One relatively common complaint that I have seen is that Modern Monetary Theory should be ignored because fiscal policymakers cannot be trusted to control inflation. This might be called the “noble lie” critique: we need to avoid discussing MMT as policymakers might make “undesirable” decisions.

(Note: This is an unedited excerpt from my manuscript MMT primer. This comes from a chapter of MMT critiques.)

This is obviously a political economy concern, related to the perennial “is MMT socialist?” debate (Section 1.2). The other issue with this critique is that this is obviously referring to a narrow definition of MMT (the parts that are related to Functional Finance). Since most online arguments about MMT are about those parts of MMT, this narrow scope matters, but as I argued in Section 1.2, that is missing too much of MMT for anyone interested in economic theory.

I am going to base my remarks here upon the article “Modern Monetary Muddle,” by Michael Edesess. This article was a review of Stephanie Kelton’s book The Deficit Myth. I have often encountered looser versions made by internet commentators. Edesess’ critique could be related to arguments made by neoclassical economists about fiscal policy, which I defer to a technical appendix.

Edesess’ Arguments

Within his review of The Deficit Myth, Edesess argues that the arguments of many prominent MMT critics – Martin Wolf, John H. Cochrane, Larry Summers, and Paul Krugman (a bipartisan group) – come down to similar theme. The theme is that the critics agree with the analytical premises of MMT, but are concerned about its effect on policy. Edesess argues:

But there is an even more basic issue raising those fears. They don’t trust Congress to make the appropriate adjustments. Would Congress, observing that - or being advised that - the economy was overheating therefore raise taxes to mop up the excess dollars, as MMT advocates? Would it restrain itself from spending programs once Congresspersons had to deal with lobbyists for various programs who had learned that MMT tells you that you don’t have to raise taxes to do it?
No, they don’t trust Congress to do that - in fact they don’t trust democracy to do it. And for good reason.
Democracy has a Tragedy of the Commons problem. A Tragedy of the Commons is, for example, a fish pond shared by many anglers, each of which, in their own self-interest, catches as many fish as they can, with the unfortunate collective result that the pond gets fished out.
[…]
Any threat to that arrangement is dangerous. To keep the unwashed masses from prevailing upon - or electing - a government that tries to provide all things to all people, as in a populist state, we must perpetuate the fiction that all new expenditures must be immediately paid for by new taxes. And we must delegate the management of the supply of money not to a democratic process, but to a quasi-authoritarian government arm, the Fed.

I do not think that Edesess’ analogy to the “tragedy of the commons” is persuasive (he discusses it further in the article); it sounds like a story out of Economics 101. The neoclassical arguments I elude to in the technical appendix is the more rigorous version of the argument. Instead, the value of the argument is that Edesess explicitly writes out the political economy argument: the “unwashed masses” need to be controlled by the “quasi-authoritarian” central bank.

I would argue that there are two reasons why one would be interested in MMT: from the perspective of economic theory (e.g., a fixed income analyst), or from a policy aspect (e.g., a political activist).I will discuss this critique from these perspectives in turn.

Economic Theory Matters

The argument that policymakers might behave badly is a complete non-issue from the perspective of economic theory. I am not going to believe something that is nonsensical just because someone might misuse the knowledge. From an academic perspective, this seems so obvious that it does not need elaboration.

The only interesting aspect is that I would argue that many people feel that theory ought to be tied to advocacy. The analysis of governmental bond markets and how they relate to fiscal policy is a major topic in financial news (roughly the only reason that government bonds are discussed at all on the media). One is typically treated to bank economists and strategists explicitly tying their market views to their political standpoint. For example, loudmouth free market fundamentalists predicting the demise of either the Japanese or American bond market is a staple attraction.

However, it is not necessary for bond investors to scream their views from the rooftops. For example, when I had any contact with outsiders, I was expected to not offer any useful information about how our fund was positioned. (The easiest way of doing this is professing ignorance of practically everything, and just nod a lot to what other people say.)

For anyone who is not broadcasting their views, what those views are should literally have no effect on what politicians do. As such, this entire line of enquiry is a non-starter.

What About Policy?

If we are interested in policy, we have a plausible reason to be concerned about policy biases. Of course, we must deliberately ignore all the policy implications of almost all of “broad MMT,” including the Job Guarantee. (Even from a conventional economic analysis standpoint, the Job Guarantee has almost no inflation implications in steady state if the wage is held stable.)

The first thing to note is that MMT is very unwelcome from the perspective of free market parties. These parties want to plead that the government cannot afford to offer social programmes, and that political strategy has been effective. So, if one wants to meet the doctrinal purity requirements of free market parties, one probably needs to keep any sympathies for MMT hidden from view.

However, not everyone wants to base their views on what is convenient for pro-market parties. In that case, the objection revolves around the question whether politicians are incapable of controlling inflation. In my view, this question devolves into a question of faith. I will return to this question in the technical appendix.

If we put aside the disputed question of whether only an independent central bank can control inflation, we are stuck with a rather unusual situation (which Edesess acknowledges). The MMT argument is that the only constraint on fiscal policy is inflation – and that fiscal policy frameworks should be based upon that premise. Turning around and complaining that this is somehow inflationary appears to be a non sequitur.

A less risible re-phrasing of this argument is that particular MMT proponents are not analysing inflation risks properly. In my view, this is the only firm ground of debate. Nevertheless, this is a long way from arguing that we need to hide the truth from the unwashed masses. I will return to the question of inflation control in Section 5.5.

Another related issue is that MMT critics seems to assume that MMT requires extremely active changes of tax rates to control inflation. If that were in fact necessary, it would be politically awkward. However, MMTers put much more faith in automatic stabilisers, and there is limited need to change tax rates as often as the policy interest rate. After all, MMTers argue that interest rate changes have little effect on inflation, yet inflation has been stable since the early 1990s in the developed countries in the absence of active fiscal policy movements.

Policy Ambitions

The main academic MMT proponents are arguing in favour of ambitious policies, such Medicare for All, as well the Green New Deal. These plans have a lot of moving parts, and each has its own inflationary and deflationary effects. Even the Job Guarantee will have some effect on the price level in the short run, and its exact effect will depend upon many hard-to-model effects.

Given the complexity of those plans, I cannot argue either way about the inflation analysis. Given that my view is best summarised by “inflation is complicated,” (a phrasing I have taken from Marc Lavoie, but I am sure he was not the first to suggest that), all I can suggest is let the dueling inflation modelling commence. Even if the unwashed masses are not interested in discussions of models, there would certainly be an interest in the real-world policy issues raised. In any event, this debate is entirely on MMT territory; the “inter-temporal government budget constraint” is likely never to come up.

Fiscal Conservatism a Dead Religion?

Finally, I would note that this argument is just a reheating of the neoliberal consensus of the early 1990s. Although there are some remnants of the political dynasties of that era still around, it is unclear how much influence it has.

The reality is that any sentimental attachment to the balanced budget religion disappears as soon as it becomes even slightly inconvenient. Free market parties have been cutting taxes and hiking military spending since the early 1980s. all the while shedding crocodile tears about governmental debt levels. Fiscal interventions in response to the Financial Crisis and the Pandemic of 2020 were robust, although the Obama administration’s response in 2008 was too small because of the mediocrity of the economic team.

The developed countries are filled with university-educated citizens who have access to the internet. I have extreme doubts about the sustainability of an economic theory that says one thing to policy-making elites, and another to the masses.

Technical Appendix: Policy Consistency

One of the big ideas of neoclassical modelling of the 1970s was time consistency of policies. This was part of the ideological attack on Keynesianism, as it was argued that fiscal policy was time inconsistent.

Since I am not writing a primer on neoclassical economics, I will outline the argument very briefly. Imagine that policymakers want to reduce unemployment while keeping inflation stable, and we assume that the framework is Old Keynesian: increase government spending to create jobs (or cut taxes), but the rise in aggregate demand creates inflationary pressures. (Needless to say, this hydraulic Keynesian framework ignores the Job Guarantee, which features full employment with no changes in the policy wage. However, the people who apply time inconsistency arguments against MMT ignore that part.)

The time inconsistency shows up in the following fashion. Assume that unemployment is “too high,” and so policymakers want to launch a fiscal stimulus programme. They argue that future fiscal tightening will offset the future inflation risks, so that the mixed policy objective is met However, in the following year, unemployment is at a more comfortable level, and inflation is higher. When trying to find the optimal policy for the policy mix, the tightening of fiscal policy is less than was forecast in the previous year. As such, even though the policy objective for trading-off inflation versus and unemployment is unchanged, future policy does not match what looks like optimal policy at the beginning: there is a bias towards running higher inflation.

The literature is premised upon using mathematical optimising models. We need step back, and ask: what are these models?

• You first assume some mathematical relationships in a system of equations (and constraints, etc.).
• You then apply the rules of mathematical operations to examine the properties of the solution of the set of equations. For example, you can simulate the results on a digital computer.

In this case, neoclassical economists have created a mathematical system that assumes that fiscal policymakers prefer a system that generates inflationary outcomes. The obvious question: why should we assume that the model applies to the real world? Has this particular model been fit to real-world data, and done a good job of explaining outcomes? The answer is: not really, but other neoclassical models have been fit to data. How convincing this defense is ends up being a question of faith. Since this is not a primer on neoclassical economics, I cannot hope to address this aspect of the critique. All that can be said is that post-Keynesian economists reject pretty much all the underlying assumptions used in the models.

References and Further Readings

• “Modern Monetary Muddle,” by Michael Edesess, a review of Stephanie Kelton’s The Deficit Myth. URL: http://econintersect.com/pages/opinion/opinion.php?post=202007020028
• The following pre-print updates the time consistency literature and discusses MMT. Mejia, Jackson, and Brian C. Albrecht. "Time Inconsistency, Inflation, and MMT." (2020). URL: https://briancalbrecht.github.io/Mejia_Albrecht_MMT.pdf

(c) Brian Romanchuk 2020