Modern Monetary Theory (MMT), which claims that a country issuing debt denominated in its own currency can finance a large amount of government spending by issuing debt or printing money without worrying much about a debt crisis or high inflation rates, has grown in popularity on the political left in recent years. But it has failed to gain much support in the economics profession. That is largely due, in my view, to problems with the theory. But the poor defense routinely offered by its more prominent advocates also contributes. James K. Galbraith’s recent article serves to illustrate.
“As anyone who has ever been responsible for legislative oversight of central bankers knows,” Galbraith begins, “they do not like to have their authority challenged. Most of all, they will defend their mystique – that magical aura that hovers over their words, shrouding a slushy mix of banality and baloney in a mist of power and jargon.” Their negative reactions to MMT can be dismissed, he implies, as self-serving efforts to maintain control. After all, MMT represents what central bankers fear: a “popular, accessible, and democratic” theory.
World economies were hit hard by Covid-19. The effects have been especially severe in underdeveloped countries, where economies are weaker and healthcare infrastructure is more limited. Covid-19 forced some underdeveloped economies to choose between serving their population’s needs during these difficult times and serving their sovereign debt. This has raised concerns regarding the fragility of the sovereign debt market.
International institutions and analysts are starting to pay attention to the future of the sovereign debt market. Kristalina Georgieva (International Monetary Fund) and Sigrid Kaag (Minister of Foreign Trade and Development for the Netherlands) argue that developed economies “need to do more to help countries with unsustainable debt burdens” because “low-income developing countries need strong financial support.” Similarly, Willem H. Buiter (Columbia University) and Anne Sibert (University of London) argue that the mechanisms of sovereign debt restructuration need to be revised because of the pressure that debtor countries receive when defaulting on their debt obligations.
Standard economic theory maintains that, in the absence of externalities, private investment works pretty well. Entrepreneurs tend to acquire the capital necessary to take on valuable projects because they stand to gain when those projects succeed and lose when those projects fail. Public investment, in contrast, is not subject to the same profit-and-loss mechanism. The relevant public sector decision makers have a hard time knowing whether a project is worth pursuing and have little incentive to act in accordance with that information when it is available.
If the resources required to take on various projects are scarce, we usually want the private sector to choose how those resources will be used. Private entrepreneurs will tend to ensure that resources are used to produce the most valuable goods and services in the least costly ways. Handing these investment decisions over to politicians is likely to result in less desirable projects. The more desirable projects that private entrepreneurs would have taken on will be “crowded out” by public sector investment.
Economists often make a distinction between fiscal policy and monetary policy. Fiscal policy involves the use of taxing, spending, and borrowing power. It allocates resources across specific industries and economic actors. Fiscal policy has traditionally been the responsibility of Congress and the Treasury.
Monetary policy involves adjusting the money supply, setting administered interest rates, or exhibiting influence on money demand or non-administered interest rates. It intends to provide monetary stability for the economy and liquidity to financial markets. Monetary policy has traditionally been the responsibility of the Federal Reserve.
To get through the current crisis, Jared Bernstein argues, we must look to Keynes. It is an old argument, reapplied to our current context. The old argument is straightforward: the free market cannot fix itself. It follows, then, that we should not expect the economy to automatically recover once the pandemic outbreak is over. A more effective approach, Bernstein and others following in the tradition of Keynes maintain, would see the market managed by the savvy hand of the state.
Yet, how precisely the state should manage the economy is unclear. And the idea that capitalism is “not to be overthrown but to be ‘wisely managed’” is a dangerous one.
As Friedrich A. Hayek explained in a famous 1945 essay on The Use of Knowledge in Society, governments are unable to acquire the requisite knowledge to allocate resources effectively. The knowledge required is decentralized–of a particular time and place. Indeed, it is often tacit, meaning it cannot even be articulated by those possessing it.
Peronism is returning in Argentina. On December 10, Alberto Fernández assumed the presidency of Argentina. The office of vice president is now held by none other than Cristina Fernández de Kirchner, who served as president for two consecutive terms between 2007 and 2015. It was under her tenure that Argentina entered a period of stagflation (stagnation with inflation).
After four years with Mauricio Macri at the helm and a failed implementation of inflation targeting, Argentina’s inflation rate is once again reaching its highest level since the hyperinflation of the late 1980s. If one takes Fernandez’s pronouncements seriously, the prospects of seeing disinflation in the short and medium terms are slim.
Argentina is in trouble again. Even after a substantial aid package from the International Monetary Fund (IMF), it is struggling to service its sovereign debt. One should not be surprised: when you keep employing the same policies, you are likely to end up with similar outcomes. This, however, is not the lesson Harvard economist Ken Rogoff draws from Argentina’s experience. Instead, he calls for even more aid flows to Argentina.
Rogoff is right to criticize President Macri’s decision to cut the fiscal deficit gradually, rather than attacking the issue more forcefully early on. That strategy ultimately required Macri to seek help from the IMF. But he is wrong to characterize the Macri tax cuts and liberalization efforts as “Big Bang reforms.” The tax cut was marginal at best. And, while capital controls were lifted under Macri, more comprehensive measures of economic freedom show no significant improvements.
The last few weeks have seen a spike in commentaries surrounding modern monetary theory (MMT). A column by Prof. Stephanie Kelton, Andres Bernal, and Greg Carlock at Huffington Post and an endorsement from Representative Alexandria Ocasio-Cortez (D-N.Y.) have triggered negative responses by a number of reputable economists. George Selgin, Larry Summers, Paul Krugman, and Ken Rogoff (just to name a few) have all expressed concerns (to put it mildly) about the implications of applying MMT.
A common thread in these (and other) responses is that it is not clear what MMT really stands for. Advocates of MMT seem to use conventional terms in unconventional ways, and that creates confusion. On top of this, what exactly MMT means changes as time goes by, thereby adding frustration to confusion.
At its core, MMT maintains that a government cannot go broke as long as it can issue its own currency. Large fiscal deficits can be paid for by “printing money” (or, more technically, monetizing deficits). Standard monetary theory maintains that such a policy causes inflation. MMT, in contrast, holds that such a policy is not inflationary, because there are idle resources.
Paul Volcker takes issue with the Federal Reserve’s two-percent inflation target. He wonders why Fed officials have become so focused at a level of decimal precision on a target that cannot be hit so precisely. It is an old point, but one worth making.
The issue with inflation targeting is not merely one of precision, however. Just as important is how such a target is interpreted for policy making. Is it a symmetric target, in which case the Fed will try its best to achieve two-percent inflation each period? Is it contingent on past performance, in which case the Fed might try to make up for over- or under-shooting its target and thereby achieve two-percent inflation on average? Or, is it not really a target at all, but rather a ceiling—an upper bound on the rate of inflation that the Fed deems acceptable?
The Sound Money Project Essay Contest is designed to promote scholarship in monetary and macro- economics. More specifically, it aims to encourage those working at the cutting edge of the discipline to consider the monetary institutions that would reduce nominal disturbances and promote economic growth.
In 1971, President Richard Nixon ended convertibility, thereby eliminating the last vestiges of the gold standard. The classical gold standard, which prevailed from 1873 to 1914, had anchored inflation expectations, enabled longterm contracting, and promoted international trade. This historical experience has prompted several reconsiderations of resumption over the years, including the Gold Commission in 1980, the International Financial Institution Advisory Commission of 1998, and, more recently, calls for a Centennial Monetary Commission. What are the merits of returning to the gold standard? Is such a system feasible today?
First Prize $10,000
Second Prize $2,000
Third Prize $1,000
Winners will also be invited to participate in the Sound Money Project annual meeting in Great Barrington, Massachusetts.
The contest is open to graduate students, post-graduates, untenured professors, and tenured professors from any discipline. Former winners and current AIER fellows are ineligible. Former entrants are eligible, but must submit new essays.
Essays must be the sole and original work of the entrant and not previously published. They should be in the format of a scholarly article. Any standard citation format (e.g., MLA, APA, Chicago, Harvard, etc.) is acceptable. Essays may either be written specifically for the contest or arise from previous work (e.g., term papers, dissertations, research projects, etc.). Essays shorter than 4,000 words or longer than 12,000 words will not be considered. AIER-affiliated scholars are ineligible.
Please submit your paper here.
Deadline: March 1, 2019