MMT and Mainstream Economics

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Posts in this series. This post begins with links to all posts in this series.

In The Deficit Myth Stephanie Kelton explains in lay terms the fundamental ideas of Modern Monetary Theory and shows that they can be used to organize a economy that works for everyone. Throughout this series I have occasionally pointed to ways that MMT differs from mainstream economics. In this post I will try to get those ideas organized.

1. Elements of Mainstream Economics.

Let’s start with this quote from the J.W. Mason review of the book:

But in my view it’s better—both more accurate and more productive—to see [MMT] as a body of arguments within an older Keynesian tradition of economics. Contrary to the sense you might get from both supporters and detractors, it’s not a crystalline logical structure where, if you remove one piece, the whole thing collapses. Rather, like most emerging bodies of thought, it’s a ramshackle assemblage of parts built at different times for different purposes, tied together with loose solder of association and inference rather than tight bonds of deduction.

The boldfaced part of this sounds to me like a fair description of mainstream economics. We can see some of the assumptions and axioms of mainstream economics in this list by Harvard economist and textbook author N. Gregory Mankiw of ten things economists agree about. The link is a good refresher course in introductory economics.

One crucial assumption is that rational people think at the margin. By “rational” Mankiw means “systematically and purposefully doing the best you can to achieve your objectives.” [1] This is a reference to marginal utility theory, invented by the mathematician William Stanley Jevons around 1870. Jevons’ book is premised on the utilitarianism of Jeremy Bentham. [2] Marginal thinking pervades mainstream economics. [3]

As an example, consider the notion of Pareto Optimality, invented by Vilfred Pareto, another early economist with a STEM background. The idea is that we add up all the individual utilities of all the members of a society at a point in time and get a total. If we change some policy, it will affect the individual utilities. If the new policy makes some people better off and doesn’t make anyone worse off, we approve the policy.

So, for example, suppose a corporation has excess cash. It could distribute the money to shareholders or it could give raises to all the workers who created the excess. Either way is fine under Pareto Optimality. In the real world, the money goes to the shareholders, and the workers are rightly hostile about their stagnant wages. If you don’t like this as a normative principle, you’ll really despise Kaldor-Hicks Optimality.

Other things that went into the early stages of economic theory are based on conditions at the time. That’s why we see the word “markets’ taking a central place. No one thinks that markets of today bear any resemblance to the markets known to Jevons or Adam Smith. It’s also why commodity money, like gold, has a central place, even though the US has only offered fiat money for decades. And it’s one reason we have this mystic reverence for capital and capital accumulation, which we have been taught was the engine of our current prosperity. This reading of history obscures the roles of slavery, government give-aways of land and mineral rights to the wealthy, and the misery of the recessions that unbridled capitalism created.

We have completely forgotten why we have these ideas. We don’t realize that we are centering the ideas of Jeremy Bentham. We never ask why we should prioritize maximizing utility for each individual, or ask ourselves what the balance is between the utility of the day, the decade, or the nation or our children might be. We forget the role of enslavement in the accumulation of capital, and deny the role of government. We ignore the damage capitalism has done to hundreds of millions of us over our history. We don’t question the need for more and more capital accumulation to push the economy where we want it to go. We don’t even ask what ends we want the economy to fulfill. We think and act like we are still on the gold standard.

I realize that many mainstream economists are more or less conscious of all this. But this is the thinking that dominates in our political discourse about the economy. All our politicians, most reporters and pundits (and all right-wing reporters and pundits), and most of us, think and act as if in essentials the “economy” is the same today as it was 150 years ago.

There is a strong tendency in mainstream economics to treat the status quo as if it were the result of the operations of natural laws. This tendency is illustrated in first part of this post.

2. MMT as an alternative.

MMT proceeds from a completely different place. It has no roots in philosophy. It seems to me that MMT is in the tradition of Pragmatism, the American philosophy of Charles Peirce, William James and John Dewey. [4] MMT starts with questions: what is money, and how does it work in our economy? There is no normative principle at work. MMT theorists proceed empirically, studying the way we use money throughout our economy. Money is a thing, and we need to understand its nature and its use. A big part of The Deficit Myth is devoted to examining these questions.

Separate and apart from this inquiry, we need to ask ourselves what we think makes for a good society. This inquiry isn’t about money or the economy, but about our goals. [5] In the US we make these decisions democratically. [6] We elect leaders by majority rule, and we lean on them to legislate and enforce our preferred policies. MMT shows that we can have legislative policies that support our overall desires. That claim, that we can have the things we want, is the real lesson of The Deficit Myth.

Of course, MMT doesn’t attempt to overthrow the entire edifice constructed by mainstream economics. Pragmatic theory says that we only change what we have to as our understanding improves. This means, for example, that ideas formed from an examination of data about other parts of the economy are not necessarily overturned by MMT. But even so, the ideas of MMT are a tool for examining the entire structure.

Conclusion.

Both political parties agree that our society can’t have what we want an need because there is no money, so we must suffer the status quo. Speaker Pelosi tells us she will impose PAY-GO. Joe Biden’s adviser Ted Kaufman says that we can’t do anything because “When we get in, the pantry is going to be bare.” In practice, this means we can only have whatever the richest people think is best for us. It’s not true. Speaking personally, it makes me angry when I see it in practice, long lines at food banks, people forced to risk their health to earn enough to eat, lead-ridden water systems in Flint and elsewhere, to name a few.

We need politicians who can read Kelton’s book. Those politicians need advisers who have studied the expanding literature of MMT. Mainstream economics is a dead end for our nation, and it will take the rich down with the rest of us as the planet catches fire and we suffer one horrible disaster after another.

Note: this is the last post in this series. Please feel free to use the comments to ask any questions or comment on any aspects of MMT.
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[1] I don’t qualify as rational under this definition. My objectives are rarely systematic, and often I’m not conscious of them. They change from time to time based on my understanding of possibilities and probabilities, as well as contacts with my fellow humans directly and through books. The closer people are to me, the more they have the ability to influence my objectives. Many of the systematic efforts I’ve made failed and others have to be realigned with new and different objectives. And it’s absurd to think that most of my everyday purchases are made with some objective in mind beyond passing fancies. I’m too lazy to change things unless I have to, so often I stay with one system when another would be cheaper and better. And so on.

[2] Jevons’ book, Principles of Economics (1871), is available to read online. It’s an effort to put Bentham’s theories of utilitarianism into the form of a calculus of pleasure and pain. This is from the Preface to the Second Edition:

As to Bentham’s ideas, they are adopted as the starting-point of the theory given in this work, and are quoted at the beginning of chapter ii.

[3] I look at these ideas in several posts, here among others.

[4] I give a short primer on Pragmatism in three posts, here, here, and here.

[5] This question is beyond this series, but I can offer something on the edge of philosophical as a starting place: The Needs Of The Soul, a short essay by Simone Weil. Or listen to a podcast by Partially Examined Life, episode 250.

[6] This is not the place to discuss the problems with our democracy, which I acknowledge are great.

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Reviews of The Deficit Myth

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Posts in this series
The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth
The National Debt Is Soooooo Big
The Wonkish Myth Of Crowding Out
MMT On International Trade
Social Security And Other Entitlements

The last two chapters of Stephanie Kelton’s The Deficit Myth are focused on the real problems facing our economy and steps we can take to deal with them. These chapters show that thinking along the lines of Modern Monetary Theory is consistent with the goals of progressives, and that MMT can be applied to support working people and our society.

In this post, I look at some of the reviews of the book. I’ll start with this one from the Wall Street Journal by John H. Cochrane. [1] Cochrane begins with a complaint: what is MMT, it’s so confusing. Then he claims he wanted to learn logic and evidence supporting MMT. Maybe a professional economist shouldn’t look for technical descriptions in a book written for the general public. He then spins out a collection of weird stuff (she praises Kennedy for helping unions!) and misreadings (she doesn’t cite peer-reviewed papers, ignoring the footnotes).

He admits that the government can print money to meet its needs. He understands Kelton’s insistence that the real constraint is inflation. But how will we know if there is slack in the economy or if we’ll get terrible inflation, he asks? He likes the concept of the Non-Accelerating Inflationary Rate of Unemployment. Kelton rejects NAIRU on the grounds that there is no such thing. Ignoring her reasoning, he sneers at her conclusion that NAIRU is a “… doctrine that relies on human suffering to fight inflation.” Here’s a chart showing the top-line unemployment rate from FRED:.

The gray bars represent recessions, most of which were caused by the Fed to fight inflation. The result is increased unemployment, which is solid evidence that Kelton is right.

He tries to make actual arguments:

“Taxes are there to create a demand for government currency.” This is a deep truth, which goes back to Adam Smith. Soaking up extra money with fiscal surpluses is, in fact, the ultimate control over inflation. But then arithmetic fails her. To avoid inflation, all the new money must eventually be soaked up in taxes. The new spending, then, is ultimately paid for with those taxes.

Well, not really. That’s why we have a national debt: it’s accounts for the actual wealth created by the government. We can raise or lower it as needed using taxes, all for the rational purpose of managing inflation. [2] There’s much more in the same vein, but that’s the flavor.

Here’s a generally laudatory review from Hans Desplain, a professor of political economy at Nichols College, in the London School of Economics blog. Despain recognizes that this is a book for lay people, and isn’t concerned about Kelton’s failure to address the ontology of money. [3]

Here’s one from the Mises Institute. The writer, Robert P. Murphy, is a senior fellow at the Mises Institute, a group focused on Austrian economics and libertarian political economy. He agrees with much of what Kelton says. His primary objection is this:

… [R]egardless of what happens to the “price level,” monetary inflation transfers real resources away from the private sector and into the hands of political officials.

“Monetary inflation” in this sentence means spending money without regard to tax revenues. Murphy’s concern is the violation of the principle that the private sector should allocate all resources, and any effort by the government to decide what society needs or wants is just bad. Another way to read this is that MMT is agnostic about government action. Kelton advocates forcefully for government action to amke people’s lives better. Murphy is on principle opposed to government spending. This is one of Kelton’s central points. We need to debate the allocation of resources as a society, and we do that through our democratically elected officials.

One final artical, this one by J. W. Mason in The American Prospect. Mason is an Assistant Professor of Economics at the John Jay College at CUNY. Based on his affiliations, he seems to be a progressive.

He points out that MMT is new, and therefore isn’t a polished structure of thought. It’s a “… ramshackle assemblage of parts built at different times for different purposes, tied together with loose solder of association and inference rather than tight bonds of deduction.” He accurately summarizes Kelton’s thesis and her solutions.

Mason disagrees with Kelton’s contention that all money comes from the government. He points out correctly that banks create money, and that Kelton does not address this point. I discussed a paper Kelton wrote on the nature of money here. She argues that money is a debt relationship, a matter of balance sheet entries, and discusses the superiority of this view to other theories. As Kelton says, quoting Randy Wray, “[m]oney is privately created when one party is willing to go into debt and another is willing to hold that debt….” [4]

In footnote 1 here, I briefly discussed the issue of bank-created money in MMT, based on this article by MMT economist Bill Mitchell. Mitchell says that banks do create money, but at the same time they create a liability, so the balance sheets of the bank and the borrower don’t change from the creation of money. When a government creates money it creates a liability on its books, and the consumer gets an asset. As I see it, the difference is that the government can decide to hold the liability forever while banks expect to be repaid promptly, which destroys the money created by the loan. Banks do lose money on loans, leaving the money in circulation, but that’s not supposed to happen. That’s one difference.

The second difference is the the government controls bank lending. It can limit or prevent banks from creating money through regulation of required reserves. Third, obviously the government has to consider bank-created money when addressing inflation. Finally, bank lending does not help in troubled times, when people don’t want to borrow. Right now, for example, personal savings are at a 60-year high, as people who still have jobe pay down debt and put off large purchases.

The ontology of money is way beyond the scope of Kelton’s book, but I do agree that at least bank-created money must be incorporated into the MMT framework more thoroughly. Edited to add this: Scott Fullwiller, an MMT economist at UKMC, commented below saying that MMT already incorporates bank-created money thoroughly. Fullwiller refers us to this post by Brian Romanchuk replying to Mason’s review.

Mason points out that this and other issues he raises don’t detract from the central insights of The Deficit Myth, saying that Kelton’s insights can stand alone and serve as a guide for action. This is a very useful review.

This is just a small sample, but it reveals one crucial thing: some serious people have begun to grapple with the actual arguments made by MMT theorists, and others will ignore the challenge MMT poses to conventional thinking, and defend their prejudices to the bitter ugly end.

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[1] Here’s the link; it’s behind a paywall, but I got it from my library.

[2] Cochrane’s Wikipedia page has a section titled Main Contributions. It states his research interests, and then offers this assessment, loosely translated as “snicker”:

That is a standard general equilibrium logic, but many financial economists do not view it as a priority and prefer to explain prices without an ultimate reference to choices of households and firms. Similarly, many macroeconomists choose not to worry about asset prices.

In this vein, Cochrane’s work has been to document some empirical patterns and offer some potential explanation….

[3] The ontology of money is a real thing. You could look it up.

[4] Fun question: is bitcoin money? Who is on the opposite side of the balance sheet?

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Social Security And Other Entitlements

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Posts in this series
The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth
The National Debt Is Soooooo Big
The Wonkish Myth Of Crowding Out
MMT On International Trade

Chapter 6 of Stephanie Kelton’s The Deficit Myth discusses the perennial conservative effort to cut entitlements. [1] Kelton defines entitlements as statutory determinations that people who meet certain criteria are entitled to certain defined payments. She discusses several of the most widely used entitlements, Social Security, Social Security Disability, Medicare, Medicaid, SNAP and welfare.

Kelton describes the history of these programs, beginning with Franklin Delano Roosevelt. FDR saw Social Security as the first step towards a comprehensive array of programs that would insure that the citizens would be truly free. He specifically chose to fund Social Security with a tax, so that people would feel ownership, making it harder for politicians to vote to take away those benefits. it worked. People are firmly attached to the program. The money is put into a “trust fund”, which holds it in the form of special non-negotiable US Treasury notes.

Politicians, goaded by their rich donors, try to weasel around this powerful attachment. They start with basic debt hysteria: the Trust Funds are Going Bust! [2] They base this on the reports of the Trustees of the trust funds, who are directed to estimate the date on which the Social Security Trust Fund will run out of money. If that happens. under current law, Social Security payments will be cut. They then claim that all they want to do is put Social Security on a firm financial footing. But they have to act now. Now! And somehow the only possible actions are benefit cuts and tax hikes for working people.

This worked the last time the deficit hawks of both parties tried it. Under Ronald Reagan both parties agreed to cut benefits, raise the retirement age, and increase FICA taxes. This increase in tax revenues was then used as cover for tax cuts for the filthy rich. The effort was led by Alan Greenspan, an Ayn Rand devotee, and no friend of working people.

Medicare is also funded with specific taxes which are put into a special Treasury account, and has a board of trustees. But there’s a big difference. Under Medicare statutes, the Treasury is directed to make all payments, regardless of the state of the trusts. So, every report of the Trustees says that Medicare is just fine. We could do the same for Social Security, and all other entitlements. That simple change would solve the problem. That’s what Kelton recommends, and it makes perfect sense under Modern Monetary Theory.

Liberals offer other solutions. We could raise the cap on the wages subject to FICA taxes. We could have a millionaires tax that would fund Social Security and other entitlements. We could impose a tiny tax on securities transactions and direct the funds to the various trust funds. I don’t think Kelton is opposed to funding social programs with dedicated taxes, and I don’t think she would object to any of these ideas or to the idea that paying dedicated taxes adds to a sense of ownership. The issue is that people think it must be this way. It doesn’t. MMT teaches us that we have the money to do what we want to do.

Taking the pressure off of funding sources does two things. It relieves the anxiety of the older people, the group Enzi is trying to frighten. But it also frees us to focus on the actual needs of the future and to plan for them. As people get older, their needs change. They need more medical care, more help at home, more and different kinds of medicine, different furniture, different living arrangements, and so on. Their desires change, too. They want to do more travel, to spend more time with their spread-out families, and to enjoy more varied kinds of entertainment, restaurants, and other kinds of get-togethers.

Kelton, writing before the pandemic hit, calls for the expansion of Social Security. She points out that it was originally intended as one leg of a “three-legged stool” of retirement planning. The other two were personal savings and pensions from employment. The latter two are disappearing.

Before the pandemic, 40% of us didn’t have savings of $400 for emergencies. Once upon a time, employers provided defined-benefit plans, which promised to pay retirees a specific amount based on pay and length of service. [3] Most of those plans are gone. Kelton cites a particularly ugly case where McDonnell-Douglas closed a plant in Tulsa and terminated a defined-benefit plan in part because so many workers were approaching retirement age when they could collect a full pension with terrible results for older workers. [4] Congress established the Pension Benefit Guarantee Corporation to cover a portion of the lost benefits when companies terminate plans. The benefits guaranteed are absurdly low.

Employers now establish defined-contribution plans like 401(k)s. The track record of these plans shows that they are an inadequate substitute for most people. They are expensive, as members pay administration costs as well as management fees to Wall Street. The national average all-in fee is 2.2%. The Center for American Progress estimates that “… the typical American worker who earns a median salary starting at age 25 will pay about $138,336 in 401(k) fees over their lifetime.” Median account sizes vary substantially by age. For those over 50, the median is around $66K. The average is much higher, around 200K, showing that these plans primarily benefit the wealthy.

Taken together, these facts show a critical need for a stronger Social Security system, not the cuts sought by conservatives.

Other entitlement programs are under attack from the deficit hawks. There are constant efforts to make it more difficult to enroll in Medicaid, like work requirements or co-pays. Fifteen states haven’t implemented Medicaid expansion as permitted by Obamacare; Missouri just added a constitutional amendment requiring implementation. SNAP benefits are under constant assault by Republicans in the name of frugality, as if these $68 billion in a 4$ trillion budget was meaningful compared to the needs of the population served.

Kelton’s point is that we have the money. We need the will to establish priorities that match our moral values, and a Congress that will legislate those priorities.

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[1] It’s one of the more bizarre conservative demands. Social Security is a crucial element of the financial lives of a very large number of older Americans; approximately 40% of retirees would have incomes near or below the poverty line without it. That’s about 21 million voters who are more likely to vote for conservatives. To protect themselves from voter anger, conservatives explicitly call for the “I’ve got mine, screw you Jack” approach: their proposals always exempt today’s older crowd, as if the younger citizens won’t notice that their parents are safe but they aren’t and neither will their parents.

[2] We are currently getting a heavy dose of this from Republicans as they try to avoid passing a pandemic rescue bill that will primarily benefit ordinary Americans. Here’s Senator Mike Enzi, from the metropolis of Wyoming, where he ran a shoe store, insisting that Social Security is the problem. Kelton has a story about Enzi. P. 41 et seq.

[3] The strange locution “defined benefit plan” comes from the Employee Retirement Income Security Act of 1974. Its counterpart is defined contribution plans, which don’t promise any specific payment on retirement. It just requires the employer to pay a specific amount into some kind of plan with whatever vesting rights and investment possibilities the employer chooses.

[4] McDonnell-Douglas eventually merged with Boeing. Here’s a story connecting its executives to the 737 Max disaster.

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MMT on International Trade

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Posts in this series
The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth
The National Debt Is Soooooo Big
The Wonkish Myth Of Crowding Out

Chapter 5 of Stephanie Kelton’s The Deficit Myth takes up international trade. Trump thinks the US is losing at trade simply because we import a lot more than we export. He promised to bring manufacturing jobs back to the US. This won him votes in many states where corporations closed US operations and moved production offshore. But it’s a lot more complicated than just the dollars. I’m only going to address a few of the points Kelton raises.

1. Trade has good and bad results

It’s true that for a number of years the US has run a trade deficit with the rest of the world. We import more than we export. This means we send other people dollars and they send us stuff we want, like oil, computers, cars and cars with computers in them that run on oil. That seems like a good trade.

Many poorer countries do not produce enough food, drugs and advanced equipment to meet their needs. [1] Their currencies are weak, so they need dollars to pay for those shortfalls. Giving them dollars for their goods is a partial fix. Also, it means their workers have jobs and can hope for better lives.

It’s a fact that we have lost a lot of good jobs, those with benefits and middle-class pay, and replaced them with poor jobs. Supposedly we get lower prices as a result, though people buying iPhones might wonder. However, most of the benefits from trade go to the richest among us, corporations and their top executives and the lawyers, accountants, and consultants hired to minimize their costs, taxes, personnel, and unions. [2]

Maybe someday foreign holders of US dollars will want stuff themselves, instead of dollars. They might buy stuff from us. If that means increasing our exports of goods and services, then it seems good. If they buy up our land, buildings and equipment, that might not be so good. If they buy our oil and export it to their countries, we might not like that. Its complicated.

2. What about the money?

This seems to bother Trump a lot. He seems to think sending dollars abroad is bad, even if we get useful stuff in exchange, which sounds stupid when you write it down. One real problem is that money spent abroad doesn’t circulate in the US. Your spending is someone else’s income. If American Airlines buys jets from AirBus, that’s money not spent in the US, and less money for Boeing employees to spend here. The result is lowered economic activity here. Kelton has an answer for this.

Let’s start with the two-bucket accounting system from the previous post. Deficit spending by the Federal Government creates a surplus in the hands of Everybody Else. So, if the FG spends $100 and taxes back $90, then FG has a negative balance of $10. EE has a surplus of $10, which is available to increase demand for goods and services.

Let’s now split the EE bucket into two pieces: US and Other Countries. Now suppose people in the US spend $5 on goat cheese from France, part of OC, and French people spend $3 on US movies. The US surplus drops by $5, and increases by $3, for a loss of $2, leaving $8. Those 2 dollars won’t be available to buy stuff in the US, reducing economic activity.

Trump’s solution to this problem is tariffs on imports from OC. Tariffs are taxes. They put money in the FG bucket, and remove it from the funds available to support domestic demand. Suppose the FG imposes $1 in tariffs on imports. The US bucket drops by $1, to $7. If the problem was reduction of demand, that’s perverse.

The real solution is more deficit spending by the FG on US goods. If the FG spends another $2 buying US goods, those two dollars add to the US surplus, returning it to $10. Problem solved, especially for people who like Crottin de Chavignol. [3]

3. It’s the jobs, not the dollars.

The real problem is not the dollars, but the good jobs that disappeared. Kelton doesn’t say so, but in fact sending jobs overseas is the result of corporate decisions, made solely in search of profits. The federal government does not explicitly support this corporate decision, but its policies do not discourage shipping jobs overseas, and in many ways support offshoring of jobs. For example, modern trade treaties contain provisions designed to protect US businesses in foreign countries, and the government is often willing to use force to protect US assets abroad which can cost the lives of our military people to protect the interests of the rich.

Mainstream economists have always praised trade deals as benefiting Americans, despite the fact that the benefits of trade for the most part flow to the rich while the burdens fall mostly on the poor and the middle class. The middle class is shrinking. Part of that is due to the loss of well-paying jobs. The response of Congress has been worthlesss, mostly job retraining and minimal recompense. [2]

Kelton once again offers the job guarantee as a solution. The proposals for legislation contemplate that all jobs will pay at least $15 per hour with benefits, which will keep people reasonably safe. But these are not an adequate replacement for good middle-class jobs. We need more effort put into solving that problem.

I’ll offer one idea. The pharmaceutical business model is to raise the price of their drugs at least annually, so as to increase profits, and thus the price of the stock. As part of the jobs guarantee, the federal government could build plants to manufacture drugs and compete directly. There would be no problem doing this with generic drugs, but the government could also do it with other drugs bearing extortionate prices, like insulin and coronavirus treatments like Remdesivir. Also see this.

The expertise is out there, and the government can buy it. People can be trained to operate these plants, and make an enormous contribution to their fellow citizens. I see this an an illustration of one of Kelton’s normative policy assumptions: the point of the economy is to make our lives better. This is a political choice. It’s not a choice we should abandon to the rich and powerful.

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[1]Kelton knows this is a problem. In short, it’s the result of a number of factors, including weak or corrupt governance. The Washington Consensus perpetuates this problem. With better governance and careful attention to some of the ideas in this book, that problem might be slowly corrected. See p.141 et seq.

[2] This entire problem was the result of a consensus among economists on the benefits of trade, a consensus that supported the desires of capitalists and giant corporations. Both liberal and conservative economists and politicians joined the chorus of assent. I discuss the impact of this disaster in four posts you can find here, beginning with The Problem Of The Liberal Elites. TL;dr: liberal elites squandered their influence pushing a bad economic theory. We have no reason to trust their judgment after the damage their advice created.

[3] Alternatively we could try to reduce the trade deficit. Kelton discusses this, but it raises several complicated issues, and I’ll just refer interested readers to pp. 135-6.

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The Wonkish Myth of Crowding Out

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Posts in this series

The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth
The National Debt Is Soooooo Big

Chapter 4 of Stephanie Kelton’s The Deficit Myth takes up the theory that federal government deficits increase the cost of borrowing by the private sector. Here’s Kelton’s typically incisive description:

In its most common form, the crowding-out myth says that fiscal deficits require government borrowing, which forces Uncle Sam into competition with other would-be borrowers. As everyone competes for a limited supply of available savings, borrowing costs move higher. With interest rates on the rise, certain borrowers — especially private businesses — won’t be able to secure funding for their projects. This causes private investment to fall, leading to a future where there are fewer factories, machines, and so on. With a smaller stock of capital goods, society ends up with a less productive workforce, slower wage growth, and a less prosperous economy. It does sound ominous! P. 101-102.

Given the amount of capital floating around in the world, much of it US dollars, it’s hard to see why this makes sense. The big problem is not the availability of capital for US businesses, but the insistence of the rich that they not be exposed to any risk of loss. What could be a better solution for that than Treasury securities? But the crowding-out theory requires a chain of reasoning, and so it appeals to the self-regard of our wonk class. [1]

Kelton first addresses the idea that there is a limited pool of savings. As she does throughout the book, Kelton uses this myth to discuss the overall picture of money as explained by mainstream economists. They claim that private savings are the ultimate source of the funds that are available to lend. [2] If the government borrows from that limited amount, there is less for others. As you can see, it’s a pinched view of government spending. It seems to mean that government spending is lost somehow, instead of going into businesses and our own pockets, in the US and elsewhere when the government buys from businesses in other countries.

Kelton asks us to consider the flow of dollars in our economy from an accounting perspective. She starts with a two-bucket system: the Federal Government is one bucket, and Everyone Else is the second. Any dollar that leaves the FG bucket goes to the EE bucket. There is no where elso for it to go. Taxes take money out of the EE bucket and put it into the FG bucket. That leads to our first equation:

FG balance + EE balance = 0

So, if there is a FG deficit then there is an EE surplus of like amount.

FG deficit = EE surplus

Deficit spending has a good side! That’s something that seems to elude the practitioners of deficit scare-mongering. On the other hand, if the government runs a surplus, we get

FG surplus = EE deficit.

That seems bad. It means we are losing some of our wealth. Where does that wealth go? Well, it’s cash. Remember that cash is a debt on the government’s books, so the cash it collects in taxes just offsets the debt, and disappears. That might be bad! That’s something else the deficit scare-mongers never mention.

Kelton emphasizes that it’s the net that counts. So, if the FG spends $100 and taxes $90, there is a surplus of $10 in the EE bucket. That’s money in our pockets, increased savings. The federal government can just issue Treasuries in that amount, converting the green dollars into yellow dollars in Kelton’s parlance. So contrary to the myth of crowding out, FG deficits don’t eat up our existing savings, they actually increase the amount of savings. It’s not an opinion, it’s just simple accounting.

At this point we might ask if there was ever any real danger of a shortage of loanable funds. The Fed publishes a weekly summary of the balance sheets of all commercial banks in the US. As of July 1, total loans were $10.6 T and total deposits were $15.6 T. [3]. The Treasury has issued trillions of dollars of securities to cover deficit spending to date and there are still $5 T in available bank credit, and with the multiplier effect [2], there’s much more. There’s plenty more where that came from. Money Market funds have a total of about $4.6 T, all of it short-term, and much of that is available for longer-term investment if there were reasonable returns for the perceived risk. But there aren’t any decent returns to cash right now. Why?

That’s Kelton’s second point. Step 2 in the reasoning chain for this myth is that competition to borrow money drives up interest rates. Not so, says Kelton. She explains that interest rates are a policy choice. The Fed has always been able to control interest rates, both short and long term. In the past, it has done so extensively. During WWII, the Fed kept interest rates at specific levels to help control the economy during the war. That continued until 1951. We have had other bouts of serious control, including immediately after the Great Crash, though that didn’t last long. The Fed is currently keeping interest rates low for both short-and long-term loans.

At other times, the Fed has controlled short-term rates and allowed the private market to affect longer-term rates. Kelton explains how the Fed controls both long- and short-term interest rates, which I’ll skip over. It’s enough to say that this puts the nail in the idea of crowding-out.

Deficits have their good side, but they can create problems, like inflation or politically-driven mis-allocation of resources. MMT doesn’t argue for deficits or surpluses. It argues that we should pay attention to the state of the economy and pick policies that maximize our political desires. I think the government should do more to take care of our citizens. I think everyone should have a job, good schools, decent transportation, clean water and clean air, a planet that isn’t catching fire, and a world not ravaged by Covid-19. MMT supports those goals. Others think we should buy more tanks and guns and do nothing else, just let the market fix things. There are MMT prescriptions for that too.

Finally, it’s worth noting something Kelton doesn’t discuss: keeping interest rates low hurts savers, whether they are saving for a rainy day, for college for the kids, for a down-payment on a home, or retirement. These are funds that people mostly don’t want to put at significant risk. But if interest rates are low, there is a real danger that inflation will slowly erode those savings. For example, health care costs are one reason people save for a rainy day. It’s likely that inflation in that sector is higher than the overall inflation rate. Low interest rates will hurt those savers. Similarly, college costs are rising faster than overall inflation, and in some cities, house prices and rents rise faster. In each case, the saver is a loser.

We should be thinking about that if we want to see progressive uses of MMT achieve their full potential.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] That’s my view, not Kelton’s. She says there is some evidence that crowding-out can be a problem for non-sovereign currencies, but not for sovereign currencies.

[2] This is accompanied by the idea that bank lending results in deposits, and those deposits fund another round of lending, etc. Each round of lending is smaller because banks are required to hold a percentage of all deposits in their reserves at the Fed. I was taught that this is the multiplier effect; it’s now called the money multiplier. We can ignore it for these purposes, because it leads to a larger number, but still one defendant on savings.

[3] Respectively, H.8, P. 2 Line 9 and H.8 P. 3, line 34.

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The National Debt Is Sooooooo Big

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Posts in this series

The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth

Chapter 3 of Stephanie Kelton’s The Deficit Myth addresses the National Debt. It’s a very big number, and politicians use it to terrorize voters. Kelton tells a story about Senator Mike Enzi, R-WY, complaining about a CBO budget outlook report, saying it should put in the zeros instead of using the word “trillion”. And that’s how seriously we should take the problem. Remember what we learned in the last post: money is a debt on the books of the US government, but it’s also an asset in the hands of a currency user. That means that the National Debt tells us how much we collectively have received in assets from the Treasury.

Kelton says that fear of the National Debt is shared by everyone in and near government across the ideological spectrum, politicians, staffers, wonks and think-tankers. When she was Chief Economist for Bernie Sanders on the Senate Finance Committee, Kelton questioned the myth.

One of the most eye-opening things I learned came from a game I would play with members of the committee (or their staffers). I did this dozens of times, and I always got the same incredible reaction. I’d start by asking them to imagine that they had discovered a magic wand with the power to eliminate the entire national debt with one flick of the wrist. Then I’d ask, “Would you wave the wand?” Without hesitation, they all wanted the debt gone. After establishing an unflinching desire to wipe the slate clean, I’d ask a seemingly different question: “Suppose that wand had the power to rid the world of Treasuries. Would you wave it?” The question drew puzzled looks, furrowed brows, and pensive expressions. Eventually, everyone would decide against waving the wand. P. 77. [1]

Wiping out the National Debt means eliminating Treasuries, and that exposed the contradiction at the heart of the myth of the Very Scary Debt. We can’t get rid of Treasuries! But the raw number scares voters so many people continued to rant about the National Debt. They never asked why voters were scared, or questioned their role in creating that fear.

Intuitively, if deficits aren’t a problem unless they cause inflation, then the national debt isn’t a problem unless it causes inflation. In the same way interest on the national debt isn’t a problem unless it causes inflation. Kelton acknowledges that there may be limits on the size of the national debt, usually discussed in terms of the ratio between the national debt and the GNP. The US is nowhere near the size of the debt to GNP ratio of Japan, for example, so there’s no immediate problem. Assuming there is some limit, Kelton turns to the various ways we could eliminate the national debt.

One way would be to run government budget surpluses, as we did when Bill Clinton was President. We could easily do that by raising taxes on the rich and their corporations, slowly depleting their total wealth. That’s a good idea on its own terms, because it would reduce their political and economic power. Kelton says that in the past when the government has run surpluses for several years the result was depressions. I would add that if we did raise taxes we’d be destroyed in the shrieks of the rich saying that their money was being used to pay for social programs like Social Security.

Or, the Fed could get rid of all of the Treasuries with just a few clicks on a keyboard, by reducing the number in the Treasury Securities account and increasing the numbers in the bank account of the holders of the Treasury securites. Economists call this monetizing the debt.

Or, we could do it by continuing to spend as we see fit subject to the inflation constraint, but stop issuing new Treasuries. As the old ones mature, the Fed pays them by crediting the accounts of the holders with green dollars. We could stop that at any time we reached a level of debt that wouldn’t frighten even the most fearful Americans. or at some higher level. [2]

Once getting rid of Treasuries would have caused a problem, because the Fed used the market in Treasuries to control interest rates. That is no longer the only control mechanism available to the Fed. [3] But then what? Kelton discusses an article by Eric Lonergan, an economist and fund manager. Lonergan asks what would happen if Japan monetized all its bonds. I quote his analysis in full:

First, let’s go through the balance sheet effects: 1. The government now has no debt. 2. The value of the Japanese private sector’s assets is unchanged – they used to hold JGBs [Japanese Government Bonds], now they hold the same value in cash. So overnight, the government’s debt is eliminated, and the private sector’s net wealth is unchanged.

The income effects are also interesting: 1. The government’s budget position improves. 2. The income of the private sector falls because bonds paying interest have been replaced with cash holding none.

So what happens to the economy?

Most people tend to say, “hyperinflation”, but that makes little sense. Why on earth would the Japanese household sector rush out and buy things when their interest income has fallen, their wealth is unchanged, and they are used to falling prices. The private sector already has a high wealth to GDP ratio and are spending less than they produce (which is precisely why the government runs a deficit).

The Yen might weaken because the yield on overseas assets has risen relative to Japanese assets, but this spread is hardly offering much compensation for exchange rate risk. My conclusion is that nothing would change in Japan if you had 100% monetization of the stock of JGBs!

The takeaway is that getting rid of Japanese government debt wouldn’t affect the economy at least in the short term. Two possible problems: a) less spending because bond income disappears from the economy; and b) weakening of currency in international markets because there are higher return available on the bonds of other countries. In the case of the US, we can add that cash previously held as Treasuries suddenly isn’t producing any return, so its owners look elsewhere for returns. That might mean an increased purchases of assets by foreigners; purchase of the debt of other countries; or something else. But that’s not all bad, and I don’t know enough to work it out.

Kelton accepts Lonergan’s logic. Paying off US Treasury Securities is possible and likely would have minimal short-term effects. Late in the Clinton Administration the US ran budget surpluses, to the point that White House economists prepared a draft report titled Life After Debt. Here’s a discussion by David Kestenbaum of Planet Money. This report got labeled PRELIMINARY AND CLOSE HOLD OFFICIAL USE ONLY”, and Planet Money got it through FOIA. Then the Republicans cut taxes for the rich, with the usual pennies for the rest of us, so the problem evaporated.

In sum, the national debt isn’t a problem as long as it doesn’t lead to inflation. A lesser constraint might be the impact on the value of the dollar, which might affect international trade in unpredictable ways.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] This is a good example of Kelton’s style. As you can see, it’s clear, simple, and direct English prose, the highest praise my high school English teacher, Brother Daniel, ever bestowed.

[2] Here’s a recent tweet from Scott Fullwiler, an MMT economist:

The core point is it should be done by the [Central Bank]—there’s no reason why the appropriate (for mkt conditions) change in risk-free, liquid securities should equal size of govt debt/surplus, & no reason for appropriate maturity structure to be same as what cost-minimizing [Treasury] chooses.

[3] For example, the Fed began to pay interest on the reserves commercial banks are required to keep at the Fed. There is a full explanation starting at P. 117.

[4] There are, of course, distributional issues for both Treasury Securities and for the interest they pay. This is a normative issue best dealt with by politicians, and not economists. One consideration is that many people benefit indirectly from interest on Treasuries through money market funds, investments by pension plans and direct purchase, because Treasuries are absolutely safe.

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Reflections on The Deficit Myth

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Posts in this series

The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation

The first three posts in this series address the Introduction and the first two chapters of Stephanie Kelton’s The Deficit Myth. In this post I add her definition of money and some of my thoughts, and invite readers to do the same, either questioning points she made or applying her ideas to our society.

1. Modern Monetary Theory starts by asking one question: how does money work in a fiat currency nation. Kelton defines money in her first published paper: The Hierarchy of Money. This is a very readable discussion of the range of opinions on this subject, focused on the argument between the Metalists and the Chartalists, which began over 400 years ago. [1] Kelton starts with a definition of money. [2]

Money represents a debt-relation or promise to pay that exists between human beings. It cannot be identified independently of its institutional usages, because money represents a social relationship. … The creation of money, then, is simply the balance sheet operation that records this social relation. (Emphasis in original.)

According to Kelton, the Chartalists called money any token representing a debt relationship. Thus, a postal stamp is a money: it represents an asset to the owner and a debt to the Post Office which is satisfied by delivering a letter. A plane ticket is money: it represents the obligation of the airline to fly the holder to a particular place at a particular time. Bank deposits are money: they are a liability of the bank which must deliver money at the direction of the account holder. The rule for creation of money is the agreement by one person to hold the debt of another. [2]

Now consider the dollar. The dollar is a creation of the federal government. Kelton writes:

Thus, State money is created when the public agrees to hold (as an asset) state-created money (a liability to the State) which is required in payment of taxes.

This explains why currency and other forms of dollars (bank deposits, treasury securities, and bank reserves at the Fed) are liabilities of the federal government. We users agree to hold these dollars as assets. We can use them to acquire different forms of assets from sellers, obtain services from providers, and pay taxes. When the government collects taxes, it matches that asset with a corresponding liability and clears to zero.

The point of this exercise is to demonstrate that money is a balance sheet representation of the debt/asset relations between human beings, a social relationship. That understanding is crucial to the arguments advanced in The Deficit Myth.

2. Kelton calls for a Copernican Revolution in the way we think about money. This, of course, is a reference to the Copernican Theory, which said that the earth revolves around the Sun, and not vice versa, despite what we see with our own eyes. The ramifications of the Copernican Revolution eventually led to a complete change in our understanding of the nature of reality. [3] The revolutionary change she describes is that US government spending is not constrained by its ability to tax and borrow, but by the actual resources available, labor, material, and the organization of production. One important part of The Deficit Myth is the description of the kinds of changes we have to make in our own thinking. But there are many more revolutions. Here are three.

a. Congress ducks policy arguments by turning them into discussions of budgets or into political games. That never made sense, because all budgeting is about priorities. Games like pay-fors or one-upmanship on military spending were always perverse, but both parties pretended these were real arguments. They aren’t. MMT strips away one more layer of pretense.

b. Mainstream economists refuse to look honestly at MMT. Marion Fourcade and her colleagues at Berkeley published a paper examining the economics profession titled The Superiority of Economists, a devastating critique of their pretensions. Among other things, economists tell us that markets should make our decisions about allocation of resources, and that anything that interferes with the operations of markets is harmful to society. When government spending is between 35 and 45% of GNP prior to the pandemic, it’s stupid to argue that markets are the best form of allocation of resources. When capitalists exercise outlandish control of government spending priorities, it’s stupid to argue that markets should determine what we can and can’t have.

Many economists hold themselves out as experts on all sorts of things, including the pandemic. In the MMT world, as Kelton points out, economists would concentrate on predicting the inflationary effect of spending choices, and get completely out of the business of telling us how we should make decisions about allocation of resources.

c. Historically, people thought that the most important problem facing an economy was to accumulate capital and turn it to productive use for the benefit of society. The chosen solution was Capitalism, and to encourage capitalists to invest, we allowed them to reap outlandish profits through monopoly, grants from the Crown, and other favors, while ignoring the fraud and corruption those policies entailed. This continued in the US, with gigantic giveaways to railroad and mining companies, ludicrous levels of patent protection, and grotesquely unfair tax rules, while mostly ignoring or even praising graft, corruption and fraud. The results of coddling capitalists are rubbed in our faces every day.

MMT gives us space to think about the way society could operate to make our lives better. It allows us to make decisions about what we need and want. We do not have to accept whatever is on offer from Capitalists. We can decide based on our principles, morals, values and dreams. MMT puts us in charge, and frees us from the domination of the rich. It opens the door to the “euthanasia of the rentier”, as Keynes calls it in The General Theory of Employment, Interest and Money.

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] Fun fact, Adam Smith may have held Chartalist views. Kelton quotes him thus:

A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money.

[2] Kelton doesn’t go into the history of money, but this BBC article is a fascinating picture of trade in Ancient Sumeria, and gives a tantalizing hint about the origin of money in record-keeping and accounting for trade.

[3] For a fascinating and occasionally comprehensible discussion of this new understanding, see Reality Is Not What It Seems, by Carlo Rovelli.

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MMT On Inflation

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Posts in this series
The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth

The second chapter of Stephanie Kelton’s The Deficit Myth deals with inflation. In Chapter 1, Kelton explains that the deficit is not a constraint on government spending. Instead, inflation is the important constraint. A deficit does not prove that the federal government is overspending. Only an increase in inflation proves Congress is overspending. Kelton says Congress shouldn’t tax and spend so as to deliver a balanced budget. Congress should spend and tax so as to deliver a balanced economy, one that serves all of us. She says that historically we have not done this, that we have chosen to focus of deficits and in so doing our economy has not served us well.

Definition and Description of Inflation

Inflation means a continuous rise in the price level. A bit of inflation is considered harmless and even something economists like to see in a healthy, growing economy. But if prices start rising faster than most people’s incomes, it means a widespread loss of purchasing power. Left unchecked, this would mean a decline in society’s real standard of living. In extreme cases, prices can even spiral out of control, gripping a country in hyperinflation. P. 44.

The danger of eroding incomes explains why everybody worries about inflation, and explains why politicians can use the threat of inflation to terrorize voters. It works, even though the problem for more than a decade hasn’t been too much inflation, it’s been too little. Ever since the Great Crash inflation has been less than 2% annually despite efforts of the Fed.

Kelton says that economists think of inflation as either cost-push or demand-pull. Demand-pull inflation occurs when consumer spending rises faster than the economy can produce goods and services. That hasn’t been a problem for a long time. Cost-push inflation can arise from disasters, which reduce the supply of something; from pricing power, as in the case of Big Pharma with its patents and trade secrets; or from workers gaining market power and demanding higher wages which businesses pass on to consumers. That last one is the only fear mainstream economists suffer, as far as I can tell.

The dominant theory of inflation stems from Milton Friedman’s monetarism:

According to Friedman, “inflation is always and everywhere a monetary phenomenon.” What he meant was that too much money is the culprit in any inflationary episode. If prices weren’t stable, it was because the central bank was trying to force the economy to create too many jobs by allowing the money supply to increase too rapidly.

The early neoliberal Friedman insisted that the Fed must never interfere with the workings of the market. Specifically, the Fed should not try to reduce unemployment below a certain level, which came to be called NAIRU, the non-accelerating inflationary rate of unemployment. Friedman thought there had to be some minimum level of unemployment in the economy. [1] The Fed bought into this view, as did politicians of all stripes. They all agreed that to keep prices stable, the US has to accept a certain level of unwanted unemployment. And to be on the safe side, maybe a bit higher level of unemployment. In practice, Congress dumped the problems of inflation and unemployment on the Fed.

But problems arose. The NAIRU isn’t visible or measurable. It can only be seen in retrospect. And now we are pretty sure there isn’t a clear relationship between inflation and unemployment, as the Fed assumed. [2] The Fed Chair, Jerome Powell, freely admitted to Rep. Alexandria Ocasio-Cortez that the Fed has been wrong about NAIRU, but defended its use on the grounds that “We need to have some sense of whether unemployment is high, low or just right.” P. 53.

2. The Problem of Unemployment

It turns out that the Fed used the purported correlation between inflation and unemployment as its primary tool for controlling inflation, ignoring all other causes of inflation. When the economy heated up and unemployment dropped, workers gained market power, and their share of national income increased. That led the Fed to raise interest rates leading to a tightening of the economy and usually a recession, as the following chart shows.

Gray bars indicate recessions.


Kelton calls this a “human sacrifice”, forcing some people out of the workforce when they want to work and can be productive. She thinks we are asking too much of the Fed. It can’t spend money into the system; only Congress can do that. All the Fed can do is change the cost of borrowing. If unemployment is too high, the Fed can make borrowing cheaper, but it can’t force anyone to borrow. Usually when unemployment is high, no one wants to borrow. I note that this was what happened after the Great Crash. The Fed cut interest rates to zero and lowered bank reserve requirements, hoping to increase money going into the economy. It didn’t work.

3. The Job Guarantee

Kelton argues that a better way to deal with unemployment is a job guarantee. Every person who wants to work should be able to get a decent job with decent pay and decent benefits. If the private sector won’t provide those jobs, the government should. [3] Kelton discusses this idea and its foundations.

It would probably be impossible for Congress to monitor the economy closely enough to manage full employment by tweaking taxes and spending. A job guarantee would act as a safety-valve and an automatic stabilizer for the economy and help solve this problem, leaving the Fed free to focus on inflation. If the private sector needs all the workers it can find them. If not, the government hires people to do jobs that need doing. There is plenty of work that needs doing, and, as Kelton pointed out elsewhere, we can always use more flowers in our parks and boulevards.

4. Preventing Inflation

So how should Congress budget knowing that the only effective constraint on spending is inflation? What would change? The way Congress currently works is that every bill that calls for expenditures gets a score from the Congressional Budget Office that assesses the impact of the expenditure on the deficit over a ten-year period. If inflation were the constraint, then the CBO would offer a score based on the probable impact of the expenditure on inflation. If the economy is, as now, operating well below its capacity for producing goods and services, the possibility of inflation would be low.

If the economy is close to capacity, either as a whole or in part related to the area of expenditures, then Congress has to make hard calls. How important is the expenditure? Can we create “fiscal space” for the expenditure with taxes? For example, in the case of the entire economy humming along, a general income tax hike would take money out of most people’s hands so they would not be buying as much, leaving room for the government to buy more. If there is a bottleneck, a more focused tax or some other step might be necessary.

Conclusion

MMT recognizes that inflation is a crucial problem. It shows how it arises and how we should protect ourselves from it.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] Marx said that the reserve army of labour is a necessary part of capitalism. Hmmm.

[2] This relationship is embodied in the Philips Curve. I discuss it here.

[3] Other economists favor a universal basic income. Both have the added benefit of freeing workers from abusive or irritating employers. Your family won’t starve if you walk out on a bad situation.

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Debunking The Deficit Myth

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Posts in this series
The Deficit Myth By Stephanie Kelton: Introduction And Index

The first chapter of Stephanie Kelton’s book The Deficit Myth takes up the biggest myth about federal government finances, the idea that federal budget deficits are a problem in themselves. The deficit myth is rooted in the idea that the federal government budget should work just like a household budget. A family can’t spend more than its income will support. The family has income, and may be able to borrow money, and the sum of these sets the limit on household spending. Those who propagate the deficit myth say government expenditures should be constrained by the government’s ability to tax and borrow. First the government has to find the money, either through taxes or borrowings, and only once it has found the money can it spend. The way things actually work is different.

In the real world, it goes like this. Congress votes to direct an expenditure and authorize payment. An agency carries out that direction. The Treasury instructs the Fed to pay a vendor. The Fed makes the payment by crediting the bank account of the vendor. That’s all that happens. It turns out that the real myth is that the Treasury had to find the money before the Fed would credit the vendor. That’s because the federal government holds the monopoly on creating money. U.S. Constitution Art. 1, §§8, 10. In practice this power is given to the Treasury, which mints coins, and to the Fed, which creates dollars. [1]

It also turns out that for the most part, the Treasury does cover the expenditure by taxing or borrowing, but because the government is an issuer of dollars, it isn’t necessary. [2] In the last few months, the Treasury has been selling securities and the Fed has been buying about 70% of them. Here’s a chart from FRED showing Fed holdings Fed holdings of treasury securities. The Fed may or may not sell those securities to third parties. If it doesn’t, they will be held to maturity and remitted as a dividend to the Treasury.

The recognition that spending comes first, and finding the money comes second is one of the fundamental ideas of MMT. Kelton describes her meeting with Warren Mosler who introduced her to these ideas; the stories are amusing and instructive. I particularly like this part:

[Mosler] began by referring to the US dollar as “a simple public monopoly.” Since the US government is the sole source of dollars, it was silly to think of Uncle Sam as needing to get dollars from the rest of us. Obviously, the issuer of the dollar can have all the dollars it could possibly want. “The government doesn’t want dollars,” Mosler explained. “It wants something else.”

“What does it want?” I asked.

“It wants to provision itself,” he replied. “The tax isn’t there to raise money. It’s there to get people working and producing things for the government.” Pp. 24-5.

Put a slightly different way, people accept the government’s money in exchange for goods and services because the government’s money is the only way to pay taxes imposed by the government. Kelton says she found this hard to accept. She spent a long time researching and thinking about it, and eventually wrote her first published peer-reviewed paper on the nature of money. [3]

The monopoly status makes governments the issuers of money, and everyone else is a user. That fundamental difference means that governments have different financial constraints than households, and that it certainly isn’t constrained by its ability to tax and borrow. Kelton offers several interesting and helpful analogies that can help people grasp the Copernican Revolution that this insight entails.

Once we understand that government doesn’t require tax receipts or borrowings to finance its operations, the immediate question become why bother taxing and borrowing at all. Kelton offers four reasons for taxation.

1. Taxation insures that people will accept the government’s money in exchange for goods and services purchased by the government.
2. Taxes can be used to protect against inflation by reducing the amount of money people have to spend.
3. Taxes are a great tool for reducing wealth inequality.
4. Taxes can be used to encourage or deter behaviors society wants to control. [4]

She explains borrowing this way: government offers people a different kind of money, a kind that bears interest. She says people can exchange their non-interest-bearing dollars for interest bearing dollars if they wish to. “… US Treasuries are just interest-bearing dollars.” P. 36. Let’s call the non-interest-bearing dollars “green dollars”, and the interest-bearing ones “yellow dollars”.

When the government spends more than it taxes away from us, we say that the government has run a fiscal deficit. That deficit increases the supply of green dollars. For more than a hundred years, the government has chosen to sell US Treasuries in an amount equal to its deficit spending. So, if the government spends $5 trillion but only taxes $4 trillion away, it will sell $1 trillion worth of US Treasuries. What we call government borrowing is nothing more than Uncle Sam allowing people to transform green dollars into interest-bearing yellow dollars. P. 36-7.

It might seem that there are no constraints, but that is not so. Congress has created some legislative constraints on its behavior, including PAYGO, the Byrd Rule, and the debt ceiling, but these can be waived, and always are if a majority of Congress really want to do something. They also serve as a useful way of lying to progressives demanding public spending on not-rich people, like Medicare For All. We have to pay for it under our PAYGO rules, they say, while waiving PAYGO for military spending (my language is harsher than Kelton’s).

The real constraints are the availability of productive resources and inflation. The correct question is not “where can we find the money”, but “will this expenditure cause unacceptable levels of inflation” and “do we have the real resources we need to do this” and “is this something we really want to do. As Kelton puts it, if we have the votes, we have the money.

In my next post, I will examine some of these points in more detail. Please feel free to ask questions or request elaboration in the comments.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

[1] Art. 1, §8 authorizes the federal government to create money; §10 prohibits the states from issuing money. That leaves open, for now, the possibility that private entities can issue money. Banks and from time to time other private entities play a role in the creation of money, but I do not see a discussion of this in the book.

For those interested, here’s a discussion of the MMT view from Bill Mitchell. I may take this up in a later post. In the meantime, note that every creation of money by a bank loan is matched by a related asset. Thus, bank creation of money does not increase total financial wealth. In MMT theory this is called horizontal money. It is contrasted with vertical money representing the excess of government expenditures over total tax receipts, which does increase financial wealth. Here’s a discussion of this point.

[2] There are, of course, constraints on government spending, especially inflation and resource availability. We’ll get to that in a later post.

[3] Kelton cites the paper in a footnote: The Role Of The State And The Hierarchy Of Money.

[4] Compare this list to the list prepared by Beardsley Ruml, President of the New York Fed, in 1946.

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The Deficit Myth By Stephanie Kelton: Introduction and Index

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Posts in this series.
The Deficit Myth By Stephanie Kelton: Introduction And Index
Debunking The Deficit Myth
MMT On Inflation
Reflections On The Deficit Myth
The National Debt Is Soooooo Big
The Wonkish Myth Of Crowding Out
MMT On International Trade
Social Security And Other Entitlements
Reviews Of The Deficit Myth

The last two chapters of Stephanie Kelton’s The Deficit MythThe Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy is now available, and I will be discussing it in a series of posts. [1]

Kelton lays out the structure of the book in her Introduction. She starts with a common bumper sticker approach to the federal deficit: Uncle Sam looking abashed while holding out his pockets to show they’re empty. That image dominates most discussion of budgeting in the US. It depicts an individual facing the limits of personal finance. It relies on this image to create panic about federal deficits. This is the dominant view among politicians of both parties. In a New York Times opinion piece, Kelton reminds us that a group of 60 Congressmen, 30 from each legacy party, are terribly worried about the deficit. This kind of deficit hawkery hit President Obama in 2010 after the weak financial stimulus offered by Democrats after the Great Crash.

That month, in his State of the Union address, he committed to a reversal of fiscal stimulus, telling the nation, “Families across the country are tightening their belts and making tough decisions. The federal government should do the same.” What followed was a sustained period of self-inflicted harm.

These 60 legislators learned nothing from the misery created by Obama’s turn to austerity, and just like Obama are prepared to hurt Americans in desperate need of assistance following the collapse of the economy, a pandemic, and political upheaval. These supposedly principled people couldn’t agree on actual proposals to increase taxes or cut programs.

Instead, they called for the Government Accountability Office to issue an annual report detailing the government’s fiscal health. They also endorsed legislation introduced last year that would create “rescue committees” to recommend fixes for Social Security, Medicare and other trust funds that are projected to become insolvent.

And they called for adopting goals for managing the debt, such as setting a limit based on its share of the economy. Such a move, they said, “would reduce debt-limit brinkmanship as long as the budget remains on a responsible path.”

It would serve them right if the GAO read Kelton’s book and concluded, as she does, that they are dangerously wrong. By the way, the Fed disagrees with these spineless wonders, and says more fiscal stimulus is needed. It goes without saying that the Fed is more likely to be right than legislators mired in the economics and politics of the past.

Kelton calls for a Copernican Revolution:

MMT changes how we view our politics and economics by showing that in almost all instances federal deficits are good for the economy. They are necessary. P. 7.

There is no doubt that Modern Monetary Theory would require a revolutionary change in our understanding of economics. Here’s a tweet from Paul Krugman [2]:

No revolutionary thinking needed says Krugman, carry on. I assume this is a reference to Krugman’s general view that the US can borrow cheaply thanks to the low interest rates set by the Fed, and that bonds will be issued to “pay for” economic support. That’s not what’s happening. The Fed is buying the securities issued by the Treasury to “pay for” whatever Congress said to pay for. Between February 27 and May 31, the national debt increased $2.4 trillion while Fed holdings of treasuries increased by $1.657 trillion. [3] In other words, the Fed bought about 70% of the new issuance, simply by marking up the Treasury’s account at the Fed. That’s blatantly creating money out of thin air. It’s important to add that no one is going to pay off the securities owned by the Fed unless the Fed decides to sell them to third parties. I wonder if the 60 Representatives who signed that letter know that. Or care. Or understand why it’s relevant.

Kelton takes up six myths about the economy in her book.

1. The US government should budget itself like a household.
2. The deficit is evidence of overspending.
3. Deficits will burden the next generation.
4. Deficits crowd out private investment undermining long-term growth.
5. Deficits make the US dependent on foreign investment.
6. Entitlements will cause a huge future problem.

Then she discusses our real crises:

The fact that 21 percent of all children in the United States live in poverty—that’s a crisis. The fact that our infrastructure is graded at a D+ is a crisis. The fact that inequality today stands at levels last seen during America’s Gilded Age is a crisis. The fact that the typical American worker has seen virtually no real wage growth since the 1970s is a crisis. The fact that forty-four million Americans are saddled with $1.7 trillion in student loan debt is a crisis. And the fact that we ultimately won’t be able to “afford” anything at all if we end up exacerbating climate change and destroying the life on this planet is perhaps the biggest crisis of them all. These are real crises. The national deficit is not a crisis. P. 11-12.

And I’ll add one more: the grotesque skewing of wealth and income to white poeple is a crisis.

This book is a joy to read. It’s written for non-economists. The language is lucid and precise, with no jargon. I hope people will discuss it in the comments as I move through it. I’ll try to answer any and all questions to the best of my ability.

I will also add my own comments, but I will separate my thinking from Kelton’s. I know of two areas I want to discuss in more detail. First, as I see it MMT is an example of a pragmatic approach to the study of economics. I offer a primer on pragmatism in three posts, here, here, and here. In contrast, mainstream economics rests heavily on Bentham and Mills’ Utilitarianism, but it’s buried deeply in the history of economics, and is never discussed as a normative principle. For an introduction to this area, search the site for William Stanley Jevons.

The value of pragmatism is that it strives to be non-normative. It leaves discussion of what should we do to political or some other discourse. Mainstream economics claims to know how things should be: the market is all-knowing and politics should never interfere with its operation.

This book lays out an argument for MMT as the foundation for an economics for progressives. It offers an understanding of the way our government funds itself which can free us from the constraints demanded by the rich and powerful. It shows us how to use federal monopoly control over money for the benefit of all of us, not just the filthy rich. With this book, we can master the basic concepts and teach them to our friends and neighbors, and especially to our politicians.
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[1] My original plan was to discuss John Dewey’s The Public and Its Problems, but that was derailed by a bad case of quarantine brain. I’ll return to that excellent book next. One of the reasons to discuss that book is that Dewey, the leading pragmatist, opens with a discussion of that theory.
[2] I replied to this tweet.
[3] The Fed’s weekly balance sheets are here. Debt figures from the Treasury are here.

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[Graphic via Grand Rapids Community Media Center under Creative Commons license-Attribution, No Derivatives]

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