The problem with modern monetary theory (MMT)

Deficits are not required for central bank money creation

Proponents of MMT often assume that deficits are necessary in order to increase the money supply, which a growing economy needs. This is wrong. While buying and selling of government bonds is the usual way the Federal Reserve creates money in the US, there are many countries where this is not the case. In countries where the primary goal of monetary policy is to maintain a certain fixed exchange rate or ensure international competitiveness, such as Denmark or Singapore, central banks usually conduct their monetary policy, and increase or decrease the supply of base money, by buying and selling foreign currencies. In principle, central banks can increase or decrease the supply of base money by buying or selling any asset, domestic or foreign. Government deficits are therefore not necessary in order to increase the money supply and indeed do not in principle have anything to do with the pace of increase in the supply of base money. It is the banking sector as a whole, including the Central Bank, that has the ability to create money. The fiscal operations of the government are quite irrelevant in that regard.

Proponents of MMT know of the ability of private banks to create deposit money, but do not seem to comprehend that this undermines their story of money as purely a creation of the government. While the banking sector does require a monetary base on which bank deposits are claims in order for bank deposits to have any value, this monetary base does not need to be provided by a government. During the era of the gold standard, bank deposits were claims on gold and could be exchanged for gold, which is a commodity that can of course be produced by the private sector. A government produced currency is thus not necessary for a monetary or banking system to function.

Monetary policy is far more powerful than fiscal policy and commodity price shocks

Proponents of MMT cannot seem to agree how (or if) monetary policy works, though they do all seem to agree that it is a relatively ineffective way of controlling inflation. Warren Mosler believes that monetary policy works in the opposite direction of that assumed by most economists. He believes higher interest rates lead to higher inflation, and lower interest rates lead to lower inflation. This is why he advised the Turkish government to decrease interest rates as a way to lower inflation.

Bill Mitchell seems to believe monetary policy has the direction the mainstream assumes, and argues against raising interest rates on the basis that it would hurt the economy. Stephanie Kelton seems to hold the same view.

Warren Mosler believes the high inflation in the US in the 70s and 80 was put to an end by lower oil prices, not the actions of the fed, and this belief is shared by other MMT proponents. This is strongly contradicted by the empirical evidence, which shows that several advanced economies, such as Australia, continued having high inflation for many years after inflation had decreased significantly in the US, because their central banks took much longer to take decisive action against inflation. In Australia inflation only began decreasing significantly in the 1990s. Other countries, such as Switzerland and Germany , saw their rates of inflation decrease significantly before the United States and before the fall in commodity prices of the 80s. This is why most economists concluded that monetary policy, not commodity price shocks, explains the high inflation of the 70s and 80s.

Furthermore, the US dollar price of oil and other commodities is of course itself affected by the monetary policy of the Federal Reserve. This is easy to see when considering the monetary policy of any other country with its own currency. Monetary policy affects the exchange rate of a currency, and therefore affects the price in local currency of internationally traded commodities such as oil. There is no reason to think that the US is fundamentally different.

An example of monetary policy dominating fiscal policy is Japan during the Abe administration. The deficit decreased significantly due to the increase in the VAT. But because of the expansionary monetary policy of Kuroda, nominal GDP growth increased significantly and the yen depreciated.

Giving elected politicians access to the printing presses is a bad idea

The claim that governments with their own fiat currency can in principle fund any amount of nominal spending is not controversial, and is accepted by virtually all economists. The question is whether allowing unlimited funding of deficits by money printing at the discretion of elected politicians is a good idea or not. Most economists believe it is not a good idea, supporting an independent central bank. Elected politicians in particular have a strong incentive to engage in expansionary monetary policy in the run-up to an election, which will provide a boost to the real economy but is likely to result in inflation later.

Argentina provides an example of what can happen when a government comes to rely habitually on the money making power of the central bank to fund its deficits. The country has had for decades inflation above 10% due to this. A change in this status quo from elected politicians is unlikely as it would require significantly cutting government spending and/or significantly increasing taxes.

A job guarantee is simply a form of workfare and would not revolutionize the economy

A central MMT proposal is the job guarantee, which will supposedly eliminate unemployment. As Matt Bruenig has pointed out, a job guarantee is essentially a form of workfare. Several European countries have already implemented requirements for those who have been on unemployment benefits for a specific duration to work for their benefits. This is part of what is known as active labor market policies. There is nothing revolutionary about job guarantees, and they would not eliminate unemployment under reasonable and currently accepted definitions of unemployment, which do not count those in government funded active labor market programs as employed.

MMT is a political movement

MMT advocates behave as a political movement. They refuse to clearly criticize each other when they disagree. An example of this is the disagreement between Stephanie Kelton and Bill Mitchell about the role of taxes in the economy (this blog post by Bill Mitchell is a reference to tweets by Stephanie Kelton like this and this, though of course he doesn’t mention this). You will never see Stephanie Kelton and Bill Mitchell engage in a discussion about this, nor will you ever see Bill Mitchell, Stephanie Kelton and Warren Mosler discuss their different opinions on the effect of monetary policy. This is the way you expect a political movement, which will of course prefer to downplay any differences, to behave. It is not the way participants in a serious intellectual project would behave.

Conclusion

Despite these fatal flaws, I expect that MMT and similar perspectives will have an increasing influence on the economics profession. This is in line with the general leftwards shift of academia, evidence be damned.