern Monetary Realism James K. Galbraith

Modern Monetary Disasters Sebastián Edwards

Modern Monetary Inevitabilities Robert Dugger Modern Monetary Nonsense

Mar 4, 2019 | KENNETH ROGOFF

CAMBRIDGE – Just as the US Federal Reserve seems to have beaten back blistering tweets from President Donald Trump, the next battle for central-bank independence is already unfolding. And this one could potentially destabilize the entire global financial system.

A number of leading US progressives, who may well be in power after the 2020 elections, advocate using the Fed’s balance sheet as a cash cow to fund expansive new social programs, especially in view of current low inflation and interest rates. Prominent supporters of this idea, which is often referred to as “Modern Monetary Theory” (or MMT), include one of the Democratic Party’s brightest new

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 2/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

stars, congresswoman Alexandria Ocasio-Cortez. Although their arguments have a grain of truth, they also rest on some fundamental misconceptions.

Fed Chair Jerome Powell could barely contain himself when asked to comment on this new progressive dogma. “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong,” Powell insisted in US Senate testimony last month. He added that US debt is already very high relative to GDP and, worse still, is rising significantly faster than it should.

Powell is absolutely right about the deficit idea, which is just nuts. The US is lucky that it can issue debt in dollars, but the printing press is not a panacea. If investors become more reluctant to hold a country’s debt, they probably will not be too thrilled about holding its currency, either. If that country tries to dump a lot of it on the market, inflation will result. Even moving to a centrally planned economy (perhaps the goal for some MMT supporters) would not solve this problem.

On Powell’s second point, that US debt is already high and rising too fast, there is far more room for debate. True, debt cannot rise faster than GDP forever, but it may do so for quite a while. Today’s long-term, inflation-adjusted interest rates in the US are about half their 2010 level, far below what markets were predicting back then, and far below Fed and International Monetary Fund forecasts. At the same time, inflation has also been lower for longer than virtually any economic model would have predicted, given current robust US growth and very low unemployment.

What’s more, despite being at the epicenter of the global financial crisis, the US dollar has become increasingly dominant in global trade and finance. For the moment, the world is quite content to absorb more dollar debt at remarkably low interest rates. How to exploit this increased US borrowing capacity is ultimately a political decision.

That said, it would be folly to assume that current favorable conditions will last forever, or to ignore the real risks faced by countries with high and rising debt. These include potentially more difficult risk-return tradeoffs in using fiscal policy to fight a financial crisis, respond to a large-scale natural disaster or pandemic, or mobilize for a physical conflict or cyberwar. As a great deal of empirical evidence has shown, nothing weighs on a country’s long-term trend growth like being financially hamstrung in a crisis.

The right approach to balancing risk and reward is for the government to extend the maturity structure of its debt, borrowing long-term instead of short-term. This helps to stabilize debt-service costs if interest rates rise. And if things get really difficult, it is far easier to inflate down the value of captive long-term debt (provided it is not indexed to prices) than it is to inflate away short-term debt, which the government constantly has to refinance.

True, policymakers could again resort to financial repression, and force citizens to hold government debt at below-market interest rates, as an alternative way of

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 3/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

reducing the debt burden. But this is a better option for Japan, where most debt is held domestically, than for the US, which depends heavily on foreign buyers.

Having the Fed issue short-term liabilities in order to buy long-term government debt turns policy 180 degrees in the wrong direction, because it shortens the maturity of US government debt that is held privately or by foreign governments. Contrary to widespread opinion, the US central bank is not an independent financial entity: the government owns it lock, stock, and barrel.

Unfortunately, the Fed itself is responsible for a good deal of the confusion surrounding the use of its balance sheet. In the years following the 2008 financial crisis, the Fed engaged in massive “quantitative easing” (QE), whereby it bought up very long-term government debt in exchange for bank reserves, and tried to convince the American public that this magically stimulated the economy. QE, when it consists simply of buying government bonds, is smoke and mirrors. The Fed’s parent company, the US Treasury Department, could have accomplished much the same thing by issuing one-week debt, and the Fed would not have needed to intervene.

Perhaps all the nonsense about MMT will fade. But that’s what people said about extreme versions of supply-side economics during Ronald Reagan’s 1980 US presidential campaign. Misguided ideas may yet drag the issue of US central-bank independence to center stage, with unpredictable and potentially serious consequences. For those bored with the steady employment growth and low inflation of the past decade, things could soon become more exciting. Modern Monetary Realism

Mar 15, 2019 | JAMES K. GALBRAITH

AUSTIN – Is Modern Monetary Theory (MMT) a potential boon to economic policymakers, or, as Harvard’s Kenneth Rogoff recently argued, a threat to “the entire global financial system” and the front line of the “next battle for central- bank independence”? For Rogoff, the threat seems to stem partly from the fear that MMT adherents may come to power in the United States in the 2020 elections. But he also makes several substantive arguments, common to many critics of the MMT movement.

First, there is the claim that, as Rogoff puts it, MMT is all about “using the [US Federal Reserve’s] balance sheet as a cash cow to fund expansive new social programs.” Second, Rogoff and other MMT opponents strongly reject the idea that, quoting Fed Chair Jerome Powell, “deficits don’t matter for countries that can borrow in their own currency.”

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 4/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

Yet, as Rogoff admits, “the Fed itself is responsible for … confusion surrounding the use of its balance sheet.” Indeed, while Rogoff decries the Fed’s “quantitative easing” – involving the purchase of trillions of dollars in public (and private) debt after the financial crisis – his argument is that QE didn’t really work, not that it was destabilizing or inflationary. He sees no threat to the global financial system in that experiment.

Similarly, despite his full-throated backing of Powell on deficits, Rogoff reverts to cautious realism about the US national debt. As he points out, today’s long-term real interest rates are “about half their 2010 level, far below what markets were predicting back then.” And he acknowledges that inflation has remained lower than “virtually any economic model would have predicted,” while “the US dollar has become increasingly dominant in global trade and finance.” Perhaps the US budget deficit is not an immediate cause for panic after all?

MMT is not, as its opponents seem to think, primarily a set of policy ideas. Rather, it is essentially a description of how a modern credit economy actually works – how money is created and destroyed, by governments and by banks, and how financial markets function. Nor is MMT new: it is based on the work of John Maynard Keynes, whose A Treatise on Money pointed out back in 1930 that “modern States” have functioned this way for thousands of years.

From this description, certain straightforward facts flow. Governments create money by spending and extinguish it via taxation. It follows, therefore, that a large country, borrowing in its own currency, cannot be forced into default. That is why the US is not Greece, and cannot become Venezuela or Zimbabwe.

Does this mean that “deficits don’t matter”? I know of no MMT adherent who has made such a claim. MMT acknowledges that policy can be too expansionary and push past resource constraints, causing inflation and exchange-rate depreciation – which may or may not be desirable. (Hyperinflation, on the other hand, is a bogeyman, which some MMT critics deploy as a scare tactic.)

But the issue with budget deficits isn’t interest rates, which remain under government control. Nor is it the possible crowding out of private investment, which assumes that the pool of finance is fixed. The issue is real resources. Here, MMT’s proposed job guarantee would keep real resource use exactly at the level required for full employment – not less, but also not more.

What about the fraught topic of central-bank independence? Rogoff sees the political threat to the Fed as a very serious issue. But to describe the Fed as having a “parent company, the US Treasury Department” creates a misleading impression of the actual relationship between the Fed and the government as a whole.

The 1913 Federal Reserve Act gave the new central bank’s leaders long terms in office, and therefore independence from the executive branch (of which the Treasury Department is a part). They do not serve – as Treasury secretaries do – at the pleasure of the president. The Fed is also self-financing, which gives it

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 5/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

independence as well from the Office of Management and Budget in the White House.

But the Fed is not and never has been independent of the US Congress. It is created by statute and subject to regular congressional oversight, codified by the 1978 Humphrey-Hawkins Act, which specified the Fed’s famous “dual mandate” of price stability and full employment. (As a young staff member of the House Banking Committee at the time, I drafted the monetary-policy provisions of that law and supervised the hearings.)

True, Congress exercises this oversight power loosely and with considerable deference. At least formally, though, the Fed is – and always has been – subject to congressional instruction.

And MMT is not about Congress ordering the Fed to use its “balance sheet as a cash cow.” Rather, it is about understanding how monetary operations actually work, how interest rates are set, and what economic powers the US government has. This, in turn, requires recognizing that the dual mandate is not a collection of empty words, but something that can – and should – be pursued on a regular and sustained basis.

There are practical, straightforward, and realistic ways for policymakers to meet this mandate. Implementing them would strengthen the country, not bankrupt it. And, contrary to opponents’ fears, global investors would not flee in terror from US government bonds and the US dollar. Modern Monetary Disasters

May 16, 2019 | SEBASTIÁN EDWARDS

LOS ANGELES – Modern Monetary Theory (MMT), a seemingly new approach to economic policy, has become a hot topic, gaining support from leading US progressives such as presidential candidate Bernie Sanders and Democratic Representative Alexandria Ocasio-Cortez. But MMT enthusiasts should heed lessons learned in Latin America, where policies based on similar ideas inevitably ended in economic catastrophe.

According to MMT’s supporters, the US Federal Reserve should print large amounts of money to finance massive public infrastructure projects, along with a “job guarantee” program aimed at ensuring full employment. A major increase in public-sector debt, MMT backers claim, does not represent a danger for a country that can borrow in its own currency, as the United States can.

This unconventional view has been criticized by Keynesians and monetarists alike. Many respected academic economists, including Paul Krugman, Kenneth

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 6/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

Rogoff, and Larry Summers, say that MMT makes little sense.

In response, MMT supporters argue that the theory’s critics do not fully understand how a modern monetary economy works. According to influential MMT advocates such as Stephanie Kelton, governments in countries with their own national currency, such as the US, do not face hard budget constraints because they can simply print more money to finance higher expenditures.

Assessing the merits of MMT is difficult, for two reasons. For starters, its supporters have not provided a unified, detailed description of how the model is meant to work. As Krugman recently wrote, MMT backers “tend to be unclear about what exactly their differences with conventional views are, and also have a strong habit of dismissing out of hand any attempt to make sense of what they’re saying.” In addition, MMT supporters have offered hardly any inklingof how the policy might function in practice, especially in the medium and long term.

Yet the approach is not unprecedented. MMT, or some version of it, has been tried in several Latin American countries, including Chile, Argentina, Brazil, Ecuador, Nicaragua, Peru, and Venezuela. All had their own currency at the time. Moreover, their governments – almost all of which were populist – relied on arguments similar to those used by today’s MMT supporters to justify huge increases in public expenditure financed by the central bank. And all of these experiments led to runaway inflation, huge currency devaluations, and precipitous declines in real wages.

Four episodes in particular are instructive: Chile under President Salvador Allende’s socialist regime from 1970 to 1973; Peru during President Alan García’s first administration (1985-1990); Argentina under Presidents Néstor Kirchner and Cristina Fernández de Kirchner from 2003 to 2015; and Venezuela since 1999 under Presidents Hugo Chávez and Nicolás Maduro.

In all four cases, a similar pattern emerged. After the authorities created money to finance very large fiscal deficits, an economic boom immediately followed. Wages increased (helped by substantial minimum-wage hikes) and unemployment declined. Soon, however, bottlenecks appeared and prices skyrocketed, in some cases at hyperinflationary rates. Inflation reached 500% in Chile in 1973, some 7,000% in Peru in 1990, and is expected to be almost ten million percent in Venezuela this year. In Argentina, meanwhile, inflation was more subdued but still very high, averaging 40% in 2015.

The authorities responded by imposing price and wage controls and stiff protectionist policies. But the controls did not work, and output and employment eventually collapsed. Worse still, in three of these four countries, inflation- adjusted wages fell sharply during the MMT-type experiment. In the periods in question, real wages declined by 39% in Chile, 41% in Peru, and by more than 50% in Venezuela – hurting the poor and the middle class.

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 7/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

In each case, the central bank was controlled by politicians, with predictable results. In Chile, the money supply grew by 360% in 1973 alone, helping to finance a budget deficit equivalent to an astonishing 24% of GDP. In Peru in 1989, money growth was 7,000%, and the fiscal deficit exceeded 10% of GDP. In Argentina in 2015, the deficit was 6% of GDP, with the annual rate of money creation surpassing 40%. And Venezuela currently has a deficit of 32% of GDP, with the money supply estimated to be growing at an annual rate of more than 1,000%.

As inflation increased in these countries, people greatly reduced their holdings of domestic money. But because governments required taxes to be paid in local currency, it did not completely disappear. Instead, the speed at which money changed hands – what economists call “velocity of circulation” – increased dramatically. No one wanted to be holding paper money that lost 20% or more of its value every month.

When the demand for money collapses, the effects of money growth on inflation are amplified, and a vicious circle develops. One serious consequence is that the currency depreciates rapidly in international markets. MMT supporters conveniently ignore the simple fact that demand for local money declines drastically when its value tumbles. Yet this is perhaps one of the theory’s biggest weaknesses, and one that makes it extremely risky for any country to implement.

The experience of Latin America should serve as a clear warning for today’s MMT enthusiasts. In a variety of countries, and at very different times, fiscal expansions that were financed by printing money resulted in an uncontrollable loss of economic stability. Economic-policy ideas are often as dangerous in practice as they are flawed in theory. MMT may be a case in point. Modern Monetary Inevitabilities

May 27, 2019 | ROBERT DUGGER

ALEXANDRIA, VIRGINIA – In a recent Project Syndicate commentary, James K. Galbraith of the University of Texas at Austin defends Modern Monetary Theory and corrects some misunderstandings about the relationships among MMT, federal deficits, and central-bank independence. But Galbraith does not explore what is perhaps the most important issue of all: the political conditions needed to implement MMT effectively.

MMT owes its newfound relevance to the fact that deflation, rather than inflation, is becoming central banks’ main concern. For a high-debt, high-deficit economy like the United States, deflation is an especially serious threat, because it delays consumption and increases debtor anxiety. Consumers forego major purchases on the assumption that future prices will be lower. Homeowners with mortgages cut

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 8/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

back their spending when they see home prices falling and the equity in their homes declining. These cutbacks worry the Federal Reserve, because they add to deflationary pressures and could trigger deeper spending cuts, stock-market declines, and widespread deleveraging.

The Fed’s inability so far to reach its 2% target for annual inflation suggests that it lacks the means to overcome persistent disinflationary forces in the economy. These forces include increased US market concentration, which diminishes aggregate demand by weakening employee bargaining power and increasing income inequality; population aging; inadequate investment in infrastructure and climate-change abatement; and technology-driven labor displacement. Making matters worse, US political gridlock assures continued commitment to economically exhausted strategies such as tax cuts for the rich, at the expense of investment in education and other sources of long-term growth. These conditions cry out for significant changes in US government spending and tax policies.

MMT is seen as a way to accomplish the needed changes. It holds that a government can spend as much as it wants if it borrows in its own currency and its central bank can buy as much of the government’s debt as necessary – as long as doing so doesn’t generate unacceptably high inflation. Both tax-cut advocates and supporters of public investment find little not to like.

MMT has been roundly criticized by economists across the political spectrum, from Kenneth Rogoff and Lawrence H. Summers of Harvard University to Paul Krugman of the City University of New York. All contend that it is a political argument masquerading as economic theory. But Galbraith and Ray Dalio of Bridgewater Associates see MMT differently. Dalio argues that MMT is real and, more to the point, it is an inevitable policy step in historically recurring debt-cycle downturns.

In his book Principles for Navigating Big Debt Crises, Dalio documents the steps that central banks have historically taken when faced with a booming economy that suddenly crumples under the weight of debt. The first step (Monetary Policy 1, or MP1) is to cut overnight official rates to stimulate credit and investment expansion. The second (MP2) is to buy government debt (quantitative easing) to support asset prices and prevent uncontrollable waves of deleveraging. If MP1 and MP2 are insufficient to halt a downturn, central banks take step three (MMT, which Dalio calls MP3) and proceed to finance the spending priorities that political leaders deem most essential. The priorities can range from financing major national projects to “helicopter money” transfers directly to consumers.

Achieving political agreement on what to finance and how is essential for implementing MP3 effectively. In a financial meltdown or other national emergency, political unity and prompt action are essential. Unity requires a strong consensus on what should be financed. Speed requires the existence of a trusted institution to direct the spending.

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 9/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

In the early 1940s, when the US entered World War II and winning the war became the government’s top priority, the Fed entered full MP3 mode. It not only set short- and long-term rates for Treasury bonds, but also bought as much government debt as necessary to finance the war effort. MP3 was possible because the war united the country politically and gave the Roosevelt administration near-authoritarian rule over the economy.

The core weakness of MP3/MMT advocacy is the absence of an explanation of how to achieve political unity on what to finance and how. This absence is inexcusable. Total US debt (as a share of GDP) is approaching levels associated with past financial meltdowns, and that doesn’t even account for the hidden debts associated with infrastructure maintenance, rising sea levels, and unfunded pensions. For the reasons Dalio lays out, a US debt crisis requiring some form of MP3 is all but inevitable.

The crucial question that any effort to achieve political unity must answer is what constitutes justifiable spending. Alexander Hamilton, America’s first Secretary of the Treasury, offered an answer in 1781: “A national debt,” he wrote, “if it is not excessive will be to us a national blessing.” A government’s debt is “excessive” if it cannot be repaid because its proceeds were spent in ways that did not increase national wealth enough to do so. Debt resulting from tax cuts that are spent on mega-yachts would almost certainly be excessive; debt incurred to improve educational outcomes, maintain essential infrastructure, or address climate change would probably not be. Accordingly, it will be easier to achieve political unity if MP3 proceeds are spent on priorities such as education, infrastructure, or climate.

The political test for justifying MP3-financed government spending, is clear: Will future generations judge that the borrowing was not “excessive”? Most Americans born well after WWII would say that the debt incurred to win that war was justified, as was the debt that financed the construction of the Interstate Highway System, which literally paved the way for stronger growth.

As the 1930s and 1940s show, MP3 is a natural component of government responses to major debt downturns and the political crises they trigger. We know much more about what contributes to economic growth and sustainability than we did in the first half of the twentieth century. To speed recovery from the next downturn, we need to identify now the types of spending that will contribute most to sustainable recovery and that in hindsight will be viewed as most justified by future Americans. We need also to design the institutions that will direct the spending. These are the keys to building the political unity that MMT requires. To know what to finance and how, future Americans can show us the way; we need only put ourselves in their shoes.

Featured in this Big Picture

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 10/11 09/07/2019 Modern Monetary Disagreement - Project Syndicate

ROBERT DUGGER 3 Commentaries

Robert H. Dugger is Managing Partner at Hanover Provident Capital, LLC.

SEBASTIÁN EDWARDS Writing for PS since 2000 10 Commentaries

Sebastián Edwards is Professor of International Economics at UCLA’s Anderson Graduate School of Management. His latest book is American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold.

JAMES K. GALBRAITH Writing for PS since 2015 4 Commentaries

James K. Galbraith is a professor at the Lyndon B. Johnson School of Public Affairs, University of Texas at Austin. His most recent books are Inequality: What Everyone Needs to Know and Welcome to the Poisoned Chalice: The Destruction of Greece and the Future of Europe.

KENNETH ROGOFF Writing for PS since 2002 182 Commentaries

Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co- author of This Time is Different: Eight Centuries of Financial Folly, his new book, The Curse of Cash, was released in August 2016.

https://prosyn.org/KyZnTgS;

© Project Syndicate - 2019

https://www.project-syndicate.org/bigpicture/modern-monetary-disagreement 11/11