Will “Modern Monetary Theory” Be the Government-Friendly Nonsense That Finally Implodes the Empire?
The currently trending econ theory would remove the very last inhibitions not to print up piles of more dollars
One of the most interesting aspects of the “Green New Deal” is that its progressive proponents hardly mention taxes at all—even as some Republican economists continue to champion a carbon tax. Faced with the political defeat of the Waxman-Markey “cap and trade” bill, as well as the failed carbon tax initiatives in Washington State, it seems that Rep. Alexandria Ocasio-Cortez and the other Green New Deal supporters are just going to accentuate the positive. In other words, they are going to focus on all the goodies contained in their proposals—such as a trillion dollars in spending projects—while downplaying taxes and regulations.
Indeed, some of the Green New Deal proponents have turned this liability into an apparent asset. When asked, “How are you going to pay for this?!” they flip the question around, by bringing up “Modern Monetary Theory,” or “MMT” for short. This is a relatively new economic school of thought that ostensibly overturns much of the conventional wisdom about government finance, in the age of fiat money. By directing the skeptics to MMT gurus like Prof. Stephanie Kelton—who served as Chief Economist for the Democratic Minority Staff of the Senate Budget Committee, before advising Bernie Sanders’ campaign—the Green New Dealers can dodge awkward questions and come out looking quite sophisticated.
In previous IER articles — one, two, and three — I have directly criticized the Green New Deal. In the present post, I will focus on its relationship to MMT, and then I will explain why MMT is even more dubious than the Green New Deal itself.
Using MMT to Defend the Green New Deal
There is a growing link between the Green New Deal and MMT on social media, but here let me link to an article from Forbes.com that spells out the connection. Author Robert Hockett explains how Ocasio-Cortez has deflected criticism by relying on the new financial framework:
Representative Alexandria Ocasio-Cortez’s announcement of an ambitious new Green New Deal Initiative in Congress has brought predictable – and predictably silly – callouts from conservative pundits and scared politicians. ‘How will we pay for it?,’ they ask with pretend-incredulity, and ‘what about debt?’ ‘Won’t we have to raise taxes, and will that not crowd-out the job creators?’
Representative Ocasio-Cortez already has given the best answer possible to such queries, most of which seem to be raised in bad faith. Why is it, she retorts, that these questions arise only in connection with useful ideas, not wasteful ideas? Where were the ‘pay-fors’ for Bush’s $5 trillion wars and tax cuts, or for last year’s $2 trillion tax giveaway to billionaires? Why wasn’t financing those massive throwaways as scary as financing the rescue of our planet and middle class now seems to be to these naysayers?
The short answer to ‘how we will pay for’ the Green New Deal is easy. We’ll pay for it just as we pay for all else: Congress will authorize necessary spending, and Treasury will spend. This is how we do it – always has been, always will be.
The money that’s spent, for its part, is never ‘raised’ first. To the contrary, federal spending is what brings that money into existence.
Although Hockett doesn’t use the term “MMT” directly in the article, he is clearly referring to the framework. (Ocasio-Cortez herself has explicitly endorsed MMT.) And so we see the clever rhetorical move: The critics of the Green New Deal who focus on its price tag are cast as Neanderthals—and hypocrites to boot—who don’t understand that Uncle Sam can “pay for” anything he wants.
Indeed, given the shot in the arm from Ocasio-Cortez, MMT is becoming such a hot topic that even Paul Krugman has been moved to gently critique it. (Incidentally, when Paul Krugman warns that your economic philosophy downplays the dangers of government spending, it’s time to reevaluate your life choices.) In the same spirit, then, in the rest of this post I’ll explain why the “insights” of MMT don’t mean what its proponents seem to think.
The U.S. Government Never Needs to Default
Perhaps the single biggest “insight” of the MMT camp is that the United States government, as an issuer of an unbacked fiat currency and an entity that doesn’t carry significant foreign debts, can never become legally insolvent. In short, no matter how many Treasury securities outsiders hold, ultimately the Federal Reserve can simply create more dollars in order to pay them off. Under a gold standard this would not be true, but ever since 1971, the U.S. government has had no official constraints on its spending.
This is why MMTers think it so old-fashioned when the critics ask, “How will you pay for the Green New Deal?”—or Medicare For All, a Universal Basic Income, etc. To ask, “How will you pay for it?” implies that there is a budget, where the federal government must first raise revenue and then spend it. But as the MMT gurus like Warren Mosler explain, under a fiat currency a government first spends the money in order to bring it into existence, and only then is it even possible to tax it back from the citizens. (This MMT mindset is quite clear in Mosler’s interview with me on my podcast.)
I hate to break it to the MMTers, but fuddy-duddy economists already knew this. Indeed, among free-market economists it is a standard pedagogical device to tell the audience that the government has three ways of financing its spending, namely (1) taxes, (2) borrowing, or (3) inflation. So this notion that only the MMTers perceive the possibility of the printing press as a means of “paying for” government programs is silly.
For proof, consider the following excerpt from Austrian economist Murray Rothbard’s economics treatise, Man, Economy, and State, published in 1962:
Many “right-wing” opponents of public borrowing, on the other hand, have greatly exaggerated the dangers of the public debt and have raised persistent alarms about imminent “bankruptcy.” It is obvious that the government cannot become “insolvent” like private individuals—for it can always obtain money by coercion, while private citizens cannot. (Rothbard, p. 1028, bold added.)
Here is another example, this one from Ludwig von Mises, speaking in 1951 on wartime finance:
What is needed in wartime is to divert production and consumption from peacetime channels toward military goals. In order to achieve this, it is necessary for the government to tax the citizens…
Part of the funds may also be provided by borrowing from the public, the citizens. But if the Treasury increases the amount of money in circulation or borrows from the commercial banks, it inflates. Inflation can do the job for a limited time. But it is the most expensive method of financing a war; it is socially disruptive and should be avoided.
There is no need to dwell upon the disastrous consequences of inflation. All people agree in this regard. But inflation is a very convenient makeshift for those in power. It is a handy means to divert the resentment of the people from the government. In the eyes of the masses, big business, the “profiteers,” the merchants, not the Administration, appear responsible for the rise in prices and the ensuing need to restrict consumption.
A truly democratic government would have to tell the voters openly that they must pay higher taxes because expenses have risen considerably. But it is much more agreeable for a government to present only a part of the bill to the people and to resort to inflation for the rest of its expenditures. What a triumph if they can say: Everybody’s income is rising, everybody has now more money in his pocket, business is booming. (Mises, bold added.)
For a third and final example, here is Henry Hazlitt, writing in his classic book Economics in One Lesson, which came out way back in 1946:
It is because inflation confuses everything that it is so consistently resorted to by our modern “planned economy” governments. We saw in chapter four, to take but one example, that the belief that public works necessarily create new jobs is false. If the money was raised by taxation, we saw, then for every dollar that the government spent on public works one less dollar was spent by the taxpayers to meet their own wants, and for every public job created one private job was destroyed.
But suppose the public works are not paid for from the proceeds of taxation? Suppose they are paid for by deficit financing—that is, from the proceeds of government borrowing or from resort to the printing press? Then the result just described does not seem to take place. The public works seem to be created out of “new” purchasing power. You cannot say that the purchasing power has been taken away from the taxpayers. For the moment the nation seems to have got something for nothing. (Hazlitt, bold added.)
As the above examples illustrate, there is nothing new under the sun. Free-market economists have long understood that modern governments have the legal ability to resort to the printing press to finance their expenditures. The problem is, creating green slips of paper—or electronic bank reserves—doesn’t generate more labor-hours or acres of farmland. The problem of scarcity isn’t banished simply because we’ve gotten rid of the pesky gold standard.
Moving the Discussion From Revenue to Inflation
Now to be fair, the more responsible MMT proponents do not say, “Deficits don’t matter.” (Though see these examples from Bill Mitchell where he does say just that, notwithstanding the other MMTers’ willful refusal to admit as such.) Rather, people like Warren Mosler and Stephanie Kelton merely point out that insolvency is never an issue. In other words, we don’t need to worry that Uncle Sam will “go broke” or be unable to pay the bills, but we might worry that too much spending will lead to undesirably high price inflation.
But if this is the essential MMT insight, then it’s old news. Again, the three examples from the previous section show that classically liberal, free-market economists have known this all along. What those economists recognized, however, is that financing government spending through taxation (and to a lesser extent, borrowing) is more “honest” in the sense that the public can better understand the actual costs involved.
Consider a simple example: Suppose the Green New Deal contains a proposal to spend $24.8 billion on electric vehicle mass transit options in certain cities. If the proposal were financed by a flat $100 tax on every adult American (of which there are about 248 million), then it would be obvious what “the cost” of the proposal was. Every adult American would have $100 less to spend on private investment or consumption, and the government would devote the $24.8 billion in funds to the “green” infrastructure projects.
But what if, instead, the Treasury floated $24.8 billion in additional bonds—thus increasing the federal budget deficit—and the Federal Reserve kept interest rates from rising by creating $24.8 billion in new money with which it bought $24.8 billion in Treasuries from the bond market? This would be a convoluted way of having the Fed effectively “pay for” the projects using the (electronic) printing press.
The political benefit of this method of finance is that no American is apparently “down” any money, and yet the lucky cities get their infrastructure projects, with all of the spillover effects (in terms of construction jobs, etc.) they entail. It seems that inflationary finance is all gain, no pain.
But of course, in reality real resources are still being diverted from the private sector into the channels dictated by the political process. The construction workers who move to the cities in question are now no longer able to work on private buildings or houses. The rubber, cement, steel, glass, lumber, and other materials devoted to the new projects are not available for use in other possible projects elsewhere in the economy.
When all is said and done, the average American still “pays for” the new government spending, but via higher prices. In other words, rather than the average American’s income dropping by $100, instead the prices of other goods and services rise slightly, so that the original income no longer fetches as much stuff in the market.
However, the two methods are not equivalent. Most obvious, the source of the (real) income drain is harder to detect under inflation. If a family can’t make ends meet because of taxes, then it knows to blame the government. But if a family sees prices rising at the store faster than the paychecks from work, it might blame greedy capitalists or trade unions or OPEC; it might not realize the Federal Reserve is the true culprit.
The MMTers are “right” in the sense that yes, modern governments that issue fiat currency need never default on their bonds. But they are wrong if they think this observation absolves Alexandria Ocasio-Cortez from explaining how she will pay for the Green New Deal. The printing press doesn’t create real resources, it only obscures the method by which the government siphons them away from the private sector.
To be sure, MMTers would respond that the economy currently suffers from excess capacity, and then we could safely accommodate large deficit finance without pushing up the CPI. Yet we have now moved beyond accounting tautologies and into competing theories of how the economy works. I am happy to have that debate as well, but much of the existing discussion involves MMTers acting as if they alone understand that the government can buy stuff by printing money. Yes, free-market economists have understood that all along, and have explained in elementary detail why it is such a dangerous option.
Source: Institute for Energy Research