A reprinted article from November/December 2019 Modern Monetary Theory Delusions By Charles Lieberman, PhD ® © 2019 Investments & Wealth Institute®, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE 2019 Modern Monetary Theory Delusions By Charles Lieberman, PhD hot debate has erupted over “modern monetary theory” A (MMT), which promoters allege With one notable exception, every time governments have justifies an increase in government printed money copiously to pay bills, the result was rising deficit spending to pay for the Green inflation and, in the extreme, hyperinflation. New Deal and other programs. The government would issue as much debt as needed to raise funds, and the Federal Reserve (the Fed) would buy by Keynesians and has been mainstream With one notable exception, every time the debt by printing the money. MMT for many years. But Kelton goes further governments have printed money copi- proponents claim there would be no by maintaining there is no limit to the ously to pay bills, the result was rising adverse consequences because the debt size of the budget deficit that can be run inflation and, in the extreme, hyperinfla- is denominated in dollars and the Fed as long as there is no inflation problem— tion. Two egregious examples are the can print as many dollars as required. and she sees no link between too much Weimar Republic and its hyperinflation federal spending and inflation. She calls in Germany in the 1920s and Zimbabwe One vocal and visible MMT promoter is such a link “hard to believe.” Others, in 2008–2009. Both printed vast, seem- Stephanie Kelton, former chief econo- however, believe that MMT misses the ingly unlimited quantities of money to mist of the Senate Budget Committee for inevitable link between too much federal finance government spending, but they the Democratic minority staff, a former spending, printing money, and inflation. paid for this behavior with runaway senior advisor to Bernie Sanders, and a inflation. Recently, Venezuela, which is professor of economics at Stony Brook THE SOMETIMES TRAGIC experiencing eroding oil revenues, has University. Kelton has argued that any HISTORY OF DEFICIT FINANCE managed its deficits by printing more country engaged in MMT doesn’t have a The legal ability to print money has long money, and its inflation rate has risen deficit problem unless it has an inflation been held exclusively by government, from around 800 percent annually in problem; she states that running very despite the best efforts of counterfeiters. 2016 to an estimated 1-million percent large deficits does not lead to rising Economies need currency with which in 2018. These are the extreme examples inflation (Helfand 2019; Malter 2019). to conduct business transactions. In trotted out to explain why printing Kelton notes that because the U.S. gov- supplying money to their economies, money is economically dangerous. ernment can print its own money to governments enjoy seigniorage, which meet any obligation (the Fed would do is the difference between the face value More moderate versions are more com- the printing and buy the Treasury’s of money, such as a $10 bill, and the mon, with lesser but still problematical newly issued debt), it is not possible for cost to produce it. Governments can results. When Italy and France had their the U.S. government to ever become print currency at little cost and use it to own currencies, both economies contin- insolvent. This is true, but others believe buy goods and services for the govern- ually suffered from higher inflation than that dire consequences will ensue. ment beyond whatever tax revenues the rest of Europe. They found it difficult they can impose on their economies. politically to pay for their high level of Kelton’s argument stands on the basic And for the most part, governments government spending with taxes, so view that increased government spend- have handled this ability to print money they made up the difference by printing ing is desirable to fight high unem– fairly responsibly. But they can and have money and tended to have higher infla- ployment, even when that spending gone overboard with severe adverse tion than their neighbors. These higher creates a deficit. This basic view is held consequences. inflation rates weakened their currencies 44 INVESTMENTS & WEALTH MONITOR © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER FEATURE | MODERN MONetarY THEORY DELUSIONS DECEMBER 2019 to offset the rise in domestic prices Figure CIVILIAN UNEMPLOYMENT RATE and to maintain competitiveness. 1 11 Neighboring governments resented that the French and Italians were always 10 weakening their currencies in order to maintain their competitiveness to sell 9 goods. So, the Europeans pressed to 8 adopt a single currency that would make competitive devaluations a thing of the 7 past. Indeed, when the Italians and 6 French pegged their currencies to the Percent rest of Europe, their higher rates of infla- 5 tion killed their competitiveness and 4 they suffered high unemployment even when they chose to run larger govern- 3 ment budget deficits. 2 1950 1960 1970 1980 1990 2000 2010 Some Latin American countries, such ■ U.S. recessions as Argentina and Brazil, also have cho- sen to fund budget deficits by printing Source: U.S. Bureau of Labor Statistics, fred.stlouisfed.org money to pay for their spending. These episodes also ended badly. Bonds issued growth for more than two decades. It Inflation results when demand for goods in their own currencies required ever also has a shrinking population as well and services exceeds supply, so rising higher interest rates to compensate as a highly acquiescent population that prices are required to offset the differ- investors for rising inflation, so these seeks order and favors existing institu- ence. For example, consider an economy governments resorted to issuing bonds tions. Workers don’t strike for higher with $19 trillion in demand that is pro- in foreign currencies, such as the wages in Japan. Redundant workers ducing $19 trillion in goods when the U.S. dollar. But the international invest- aren’t fired; they0 are givendead -end government chooses to increase its ment community’s appetite for Latin jobs with nothing to do. It isn’t clear spending by $1 trillion financed by American bond issues in the U.S. dollar that any other–10,000 nation could mimic the printing money. There is now demand was sated when foreign investors wor- Japanese economy, assuming it wished for $20 trillion of goods and services, ried they’d never be repaid. A buyer’s to do so. Regardless,–20,000 we haven’t yet seen but only $19 trillion is being produced. revolt resulted in a financial meltdown in how Japan’s huge budget deficit will There are two possible outcomes. The –30,000 Latin America in the 1980s, because play out. first is that the economy expands more those governments could no longer fund quickly so output increases to meet that –40,000 their deficits.1 THE CASE FOR AND higher level of demand. This is feasible AGAINSTMillions of Dollars MMT when unemployed workers can be hired –50,000 Even the United States has succumbed Kelton’s argument seems to be based on to increase output. In this case, deficit to this temptation. In the 1960s, when the observable–60,000 fact that the U.S. govern- spending may be desirable. Indeed, this Lyndon Johnson sought to finance ment is running a large budget deficit is precisely when Keynesians argue that “guns and butter” spending on Great today without–70,000 experiencing worrisome fiscal stimulus should be used to help Society programs and also pay for a war rising inflation. MMT advocates1995 don’t2000 the2005 economy get2010 back to full2015 employ- in Vietnam, inflation surged. The Fed seem to offer any■ U.S. explanation recessions of what ment quickly following a recession. imposed historically high interest rates does cause inflation, and Kelton rejects in order to squeeze inflation out of the outright the possibility that inflation The second possibility is that the excess U.S. economy and bring down federal may increase in response to large budget demand drives up inflation. The gap deficits. deficits albeit with a lag. MMT adher- between $20 trillion in demand and ents also claim that if inflation were to $19 trillion in supply can be closed by The notable exception to large budget increase, then government could prevent a 5-percent price increase across the deficits without rising inflation is Japan, a surge by raising taxes. That may be board, so that the $19 trillion in supply is where the debt to gross domestic prod- true in theory, but in practice, govern- repriced to cost $20 trillion. This situa- uct ratio is about 2.5, well above the U.S. ments raise or lower taxes when such tion arises when the economy is already ratio of about 1.0. Yet Japan has been in action is politically expedient, not when at full employment, hiring is difficult recession or experienced rather little it is most appropriate for the economy. because unemployed labor is scarce, and INVESTMENTS & WEALTH MONITOR 45 © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE | MODERN MONetarY THEORY DELUSIONS 2019 Figure SHORT-RUN PHILLIPS CURVE injected incremental spending into an 2 economy already enjoying low unem- ployment. Most economists expected the 8% tax cut to prove inflationary. The very fact that it has not resulted in a surge in inflation has been taken up by MMT pro- ponents as evidence to suggest it won’t 5% and shouldn’t be expected to do so.