Modern Monetary Theory and the Deficit Myth
Stephanie Kelton, Economist and Advisor to Bernie Sanders, has written about the Deficit Myth and Modern Monetary Theory
There is a fascinating new economic insight emerging that is changing the debate over government spending and “deficits”. It’s called Modern Monetary Theory and one of its vocal proponents is Stephanie Kelton, who was Bernie Sanders’ economic advisor during his presidential campaign. She has a book (to be released June 8, 2020) called the Deficit Myth which lays out the concepts behind Modern Monetary Theory.
It is a concept of wide-reaching implications and is becoming increasingly embraced by serious economists and policy makers. It’s still quite a novel and counterintuitive idea and if you haven’t heard about it you will undoubtedly be bombarded with it soon, specially as the coronavirus epidemic puts new pressure for government spending for vital public needs.
In essence Modern Monetary Theory (MMT) says government deficits are not necessarily bad. Since our government has the authority to “print” money it cannot go bankrupt. In this way the government is not like a household which must balance its income with its expenditures. We shouldn’t even label the gap between taxes and public spending as a “deficit”. To the economy at large, such as the American households, the small businesses, the NGO’s, the corporations etc. the extra spending by government means a surplus. So the deficit is really a surplus when viewed from the point of view of the actual economy.
Yes, the government can overspend, but that can’t result in bankruptcy The accumulated debt is NOT something we are leaving for our children to repay – the only possible harmful side effect is inflation.
But here’s the key insight: as long as the spending is for useful purposes, and as long as there is a slack in the economy (i. e. surplus capacity to produce goods and services) the government deficits will not produce inflation. In effect we can get a big stimulus, a huge boost to stir up jobs, build the infrastructure, provide healthcare, clean up our environment, develop new technologies and make education affordable without constraints on how to pay for all these things because we do not have to balance government expenditures with taxes. We might be constrained by resources to do all this: manpower needed, skills needed etc – there is an upper speed limit to how fast we can produce new highways, new services, new education, new technologies etc. If we outrun these resources we will create inflation as stimulus money will be wasted in non-productive activities.
But the good news from Stephanie Kelton (and others) is: we are nowhere near capacity in the US; there is plenty of surplus resources not used. Even before the COVID-19 induced economic slowdown we could easily spend $500 billion to a $1 trillion more per year in “deficits” without any overheating of the economy. Now with 30 million (and more) people out of work there is a huge slack in the US economy. Redirecting these idle resources into rebuilding America should not be constrained by a fear of deficits.
Here is a quote from Stephanie Kelton in a recent Bloomberg article:
The claim that deficits are a sign of overspending is just one myth distorting the national debate about the deficits. Liberals as well as conservatives have argued that the trillion-dollar deficits the U.S. is projected to run, beginning as early as 2022, are putting America on a dangerous and unsustainable path. Distinguished economists on both the left and the right have warned that a debt crisis is coming, and that we should act sooner rather than later to deal with our looming budget problems.
Both sides have this wrong. This is not a trivial complaint. Myths and misunderstandings about budget deficits distract from the many legitimate challenges facing our country and leave us poorer than we could otherwise be.
Here’s a YouTube video of a lecture on MMT by Stephanie Kelton. Worth seeing as she goes in some depth.
Implications For Us Today
What does this mean as we reel from the impact of the health crisis?
The coronavirus has shone a very unflattering light on the U. S.. The picture is not pretty.
We see grotesquely lit, in front of our eyes, something that was lurking in the shadows: a country whose public institutions have been allowed to rot; where not only the poor, but much of the middle class lives one paycheck away from choosing between paying rent or eating, and where the infrastructure is worse than many of the poorest countries. Now more than ever we need an epiphany – a Roosevelt like New Deal to rebuild our fractured society from the bottom up, and to undo decades of deferred maintenance on our infrastructure and our institutions.
Bernie Sanders and many in his camp (like Alexandria Ocasio-Cortez, Ro Khanna, Elizabeth Warren and Ed Markey to name a few) saw the hollowing out of America even before the COVID-19 crisis. They have been suggesting urgent action, what they call a Green New Deal (GND), a very audacious program to bring our country’s backbone into the 21st century while solving the issues of middle class poverty and alienation. Their New Deal for America contained a very bold re-prioritization of our economy:
- A massive overhaul of our infrastructure into the 21st century: roads, ports, sewers, utilities, green tech, intelligent grids, solar and wind power to replace fossil fuels, zero emission housing and factories etc. Non-exportable, decent blue collar jobs would be created in the private sector to rejuvenate the rust-belt rot and the globalization-induced job losses. The America Society of Civil Engineers estimates a deferred maintenance in our infrastructure to be $4 Trillion. Fix this backbone and you might get a 100-fold return on your $4T, as we did in the original New Deal.
- Healthcare, paid for the government (like Medicare) but possibly delivered via the private sector, for all people living in (or visiting) the U. S. Healthcare to be enshrined as a fundamental right and value of our society.
- Free college education for all who want it. Forgiveness of existing college debt.
- Rebuilding of our public institutions to provide a public-private partnership in enhancing the efficiency and resiliency of the country. Strengthening of Institutions like the CDC, EPA, DARPA, FEMA, Energy Department etc. that reduce risk to society. (By the way to get a better flavor for the benefits of reduced societal risk please read the excellent book by Michael Lewis, The Fifth Risk. I promise you won’t be able to put it down and will learn a lot.)
Not many argued against the benefits of doing this but the question most persistently asked was: How are you going to pay for it? The question was not answered well: I winced as Bernie Sanders and Elizabeth Warren, the presidential candidates, stammered defensively every time the question was asked.
We’ll tax Wall Street, they said.
Corporations have made obscene profits, they must pay, they avowed
A wealth tax on the rich, they offered.
And these, of course, were non starters. We are talking about large amounts of money, something like 15 Trillion dollars over 10 – 15 years by some estimates. Give or take. (Although to put this in context it is about 3 – 5% of GDP over 10 years.).
Bernie and his ideas scared many. The Green New Deal was considered pie-in-the-sky, wishful thinking, pollyana-ish. The Democratic Party got scared and acted to make sure he would not prevail. To be fair he did not explain it very well in MMT terms. It’s possible he did not grasp the full impact of his advisor, Stephanie Kelton’s views. It must have sounded too good to be true – naively interpreted she says: spend as much as you want without any negative consequences! Had we learned the lesson from the subsequent coronavirus health disruption, we would have realized that the costs of social catastrophe are even larger when fundamental well being is neglected.
So how would we pay for all the projects of the Green New Deal? Would we raise taxes; would we run ruinous “deficits”; would we leave our children with unsustainable debt?
That’s where MMT comes in. It teaches us that that the debate is not about how we’ll pay for it but about what we should do and how to design and implement a practical plan that serves us to become strong and prosperous. The Green New Deal was the start of the debate. Maybe we can all join the debate, and fine tune the ideas in the plan and embark on a rejuvenation course with new vigor.
If so the coronavirus emergency will have taught us a valuable lesson and we will be stronger for it.
Hi Ashok,
Interesting theory.
I think people get confused between a country’s debt (bonds that the Treasury issues and that must be paid back) and our cash monetary supply (dollar bills that we print). Our debt is indeed large. I think out of each dollar of our country’s income (income tax, license revenue, etc) about 19-20c goes to pay bonds (someone can correct my numbers). Our cash supply is, of course, infinite. Its effect is on inflation. That will happen once this cash reaches the consumer’s hand, which it is rather slow in doing.
Thanks for the blog. I always en joy reading them.
Best.
Parvati
Parvati,
Thanks for your comment. The point here is that all government debt can be monetized, even the treasury debt and required interest payments. The Fed can buy these so the government cannot default. The amount that the government pays in interest can also be “printed” by the Fed – i. e.stay on their balance sheet for ever. The debt need not be paid off via taxation, ever. Even today a large part of debt payments by the Federal government is to the Federal Reserve Bank which holds a large part of the debt, just an entry on their books. So the country’s “debt” is not like a conventional debt which must be paid back – a very important distinction.
Inflation is the only possible downside. But this risk is smaller than anyone conventionally imagines. No country has ever suffered hyperinflation because of over-monetization.
For western economies deflation is a bigger problem than potential inflation. Also inflation is like a wealth tax – it effects the richest segment. so it is a flattener of inequality.
Roosevelt expanded the money supply by almost 100% and created public programs. The inflation that resulted was modest and much needed. The $4.5 Trillion printed after the 2008 recession did not result in perception;e inflation.
Would love got discuss.
A
MMT is unfortunately named. It is actually not a theory, rather it is an objective description of how money has ALWAYS worked at the federal level. At our founding, laws were established giving the federal govt the power to create a currency, and Congress the power to control it. The life cycle of the dollar begins with Congressional legislation authorizing spending, and ends with some of those dollars paying federal taxes and immediately being removed from the money supply. Other dollars knock about the economy, being spent and respent generating jobs, still other dollars are parked in savings accounts or Treasury notes (which are not loans to the government, since the govt can create new dollars at will, thus having no need to borrow). As with all federal spending, newly created dollars pay the interest on Treasuries.
Right on, brother.
There have begun to be noises in the public discussion about moving in this direction. Certainly, the dire circumstances the country finds itself in could be flipped over and viewed as a marvelous opportunity to re-build much that has been lost in the country; and if broadly discussed to bring in viewpoints from right and left, could ideally bring a fairly broad consensus about which items should be included. The fly in the ointment, of course, is the remnants of what was formerly known as the Republican Party, which would object by screaming about the risks of deficits but could arguably be dismissed as the usual argument that “we/I don’t want to see my money spent to help THOSE people. So the challenge will be to bring enough folks on board via a smart leading of the discussion to de-fang the inflation fears in such a way as to deprive the bigots and nasties of their fig leaf. Can Warren tutor Joe to set out a 4-year plan that fits the bill? Would need all the Dems to then synchronize their arguments, and a large handful of moderate Republicans to have been brought on board in advance.
Mike,
Your comment is very perceptive indeed! From a money point of view it makes every sense to use this opportunity to chart a bold path in fixing many of our ills. We need not ask the question, “How will we pay for it?” The issue is political not monetary.
How do we elect the right leadership? How do we get the leadership to design, articulate and sell a bold plan of action, and forge a consensus to build much that has been lost. Can Sanders and Warren educate Biden and help him in this election cycle or will it take much more pain for us to see what needs doing?
Generally when a solution exists America seems to find a way to embrace it. The good news is that a solution does exist.
Ashok, to what extent China has already used this theory? China according to many economist has huge bad debts that are hidden through nationalized banks. Loans given to public or private enterprises by the Nationalized banks is in essence “deficit”. What do you think?
Mashru,
I believe you’re dead on. China has printed money like mad to bring 700 million people into the middle class and rebuild the country. There are very few private banks in China – the PBOC (peoples’ Bank of China) pretty much strews liquidity for everything. Yet there has been growth without appreciable inflation. Unsympathetic China watchers like Peter Zeihan keep predicting a financial collapse for China based on conventional ideas of debt. MMT says that is falling into the deficit myth.
Its a great idea and sensible approach! Success hinges on how the elected choose to justify investing in the long term and in what sectors. But it also means the general population must take a collective long view too. Unfortunately, our cultural and institutional mindset has long been almost exclusively oriented towards profiting from the short term, so this would be a huge shift in thinking. In Germany when there are cost overruns on infrastructure they dont see it as a loss, but as an investment in the future (i.e. the banks/government tend to lend more instead of jumping to write off the loss). We need to do the same.
Consensus on the long view and its worth is hard to come by these days. The other challenge is how we might overcome the naysayers who oppose only because it’s not their idea (so rational arguments don’t stand a chance).
My initial thought is that : the possibility to print and distribute, and not think about anything apart from inflation, is maybe only possible for US, as the defacto currency standard. The Bretton Woods agreement effectively gave the USD the standard on which everything else was measured. Now if the standard is changed (by printing money), no one cares. In fact USD demand zooms up in times of crises and heavy printing (for all other countries, if they start printing money, its currency collapses). For rest of the world, the moment it starts printing more money, its currency will collapse vis-a-vis the USD, and imports will become expensive. External debt will become un-manageable. No one will be interested in its bonds. Interest rates have to go up. Which will make industries suffer. So the impact of all that is much much more than just inflation.
Fundamentally, US got away when they delinked the currency from the gold standard. But each time now the US “prints” more money, it reduces its stronghold as the currency standard. The Economist leader article for this month on how Yuan is slowly becoming the currency of trade is interesting in the same construct.
Finally, lets look at it it differently. See how we set weight standards scientifically. We choose something which is stable, reliable and doesn’t decay as a standard on which we measure weight/time/length etc etc. Currency standards should ideally also follow the same principle. When that is not the case, scientists look to “replace” the standard with a different one?
The U.S. does have a special status with the US dollar being the world’s reserve currency, But that doesn’t really have a big bearing on MMT. As long as a country has an independent fiat currency, e.g. China, Japan. UK, India it cannot go bankrupt. So the leader of that country can think that he/she has another potential source of funding of the country’s important economic needs. So if India needs to build its infrastructure and requires to spend 5% of its GDP extra over five years, say it can choose to do so without raising taxes or borrowing abroad. It can “borrow” from its own reserves which are “limitless”. Of course the spending has to be justified, properly implemented and sold. The money is not free in that sense. But in this example India does have an untapped alternative to fund important societal needs. China has been doing this for decades and has lifted 700 million people into the middle class without much inflation.
Why is there no inflation? Because the money is being used as a beneficial investment and ther are more goods and services to compensate for the extra money sloshing around.
The idea is a more powerful variant of Keynesianism. Gives policy makers more options.
Practically I doubt it is possible to firewall all the spend without it impacting inflation. Most infrastructure projects are long term which means that the returns in terms of better capacity and more goods/services comes after many years. But the expenses reach the demand side much faster.
Take the MNRGA project of Indian Govt. it was meant to pay for micro infra projects in rural areas. Ideally better irrigation / better roads in rural areas would make it more productive and efficient. It immediately jacked up the inflation heavily. The benefits will probably accrue later. But the money has already flowed to the beneficiaries resulting in inflation.
Interesting theory, Ashok. Does make you pause ans reflect. However, I have one question:
The almighty USD is the defacto global currency. So, “printing” more dollars should not effect the “how will you pay it back” ?. I agree. But, if some other currency became the global standard (Chines Yuan or Bitcoin. etc…) how ill that change the “printing” MMT theory?
-Vasan.
Ramesh Kapur
Ashok, as long as the dollar is the world’s reserve currency, we can print all the money we want and it will not harm our monetary system. China tried to dislodge the dollar by dealing with Saudi Arabia and Russia in Oil trades but failed a few years ago. All printing money will do is create inflation. The country has been running a deficit of $1T/yr for the past few years and the inflation has not gone up (1-1/2% or so). Even if the inflation goes up, the cure is painful but not really bad, jack up the rates as high as to put the brakes on economy. My concerns at this time is deflation. With the unemployment so high at this time, the Feds have to give more stimulus or there might be a possibility that we might get into deflation. If that happens, Fed can lower the rate to negative which Jerome Powell talked about last week. With Deflation, it is hard to do the reverse and gets rates low enough and specially when they are already 0 to provide the stimulus that will drive the economy out of the ditch. Japan has been trying for the last 30 years and has not been successful. I am fearful of getting into the deflationary financial situation.
Many comments regarding the USD as the reserve currency. However, Japan has had debt to GDP ratios of over 200% for decades and cannot meet inflation targets.
It is time for a theory that explains the Japanese economy, which MMT does.
Vehemently in agreement with you, Ashok! Well written, most salient points captured.
The only other point I’d like to add: the most prevalent deficit myth besides grandchildren being burdened is that money printing causes inflation and leads to hyperinflation!
Nothing could be farther from truth. The assumption feeding this myth is that more money creates more demand for goods which jacks up prices. Historically, every hyperinflation has been caused by shortage of productive capacity/goods, and not from more availability of $$.
In 1971 when US decoupled from Au, and every other country bar none, followed suit, US debt was $20 T … 50X. And CPI has remained well in check. Traditionally, inflation has responded absolutely directly to OIL, like in the early 80’s.
Japan is another example of Abe’s excessive printing in an attempt to inflate … in vain! BTW, USD is not the only reserve currency, there’s Euro, Yen, Pound, Yuan …
Ashok, have you previewed Kelton’s book yet? Not sure if there’s anything new she can add … I quite enjoy her YT videos with Mosler.
Correction:
In 1971 when US decoupled from Au, and every other country bar none, followed suit, US debt was < $400 B, today that debt has soared to $20 T … 50X. And CPI has remained well in check.
Bill Black: “There’s something invigorating about people freaking out about modern monetary theory (MMT). They treat MMT as akin to the Ark of the Covenant in the first Indiana Jones movie. They are petrified that knowledge of the financial equivalent of the ‘holy of holies’ will be released to normal people because they project their greatest terrors onto the possibility that the public will be transformed and empowered by their knowledge of matters that much of the financial world has understood for at least a century.”
http://neweconomicperspectives.org/2015/01/public-understood-money-works.html
Hi Ashok,
Thanks for getting everyone engaged in this interesting dialog. Sorry for being late as I wanted to read the book to try to understand this very intriguing theory. On a first glance, the theory sounded too good to be true. More I read the book, as a layman, more I got intrigued by the concept but still remain confused. If MMT is that simple, why tax anybody?
My other confusion has been that we have been printing money (more than $10 trillions) like drunken sailors over the last decade to pay for the deficits. In my opinion, that is MMT incognito. What is so new about this concept? May be, it is how our policy makers implement the theory. The country has seen the largest gaps between the haves and the have nots during the period of the three last administrations, both republican and democrat (GW, Obama and Trump). The Wall Street has gone up but the Main street is left behind. Both parties are accountable for this. How do we know that the policy makers who delivered these “bill of goods” will be more visionary and competent in future to prevent repetition of the same outcome. The bottom line is that the concept of MMT may be a good one but its implementation in our broken democratic political system will be nearly impossible. Did anyone think about how to eliminate our current business trend of “winner-take-all” culture? May be, that will be a good place to start for the MMT to have any beneficial traction. Just a thought from a layman.