Paul Krugman must be pulling his hair out about now. He recently complained that it was almost impossible to figure out what MMTers were advocating, and then tried to pin them down with some very specific questions:
Are MMTers claiming, as Kelton seems to, that there is only one deficit level consistent with full employment, that there is no ability to substitute monetary for fiscal policy? Are they claiming that expansionary fiscal policy actually reduces interest rates? Yes or no answers, please, with explanations of how you got these answers and why the straightforward framework I laid out above is wrong.
Today, Stephanie Kelton responded as follows:
Quick responses first, followed by explanations behind my thinking.
#1: Is there only one right deficit level? Answer: No. The right deficit depends on private behavior, which changes. MMT would set public spending always to the level required to achieve full employment, and then accept whatever deficit may result.
#2: Is there no ability to substitute monetary for fiscal policy? Answer: Little to none. In a slump, cutting interest rates is weak tea against depressed expectations of profits. In a boom, raising interest rates does little to quell new activity, and higher rates could even support the expansion via the interest income channel.
#3: Does expansionary fiscal policy reduce interest rates? Answer: Yes. Pumping money into the economy increases bank reserves and reduces banks’ bids for federal funds. Any banker will tell you this.
#4: Does MMT accept Krugman’s “straightforward framework”? No. We can come back to this at the end.
I can’t even imagine Krugman’s reaction to all this. First of all, although she says “no” in answer to question #1, her explanation makes it quite clear that she is actually answering “yes”, especially when you combine the answers to questions #1 and #2. Krugman is asking whether, assuming a given macroeconomic situation (including a given level of private spending), there is only one budget deficit consistent with full employment. She clearly thinks the answer is yes. So why does she answer “no”. I suspect she doesn’t understand Krugman’s question (which is pretty straightforward.)
Answer #2 is completely wrong, as she seems to ignore the hot potato effect from adding high-powered money when interest rates are positive. She also answers question #2 as if it is a separate question from #1, whereas it’s obviously just a clarification of question #1.
The third response is a complete non sequitur. Krugman asks if expansionary fiscal policy reduces interest rates and she responds that expanding the money supply reduces interest rates. Huh?
And people wonder why Krugman gets frustrated.
READER COMMENTS
Mark
Mar 1 2019 at 12:54pm
The MMT arguments seem based on the premise that all government finance occurs by creating or destroying money supply. Thus, according to Kelton’s article, public spending expands the money supply because the government spends by printing money to give to banks. Higher interest rates according Kelton also expand the money supply (and the “interest income channel”) because the government prints more money to pay bondholders the higher interest rates.
If my reading is correct, then MMT could and should be explained in much simpler terms. In that case, laypeople would easily see that it is a recipe for hyperinflation.
Mark Bahner
Mar 1 2019 at 1:32pm
Yes, this statement is puzzling/troubling to me:
Last year, the deficit was $779 billion. And last year was a year with low unemployment. (Possibly “full employment”?) So it’s OK for deficits to go much, much higher than that? The only way I can see for that to work is massive AI-driven economic growth. There’s nothing but AI that I can think of that could provide the level of economic growth required to make such high deficits OK. I think that massive AI-driven economic growth will happen, but counting on that to happen seems pretty dangerous.
P.S.
Mark Bahner
Mar 1 2019 at 1:42pm
I’m pretty sure that she’s saying expanding the money supply by expansionary fiscal policy reduces interest rates. In other words, through the Green New Deal, the federal government pays $1 trillion people to produce wind turbines in every state, and the money supply expands (because the government is spending foolishly on wind turbines in every state). Interest rates go down. We reach full employment. Everything is wonderful. (And we can use the wind turbine blades for huge seesaws when people don’t want huge wind turbines in their backyards.)
Mark Bahner
Mar 1 2019 at 1:45pm
Oops. That comment about $1 trillion spending on wind turbines was meant as a stand-alone response to Scott’s original post.
Scott Sumner
Mar 1 2019 at 2:56pm
Mark, You said:
“The MMT arguments seem based on the premise that all government finance occurs by creating or destroying money supply.”
Perhaps she did, but:
A. That’s false. The Fed determines the money supply.
B. Not a very useful assumption when Krugman is asking about the difference between the efficacy of fiscal and monetary policy.
If that was her assumption, then her answer #2 makes no sense, as it assumes a distinction between the two.
In any case, you’d think MMTers would at least want explain their views using Krugman’s terminology, instead of redefining terms like “fiscal policy” in ways that conventional economists don’t accept. How do they expect to make any headway with responses like that.
I’m no Keynesian, but I’m perfectly capable of explaining my views on macro in language that is familiar to Keynesians.
Rajat
Mar 2 2019 at 2:00am
Scott, I think Mark is right that Kelton and MMTers see budget deficits as funded in the first instance by money creation – which may reduce interest rates, or at least short term rates – and only secondarily by tax rises or other spending cuts.
This article makes a genuine attempt to interpret MMT ideas and to critique them as sympathetically as possible, pointing out some of the formal and effective problems with the money-financing paradigm: https://link.medium.com/dDqRdk98AU
Scott Sumner
Mar 2 2019 at 8:27pm
Rajat, They are free to argue that deficits are financed by money creation, but that claim happens to be false.
Jerry Brown
Mar 1 2019 at 3:41pm
Scott, Paul Krugman is the one responsible for phrasing his questions however he wants to. He is an accomplished writer of the English language. When he says that these are going to be “very specific questions” then you might expect the response to be for those “specific” questions as they are actually worded. Kelton’s response does that yet you criticize her for not answering a question you think Krugman might have intended but didn’t actually ask. Come on.
Mark @12:54 is correct when he says “The MMT arguments seem based on the premise that all government finance occurs by creating or destroying money supply.” I told you several days ago that this is how MMT views federal spending and taxation. You can think it is silly to do that but that happens to be the MMT view.
And MMT does not believe that all money creation by the government will always result in some “hot potato effect”. And you don’t either. MMT acknowledges that hyper inflations can occur in some circumstances of course, and that at that point it might be reasonable to consider money as a hot potato- but these are rare and there are specific reasons for that to happen.
Scott Sumner
Mar 1 2019 at 3:49pm
Jerry, You completely missed the point. Kelton answered his question, and her answer was basically “yes.” Then she described her answer as “no”. That’s weird.
The hot potato effect occurs whenever rates are above zero, which is the scenario that Krugman was specifically asking about.
It will be interesting to see how Krugman responds. I predict he’ll have the same reaction as I did.
Jerry Brown
Mar 1 2019 at 5:22pm
Well, he responded in a twitter and has much the same reaction as you. So you are right about that.
IVV
Mar 5 2019 at 11:15am
Not weird, just weasely. But that’s typical if you’re taking a position that isn’t defensible from the data. It means that the position is not internally consistent, but, well, it isn’t internally consistent.
Mark Bahner
Mar 1 2019 at 3:54pm
I can’t tell the players without a score card. 🙂
Scott, pardon me if I’m wrong, but you’re a Market Monetarist, right? The “MMT” (Modern Monetary Theory, correct?) as explained in Stephanie Kelton’s responses to Paul Krugman seem nothing like what I think you’ve been advocating. She seems to be saying that the really powerful tool here is federal government spending. Back in the late 70s-early 80s when I was in school, I thought that was called fiscal policy, not monetary policy.
Are you and Stephanie Kelton on the same team? 🙂 Is you both on the same team, but running different plays? (That usually doesn’t work out too well!) 🙂
Scott Sumner
Mar 1 2019 at 7:51pm
Yes, we have completely opposite views.
Mark Bahner
Mar 1 2019 at 9:21pm
Well, that’s certainly messy…if your views are “Market Monetarism” and hers are “Modern Monetary Theory”…and they’re completely opposite! (Especially since your views–as I think I understand them–are “modern” relative to the “monetarism” that I learned/didn’t learn circa 40 years ago.)
LK Beland
Mar 4 2019 at 2:59pm
Market monetarism and MMT are completely different beasts and theories.
MMTs are essentially chartalists.
Market monetarists proposed–in my view–a synthesis of the old- and new-Keynesianism and monetarism. They use a framework that’s fairly orthodox, albeit some of their views are seen as controversial and somewhat marginal–e.g. full monetary offset even at the ZLB, and tight monetary policy being the main factor driving the Great Recession. Many of their proposals (e.g. ngdp targeting) have been studied by New Keynesian economists. They tend to endorse them, or at least view that they have serious benefits.
One aspect–once again, this is my personal view as a non-economist–that MM and MMT have in common is that their communities tend not to be very mathematically inclined. On the other hand, to the best of my knowledge, MMT provides no guidance to build quantitative models, while MM does (as explained above, sophisticated models have been employed by non-market-monetarists to investigate many proposals endorsed by market monetarists). In fact, this is a key ingredient which could make Market Monetarism more mainstream: math- and quantitatively-inclined Market Monetarist modelers.
TheNumeraire
Mar 1 2019 at 5:13pm
Scott, why did your write-up stop short of addressing Kelton’s response to Krugman question #4? It seems to me that her response is full of all sorts of dubious claims about monetary economics, specifically where she cites Minsky and Galbraith.
“Monetary policy “works” by driving people into debt. ”
This seems to be saying that monetary policy is not very effective at increasing AD within interest-rate targeting regime, but doesn’t even address other policy regimes (like NGDPLT or other direct quantity-adjustment regimes).
“There are two ways to get the increase in total spending that we call ‘economic growth.’ ”
This quote seems to imply that increases in AD and economic growth are exactly the same thing.
Scott Sumner
Mar 1 2019 at 7:54pm
Numeraire, Yes, there are many other problems, and I agree with your post. Monetary policy has nothing to do with driving people into debt.
And yes, increases in spending are completely different from economic growth. Spending is a nominal concept and growth is a real concept.
Mark Z
Mar 1 2019 at 10:47pm
Scott, I’m guessing she’s saying that: increasing the money supply has its effect by giving banks more money to lend, ultimately to businesses, homeowners, etc., inducing them to spend more of course, also increasing their debt load, which she seems to think is bad.
Thaomas
Mar 2 2019 at 7:18am
Well there IS only one optimal deficit that is consistent with full employment (given proper monetary policy) : the one is which spending is guided by an NVP investment criterion.
Michael Sandifer
Mar 2 2019 at 7:50am
Scott,
Here’s Krugman’s short summary about Kelton’s reply, from Twitter:
“Sorry, but this is just a mess. Kelton’s response misrepresents standard macroeconomics, my own views, the effects of interest rates, and the process of money creation. Otherwise I guess it’s all fine. See what I mean about Calvinball?”
JK
Mar 2 2019 at 7:41pm
It seems to me inflation expections are completely lost on the MMT crowd, if I’m reading this correctly.
Financing deficit spending with printing dollars (not debt, which must exit the system later) and those holding deposits (banks, savers) will demand compensation in excess of that expected lost value, so rates would go up…not down (that concepts seems crazy to me… supply is flush so rates should fall??… No, supply is flush so dollar value should fall, and rates should rise).
If you ran retail and expected this depreciation of dollars you also would raise prices, and higher prices would have the same counter-cyclical effect as higher rates (which I think you would also see).
They are acting as if no currency has ever failed from over supply, and depreciation, and that the USD is impervious to macro forces and expectations.
I don’t get it.
Benjamin Cole
Mar 2 2019 at 8:31pm
MMT…
You know, the MMT crowd does make some interesting points.
If you wish to stimulate economy would it not make sense to, say, give $1000 to every person in the lower quadrant of income— low income people would tend to spend the money.
The monetary approach, that of lowering interest rates or conducting QE does seem a bit claptrappy and Rube Goldberg-ish, although worth doing. You are hoping for endogenous money creation and for a hot potato effect (how much of a hot potato effect can be generated when capital markets are global is another interesting question). Paul Krugman says monetary policy works through housing markets and exchange rates, which is another puzzling aspect—-I assume a cheaper dollar means more exports and less imports, and thus a boost to gross national income. America First?
I think where the MMT crowd makes a mistake is they advocate more government spending, rather than automatic tax cuts, say whenever unemployment tops 4%.
Like many people, I am dubious about federal government spending including that for national security.
The MMT crowd would get more traction if they would simply advocate cuts in Social Security payroll taxes offset by QE-financed contributions to the Social Security fund, whenever unemployment tops 4%.
Mark Bahner
Mar 3 2019 at 11:08am
That would make sense to me. But if that’s what MMT people like Stephanie Kelton are advocating, they need to make that very clear. Because when she writes, “MMT would set public spending always to the level required to achieve full employment,…” that makes me think of “public spending” like the federal government giving California money to build high speed rail. (Or building a wall on the border with Mexico for that matter. Think of the employment in the cement and steel industries!)
P.S. And neither your example nor my examples do I consider to be “monetary” actions. They’re all “fiscal” actions.
Benjamin Cole
Mar 3 2019 at 10:39pm
Mark B–
Yes, as I stated, I think the MMT crowd has badly erred in positing more federal spending as the cure. When I look at federal military and other spending, I am not encouraged we need more.
The MMT should argue for automatic tax cuts when unemployment tops 4%, while keeping federal spending to a bare minimum (say 15% of GDP, or less if you exclude Socials Security outlays from federal spending).
I prefer automatic tax cuts on FICA payroll taxes. This would mean employing people would cost less for employers, and a bigger take home check for workers. They would spend the money, although there is an added side-effect that such tax cuts would also be disinflationary.
Surely, such tax cuts make more sense than than trying (only) to stimulate an economy through the dubious, clap-trappy, sometimes counter-productive workings of a central bank—especially a central bank obsessed with inflation.
Scott Sumner will say “Fed offset.” Maybe he is right. But the Fed really can’t stimulate an economy much, unless it wants to go to much, much larger QE programs. Much larger. Like several fold.
Dudes, for stimulus, we are stuck with fiscal, and it can work quickly, through the tax-cut side.
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