A Closer Look at Modern Monetary Theory Part 1
December 15, 2010
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(Note: I realized that this post would end up being too long, so I am dividing into parts. Wish I could make it shorter, but it's just not within my talents.)
In preparation for this post on MMT, I have spent some time getting you familiar with a couple of topics. (See: here, here, here, here, and here) The most important of these concepts is understanding the role of subjective value scales in economics. Humans use subjective value scales to judge the usefulness of goods and services at their disposal. In order for market activity to accurately represent these preferences, exchanges must be arrived at voluntarily. Involuntary exchange, derived from coercion, does not reflect but rather alters these value scales. The science of interpersonal exchanges is known as callactics. It is the building blocks of a coherent economic theory.
What happens when we try to develop a theory that strips away all that crazy talk about real humans and their preferences? We no longer need to concern ourselves with how prices are formed in a voluntary, subjective manner. We don't need to worry about prices at all, if we are to be honest. For, if we can use coercion to impact economic decisions, e.g. in the use of money, certainly we are not limited by such a silly notion as prices derived from the imaginary feelings of market actors. The only thing stopping us from regulating prices is our own political will. Any shortages or surpluses caused by uncooperative market actors failing to understand the State's authority, are again easily overcome by political will.
As you can see, a theory that begins with the premise "money derives its value from the State" is going to have a difficult time telling you exactly where the State's authority in economic matters begins and ends.
Such is the dilemna facing Modern Monetary Theory, a growing school of thought that is neither modern nor a truly ecompassing theory. In some ways, MMT is an improvement on the neoclassical approach of the Keynesian and Monetarist traditions. In other ways, it is at a complete loss to explain the basic fundamentals of economic activity. It's worth getting to know, however, and I'll try to present it as accurately as I can.
Introduction to Modern Monetary Theory
MMT consists primarily of two parts The first is an analysis or description (probably the better term) of the world's monetary system since 1971, i.e. in a completely paper money regime worldwide. The second is a set of policy prescriptions derived from the initial analysis.
The roots of MMT go back much farther than 1971, however, though to the popular MMT bloggers like The Pragmatic Capitalist, those roots do not matter. However, I like to know where ideas come from, so I looked into it further.
The original MMT'ers were the Chartalists, paper money supporters that have argued with hard money theorists since at least the 16th century. Chartalism comes from the Latin word 'charta', meaning paper or writing. Keynes, in fact, wrote favorably about Chartalism in his book A Treatise on Money (1930). Oftentimes you will see MMT'ers also referred to as neo-Chartalists, post-Keynesians, or Nominalists. It seems these are not interchangeable, but understanding the nuances is not relevant to a post of this nature (and probably not relevant at all in the big picture.)
If you can say that MMT has an intellectual grandfather perhaps it would be Georg Friedrich Knapp (1842-1926), a German economist of the Historical School. The German Historical School rejected the idea that economics should be built on theory. They embraced empiricism, had an affection for the State, and become increasingly Marxist throughout Knapp's time. Knapp followed the first two traditions but could never be accused of being a Marxist. Knapp's most significant work was The State Theory of Money, which is a self-explanatory title. Modern Chartalism is a mixture of pro-market policies but always places the State atop the heirarchy of economic affairs.
Another prominent Chartalist was diplomat/economist Alfred Mitchell-Innes (1864-1950). Innes, like other paper money supporters, denied the connection between rising prices and currency debasement. In a famous article titled What is Money? attempts to show that the State has always had the sole power to produce money, that the money unit's weight was not relevant to the money's value, and that money did not come about naturally.
Finally, we get to today's MMT proponents: L. Randall Wray (Professor of Economcis at University of Missouri-Kansas City), Warren Mosler (Senate candidate and economic theorist?), the aforementioned very popular writer Pragmatic Capitalist, and Australian Bill Mitchell of the Center of Full Employment and Equity.
Major Insights of Modern Monetary Theory
Domestic private sector net saving of financial assets is by definition equal to the government sector’s deficit.
Take a look at this chart. Whether you are trained in neo-classical economics or a self study Misesian like me, that chart and the previous italicized sentence may throw you for a loop. Are they really saying that the government's deficit is always equal to private savings? Well, yes and no.
First, the MMT definition of savings is a nominal one. An increase in savings means an increase in financial assets in the private sector. That's not savings in any economic sense (ok, in really bad economics that could pass as savings.) In an economic sense, savings is an action. Savings is the foregoing of consumption in order to consume or produce more down the road. As a simple example, a fisherman that decides not to fish for a day (and therefore, eat less) in order to build a net is saving. It's an action. The result is higher consumption down the road. The MMT insight is referring to financial assets. The value of those financial assets is not increased, however, by merely increasing their number. MMT proponents do not dispute that.
However, in a true Keynesian twist, despite recognizing that merely increasing paper assets doesn't actually make you wealthier, MMT'ers advocate increasing government sector deficits during a recession. Why? It appears for the same reason as Keynesians. They claim that a recession can be eased by increasing the deficit (and therefore, net financial assets in the private sector) and the deficit can be reduced during good times.
This brings us to MMT policy proposals where concerning deficits they appear to turn Republican and advocate lower taxes rather than higher government spending (again, to increase the deficit) during hard times. If this confuses you it shouldn't. You can advocate for a bigger deficit either way and MMT'ers are fairly pro-market (at least more so than Progressives). In fact some go as far to say that all Federal taxes in the US are unnecessary (leaving only State taxes needed to chew up some of the excess currency) but that is another matter, entirely (to be covered in Part 2.)
To simplify, let's say that this first rule of Modern Monetary Theory boils down to the not-so-Earth-shattering insight that you can't have funny money in your hand unless the clown makes it. And since the clown makes it by spending it (the government only needs money to buy things it wants, as opposed to producing money for your benefit), you can't have any unless he buys something first. The clown buys from the banks. The banks give you the money (at interest, and with penalties, of course.)
One more thing on that infamous chart above. When I look at that chart, I don't think to myself, "wow, if we just increase the deficit, there will be more savings!" I look at it and shrug, "Yep, no one has actually saved since we started using paper money." If you don't understand why I would come to that conclusion, hit me up in the comments and I'll try to expand my analysis.
The US government is never revenue constrained
This is another popular chant of the Chartalist. It's a bit silly, and I can't quite figure out why they spend so much time on it. Let's say that I was the monopoly money producer in your neighborhood. Let's say that I had a really really big gun. And I said that no matter what, you have to accept my money if I need to buy something. And I can print up as many notes as possible.
Would I ever be "revenue constrained"? Well, not as long as my printing machine (and my gun) were working. So why is this some big insight?
It's not. Mainly, the MMT'ers are trying to reframe the debate over deficits by pointing out (correctly) that as long as the US has the power to print its own money, its just a matter of political will as to how much they can spend. So the point here is to convince the powers-that-be to get over their silly superstitions and stop fretting over deficits. The more important questions are about how to get the economy working smoothly.
You can almost start to see their point, unless you understand how interpersonal exchanges work. Then you realize that the supply of a currency can have a dramatic effect on prices. From the MMT framework, "excess capacity" - a statistical aggregate with no economic meaning - determines inflation. As long as this mythical creature (winged or hooved, I'm not sure) is greater than the amount of paper money produced, there will be no inflation. If there is inflation, the government can simply increase taxes in order to remove money from circulation and reign in rising prices.
There is reality and then there is Operational Reality
MMT'ers focus entirely on something they refer to as "operational reality." It's an attempt (justifiably) to present Modern Monetary Theory as a value-free economic science. Just like every other economic science, however, value-free judgments lead you to certain conclusions that are not value-free. For example, most Austrian School economists are libertarians simply because the conclusions are that State interference in the market causes unwelcome effects. However, libertarianism is not value-free. Get it?
The MMT school proposes to deal with "operational realities." In other words, the world is on paper money. Let's deal with that and make it work as well as possible. This approach can be good and bad. On the positive side, MMTers like the Pragmatic Capitalist often do a great job of exposing fallacies concerning the operations of the Federal Reserve. They can pinpoint exactly why (in their framework) certain Fed policies simply won't work as intended.
But when the MMT school starts to get into policy proposals, the framework is often not value-free. The first and foremost judgment of MMT is that the State has the authority to regulate every aspect of our economy. That is not a value-free judgment. In fact, some of the judgments get awful ghastly:
How do I enforce your use of these “reserve” notes? I create jobs via a military and a police force and pay them well (notice that when government spends money they are simply buying up private sector productivity). Don’t want to pay your taxes? Say hello to officer Joe. A group doesn’t want to pay their taxes? You can protest, but if you get out of control I will introduce you to 500 men wearing body armor holding M4 carbines. In other words, don’t question the currency or else….The United States Secret Service was in fact created specifically for this purpose – to protect the US Dollar. There is arguably, nothing more important to government stability than maintaining the value and faith in the sovereign currency. - Understanding Modern Monetary Theory, The Pragmatic Capitalist, here.
This sounds familiar... wait for it... wait for it...
(from Wikipedia)
The hut tax was a type of taxation introduced by British colonialists in Africa on a per hut or household basis. It was variously payable in money, labour, grain or stock and benefited the colonial authorities in four related ways: it raised money; it supported the currency (see chartalism); it broadened the cash economy, aiding further development and/or exploitation; and it forced Africans to labour in the colonial economy.[1] Households which had survived on, and stored their wealth in cattle ranching now sent members to work for the colonialists in order to raise cash with which to pay the tax. The colonial economy depended upon black African labour to build new towns and railways, and in southern Africa to work in the rapidly developing mines.
Well, just because the guys at Wikipedia think Hut Tax policy is similar to Chartalism, that doesn't necessarily mean that Chartalism can't work. We'll look at that and a host of other issues in Part Two.
To Be Continued
David in Qatar
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