The case against Modern Monetary Theory

 Stephen King in The FT

In a world in which government debt is rapidly rising, it’s hardly surprising that there’s growing interest among investors in Modern Monetary Theory. After all, one of its central claims is that budget deficits are, from a financing perspective, an irrelevance. So long as increased government borrowing doesn’t lead to inflation — and, at the moment, there really isn’t much of it around — we can all afford to relax. 

 As Stephanie Kelton notes in her book The Deficit Myth, governments with access to a printing press are “currency issuers” (exceptions include, most obviously, members of the eurozone). As such, all their spending could, in principle, be financed via the creation of cash. Taxes may serve other purposes — the redistribution of income and wealth, the discouragement of “sinful” behaviour — but, in the world of MMT, they serve no useful macroeconomic role. 

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In the real world, however, taxes are crucial. The fundamental difference between government finances and those of companies and households is not access to a printing press but, instead, the coercive power to raise taxes. A company making a severe loss cannot reduce that loss by imposing taxes on everyone else. A government can. A worker receiving a pay cut cannot force others to make up the difference. A government can.  

Armed with this knowledge, creditors are understandably willing to accept mostly lower returns on government bonds than on other investments. Put simply, the risk of government default in the face of an adverse economic shock is lower than for other would-be borrowers. 

 Admittedly, there are limits, dictated largely by the political capacity of a government to raise revenues in difficult circumstances. Emerging markets often end up resorting instead to devaluation, default or inflation. In anticipation, borrowing costs spike. 

Still, imagine for a moment that governments embrace MMT. Imagine too, as MMT proponents suggest, that control of the printing press is taken away from unelected central bankers and given to “accountable” elected fiscal representatives. Would we be any better off? 

Far from it. Giving elected representatives the keys to the printing press is the equivalent of giving a gambling addict the keys to the casino. For many politicians, the primary objective is to remain in power. As such, they will too often be incentivised to pursue instant gratification at the expense of longer-term stability. In the early-1970s, the UK embarked on what became known as the “Barber boom”, thanks to the efforts of Conservative chancellor of the exchequer Anthony Barber to engineer an election victory in 1974. As it turned out, the Tories lost and, two years later, the UK ignominiously had to accept a bailout from the IMF. Central bank independence provides a useful bulwark against such behaviour. 

More importantly, inflation and taxes are, in many ways, simply two sides of the same coin. Those governments without access to tax revenues can instead “debase the coinage”. Supporters of MMT claim this will never happen, yet history suggests otherwise: after all, it has been a tried and tested policy of kings and queens over hundreds of years. Too often, those with access to the printing press are prepared to take undue risks in the hope that “this time it’s different”. 

In truth, inflation helps solve the financing issues that proponents of MMT claim no longer exist. Negative real interest rates, a result of higher-than-anticipated inflation, serve to redistribute wealth away from private creditors (pensioners, for example) to public debtors. Much the same could be achieved through a wealth tax. At this point, we come full circle: the distinction between the printing press and taxes begins to break down.  

Thanks to Covid-19, government debt is rising rapidly and, for that matter, appropriately. In the face of recurring lockdowns, we are better off allowing companies and workers to enter a period of economic “hibernation” in the hope that, once the virus is under control, they can thaw out. The alternative of multiple business failures and mass unemployment is of no use to anyone. In the process, however, we are in effect borrowing from our collective economic futures. At some point, some of us will be presented with a bill which, if hibernation policies succeed, we will be in a reasonable position to pay. The political process will decide whether that bill comes in the form of higher taxes, more austerity, rising inflation or eventual default. That, I’m afraid, is the deficit reality.

America’s unexpected socialist dawn

 Edward Luce in The FT

Anyone who thinks America’s populist moment has passed should think again. Donald Trump promised to make America great again. Half of the Democratic party now vows to make their country socialist for the first time. Much that is solid is melting into air. A few years ago, most Democrats were scared to call themselves liberal. Now they embrace socialism with abandon. 

It may end in tears. A defeat to Mr Trump in 2020 would deliver an early grave to America’s socialist dawn. Until then, however, US voters are catching a glimpse of something rare — a genuine ideological debate. It would be rash to predict the outcome. 

The chief exhibit is Alexandria Ocasio-Cortez’s Green New Deal. By any measure, her bill is preposterously extravagant. On one estimate Ms Ocasio-Cortez’s proposed new entitlements and public works would cost $6.6tn a year, which is two-thirds larger again than America’s $4tn federal budget. 

The fact that a 29-year-old former bartender has gone from zero to the ubiquitous abbreviation of AOC in a few months tells us something about America’s appetite for change 

Nothing like it has been seen. Moreover, Ms Ocasio-Cortez seems to have little idea how she would pay for it. Some say the bill would be self-funding because it would stimulate the economy. Others are punting on cost-free debt. According to modern monetary theory, governments can simply create new money without causing inflation. 

Few Democrats are yet concerned with such details. Having watched Mr Trump take office with his brand of magical thinking, they are following suit. It would be tempting to write it off as a lengthy suicide note. But that would underestimate America’s restlessness. Almost every Democratic presidential hopeful in the Senate — including Kamala Harris, Cory Booker, Elizabeth Warren and Kirsten Gillibrand — supports Ms Ocasio-Cortez’s resolution. It has turned into a litmus test of a candidate’s credentials. There are three reasons to take it seriously. 

The first is that the Green New Deal is already branded in the public’s mind. Just as Ms Ocasio-Cortez is known by her initials — AOC — her bill is already known by its shorthand, GND. Few politicians, or bills, make that distinction. Think of John F Kennedy (JFK) or Franklin Delano Roosevelt (FDR). The fact that a 29-year-old former bartender has gone from zero to ubiquitous abbreviation in a few months tells us something about America’s appetite for change. She is now the most influential figure in US politics after Mr Trump. 

Second, Ms Ocasio-Cortez’s resolution is a bold declaration of intent rather than a serious legislative proposal. Much as Mr Trump’s supporters were said to have taken him seriously but not literally, the same applies to the green deal. Those doing the accounting may be missing the point. Its aim is to shake up the US debate. By that measure it has already succeeded. The term “green” is no longer a lifestyle preference. It is a part of the economic calculus. Global warming and public investment are now linked in the popular mind. 

Third, Americans seem to crave a choice. There was a time when US elections could be caricatured as Coca-Cola versus Pepsi — incrementalist Democrats versus free-market Republicans. For the time being, such timidity is over. Mr Trump’s example has bred imitation. The choice now looks more like vodka versus supergreen juice. When politics is framed this starkly, there are few places to hide. 

Mr Trump sees green socialism as his chance of electoral salvation. Democrats want to take away your cars and your cows, he says. Moreover, they would force you to travel by train, which is the US equivalent of being sent to the gulags. If his instinct is right, Ms Ocasio-Cortez could become Mr Trump’s secret weapon. Forcing Democrats to vote on her bill is an opportunity Republicans will not pass up. A vote against it could damage a Democratic senator’s prospects with the party’s base. A vote in favour could make them unpalatable to a general electorate. 

History suggests Republicans have the tactical advantage. But what went before is not necessarily a useful guide. The past told us Mr Trump had little chance of taking his party’s nomination. Experts made the error of taking him literally but not seriously. Today, a majority of American millennials describe themselves as socialist. In practice, they are thinking of Scandinavia rather than Venezuela. Persuading them to turn out in higher numbers is the holy grail of Democratic politics. If Ms Ocasio-Cortez does that, she will have changed the climate of US politics.