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Are We All Modern Monetarists Now?

Posted on Dec. 17, 2020

Modern monetary theory (MMT) has gone mainstream — sort of. Long regarded with disdain by sober-minded policy experts, this heterodox branch of economics has been making inroads in polite society. On some level that isn’t surprising, given its permissive message: Stop worrying about deficits — they’re fine.

Traditionally, most fiscal policy experts have not been fine with deficits. Sure, they’ve accepted and even embraced them in certain circumstances, especially when the economy has been weak or the country has faced extraordinary challenges (like a war or a pandemic). And they’ve never worried too much even about chronic deficits as long as they remained modestly sized.

MMT, however, allows for very large and more or less permanent deficits as long as inflation and interest rates remain low. Traditionally minded economists, both left and right, tend to find that unsettling, to say the least. But in recent years, they’ve also been forced to acknowledge that MMT — or at least elements of it — can help explain a puzzle that more traditional economic theories don’t, at least not well: Why have interest rates remained persistently low despite years of large federal deficits and soaring government debt?

Typically, all that borrowing would tend to force interest rates up and “crowd out” private investment that also depends on loans. That would slow economic growth, making almost all problems worse for just about everyone. Basically, it’s a bad deal.

But for many years now, that traditional view of government debt, interest rates, and growth hasn’t worked out as predicted. The government has been spending more, taxing less, and racking up plenty of debt. Yet interest rates have remained low, as has inflation. So what gives?

MMT has some answers to that puzzle — answers that have won it attention in some unlikely places, including Wall Street. But there also seems to be a widespread suspicion that MMT has invaded the soul of the Democratic Party — a perception aided, no doubt, by the favorable attention given to it by party luminaries like Rep. Alexandria Ocasio-Cortez, D-N.Y.

But in fact, MMT remains if not a fringe theory, at least an outlier in the world of respectable, think-tank-driven economic analysis. A wide range of officials and official-adjacent scholars have distanced themselves from it. Federal Reserve Chair Jerome Powell, Treasury Secretary nominee Janet Yellen, former Treasury Secretary Lawrence Summers, and many others have all had their say — and little of it has been nice.

But if MMT proper has remained a pariah in most Washington circles, MMT-lite is doing much better. The rising prominence of MMT has occurred within a broader shift in thinking about fiscal policy — a shift evident not just among the practitioners of the MMT dark arts, but also among more traditional economists. And this shift shares some key elements with MMT, although both sides would probably argue with that assertion.

But judge for yourself. In a recent paper, Summers and former Council of Economic Advisers Chair Jason Furman suggest the need for a “revolution” in thinking about fiscal policy. The substance of that revolution? It’s best summarized by the title of another jointly authored work, their 2019 article for Foreign Affairs: “Who’s Afraid of Budget Deficits?

When a former secretary of the Treasury and a former chair of the Council of Economic Advisers agree that it’s time to stop worrying so much about deficits, you know the ground is moving underfoot. And for tax people, this second fiscal revolution — not to be confused with the first fiscal revolution chronicled by Herbert Stein in his book by the same name — portends big changes. MMT, and to a lesser extent the new deficit insensitivity popular among mainstream economists, suggest that tax increases will be less common in the years to come. After all, if we can spend money on things the country needs and not worry (so much) about how to pay for it, why go to all the trouble of raising taxes?

A Theory Maligned

So what is MMT? Most answers to that, mine included, tend to oversimplify the complex ideas grouped under that moniker. And that oversimplification can easily shade into caricature, as I think mine probably has already. Because just to begin with, it’s untrue that MMT suggests that deficits don’t matter.

First, however, MMT begins with an observation: Countries that issue their own currencies can never “run out of money” the way individuals or even businesses can. They can always just print more money. This may sound outrageous, or at least dissolute, but it’s also accurate. Even Summers and Furman accept it as a starting point. As they wrote in Foreign Affairs:

Some commentators worry that rising deficits don’t just slowly eat away at economic growth, as the textbooks warn; [the commentators say] they could lead to a fiscal crisis in which the United States loses access to credit markets, sparking an economic meltdown. There is precious little economic theory or historical evidence to justify this fear. Few, if any, fiscal crises have taken place in countries that borrow in their own currencies and print their own money.

Japan is always the go-to example for people making this case. Summers and Furman cite the Japanese experience as evidence that government debt doesn’t always spell disaster. “In Japan, for example, the national debt has exceeded 100 percent of GDP for almost two decades,” they wrote. “But interest rates on long-term government debt remain near zero, and real interest rates are well below zero.”

The policy upshot of this observation about sovereign currencies is that countries like Japan and the United States are free to spend more. How much more? More than might seem prudent, at least to those accustomed to using debt-to-GDP ratios as a metric of fiscal sustainability (Summers and Furman specifically reject this way of measuring fiscal prudence). MMT advocates and their mainstream colleagues increasingly insist that U.S. deficits are too small, especially relative to the needs of American citizens and the economy in which they live.

MMT has some interesting things to say about taxes. Most basically, it challenges the idea that taxes are linked to spending in any meaningful way. Under traditional ways of thinking, the government collects money through taxes and then decides how to spend it. Under an MMT way of thinking, the government decides how to spend money and then just goes ahead and spends it. Whether the government decides to levy taxes depends on other factors, not on the need to raise money for its spending priorities.

Revenue, in other words, does not constrain spending in the world of MMT. And to be fair, this seems like a pretty good description of the way the United States has been making spending decisions for a while. Sure, thanks to budget rules, there are some limits on what gets spent, and those limits are tied (somewhat notionally) to what tax revenues get collected. But it’s fair to say that in many respects, spending decisions do come first in Washington, with tax decisions playing a secondary role. Hence the deficits.

Under MMT, taxes still have a role to play. Two roles, in fact. First, a government levies taxes to make its sovereign currency valuable. By requiring people to pay their taxes in dollars, the U.S. government guarantees that people will do many other things with those dollars — earn money, spend money, lend money, etc. Taxes make dollars the currency of choice, rather than some alternative like bitcoins or euros.

The second reason a government levies taxes in a world defined by MMT is to control inflation. Because here’s the thing to remember: MMT theorists do believe that inflation is a threat. They understand that unchecked government spending, in particular, might push prices higher. And they endorse the use of taxes to help control those inflationary pressures.

That point is important, if only because one of the most common charges hurled at MMT advocates is that they don’t care about deficits. First of all, that’s untrue on its face: Most of the time, they care about deficits because they like them and want to see them get bigger. But other times, MMT champions care about deficits because they understand that they become inflationary, and inflation needs to be controlled — with taxes.

Problematic Politics

The problem with using taxes to control inflation is that it requires politicians to play the heavy. And to do it quickly. The assumption that members of Congress are willing to play this role — or even capable of it — seems heroic. Lawmakers are skilled at handing out goodies, but they are less good at asking for sacrifice. I’m dubious that they would find the political will to impose heavy tax increases, even in the face of rising inflation. I’m even more dubious that they can do it quickly enough to stop inflation while it’s still gathering steam.

In the past, Congress has tried to use taxes for inflation control, most notably in wartime. But while that worked during World War II (politically, at least), it was much harder during the Vietnam War. And given the “free lunch” ethos that seems to pervade Capitol Hill, I’m skeptical that lawmakers would be able to do the dirty work that they have long since outsourced to the Federal Reserve.

Still, this problem with MMT — its reliance on taxes as an inflation-control device — is a late-stage issue; presumably it would arise only after policymakers had already gone down the road of MMT deficit spending. But what if we return to the watered-down version of MMT that seems to be gaining traction with the Summers-Furman crowd?

In that case, inflation and rising interest rates are still distant threats. And in this current environment, the deficit insensitivity pioneered by MMT theorists may actually have a future in U.S. politics. The key is its bipartisan appeal.

Something for Everyone

Liberals generally believe government is investing too little in things that the country needs. And if deficits aren’t much of a real threat, we should be investing more. As Summers and Furman suggest in their recent paper, “Many public investments pay for themselves, or come close to paying for themselves, and the risk of not undertaking these investments is larger than the risk of doing too little deficit reduction.”

That’s a happy outlook for the left. But what about the right? As it turns out, conservatives can find things to like about deficit insensitivity, too. If deficits from spending are no big deal, then deficits from tax cuts aren’t either, right? Liberals will object that most tax-cut-driven deficits don’t fund things the country needs — that the money is going to the wrong places and people. But that’s just an argument about priorities, not economic peril or the lack of it.

Some conservatives have already embraced MMT for its permissive stance toward deficits — and by implication, tax cuts. Ron Biscardi, chief executive of the investment firm Context Capital Partners and a self-described libertarian, told The New York Times that to him, “modern monetary theory means not only more government spending on infrastructure, but also lower taxes on the wealthy. After all, if government deficits can grow larger, there’s no need to raise as much revenue.”

Still, despite this aisle-crossing appeal, the smart money in Washington, as always, is on dysfunction, not compromise. Skeptics have predicted that Republicans operating under a Democratic president will rediscover their passion for fiscal responsibility, especially on the spending side of the ledger.

Perhaps. But that’s where MMT-inspired thinking might pave the way for compromise — by moving some of the red ink to the tax side of the equation. Matthew Yglesias, formerly of Vox and now an independent blogger also associated with the Niskanen Center, has argued for an “ice cream party.”

“There is an alternative to ‘eat your peas’ politics — a push for a different kind of bipartisan deal in which, rather than giving up on progressive spending priorities, Biden tries to secure support for them by giving in to big, GOP-friendly tax cuts,” Yglesias explained in one of his last pieces for Vox. “In an ‘ice cream for everyone’ scenario, instead of offsetting his spending ideas by rolling back the Trump tax cuts, Biden could consider doing the opposite: swapping his spending ideas for the GOP’s tax ideas.”

With deficit worries off the table, that kind of bargain starts to seem realistic, politically at least. Especially when the ranks of the deficit-insensitive have expanded to include a range of formerly sober policy experts, including some erstwhile deficit hawks. It’s not just Summers and Furman willing to run up the red ink, but Yellen, Powell, and any number of other reasonable people. Most of those luminaries are among the ranks of the MMT-skeptical. But they have also embraced the deficit insensitivity that lies at the heart of MMT.

The only questions remaining to be answered are: (1) Will Democrats agree to give Republicans the tax cuts they want if it means they can have the spending that only Senate Majority Leader Mitch McConnell, R-Ky., can give them (depending on those Georgia runoff elections)? and (2) Will Republicans agree to give President Biden a big win on spending programs when delivering him a humiliating defeat is such an appealing option?

Only time will tell. But if the last 75 years of U.S. fiscal history has anything to teach us, it’s that fiscal slack makes many things possible, including compromise. In the past, fiscal slack has typically been delivered by a combination of economic growth and rising tax revenue. In the future, that combination might possibly deliver again.

But in the short term, fiscal slack is more likely to come from a healthy dose of reckless abandon. Or not so reckless, if you believe the fans of MMT and their more restrained cousins in the traditional policy community.

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