Modern Monetary Theory (MMT) is a relatively new and revolutionary economic theory. It states that a government that can print its own currency does not have to worry about budgeting large deficits since it can print the money to pay for it. Instead it states that such a government should focus on inflation. When inflation runs too high the deficits should be reigned in. Stephanie Kelton explains the theory in her book: The Deficit Myth. What follows is a review of MMT as presented in Kelton’s book.
To understand MMT it is essential to have an understanding of Inflation.
Inflation
In traditional economic theory, general Inflation is attributed to ”the creation of excess money and credit”. This happens when a central bank causes the supply of money to increase. If spenders
spend more on the same goods and services, this drives up the prices of goods and services. However, this nice equation depends on “other things being equal”. This is seldom the case. What are those other things?
We have identified several non-constant things that can disrupt the inflation equation.
The first of these is variations in the cost of producing goods and services. The globalization of manufacturing and services that occurred in the 20th century has been a major factor in continuing to lower prices by shifting the provision of goods and services to lower wage countries such as China and India.
Globalization and increasing world trade has also led to increased competition from countries such as Japan and Germany. Increases in supply, which if they lower costs, acts as deflationary forces. This has also been a feature of the globalization that has occurred in the 20th and 21st centuries since the second world war.
Technology innovation is another major and ongoing deflationary force. New technologies have universally lowered costs, increased profits and caused expansions of existing businesses and the creation of new businesses. The development of the automobile, reducing the cost of transportation; the invention of the Personal Computer starting in 1975, reducing the costs of the creation, transmission, and filing of documents and schedules; and the arrival of the Internet, reducing the costs of communications, are good examples.
But the best is yet to come. The advances in computer chip technology, led by Intel, have increased capacity and lowered costs exponentially for decades. As Thomas Friedman has written in his book: Thank You For Being Late, the advances similar to those in chip technology have been occurring in other fields. He lists computer storage of data, networking systems, software applications and the advances in data sensors. These combine, he says, to allow the development of the Cloud, a new system of provision of computing power that is cheaper, more powerful, and more prolific than prior systems. The applications of Cloud technology are just getting started.
Perhaps the current explosion in technology innovation is giving MMT a “free lunch ”. By that I mean that the deflationary effect of technology innovation is allowing MMT-like large deficits to occur without raising consumer price inflation.
There are other disinflationary forces at work today. An important one is the price of oil. In 1973 and 1979, two oil crises initiated by a falling off of oil production in the U.S. and successful oil cartel (OPEC) actions and two wars in the Middle East disrupted the supply of oil from OPEC countries causing large increases in the price of oil globally. This in turn led to the large increases in general prices experienced in the 1970’s and 1980’s. In the 21 century the price of oil has shrunk significantly and steadily, as new oil production from shale oil has made the U.S. an exporter of oil and reduced the price of oil products.
The evidence is that these deflationary forces have held inflation in check, while the U.S. and most other countries with their own currencies have continued to print money. Further no end is currently in sight. This suggests that MMT may be with us for years to come.
This seems like an Idyllic state. Is there anything that could disrupt it? Unfortunately, the answer is yes there is.
Asset Inflation
In The Great Reflation, J. A. Boeckh points out that even if there is little consumer price inflation, new money will find other places to go. One of these other places is asset prices, increases in the prices of homes, commodities such as gold, and the stock and bond markets. Initially increases in asset prices are favourable, increasing wealth and financial wellbeing. But if they are allowed to mushroom, they can lead to bubbles and bubbles usually lead to crashes, destroying value.
There have been many examples of such bubbles and crashes as John Kenneth Galbraith has described in his book: A Short History of Financial Euphoria. Examples run from the South Seas Bubble and the Tulip Bubble to the 2008 Financial Crisis.
The 2008 financial crisis was precipitated by a U.S. housing bubble, encouraged by Freddy and Fannie Mae which made less expensive mortgages available. These mortgages were fraudulently packaged into mortgage-backed securities. These securities eventually imploded when the truth became apparent and lead to the greatest recession since the great depression of the 1930’s. Clearly bubbles are dangerous and to be avoided. So, governments have to be on the watch not only for high inflation of consumer prices but also for asset bubbles.
Globalization
Now on to globalization and the impact of global trade and financing.
This is an even more complex area than getting a handle on inflation. This is in part because it introduces a number of other players. To get to the bottom of it one has to develop an understanding of these other economies and their relationships to the U.S. economy. Factors such as trade balances and capital flows need to be analyzed.
Because of large fiscal deficits and large trade deficits in recent decades, the U.S. dollar has been under severe and long-term deflationary pressure. This has been relieved by the fact that the U.S. dollar is the world’s reserve currency and the fact that foreign central banks have been willing to accumulate large holdings of U.S. dollars as their reserve currency. As a result, they have vested interests in seeing the U.S. dollar maintain its value. Further, many countries have been in the same position as the United States in needing to run large fiscal deficits to keep their economies from crashing. So they are in no position to threaten the U.S. dollar’s value. The result is that while the U.S. dollar has been steadily losing its value over recent decades, the loss has not been precipitous. Globalization has not harmed the U.S. yet. But things could change.
The greatest threat may come from the rise of China as a global superpower. This is very important on several fronts. For one thing China may be replacing the U.S. as the world’s dominant superpower. China’s purchase power adjusted GNP or total output of goods and services has already passed that of the U.S. For another, China has powerful initiatives such as its Belt and Road development that will reinforce economic dominance over other nations. Finally, all of this may be creating the prospect of the Chinese currency, the renminbi, (Yuan), replacing the U.S. dollar as the world’s reserve currency. This would be a catastrophe for the U.S. Hopefully it will be a long time happening and perhaps will be avoided, since other countries except China would be hurt badly as well.
Curing Global Problems
Now, we would like to deal with Stephanie Kelton’s suggestions regarding government fiscal policy and the actions governments might take to put the ongoing fiscal deficits to good use. She suggests that the fiscal deficits be used to right some of the problems of our world today.
A principal component of the MMT plan is a General Job Guarantee. As presented by Stephanie Kelton this job guarantee would be an automatic fiscal stabilizer. As general unemployment rises more people would find employment from the government under the General Job Guarantee program and government expenditures would rise; as unemployment in the private sector shrinks, fewer people would need to seek employment under the Job Guarantee Program so government expenditures would drop. As a result, the General Job Guarantee program would act as an automatic fiscal stabilizer.
Kelton argues that the employment offered by the General Job Guarantee Program could be used to solve many serious problems in our world today, such as climate change, income inequality, meeting infrastructure maintenance and improvement needs, ensuring adequate housing for all, ensuring adequate health services for all, and providing each worker with adequate and appropriate advance education and job training.
This all sounds wonderful, but we foresee several problems in the planning and implementation of such a program.
The Rate of Unemployment is another complex economic factor. The official general unemployment rate in the United States, in 2020 pre-pandemic, was about 3.6% according to the U.S. bureau of Statistics. This was at or near the all time low.
The U.S. Bureau of Statistics also provides data on the Participation Rate in the U.S. In January 2020, the Bureau shows 259 million people in the civilian noninstitutionalized population. Of these, 164 million were employed while 6 million were unemployed. The number of discouraged workers (those seeking work but not finding it) was just 337 thousand, about 0.2% of the total labour force.
These facts suggest that a large part of the unemployed are not seeking work. This suggests that there may be a natural rate of unemployment that cannot be reduced by a General Job Guarantee. Undoubtedly a General Job Guarantee would encourage more people to take advantage of it. This would reduce the general rate of unemployment but apparently not by as big a factor as suggested by MMT advocates.
Another factor that would reduce the effectiveness of a General Job Guarantee is matching the jobs to the unemployed people seeking work. In many cases the Job Guarantee work would be different from the prior work of the unemployed. It would require careful planning, re-education and training and placement services to be effective. This would all take time. Still, this could happen in time, and there are many examples of it occurring today. One example is the ATT $100 million a year program to help its employees to adapt to the new technology for data communications, by letting them know what new jobs are required, what training is needed, where to get it, and how to apply for the new jobs.
Another problem with a General Job Guarantee is that it would compete with existing jobs for employees. This might decrease the willingness of employees to do their existing work, or cause wage demands to inflate.
The Idea of a General Job Guarantee is attractive, because it would provide an automatic fiscal stabilizer once implemented and would serve to reduce income inequality by boosting the collective remuneration of employees. But there would be significant problems to be dealt with in planning the program and in its execution.
Summary
MMT theorizes that a government that can print its own money, should not be concerned about large deficits. Instead it should be watching to ensure inflation is under control.
We believe there are other issues that need to be watched.
Asset inflation may be a potential problem even if consumer price inflation is benign. Asset inflation that runs out of control leads to bubbles and bubbles usually lead to catastrophic busts. Witness the Tulip Bubble, the South Seas Bubble and recently the 2008-9 Housing Bubble and financial crisis.
We also have to monitor international developments. Large fiscal and trade deficits in the U.S. can occur without debasing the U.S. dollar only as long as other governments are willing to hold the U.S. dollar as a reserve currency or invest in U.S. businesses and securities. This state appears favorable today, but it could change. A factor that needs to be carefully watched is the risk of dominance by China. In the extreme, China’s currency, the renminbi could replace the U.S. dollar as the accepted reserve currency. This could be catastrophic for the U.S. economy.
Today, consumer price inflation seems benign. Because of the deflationary forces we have outlined, this state seems likely to persist for some time. But there are a number of factors that need to be watched to determine if and when large deficits need to be reigned in.
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