Postscript To Misunderestimating MMT

Gerard MacDonell has a follow up article to his earlier critique of MMT (my previous article was my response to his critique). I just want to expand on a couple of points, and respond to his response...

Policy Space and MMT

Gerard wrote:

I would invert the second part to say that MMT does not open up any obvious policy space, even though it does change the analytics.

Although I cannot say this is wrong, it does depend upon what you think about as "policy space." My comments in the original version of my article perhaps undersold MMT.

I will note that some people have interpreted some MMT arguments as saying that we can abolish taxation outright (which would obviously open up policy space). This interpretation is incorrect. I cannot remember seeing text written by one of the MMT academics that I interpreted that way; I only saw this interpretation on the internet. There is no value in discussing incorrect interpretations of a theory.

However, there are two policy proposals by MMT, which could be interpreted as "opening up policy space," although it is possible to argue that they can be understood using conventional analysis. This is a semantic point I do not care to discuss; what matters are the merits of the policy proposals.

1. The elimination of bond finance. The central government just issues base money (see technical appendix below). Interest rates are locked at 0% forever. One might argue that this step eliminates policy space, as monetary policy no longer exists, but that is the objective (the mainstream focus on monetary policy is part of the problem, not the solution). With interest rates locked at zero, arguments that fiscal policy is "unsustainable" themselves are (ahem) unsustainable. I discussed this proposal in the original article.
2. The Job Guarantee. This is the signature MMT proposal. The proposal relies on MMT analysis of the labour market. I did not discuss this in my original article, but I would argue that it is a better policy than the existing framework, and so would open up "policy space" (since it is not being considered by the mainstream).

Gerard did not discuss the Job Guarantee, and I argued that his attempt to deal with the elimination of bond finance was unsatisfactory. (In fact, he was originally unsure whether that was the proposal.) As a result, he is not going to see a lot new in MMT policy proposals -- since he was unaware of (or ignored) the ones that existed.

I will note that there are a lot of other economists (pretty much the entire mainstream) that would agree with Gerard's view that we need interest rate policy to contain inflation; that said, a lot of people used to believe in witches. Whether or not an economy can reasonably function with a permanent ZIRP under all circumstances is an interesting open economic debate.

However, my discussion so far about policy space undersells the policy relevance. Not being utterly wrong adds a lot of room to policy space. 

• The euro area would never have been created without a strong central fiscal agency if European policy makers followed MMT principles. This would have saved a spectacular amount of misery for those unfortunates stuck in the euro area periphery.
• The entire disastrous austerity drive after the Financial Crisis would not have happened.
• People would not have wasted time looking for magical debt-to-GDP ratios.
• We would see that the drive to create fiscal watchdogs as just being another attempt by unelected technocrats to grab power from elected politicians, on the basis of mainstream economic mumbo-jumbo.
• We would be spared the idiots calling for imminent hyperinflation in Japan. (Although I do find they provide a great deal of entertainment value.)
• The idiocy around the debt ceiling in the United States could be avoided.
• The big idea of DeLong and Summers -- that we should invest in infrastructure because interest rates are low -- would be seen as silly. Instead, the debate would be: does the United States need infrastructure investment, and are the real resources available to make the investment possible?
• The entire premise of hydraulic Keynesianism -- we just need "aggregate demand" to deal with unemployment -- would be seen as questionable. We instead need to look at the real side of the economy, and ask whether the demand created will match the available pool of unemployed/underemployed labour. (This was Minsky's critique in the 1960s, and explains why the Job Guarantee is a lot more sophisticated than brute force "Keynesian" approaches like brute force infrastructure spending.)

In summary, we would have been spared practically all of the verbiage dumped by mainstream economists on fiscal policy over the past decade. This is an advantage that cannot be minimised.

Permanent ZIRP

Gerard had a section "My post wasted time considering the case of the Fed paying interest on reserves...."

He wrote:

 It would be so if MMT advocates were never to offer US fiscal policy advice, except in the context of being crystal clear that they assume that the institutional set-up at the Fed is entirely different from what it actually is.

This is wrong. The MMT policy proposal is to abolish bond finance; but it can analyse the current system. The MMT analysis is that Gerard's first case (paying interest on reserves) is exactly the same as QE, and MMT says that QE is completely ineffectual since it is functionally equivalent to bill finance.* Since MMT says the policy is ineffective, an analysis that tells us it would not work is useless as a critique of MMT.

I believe that Gerard argues that QE is ineffective, because it is equivalent to bill finance. Since his analysis is exactly the same as MMT's, I think his complaint here is somewhat silly.

More generally, MMT consists of analysis and policy proposals. Just because MMT prefers floating currency regimes, it does not mean that you cannot use MMT principles to analyse a fixed exchange rate system. The points of failure of a fixed exchange rate system are exactly why MMT advocates a floating rate system.

Saying that economists should not give policy advice if the real world does not conform to their theory's assumptions is pretty dangerous for someone who thinks Paul Krugman is worth reading. I would stack up MMT's assumptions versus mainstream assumptions any day of the week.

At this point, I need to emphasise that I am including broader post-Keynesian analysis as being "MMT" -- which is exactly what the MMT academics do. Modern Monetary Theory inherits analysis (such as Stock-Flow Consistent models) which were developed by post-Keynesians who are not considered part of the MMT school of thought. MMT is an attempt to create a single cohesive world view out of a broader, somewhat self-contradictory post-Keynesian literature. It has a narrow focus, in order to keep everyone on the same theoretical page, but we cannot lose sight of the broader literature if we are discussing topics outside of that focus.

Arguments about the MMT Canon

The bulk of Gerard's article revolved around his understanding of the MMT literature. The obvious solution: he should buy Understanding Government Finance (conveniently available in ebook and paperback forms!).

My less flippant answer is that we need to focus on more concrete substantive examples, and not worry about terminology. I have attempted to deal with what I see as Gerard's concrete objections, but I am not attempting to address his complaints about how MMT puts itself forward.

I doubt that Gerard wants to read hundreds of academic primers on MMT, but at the same time, criticising a theory without actually reading the literature seems like a strange exercise. My solution to this is to discuss how the MMT analysis differs from the mainstream with regards to concrete issues, and then let the reader find the primers if interested.

Appendix: Eliminating Bond Finance

One possible point of confusion about the MMT proposal to eliminate bond finance revolves around Treasury bills. The people behind the development of MMT are very well aware of the institutional framework for fixed income (Warren Mosler made a reasonable amount of money by setting up a fixed income hedge fund.) This institutional awareness means that the proposal is slightly more complex than what would be suggested by the simple version used in an economic model.

The simple version of the proposal is that the government just issues "base money," with an interest rate of 0%.

In the real world, this policy would need to be supplemented by the issuance of Treasury bills. This is necessary as there are non-banks that need to hold safe assets on their portfolios, and they cannot realistically stockpile currency, nor leave deposits at the central bank.

The difference is the issuance scheme: the central government issues Treasury bills at a fixed price (I believe that a yield of 0.25% is the suggestion), and the private sector can buy as many bills as it wishes at that fixed yield. As a monopolist, the government can issue Treasury bills by allocating on a price or quantity basis; the hidden assumption that the allocation has to be done on a price basis is wrong.

As a result, one might technically need to say that interest rates would be locked at 0.25%, and not 0%, forever.

Footnote:

* Why does MMT say that increasing excess reserves is the same as bill finance? The preferred MMT analytical approach is to consolidate the central bank with the rest of the government (regardless of the institutional framework; the only exception might be if you wanted to model a sovereign default). Once you consolidate the central bank, we see that:

• excess reserves are a government liability that pays the short-term rate; and
• Treasury bills are a government liability that pays the short-term rate.

In other words, they are functionally equivalent, and so lead to equivalent outcomes.

(c) Brian Romanchuk 2017