by The Deficit Myth: a review One common objection to neoclassical economics is that it underweights the importance of history and class. It is therefore paradoxical that Stephanie Kelton’s The Deficit Myth, which claims to challenge orthodox economics, should be guilty of just these vices. Let’s start by saying that I wholly agree with the main claims she makes — that a government which enjoys monetary sovereignty can always finance its borrowing. Asking how we will pay for public spending is therefore daft. Instead, the question, as Dr Kelton says, is: can the extra spending be resourced? The constraint on raising health spending for example — if there is one — is a lack of doctors and nurses, not a lack of finance. Where there are resources lying idle,
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The Deficit Myth: a review
One common objection to neoclassical economics is that it underweights the importance of history and class. It is therefore paradoxical that Stephanie Kelton’s The Deficit Myth, which claims to challenge orthodox economics, should be guilty of just these vices.
Let’s start by saying that I wholly agree with the main claims she makes — that a government which enjoys monetary sovereignty can always finance its borrowing. Asking how we will pay for public spending is therefore daft. Instead, the question, as Dr Kelton says, is: can the extra spending be resourced? The constraint on raising health spending for example — if there is one — is a lack of doctors and nurses, not a lack of finance. Where there are resources lying idle, governments should raise spending to employ them. Dr Kelton explain these ideas wonderfully clearly, so I recommend this book to all non-economists interested in government finances.
For this economist, though, it poses a problem. I remember writing a research note for Nomura back in the early 90s arguing that increased government borrowing would not increase gilt yields because the same increased private saving that was the counterpart of government borrowing would easily finance that borrowing. Nominal gilt yields, I said, were determined much more by inflation than by government borrowing. But nobody accused me of originality. And rightly so. I was simply channelling Kalecki, Beveridge, Lerner and Keynes, who famously said back in 1933:
“Look after the unemployment, and the Budget will look after itself.”
For me, Kelton is – albeit very lucidly – reinventing the wheel …
At one stage she claims that MMT “didn’t exist” before the late 90s. But whilst the phrase did not exist, the ideas certainly did. Randall Wray is right to say that “the main principles of functional finance were relatively widely held in the immediate postwar period.”
Yours truly thinks that Dillow gets it right here on the question of the originality of MMT.
As has become abundantly clear during the last couple of years, it is obvious that most mainstream economists seem to think that Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with. That is actually very telling about the total lack of knowledge of their own discipline’s history these modern mainstream guys like Summers, Mankiw, and Krugman has.
New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:
It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank …
A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system …
We intend therefore, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers.
What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.
In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover, and taxing and borrowing are degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.
In the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.
What mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!
It is true that MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfill our basic economic objectives — full employment and price stability.
Governments can spend whatever amount of money they want. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary.