So Are We All MMTists Now?

Larry Summers attracted a great deal of attention with arguments that post-Keynesian theories ought to be taken into account, and the ability of central banks to stimulate the economy are limited. One could argue that the zeitgeist is shifting in the direction of Modern Monetary Theory (MMT): the role of fiscal policy may be increasingly important. However, I am unsure how far actual economics debates will shift.

One may note that Summers dodged discussing MMT in his initial tweets; in fact, he referred to Thomas Palley, whose main contributions in recent years has been his sectarian attacks on MMT. My guess is that this will be a fairly standard approach.

Policy Shifts?

It seems entirely likely that during the next recession, policymakers will not engage in pointless fiddling with monetary policy while the economy burns. Fiscal policy -- probably in the form of tax cuts -- will be discussed far more. It may be that "helicopter money" (the central bank sending money to households somehow) will be floated as an idea, as that is somehow completely different than fiscal policy (even though the effects are indistinguishable in a mathematical model).

Of course, negative rates and quantitative easing will be tried, but very few people will expect them to do much of anything.

Nevertheless, it is unclear how much of a practical difference that makes. Fiscal policy was deployed in response to the Financial Crisis. It was too small to make a big dent in the downturn, but at the same time, it is unclear whether the next recession will be a similar magnitude. Relatively scaled-down fiscal stimulus might be what the consensus views as sufficient.

Secular Shift?

From the point of view of a long-term bond investor, the possibility of more activist fiscal policy does raise the possibility of a secular rise in interest rates. Central banks might be concerned about inflation risks, and so they might actually raise rates at a non-snail's pace. From a MMT perspective, rising interest rates raise the interest income received by the non-government sector, raising domestic demand. This would help sustain any inflation that manages to appear.

The previous scenario is what I believe is the scariest campfire story bond bears can tell. However, I am unsure how large the risks are. Post-Keynesian theory argues that the inflation process is about conflicts between employees and firms over income shares. Unless fiscal policy does something drastic, it is unclear whether employees can make wage increases stick, even with greater domestic demand.

Furthermore, we need to be cautious regarding how widespread the adoption of fiscal-friendly views are. Two of the high profile neoclassicals that are discussing the increasing importance of fiscal policy -- Larry Summers, and Paul Krugman -- are firmly in the Clintonite wing of the Democratic Party. Very few Republicans care what Paul Krugman thinks. As a result, this may just be a shift within the Democratic Party. Such a shift is hardly surprising. The Clintonite's claim to fame is that they won a pair of elections almost 30 years ago. The time separation between now and then is comparable to the separation between Bill Clinton's first victory and JFK's.

The modern free market parties (like the Republicans) are consistent: they are in favour of shrinking the welfare state, and letting businesses get what they want on the regulatory side. Tax cuts fit their agenda, and so there is no problem to enact them when recessions hit. However, it is extremely unlikely that they will not call for cuts to welfare state programmes when fiscal deficits blow out -- no matter what some ivy league academics have to say.

Rise of Post-Keynesian Theory?

In a world where economists followed the conventions of other branches of academia, neoclassical economists would cite post-Keynesian authors, and take their theory into account. One could be optimistic and hope that the younger generation will take this route, particularly if some high profile neoclassicals offer an example.

I have long been cynical that this would happen, but I will put that cynicism aside for now. However, even if (some) neoclassical authors start engaging with post-Keynesians, there is still a large gulf to be crossed.

If we focus on fiscal policy, I expect that the neoclassical bias will still be towards aggregate demand management policies. Although that appears to be a step towards what MMTists are arguing in favour of, it is only a half step. This would only be the mainstream regressing back towards the 1960s Old Keynesian policy mix. Aggregate demand management has its pitfalls, as Minsky and MMTists have argued.

In other words, the question is whether there will be a fundamental re-think to approaches, or perhaps just a cherry-picking of a few concepts, and then returning to business as usual.

(c) Brian Romanchuk 2019