MMT and Its Critiques

Eric Tymoigne
Modern Money
Spring 2015
Road Map
• 1- Krugman’s criticism
• 2- Palley’s criticism
• 3- Lavoie’s criticism
• 4- Guinan’s criticism
What will you learn?
1- Arguing from a constant deficit throughout the business
cycle is not tenable: That automatic stabilizers reduce the
deficit during an expansion and raises it during an expansion
(slide #5)
2- Monetary financing and bond financing are not substitutes:
Even if treasury got all its money from the Fed directly, bond
issuance would still be needed for monetary policy purpose
(slide #3)
3- The political economy of MMT needs to be developed
4- One can work with or without the consolidation but should
reach the same conclusion (slides #3)
5- Fiscal deficit can occur because non-government sector are
willing to save the currency for other purposes than to pay
taxes: if currency is used for no other purpose than to pay tax
then equilibrium deficit is zero. (slides #5)
Krugman’s criticism, March 2011
• Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of
thought — the modern monetary theory people — who say that deficits never matter, as long as you
have your own currency.
• So suppose that we eventually go back to a situation in which interest rates are positive, so that
monetary base and T-bills are once again imperfect substitutes; also, we’re close enough to full
employment that rapid economic expansion will once again lead to inflation. […] Suppose, now, that we
were to find ourselves back in that situation with the government still running deficits of more than $1
trillion a year, say around $100 billion a month.
• And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers —
nobody is willing to buy U.S. debt except at exorbitant rates.
• So then what? The Fed could directly finance the government by buying debt, or it could launder the
process by having banks buy debt and then sell that debt via open-market operations; either way, the
government would in effect be financing itself through creation of base money. […] And in my
hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s
not crucial) roughly in proportion to the increase in monetary base.
• once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a
recipe for very high inflation, perhaps even hyperinflation. And no amount of talk about actual financial
flows, about who buys what from whom, can make that point disappear: if you’re going to finance
deficits by creating monetary base, someone has to be persuaded to hold the additional base.
Krugman’s criticism, August 2011
• But I do get the premise that modern governments able to issue fiat money can’t go bankrupt,
never mind whether investors are willing to buy their bonds.
• Suppose that at some future date — a date at which private demand for funds has revived, so
that there are lending opportunities — the US government has committed itself to spending
equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues. […]
for whatever reason, investors refuse to buy US bonds. [This] poses no problem, say the MMTers
[…]: the US government can simply issue money, crediting it to banks, to pay its bills
• We’re assuming that there are lending opportunities out there, so the banks won’t leave their
newly acquired reserves sitting idle; they’ll convert them into currency, which they lend to
individuals.
• I’m not clear on whether they realize that a deficit financed by money issue is more inflationary
than a deficit financed by bond issue.
• The point is that there are limits to the amount of real resources that you can extract through
seigniorage. When people expect inflation, they become reluctant to hold cash, which drive
prices up and means that the government has to print more money to extract a given amount of
real resources, which means higher inflation, etc..
• The point is […] the direct effects of the deficit on aggregate demand are by no means the whole
story; it matters whether the government can issue bonds or has to rely on the printing press.
And while it may literally be true that a government with its own currency can’t go bankrupt, it
can destroy that currency if it loses fiscal credibility.
 Main points in logical terms
• Assume the economy has recovered and the Treasury is running permanent large deficits of 10% of GDP
• Premise is odd: automatic stabilizers lower a deficit rapidly during an expansion.
• Treasuries buyers dry up “for whatever reason” because T-bills and cash are imperfect substitutes in
normal times.
• Can’t happen: today primary dealer system
• banks always prefer T-bills over reserves they have in excess(because T-bills pay interest for the same credit risk)
• Central bank must finance the Treasury to cover the deficit, and so there is a net injection of reserves
• This happens all the time no matter what: deficit injects non-borrowed reserves and pushes down FFR.
• In time of recession, banks hold onto reserves and do not lend reserves out so monetary financing is ok.
• In a normal recession, if banks do not want the reserves, the FFR falls below target and the Fed drains everything
in excess.
• Banks do not lend reserves: nobody else but banks can have a checking account at the Fed. Banks can’t buy or
lend anything with the reserve balances to non-banks because you and I do not have a checking account at the
Fed so reserve balance can’t be passed on to other agent than banks.
• In current recession, fed can still raise rate independently of amount of excess reserves: discourage potential
customers to take bank credit.
• In times of expansion, bank covert reserves into cash and lend the cash out to individuals
• Private banks do not operate by lending cash (or more broadly in function of the reserves they have).
• People spend and so it is inflationary, which may ultimately lead to hyperinflation
• Public or private spending is not inflationary by itself, it depends on the state of the economy.
• Thus contrary to MMT, one cannot say:
• that deficit never matter
• MMT never said that: fiscal balance matters in terms of its relationship to price stability (too high G- T : inflation, too low G - T:
deflation) gP ≈ (gw – gAPL)sW + (gAD – gAS)sΠ (fiscal position impacts gAD)
• that financing methods of deficit is irrelevant: bond financing is not inflationary, monetary financing is.
• Misunderstand fiscal operations: deficit always lead to a net injection of reserves
• If needed, there must be bond issuance to drain excess reserves to prevent the FFR to fall: even if treasury got all its money
from the Fed directly, bond issuance would still be needed for monetary policy purpose (or pay interest on reserves with
various rate for various maturity of accounts (CD-like account of banks at Fed).
 Palley’s Criticism, 2014
• MMT sets up unnecessary controversy by asserting that the obligation to pay taxes is the exclusive reason
for the development of money.
• No MMT never said that. Everybody can create monetary instrument the point is to get them accepted.
Government does it by taxing people.
• Non-government sector may want to save government currency more for purpose than paying taxes: this is what
allows government deficit to occur.
• The critical question is not whether government can finance spending without taxes. Everybody knows it
can. Instead, the question is what are the macroeconomic consequences of doing so and should
government do so? MMT analysis is deficient in answering these questions
• MMT spends quite a bit of time looking at this: Impact of deficit on interest rate, impact of deficit in price stability,
impact on employment.
• Governments that issue sovereign money can, in principle, finance spending by printing money. However,
that also requires a particular institutional arrangement between the fiscal authority and the central bank.
[…] Simple T-accounting shows that the central bank must be willing to provide the government with the
initial money balances to finance its spending. In effect, that implies the fiscal authority and central bank
act as if they were a consolidated single actor. […] . This is an important issue of political economy. MMT
dismisses this political economy and assumes there is and should be full consolidation of the fiscal
authority and central bank
• The current system works indirectly through the private sector: central bank indirectly funds the treasury. This is
the case because the treasury operates by using central bank currency so taxes and bond issuance can’t occur
without first injecting the central bank currency.
• MMT does not require consolidation to make its argument. Consolidation just drives home the argument more
directly
• There is no finance constraint on G because of the capacity to issue sovereign money. However, once the
economy reaches full employment output, taxes (T) must be raised to ensure a balanced budget […] In a
no growth economy, having the fiscal authority run persistent money financed deficits will cause the
money supply to increase relative to GDP, in turn causing inflation
• No. taxes are raised before full employment. T = t*Y so for given tax rates (t) as nominal GDP (Y) rises T rises.
• Budget position will depend on desired net saving of other sectors at full employment.
• MMT which denies the need to finance deficits with taxes. In a static economy that means the
money supply would keep growing relative to output, causing inflation that would tend to
undermine the value of money.
• This depends on the willingness to net save the currency. If non-government is willing to net save in a
static economy then no inflation.
• Money-financed budget deficits increase the supply of high-powered sovereign money, which
embodies latent purchasing power . Even if not activated immediately, high-powered money
may be activated at a future date and it can be difficult to deactivate it in non-disruptive fashion.
Moreover, deactivating it is especially difficult given that MMT advocates abandoning activist
interest rate policy (about which more below). […] Future inflation has been the traditional
concern of money-financed deficits that generate large liquidity build-ups .
• Reserves in the banking system can be removed easily by the Fed. They do so all the time in period of
expansion or recession.
• Adding and removing reserves is done for any level of FFR target. A low FFR does not mean that a lot of
reserves are in the banking system: it is all demand driven unless FFR is zero in which case excess
reserves may be left by the central bank if required.
• Such deficits increase the supply of high-powered money and the money created must be
willingly held. Some of the increase in supply will be directed to the acquisition of foreign
money balances and purchases of imports, which will generate exchange rate depreciation
• Banks can’t buy anything from others with their reserve balances.
• If banks do not want to hold the reserves they have, the only thing they can do is offer them in the
overnight interbank market: FFR will go down. In that case the central bank intervenes to drain the
excess reserves. Thus, except in exceptional circumstance like today, there can’t be excess reserves that
banks do not want to hold.
• The logic of this interest rate policy is as follows. First, as a sovereign money issuer, government
does not need to borrow money and pay interest to finance the budget deficit; it can just issue
money. So why pay interest at all? Instead, just set the interest rate equal to zero and keep it
there. […] This interest rate policy passivity is tantamount to believing that financial markets are
stable and set interest rates and asset prices appropriately
• No the interest rate on overnight lending is zero. Does not mean others rate are zero.
• Other means to regulate bank credit are preferable to the interest rate: too passive. Use credit control,
underwriting rules first. Raise rates as a last resort.
Lavoie’s criticism
• I am in support of many neo-chartalist arguments that deal with the monetary and fiscal nexus. My worry, however, is
that neo-chartalists are so zealous in demonstrating that there are no financial barriers to running ELR, or other
government expenditure programs, that their efforts may eventually become counter-productive. […] Modern monetary
theory is certainly an improvement, but in order to convince more economists of the validity of their analyses, the
advocates of this theory should give up the counter-productive statements and the convoluted logic associated with the
fictitious consolidation of government and the central bank.
• They skip one fundamental step that makes incomprehensible the leitmotiv sentence that “government spends first.”
Any agent must have funds in a banking account: Before being able to spend, the treasury must somehow replenish its
deposit account at the central bank (or at private banks). Many neo-chartalists skip this step because they prefer to
consolidate the central bank and the federal government into one entity, the state. Such a consolidation, in itself, is not
illegitimate. Other authors, including Wynne Godley (1999B), have occasionally consolidated the central bank with the
government. But such integration may not be appropriate for the purpose at hand, as it confuses the readers who
already have a hard time understanding the mechanics of the clearing and settlement system and who are accustomed
to distinguishing the government from its central bank. […] If one accepts to consolidate the central bank and the
government into a single entity, then some other highly controversial claims make more sense.
• In a nutshell, as long as the other characteristics of a “sovereign currency” are fulfilled, it makes little difference, as the
cases of Canada and the USA illustrate, whether the central bank makes direct advances and direct purchases of
government securities or whether it buys treasuries on secondary markets, as long as the central bank shows
determination in controlling interest rates. […] But then, if it makes no difference, why do neochartalists insist on
presenting their counter-intuitive stories, based on an abstract consolidation and an abstract sequential logic, deprived
of operational and legal realism
• Economists are so accustomed to the loanable-funds approach and to the IS/LM framework — where an increase in
government expenditures tends to drive up interest rates — that it is difficult for them to shake off established
theoretical habits. However, a proper understanding of the payment system reveals that it cannot be otherwise. When
the government pays for its expenditures through its account at the central bank, settlement balances (reserves) are
added to the clearing system. This tends to reduce the overnight rate, as banks are left with excess reserves that no
other bank would borrow. Keeping the rate at its target level requires a defensive intervention of the central bank.
• The purpose of this whole exercise is to show that there is no point in making the counter-intuitive claim that securities
and taxes do not finance the expenditures of central governments with a sovereign currency. Even in the case of the U.S.
federal government, securities need to be issued when the government deficit-spends, and these securities initially need
to be purchased by the private financial sector. The consolidation argument — the consolidation of the central bank with
the government — cannot counter the fact that the U.S. government needs to borrow from the private sector under
existing rules
• Consolidation is a theoretical argument aiming at laying bare the causalities at play in the monetary system. It is not meant
to be descriptive.
• Yes Treasury needs to borrow from private sector, but all private sector funds that the Treasury borrow come from the
central bank:
• Treasury does not spend the money you send to pay tax or buy treasuries. It spends by using a central bank account: all funds
obtained from tax and sale of treasuries are then transferred to the TGA account and so lead to a reserve drain so reserves
must be provided first.
Guinan’s criticism
• At a deeper level, modern monetary theory has a political economy problem. It is a somewhat
technocratic theory, implying that if only the monetary and fiscal policy space open to
monetarily sovereign governments can be properly grasped by policy-makers and the public
then the means to bring about change will be readily available. This is a bit thin […] This leads to
a certain naivety. For example, the flagship MMT policy prescription – the job guarantee – is
likely to encounter stiff opposition for reasons other than the theoretical; for it to be enacted
would require more than just winning the argument. There has been a deep-seated resistance
throughout much of the recent history of capitalism, from business leaders and their political
representatives, to policies and programmes that aim to secure full employment, even though
higher output and employment would lead to higher profits.
• MMT is in need of a more robust political economy. At the same time, if it is to become more
than a counterintuitive abstract theory that can be safely ignored by the powers that be, MMT
will need to be articulated to a much broader political audience. […] In all this there is something
more at work than mere ignorance. In a 1995 interview, Paul Samuelson, the Nobel Prize-
winning father of modern economics, argued for the utility of ‘myths’ in keeping the public in
line: “There is an element of truth in the view that the superstition that the budget must be
balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks
that every society must have against expenditure out of control. (Wray, 2012, 200) It is a
shockingly anti-democratic admission. But there is little reason to suppose that the bien pensant
social liberals of the Labour right, with their mini-manifestos for fiscal conservatism, have any
more interest than the economics establishment in promoting greater public knowledge of the
true state of monetary affairs.
• It will fall to the rest of us to figure out how to swim against the current of deeply held cultural
assumptions and sharply opposing interests to engage in the kind of massive movement-building
and educational effort necessary to bring about a popular democratic understanding of money.
It can be disheartening to recall that the last time this was accomplished was by nineteenth-
century American Populism.