Modern Monetary Theory: Neither modern, nor monetary, nor (mainly) theoretical ?

<h3>Macroeconomics – Review</h3>

Voltaire once said of the Holy Roman Empire that it was “Neither Holy, nor Roman, nor an Empire”. Something similar might be said of Modern Monetary Theory, which has shot to prominence in policy debates recently. It is neither modern, nor genuinely monetary, and it is at least as much a set of policy proposals as a theory.
It might be thought that “modern” refers to the fiat money world in which we have lived since major currencies broke with gold convertibility in the 1930s (the final vestiges of the gold standard disappeared with the end of the Bretton Woods system in 1971). In fact, however, it is a kind of inside joke, motivated by this observation of Keynes

The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contracts. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time – when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern states and has been so claimed for some four thousand years at least. (Keynes 1930, p. 4, emphasis added).

As regards “monetary”, MMT is notable for its rejection of concerns about the money supply, and monetary measures of budget balance and public debt. On the contrary, its focus is on the employment of the real resources available to the economy. As Mitchell, Wray and Watts put it (p256, bold in original) “The real cost of any program is the extra real resources that the program requires for implementation”.

Finally, in theoretical terms, MMT offers little in the way of radical innovation. Rather it is a variant of traditional Keynesianism, drawing heavily on the functional finance approach of Abba Lerner (1943), and rejecting both the Hicks-Samuelson neoclassical synthesis and (even more strongly) the ‘New Keynesian’. The central point of functional finance is that, since the budget balance is a policy instrument, it is incorrect to think of taxes as ‘financing’ public expenditure. Rather, for any given level of public spending, taxes ensure that the budget balance is at a level (which may be a surplus or deficit in conventional accounting terms) sufficient to keep the economy in a stable equilibrium with full employment and low inflation.MMT incorporates some post-Keynesian ideas, such as Minsky’s (1982) model of financial instability, but makes little use of other post-Keynesian ideas, such as that of fundamental uncertainty.

MMT is also prominently associated with particular policy proposals, such as that for a Jobs Guarantee. This is a variant of the traditional Keynesian case for full employment based on aggregate demand management, but is not unique to MMT. Indeed, the first version of the Mitchell-Watts jobs guarantee (Mitchell and Watts 1997) proposal predated MMT and coincided closely with that of Langmore and Quiggin (1994), based on mainstream Keynesianism.

To complicate things even further, there are two versions of MMT circulating in popular discussion. The one we’ve been discussing so far, which might be called ‘academic’ MMT, is the macroeconomic theoretical analysis and policy program derived from a synthesis of Keynesian aggregate demand analysis, functional finance and support for public job creation to maintain full employment.

The second, which might be called ‘popular MMT’, or, more pejoratively, ‘vulgar MMT’, is a movement in which the statement ‘taxes don’t finance public expenditure’ is interpreted to mean that governments can increase spending as much as they like, with no need for an offsetting increase in tax revenue. This view was presented by pastor Delman Coates, speaking at the Third Modern Monetary Theory conference at Stony Brook University

I don’t want my community to have to wait until we tax Jeff Bezos and Amazon in order for us to have dignified jobs, Medicare for All, and a Green New Deal, or to have our roads and infrastructure rebuilt in America.

The relationship between academic and popular MMT is complex. On the one hand, economists who espouse MMT understand that the ‘free money’ view is incorrect. On the other hand, they favour a more expansionary fiscal policy, which implies at least some increase in expenditure relative to taxation. Moreover, like most people who find themselves leading a popular movement, they find it more appealing to criticise the errors of their opponents than those of their supporters.

The result in many cases is a ‘motte and bailey’ rhetorical strategy in which MMT advocates make strong statements which sound as if they match the popular view, but retreat to a less interesting but more defensible position (the ‘mottte’ in the medieval castle that gives rise to the analogy) when challenged.

With all these complexities in mind, the publication of Macroeconomics by Mitchell, Wray and Watts is a welcome development. At more than 500 pages in length, it is both an introductory textbook and an exposition of the central ideas of MMT. The task of reviewing the book raises many questions, of which this review will address three?

First, how well does the book perform the role of an introductory textbook? Second, how does it illuminate the differences between MMT and the standard version of Keynesianism ? Third, what position does it take on the gap between academic MMT and the popular ‘money for nothing’ view.

Considered as a textbook, Macroeconomics does a good job on the basics: explaining what the subject is about, introducing the concepts behind macroeconomic statistics and setting out the Keynesian aggregate demand framework which is the basis of the distinction between macroeconomics and microeconomics. Index numbers, labour market statistics and the national accounts are all covered well.

There is also plenty of historical context, including discussion of the development of capitalism and of economic theory. The presentation is far from neutral, with a sympathetic treatment of a variety of heterodox schools of thought, and consistent criticism of neoclassical orthodoxy. But this is still preferable to the ahistorical treatment common in many introductory textbooks, where the relatively short-lived consensus that prevailed from the early 1990s to the GFC (Keynesian short run, classical long run, monetary policy as the primary tool of macroeconomic management) is presented as if it were scientifically established truth, with no intellectual history.

The theoretical presentation here is, in most respects, a standard presentation of Keynesianism, as it was generally understood before the emergence of the Phillips curve, which generated a long and ultimately futile debate about the existence of otherwise of a long-run trade-off between unemployment and inflation. Having argued elsewhere that macroeconomics has been on the wrong track since 1958 I sympathise with this approach, at least in an introductory text.

The emphasis throughout is on the case where, in the absence of government action, the economy is substantially below full employment. This is evident, for example, in the presentation of the macroeconomic demand for labour (p212) with a graph in which there is no money wage consistent with full employment (the graph line is cut off just above the zero wage line, still far from full employment).

This focus is consistent with the primary criticism of the Hicksian IS-LM framework, based on the claim that the money supply is endogenous and not controllable by policy. This leads to the view that ‘the LM curve will be horizontal at the policy interest rate’, that is, that the economy is always in a liquidity trap.

Keynesians have long been dubious about the capacity of monetary policy to stimulate the economy out of a low-employment equilibrium – the phrase ‘pushing on a string’ expresses the traditional view on this. The continued appeal of the IS-LM approach rests largely on the observation that, over a wide range of conditions monetary policy can be effective.

Most obviously, contractionary monetary policy is highly effective in reducing what is seen to be an excessive, and potentially inflationary, level of economic active. Often, indeed, it is too effective – excessively contractionary monetary policy was the primary cause of the early 1990s recession in Australia. It isn’t made really clear how this experience fits with the model presented here.

Finally, how do MWW respond to the idea that, given functional finance, governments can spend as much as they want without increasing taxation. Their answer (p323) is entirely in line with mainstream Keynesianism.

Taxes create real resource space in which the government can fulfil its socio-economic mandate. Taxes reduce the non-government sector’s purchasing power and hence its ability to command real resources for the government to command with its spending.

Take a situation where the national government is spending around 30 per cent of GDP, while its tax revenue is somewhat less, say 27 per cent. The net injection of spending coming from the national government is thus about 3 per cent of GDP. If we eliminated taxes (and held all else constant) the net injection rises towards 30 per cent of GDP. That is a huge increase in aggregate demand and could cause inflation.

Ideally it is best if tax revenue moves countercyclically, increasing in an expansion and declining in a recession.

MWW go on to suggest (p 325) that the government’s fiscal balance should be set equal to the value of the current account deficit at full employment. This formulation takes the income-expenditure identity used by advocates of the ‘twin deficits hypothesis’ (correctly criticised by MWW) and inverts it.

Overall, then, the position advanced by MWW is that of traditional Keynesian economics, with some distinctive presentational features and policy proposals. Anyone looking for a defence of the claim that we can have a Green New Deal, or some other large-scale expansion of public spending, without any increase in taxation, will be disappointed.

On the other hand, the authors miss the opportunity to set their own followers straight on this point. While the errors of orthodox economists are pointed out in the sharpest terms, the criticism of the idea that taxation is unnecessary is brief and anodyne. The result is that we are likely to see a continuation of ‘motte and bailey’ rhetoric for some time to come.

Overall, this text would work well for a course taught from the MMT perspective, and would provide a useful counterpoint to the standard text for a mainstream course. A more advanced book, giving a comprehensive treatment of the relationship between the various flavours of MMT and of Keynesianism would be a valuable followup.