Modern Monetary Theory: the rise of economists who say huge government debt is not a problem

by John Whittaker, The Conversation:  https://theconversation.com/modern-monetary-theory-the-rise-of-economists-who-say-huge-government-debt-is-not-a-problem-141495

There is no limit to the quantity of money that can be created by a central bank such as the Bank of England. It was different in the days of the gold standard, when central banks were restrained by a promise to redeem their money for gold on demand. But countries moved away from this system in the early part of the 20th century, and central banks nowadays can issue as much money as they like.

This observation is the root of modern monetary theory (MMT), which has attracted new attention during the pandemic, as governments around the world increase spending and public debts become all the more burdensome.

MMT proponents argue that governments can spend as necessary on all desirable causes – reducing unemployment, green energy, better healthcare and education – without worrying about paying for it with higher taxes or increased borrowing. Instead, they can pay using new money from their central bank. The only limit, according to this view, is if inflation starts to rise, in which case the solution is to increase taxes.

MMT’s roots

The ideas behind MMT were mainly developed in the 1970s, notably by Warren Mosler, an American investment fund manager, who is also credited with doing much to popularise it. However, there are many threads that can be traced further back, for instance to an early 20th-century group called the chartalists, who were interested in explaining why currencies had value.

These days, prominent supporters of MMT include L Randall Wray, who teaches regular courses on the theory at Bard college in Hudson, New York state. Another academic,  Stephanie Kelton, has gained the ear of politicians such as Bernie Sanders and, more recently, Democrat US presidential candidate Joe Biden, providing theoretical justification for expanding government spending.

There are more strands to MMT besides the idea that governments don’t need to worry overly about spending. For instance, supporters advocate job guarantees, where the state creates jobs for unemployed people. They also argue that the purpose of taxation is not, as mainstream economics would have it, to pay for government spending, but to give people a purpose for using money: they have to use it to pay their tax.

But if we overlook these points, the main policy implication of MMT is not so controversial. It is not too far from the current  new-Keynesian orthodoxy which advises that if there is unemployment, this can be cured by stimulating the economy – either through monetary policy, which focuses on cutting interest rates; or through the fiscal policies of lower taxes and higher spending.

Against this position is the monetarist doctrine that inflation is caused by too much money, and the common belief that too much government debt is bad. These two principles explain why central banks are strongly focused on inflation targets (2% in the UK), while the aversion to debt in the UK and elsewhere was the driving force behind the “austerity” policy of cutting government spending to reduce the deficit – at least until the coronavirus pandemic made governments change direction.

The crux

So, who is right – the MMT school or the fiscal and monetary conservatives? In particular, is it sensible to pay for government spending with central bank money?

When a government spends more than it receives in taxation, it has to borrow, which it usually does by selling bonds to private sector investors such as pension funds and insurance companies. Yet since 2009, the central banks of the UK, US the eurozone, Japan and other countries have been buying large amounts of these bonds from the private-sector holders, paying for their purchases with newly created money. The purpose of this so-called “quantitative easing” (QE) has been to stimulate economic activity and to prevent deflation, and it has been greatly expanded in response to the pandemic.

At present in the UK, over £600 billion or 30% of government debt is effectively financed by central bank money – this is the value of government bonds now held by the Bank of England as a result of QE. There are similar high proportions in the other countries that have been undertaking QE.

Despite all this creation of new central bank money and the large increase in government debt in the UK and other large economies since the financial crisis of 2007-09, nowhere has there been a problem with inflation. Indeed, Japan has struggled for three decades to raise its inflation rate above zero. This evidence – that neither large debt nor large money creation has caused inflation – seems to vindicate the MMT policy recommendation to spend.

UK public debt as a % GDP

Trading Economics

Of course, there are many counterexamples in which these conditions have been associated with hyperinflation, such as Argentina in 1989, Russia at the breakup of the Soviet Union, and more recently Zimbabwe and Venezuela. But in all these cases there was an assortment of additional problems such as government corruption or instability, a history of defaults on government debt, and an inability to borrow in the country’s own currency. Thankfully, the UK does not suffer from these problems.

Since the outbreak of the coronavirus pandemic, UK government spending has been rapidly increasing. Debt is now about £2 trillion or 100% of GDP. And the Bank of England, under its latest QE programme, has been buying up UK government bonds almost as fast as the government is issuing it.

Thus the crucial question is: will inflation remain subdued? Or will this vast new increase in QE-financed government spending finally cause inflation to take off, as the easing of lockdown releases pent-up demand?

If there is inflation, the Bank of England’s task will be to choke it off by raising interest rates, and/or reversing QE. Or the government could try out the MMT proposal to stifle the inflation with higher taxes. The trouble is that all these responses will also depress economic activity. In such circumstances, the MMT doctrine of free spending will not look so attractive after all.

Bernie Sanders’ Economic Adviser Has a Message for Australia we Might Just Need

by Steven Hail, The Conversation:  https://theconversation.com/bernie-sanders-economic-adviser-has-a-message-for-australia-we-might-just-need-130182

Debate over what the Reserve Bank governor and the treasurer should do usually runs along familiar lines.

The bank is supposed to set its cash rate to keep inflation low and stable, while the government is supposed to avoid deficits, at least on average, over the economic cycle and preferably run surpluses.

We have heard it so often that it seems like common sense. So when a famous economist comes along and contradicts it - an advisor to a US presidential contender no less – it’s understandable that people are shocked.

Yet that’s the message of Stephanie Kelton, a senior economic adviser to Bernie Sanders, and before that chief economist on the US Senate Budget Committee.

Professor Kelton, a leading modern monetary theorist, is the 2020 Visiting Harcourt Professor at the University of Adelaide, and during her visit in January was interviewed by most Australian newspapers, and many radio and TV outlets.

Professor Stephanie Kelton, “The Deficit Myth” University of Adelaide, January 15, 2020.

According to modern monetary theory (MMT), the narrative we have become used to is based on an outdated and misleading description of monetary systems. The key thing that’s been missing is an appreciation of the difference between a currency issuer and a currency user.

You and I, along with businesses and not-for-profits, local councils, state governments, governments with foreign currency debts, and even governments within the Eurozone, are currency users.

Before we can spend money, we need to find it – either by earning it, begging for it, digging into savings, or borrowing it.

Governments create, rather than raise, money

If we borrow money, we need to repay it at some point in the future or risk going broke.

The Australian Commonwealth government, and other national governments that issue currencies in the same way that our government does, are in a completely different position.

They have nothing in common with currency users. They can’t go broke, ever. It isn’t even possible, given the way our system works.

Our government is the monopoly issuer of the Australian dollar. Every dollar that it spends is a new dollar. It doesn’t need to raise taxes or or borrow before it can spend, although that is what it appears to do to those who don’t know how our monetary system works.

In reality, it is the other way around. Governments like ours need to spend dollars into existence before they can be used to pay taxes or to buy newly issued bonds. We need the government’s money - they don’t need ours. They issue the dollar. We use dollars.

Think of the economy as a bath

The economy is like a bath. It needs to be pretty full, but not too full. Shutterstock

Think of the economy as a bath, with government spending being the water coming out of the tap into the bath, and taxation and saving being the water that goes down the drain.

The spending comes first.

The macroeconomic role of taxation is to stop the bath overflowing – to stop total spending in the economy going beyond the productive capacity of the economy and creating the risk of accelerating inflation.

Taxation limits the spending power of the private sector, creating room for the government to spend on public goods and services and investments without driving prices up.

A budget deficit is simply the government making a net contribution of dollars to the economy, putting more dollars into the bath (into private bank accounts) than it is taking out in tax. It needs to, when the bath isn’t full enough. Its deficit is our surplus.

It isn’t a problem in an environment of unemployed resources and low and stable inflation where the bath isn’t full. It is a way of supporting the economy, and of adding to business sales and profits.

When the government runs a surplus, it puts less into the private sector than it takes out in tax. It vacuums up dollars and destroys them. It runs the risk of either driving economy into recession (as happened under Paul Keating) or driving households into debt (as happened under Peter Costello). Its surplus is our deficit.

There may be times when government surpluses are appropriate, but in a country not running large trade surpluses, those times will be rare indeed and won’t last for long. Australia has never run surpluses for long.

Governments choose to borrow, but needn’t

As for government debt – so often misnamed the national debt – it is better described as dollars that have been spent into existence and not yet taxed away. It might be better to call it the net money supply, than to label it as a debt.

The government chooses to issue bonds to the private sector and foreign investors also choose to buy them. But it needn’t. It could fund itself without borrowing. It issues the currency. It can’t go bust. And when there is spare capacity it won’t cause inflation.

There is of course a great deal more to MMT than I can fit into 800 words. It is based on more than 25 years of detailed research by many economists, including Australia’s Bill Mitchell and Kelton herself. But I hope there’s enough here to show you why it has become the first serious challenger to the narrative we have become so used to in decades.

You can learn more about it by watching Stephanie Kelton’s recent Harcourt Lecture at the University of Adelaide, or by reading her new book, The Deficit Myth, which will be published in June.