Comments On Tavlas' MMT Critique

Having finished off the publishing tasks on "Modern Monetary Theory and the Recovery," I am now turning to some MMT critiques that popped up too late for inclusion in the book. The first is by George S. Tavlas, the Alternate to the Governor of the Bank of Greece on the European Central Bank’s Governing Council, which is titled "Modern Monetary Theory Meets Greece and Chicago." It contains a broad overview critique of MMT, which overlaps discussions found within my book. Of more interest was the discussion of Greece. 

Unfortunately, I had skimmed over most of the article when I first read it, since a lot of it seemed to be boilerplate that I have seen variants of hundreds of times before. However, once I started digging into it to write this response, I was shocked at the weakness of the discussion. Instead of dropping the article, I decided to publish this to provide yet another horrible example of the failings of senior mainstream economists in engaging with heterodox economics.

In order to demonstrate the usefulness of my own book (and avoid re-writing text that I have been staring at for months), I will refer to section numbers of my book throughout the text when responding to points raised by Tavlas. The most entertaining aspect of this is that many of these are in response to points that are allegedly not addressed by MMT.

Tavlas' Summary of MMT

Tavlas starts off with a summary of MMT. Unlike many earlier mainstream criticisms of MMT, it at least it is based on what Stephanie Kelton wrote in The Deficit Myth, and then the early post-war Functional Finance school. As is entirely typical of the academic rigour of mainstream economists, Tavlas only cites a single MMT author -- Kelton -- and that reference is a best-selling popular book. (He also cites Lerner, but note that although MMT has adopted some ideas from Functional Finance, MMTers differ from Functional Finance in terms of policy analysis.) Meanwhile, he of course cites a vast number of mainstream authors, including his own work. 

As for Tavlas' summary of MMT, I do not want to lose time over it. Obviously, I believe that my short summary (Section 1.2) is far more reliable. (Please note that I deliberately placed that section right at the front, and it appears in the free preview at online bookstores.)

The only substantive point I want to note in that section is the following quote: "Apart from the minimum wage’s anchoring role under the federal job program, how would Kelton keep inflation in check? She is very vague: 'MMT would make us safer [against inflation] because it recognizes that the best defense against inflation is a good offense.'" Accusing MMT being vague about inflation is relatively common, to be perfectly fair.

I discuss MMT's theory of inflation in Section 4.6, and Sections 5.5 and 5.6. I have no doubt that mainstream economists will be unhappy with my discussion of the topic, given that I feel that I still need to delve deeper into inflation theories. Nevertheless, I give references to allow a research survey to start going. As for Kelton's The Deficit Myth, I want to point out that it is almost certainly selling more copies in a day than my book will sell in a year (barring some miracle). One of the reasons is that I have long-winded argle-bargle about competing theories of inflation, and her book features clean text that is understandable to a wide audience. However, "peer-reviewed journals" were invented to deal with the complicated stuff that will not make it into the New York Times Bestseller list.

Kitchen Sink Critiques

Tavlas asserts that MMT has faced tough criticism, and runs through a kitchen sink of complaints. I will break his text (originally in a paragraph) into point form for simplicity. I omitted some words between the various quotations as part of the textual restructuring.

1. "Kelton’s rendition, for example, has been criticized for (1) its neglect of the 1970s, a period during which expansionary policies led to increases in both inflation and unemployment (Cochrane 2020);" I ignored the Cochrane review since it was a bad faith critique, which falls under Section 5.2. I also ignored the 1970s, because not everyone is stuck re-living that decade. The longer answer is that MMTers disagree vehemently with the mainstream narrative about that period, but that is now a question of economic archaelogy.
2. "the likelihood that it would induce unexpected inflation, reducing the purchasing power of those caught holding “old money” as “new money” is printed (Andolfatto 2020, Dowd 2020);" I have not read these critiques, but Tavlas makes it sound vaguely Monetarist. For reasons to be discussed later, I am not interested in that angle.
3. "its strong proclivity to increase the size of the government in the economy, thereby diverting resources from productive firms to the quixotic public sector (Coats 2019, Tenreiro 2020);" This is a political economy complaint, buried under pseudo-science (Section 5.2). As I discuss in Section 1.3, although MMT supporters are generally progressive, the theory itself is largely neutral with respect to the size of the state (although libertarian fantasies about the state disappearing are not supported).
4. "its neglect of the fact that, in the absence of monetary accommodation, fiscal expansion can be a weak policy instrument (Greenwood and Hanke 2019);" MMTers are quiet vocal in their beliefs that monetary policy is weak (or even works backwards from conventional thinking) -- Section 2.5.
5. "its neglect of the literatures on central‐​bank independence, the term structure of interest rates, and the effects of portfolio‐​balance decisions by investors on the way that policies interact with key economic variables (Edwards 2019)." Once again, covered in Section 2.5.
6. "Krugman (2019) likened MMT to Calvinball, a game under which its adherents keep changing their arguments in response to criticisms; Rogoff (2019) called MMT 'nonsense'; and Summers (2019) wrote that it is 'a recipe for disaster'" This is what scholars call appeals to authority. In all of these cases, the so-called "authorities" just made stuff up about MMT (Section 5.2). It seems clear that it was a connected group of people who decided that if they repeated the same lies often enough, people would believe them.

In summary, for anyone who read my book, there's nothing new here (other than the Monetarist bits).

Greece

The reason why I was interested in Tavlas' article was the discussion of Greece. As seen in Section 5.10, the currency sovereignty of smaller economies (in the limit, every country except the United States) is a major point of controversy.

The first thing to note is that mainstream economists love to invent policies that they attribute to MMT, yet they ignore actual policy recommendations. In this case, the policy that matters is: currency pegs, like the euro are a spectacularly bad idea. The Greek elites rush into the euro -- even to the point of “massaging” statistics to gain entry. The fact that they needed to paint the books to get into the euro should have been a signal that perhaps it was not the brightest decision.

The results were disastrous for the Greek population.

The chart above shows the collapse in nominal GDP -- an extreme rarity for developed economy managed to do in the post-Bretton Woods era. The collapse in nominal GDP coincided with a downturn that had severe consequences for the Greek population (but not necessarily the Greek ruling elites). The country was sacrificed on a cross of hard money dogma. MMT proponents said: don't go there, yet the Greek elites did. Any discussion of counter-factual scenarios has to accept that Greek economic mismanagement was abysmal, and it would take a strong effort to perform worse.

Tavlas Misrepresents What Kelton Wrote

Tavlas is attempting to paint a story that MMT is wrong about currency sovereignty. He makes the following statement:

Second, Kelton’s argument that interest rates on Greek government debt “skyrocketed” beginning in September 2008, which, if accurate, would support her contention that the origination of the Greek financial crisis lay with factors external to Greece, is similarly incorrect. As clearly shown in Figure 1, interest rates on Greek sovereigns began their ascent in October 2009, coinciding with the market’s recognition that Greece’s fiscal situation was unsustainable. 

Notice how "skyrocketed" was not given context. What is the actual context? The sentence in Chapter 4 of The Deficit Myth reads: "In Greece, the poster child for the crisis, interest rates on ten-year government debt skyrocketed from 4.5 percent in September 2008 to nearly 30 percent by February 2012 [emphasis mine]." Kelton's statement is correct, and Tavlas misrepresented her position, as nothing he writes in inconsistent with rates being higher in 2012 than in 2008. She picked a sensible start date for the comparison, and nothing she wrote implied that yields immediately skyrocketed, as Tavlas straw-manning implies.

As a senior fixed analyst that was employed by a large fixed income manager that had chunky positions in euro sovereigns and quasi-sovereigns both before and after the Financial Crisis, Tavlas' description of what happened in Greece is questionable. (Since Greece was obviously an accident waiting to happen, I was not directly implicated in the day-to-day events. However, I followed the news flow and market chatter.) The European banking system was shaky after the crisis, holding a lot of toxic assets on their balances sheets. Peripheral debt was one category of such assets. Banks had to extricate themselves, and cross-border financing was strained. The Greek debt market failed when the ECB threw them under the bus for political reasons (while other peripherals were bailed out). Being subject to arbitrary decisions by an unaccountable central bank is exactly one of the risks MMTers warned about. In any event, the fiscal crisis in Greece is still an outlier in modern developed countries.

Yet Another Misrepresentation

Near the beginning of the article, Tavlas writes:

The fiscal profligacy led to high inflation, something that, as we shall see, Kelton says will not happen to a country that has monetary sovereignty.

This is a bizarre assessment of what Kelton wrote, and it is not even internally consistent with the rest of Tavlas' description of MMT. (That said, he repeats the claim, as we shall see next.)

The Earlier Greek Crises

Tavlas refers to various vague financial crises that happened some time in the 1980s or 1990s. (I think it's mainly an episode around 1994, but his timeline for these alleged crises was vague.)

Tavlas:

The key macroeconomic performance indicators during 1981 to 1994 tell the resulting story: the nominal interest rate on the 10‐​year government bond was consistently near 20 percent, despite the activity of the Bank of Greece in the sovereign‐​bond market; inflation—something that Kelton says will not happen to a currency issuer [emphasis mine]—averaged 18 percent; real growth averaged 0.8 percent; and the current account consistently registered deficits in the range of 3 percent to 5 percent of GDP. In those circumstances, the country faced a series of financial crises as the drachma came under attack. Several adjustment programs were undertaken, but they were subsequently abandoned in favor of a reversion to fiscal and monetary expansion.

The first thing to note is the boldfaced text -- Tavlas doubled down on his blatant misrepresentation that Kelton says that currency sovereigns are inflation-proof. 

The next thing to note that Tavlas' idea of a "financial crisis" is high bond yields. I do not have a chart of Greek yields handy, but let us check out something that is more relevant.

The above chart shows the drachma overnight rate. If we look at it, anyone with any understanding of interest rate formation will immediately see why Greek bond yields traded around 20% -- that is where the overnight rate was.  It is inconceivable how anyone with any knowledge of modern economic or financial theory would expect otherwise. (There was a blow-up in 1994, presumably collateral damage of the global fixed income bloodbath of that year. Although I have never looked at the history, that type of rate spike is typical for a central bank defending some level in the currency -- which is not what a currency sovereign does.)

This puts the alleged "crisis" in bond yields in perspective. The Greek authorities kept nominal interest rates near 20%, but this did very little to suppress inflation or support the currency. This is exactly what MMT proponents say will happen (Section 2.5). The Greek authorities were not following a MMT script, although I am unaware of what they thought they would accomplish. Keeping rates high for a sustained period just inflates the fiscal deficit, offsetting whatever moderation high interest rates allegedly provide.

Tavlas made the following comment:

 Consequently, monetary policy’s role was to help finance the fiscal deficits—annual money growth averaged more than 20 percent during the period 1981 to 1994.

This statement is puzzling, but this is due to its vagueness. Money is growth is quoted as being meaningful, which is typical Monetarism. If the Bank of Greece wanted to "help finance the fiscal deficits", it would have reduced the overnight rate. My guess -- and I underline that it is a guess -- is that Tavlas is referring to policies like required reserves. Such policies are a form of financial repression -- lowering the average interest cost of all governmental liabilities by forcing money holdings. This reduces the stimulative effect of high interest rates, but it is not a policy stance that is given much attention by MMT proponents. Nevertheless, it is a far cry from replacing debt with money completely, dropping the interest cost to zero, which is a policy discussed by MMT proponents (Section 3.5).

(The alternative explanation is that this statement relates to Monetarist beliefs about monetary policy -- the central bank sets the growth rate for money. These Monetarist beliefs about monetary policy are incorrect, but are incoherent enough to possibly be related to his statements. That said, the wording he uses does not fit the pattern I am used to seeing from Monetarists, and the linkage to central bank operations is unclear.)

The reality is that Greece has surrendered its currency sovereignty, and shows no will to take it back. This makes delving into Greece's economic past a subject purely a subject of economic history, as the only relevant MMT analysis now revolves around the euro framework. It is entirely possible that the topic of analysing the Greek policy framework in the 1980s will become the subject of a research monograph, but it is clear that this is a fringe research area. As such, debating Greece’s historical policy options is probably not going anywhere.

In any event, this is not really a complicated story. A free-floating currency is not proof against economic ills if policymakers believe myths about economic policy. The entire premise of Kelton's book was that policymakers were subject to those myths. I find it completely unremarkable that Greek policymakers made serious policy mistakes in the decades before they made the mind-bogglingly bad decision of entering the euro. 

Monetarism

The end of the article features Tavlas rehashing some old Chicago School/Monetarist blah-blah about money. Of course, he is condescending:

 An important consideration in evaluating Kelton’s proposal is that the author has ventured into an area—the subject of money—which appears to be uncharted waters for her.

He also implies that she is a monetary “crank." This is particularly rich coming from someone who quotes approvingly the intellectually defunct school of Monetarism. 

I am not interested in discussing Monetarism further, since it is no longer the 1970s.

Concluding Remarks

It is not a great look for the senior members of the economics mainstream if they need to resort to obvious misrepresentation in intellectual debates.

(c) Brian Romanchuk 2021