USA Announces Phase 1 Clinical Trial of Modern Monetary Theory

I remember the Reagan tax cuts in 1981.  The Bill was called ERTA - the Economic Recovery Tax Act.  It was a Keynesian stimulus bill, with the stimulus largely coming from tax cuts, allowing people to keep more of their money to spend.  Trouble is, it created a significant deficit quite quickly, and it favored the rich.  So, a year later, Congress dealt with these problems by passing a Tax Equity and Fiscal Responsibility Act.  Who could complain about that - we like tax equity and fiscal responsibility, right?   But it wasn't enough.  In 1984, the deficit was still rising, and it became necessary to take the gloves and the sugar-coated names off.  We passed the Deficit Reduction Act, raising taxes again, or at least closing some "loopholes," i.e., revenue losers that some people don't like.  (Sorry, no link.)

Now, we get to do it all over again, maybe.  The recent tax law and today's budget agreement are budget-busters.  They will cause the deficit to grow.  Self-styled fiscal conservatives are aghast.  And yet, this time there is a new player in the game, a theory of money that says deficits and (monetized) national debt aren't inherently bad.  Fiscal conservatives' hearts may be in the right place, but their minds may be in the wrong century.

The thing is called Modern Monetary Theory (MMT). (Knock yourselves out.)  Here's the short version of it.  If there were no taxes, and the government just printed all the money it spent, the currency would go splooey, because no one would know that money was rare enough to use as a medium of exchange.  But nothing else bad would happen.  The country wouldn't go "bankrupt," because it could just keep printing money to pay its debts.  So, if the trouble with not taxing is that the money would become worthless, we must conclude that the reason to raise taxes is not to "pay for" things, but to protect the currency from the effect of paying for things with printed money.

This is a big deal, says MMT, because the amount of taxes necessary to protect the currency does not necessarily equal the amount of money printed by the government to pay its bills.  What if taxes fell a dollar short each year?  What would be the harm?  Surely, our economy can absorb on extra dollar every year without a loss of faith in our money.  Well more than that is counterfeited every year, and life goes on.  While it's easy to say that zero taxation would result in hyperinflation, it is much more difficult to say how much money could be printed without damaging the currency.  In other words, why is it necessary or wise to run a balanced budget when some things could be paid for simply by printing money?

MMT is not about borrowing money; it's about printing it.  Our laws don't allow the government to print money per se, but a cooperative Treasury and central bank can, together, effectively do so.  Thus, one "solution" to the increased interest cost of the new debt arising from the new deficits would be for the Fed to buy the bonds.  The Fed sends the interest it collects right back to the Treasury, effectively neutralizing the interest costs associated with those bonds. That's "printing money" for all intents and purposes.

The transmission mechanisms whereby printing too much money leads to inflation are beyond the scope of this memo (because they are beyond the scope of my knowledge), but the general drift is this: if the Fed buys up bonds, interest rates will fall too low, too much credit will be created, and too many dollars will soon be chasing too few goods.  Inflation isn't driven by the government spending; it is driven by the private credit created when government spending does not compete for the same private dollars.

But that's the thing: the problem always comes down to inflation, and inflation always requires a "shortage" of goods or services, including labor.  I put "shortage" in scare quotes because I mean only a scarcity relative to demand.  There may be no unusual bottleneck in production; hyperdemand can create a "shortage" even when the production facilities are operating perfectly well.

The heart of the MMT argument, then, is this: We live in an era of rapidly rising global supply of everything we need, including labor.  The growth in output is reminiscent of the deflationary days of the late nineteenth century in the US, when the money supply could not keep up with the output of goods.  MMT says that there cannot be inflation without shortage, and shortage will not happen even the face of a surge in demand, because global capacity is growing, and the time necessary to bring even more capacity on-line is shrinking.  Indeed, "supply" might even be reckoned to include the supply that could show up in six months if the need were known.  Mickey's broomsticks are running wild, and we need a mop to clean up the water they are bringing from the well; that mop is printed money, or, at least, so says MMT.

If the MMTers are right, the deficits created by the recent legislation will be "handled" by an economy that can easily absorb the resulting spending.  The issue is interest rates.  Will the Fed raise rates to cool the economy, causing an unnecessary recession, or will it accommodate the new budget by monetizing some of the debt and watching to see if the extra money in the economy actually causes inflation.  1937 suggests the former.  In that year, skittish conservatives looked up, saw their shadows, and pulled the fiscal plug on the New Deal.  A theretofore recovering economy saw five more years of winter until the exigency of war overcame our aversion to debt. 1982 and 1984 say the same thing. What if we had let the Reagan deficits run?  What did the supply curve look like back then?

But this is 2018.  All Congress has to do to test whether the new laws are unduly inflationary is nothing.  The Fed will be the key.  Will it monetize the debt and see if inflation happens, or will it assume that undue inflation will happen and end the trial of MMT that Congress is now conducting?  Time will tell.  For now, however, I would urge fiscal "conservatives" to inform themselves about MMT and ask themselves not whether they "like it" - they won't - but whether there is anything about it they actually disagree with.  In my experience, no one disagrees with the principles of MMT, but most people disagree with its conclusions.  What a piece of work is man...