But Alexandria Ocasio-Cortez (AOC) is a phenomenon and, at least at the moment, a media darling. And she has recently been talking about something I had never heard of before called "Modern Monetary Theory" (MMT). That sounds like economics, and not the old, dusty, Keynes/Friedman, stuff we have been arguing about for at least the last fifty years. So, I decided to check it out and let you know what I found.
Warning: This is definitely NOT a light and fluffy post. But, on the other hand, I think it is easy to follow. You've been warned.A good place to start is with the Wikipedia article on the subject. Even though I recommend the article I'm not going to do that in this case. Instead I am going to use a paper by Tymoigne and Wray that was published by the Levy Economics Institute of Bard College as the basis for my discussion of MMT. You can find it by checking the references in the Wikipedia article. So what is MMT, also called Mosler Economics (ME), and some other things? (MMT is the name AOC used so that's what I am going to go with.).
MMT is an approach to making sense of fiscal/monetary policy. In doing so it relies on some basic ideas from accounting. As an example, the accounting equivalent of Newton's famous "for every action there is an equal and opposite reaction" is "for every Asset there is an equal and offsetting Liability". MMT analysis applies to countries like the US and the UK that control their currencies but not to countries like France and Germany that don't.
MMT then introduces something called "Circuit theory" and posits that it applies to "Currency". The economy consists of a "simple circuit" and Currency (their term for money) is confined to it. There are basic versions (simple circuits) and more elaborate versions that add more paths. But MMT argues that the simple circuit actually works pretty well in terms of telling us what's going on. The more elaborate circuits, while superficially representing the real economy more accurately, don't really tell us much that can't be derived from studying the simple circuit model So I am going to stick pretty much with the simple circuit.
In the simple circuit model the economy consists of two boxes. The first box is the government, in our case the US Federal Government including the Federal Reserve. The other box consists of what I am going to call the economy, roughly everything else. "Currency", the preferred term for money in MMT, circulates between the two boxes. Currency is created by transference from the government to the economy. It is destroyed by transference from the economy to the government. (BTW, this is not how money actually works.)
Put another way, government spending creates Currency and injects it into the economy and paying taxes takes Currency out of the economy and destroys it. (I am sticking with the definitions and usage of these terms and ideas in MMT so these statements do not always mean what they do in normal conversation.) To actually understand what's going on we need to drill down into the details but only a little.
In this model we look at assets and liabilities. Lumping everything into a few general categories works just fine. So we have "physical assets and financial claims owed to the government" (all one thing). We also have "monetary liabilities held by banks" (one kind of liability), and "other liabilities" (the only other kind of liability we need at this point).
We eventually end up needing some other things like "G", the government sector, "DP", the domestic private sector, and eventually, "F", the "foreign" (external to the US) sector. We also need "FA", financial assets, "RA", real assets, "FL", financial liabilities, and "NW", net worth. Finally, throw in a "T" for taxes. But that's all we really need. Not much to model the entire US (or, in the elaboration that requires adding "F" to the mix, all we need to model the economy the whole world).
That's not much but MMT contends it is enough (if we add some high school algebra) to understand how and why things work the way they do. I am not going to go into how all this is done. I am just going to skip to the results. It is these results that are why MMT is popular in some circles. They shed light on important economic issues and provide some interesting policy guidance So let me list some of them:
The government has an unlimited ability to provide funds. As such insolvency and bankruptcy is impossible. It can always pay what it owes in full. Constraints on borrowing and spending are artificial and can always be changed or eliminated given a little political will. What this means is there is no reason not to run a budget deficit.
In fact, because of the "closed loop" nature of the model, if the private sector is going to be allowed to grow by generating profits, savings, retained earnings, etc., this surplus is automatically offset by government debt and deficits. The private sector can't grow unless the government sector goes into debt. So government debt is actually a good thing. To a certain extent, the more, the merrier.
It is a necessary condition for currency to have value that the government accept it as the vehicle by which taxes and fees owed by the government are paid. MMT observes that this "you must pay your taxes in dollars (in the case of the US)" is what underpins the fact that the dollar is generally accepted as a repository of value and becomes accepted for payment by the private sector. MMT loudly proclaims that this is a "necessary" condition but MMT makes no claim that it is a sufficient condition. History seems to bolster this argument.
Taxing, borrowing, and money creation are not exclusive methods of funding the government. In other words, an increase in one does NOT require a decrease on one of the others. This means that none of the traditional reasons for running a balanced budget are actually true. And this is a good thing. Because, as noted above, running a deficit is actually good for the economy. This is also where MMT people say this whole "family budget" model for how the government should be run is wrong so it shouldn't be used.
Now we get to the interesting part. MMT demonstrates that there is no reason not to maintain a full employment posture. Full employment can be maintained while meeting other objectives like low inflation.
In fact, MMT supporters believe that the ideal Fed Funds Rate (FFR - the rate at which banks can borrow money over short terms) should be zero. This, in turn, implies an inflation rate at or near zero. If you follow the MMT logic it is entirely possible to simultaneously have a growing economy, low inflation, and full employment. There are enough "economic knobs" to do all of this at the same time.
I think you can now see why MMT is so popular in some circles. And if MMT was the whole story then we should all jump on the bandwagon. But, alas, there is no such thing as a free lunch.
The first, and perhaps most important question to ask is - does the economy behave as MMT says it should? The answer should not be a surprise, It is "no". So should we toss MMT out the window? Also, "no". MMT does provide a lot of useful insight. And remember that its older and more mainstream competitors also get it wrong regularly. If we only looked at economic theories that always worked we would have no economic theories to study.
The first and most basic problem with MMT is a problem that plagues all economic theories, the "rational person" assumption. Economic theories assume that people always act rationally and always act to advance their own interests. So how does this play out with respect to MMT?
Government injection of money ("Currency", in MMT speak) is supposed to result in increased economic activity. So if you inject more and more money into the private sector it hires and hires and eventually the economy will reach full employment. That in short, (and not only in MMT but in pretty much any economic theory) is one way to get to full employment.
Is this how the real world works? To answer that question let's start by ignoring company activities and instead just focus exclusively on workers. (We will add companies back later so don't panic just yet.) We will arbitrarily divide them into three groups, the rich, the poor, and the middle class. Now let's examine the behavior of a typical member of each group if given more money.
If we give more money to poor people they will go out and spend it immediately. They have many heretofore unmet needs (food, clothing, shelter) and the extra money allows them to better satisfy those needs. So, from an economic perspective the economy sees pretty much all the money going back into the economy where it generates additional economic activity including additional hiring. (Giving more money to poor people is a good way to move the economy rapidly toward full employment.)
But rich people don't have unsatisfied needs. They have had the money necessary to buy everything they want or need for some time so they have already bought it. As a result, the extra money is likely to go into savings and investment. So the extra money has little economic impact. And we see little or no movement toward full employment.
The middle class case falls somewhere in between. Their needs are not as acute as it is in the case of poor people. But they do have unmet wants and needs. So a good chunk of the new money they get will be put right back into the economy with only some of it going toward savings and investment.
Rich people on a per-capita basis spend more and thus put more into the economy than a poor or middle class person. But there are only a few of them so the aggregate economic impact of making the rich richer is small. Putting money into the pockets of the poor gives the economy an immediate and substantial boost. The boost attained from adding to the incomes of middle class people is not as pronounced as in the case of poor people but there are a lot of them (we hope) and most of the added income goes back into the economy relatively quickly.
The same is true of businesses and corporations. Many large companies generate a lot of "free cash" which they can use to take care of pretty much all of their spending and investing needs internally. So making it easier for these businesses to get a loan or forcing interest rates low makes little or no difference to their behavior. They just keep on keeping on without their behavior being influenced much by the availability or cost of loans.
Small businesses behave much like poor people. If loans are easier to get or interest rates are lowered they tend to borrow more and immediately put the borrowings back into the economy. The economy grows.
Medium sized businesses behave analogously to middle class people. So the above analysis is easily extended to realistically cover the whole economy.
Another problem with MMT is Currency versus money. They sound like the same thing. And the "Monetary" in MMT has to do with money. But money in the real economy does not behave like Currency does in MMT.
In the real economy money is created by making loans. Consider bank A. Alice deposits $1,000 in bank A. Now the books show total deposits of $1,000. Bob now gets a $500 loan from bank A. This is okay because the bank holds Alice's $1,000. But if we look at the bank's books total deposits now amount to $1,500. $500 has just been created out of thin air. Now, if Bob pays Charlie $100 his balance goes down by $100 and the bank's total assets are now $1,400. But most likely Charley will deposit the $100 into his account in bank B. If we add the total deposits of both banks together we get the same $1,500. So Bob paying Charlie changes nothing.
Similarly, if Bob uses the loan for a productive purpose he soon has some extra money so he pays off $50 of his loan. This causes Bank A's total deposits to go down by $50. The loan payment has caused $50 of money to be destroyed. If Bob also pays $5 in interest that money just goes into a different account in bank A. So, like when Bob paid Charlie and nothing changed, the interest payment changes nothing.
In short, money is created by the origination of new loans and money is destroyed as a loan's principal is paid off. And this loan origination/payoff happens in the "economy" box and does not involve the movement of Currency between the boxes. So Currency does NOT behave like money. And MMT explicitly says that Currency is created and destroyed only as it moves around the loop. Since loan origination and payment happens within the "economy" box no Currency is created or destroyed. What this means is that the Currency of MMT is not the "money supply" that people usually talk about.
Government spending can be directed to the public good like investments in infrastructure, education, aid to the poor, support of retired people, etc. Since the MMT idea that the government can run substantial deficits and the economy will purr along means that the "we can't do that because it will run up the deficit" argument is a specious one.
That said, the MMT people apply "rational person" thinking to government policy. The officials in charge will do reasonable things, they opine. So inflation, for instance, is a manageable problem. But if recent political history has demonstrated anything, it's that you can't count on the government sticking to the reasonable and avoiding the unreasonable.
And that's a problem when with the MMT approach to both full employment and inflation. I think it is important to remember that the last time inflation was a serious problem in the US was in the late '70s. A lot of MMT advocates weren't even born at that time so they have no personal experience to guide them.
On the other hand, for the entire time these same people have been alive getting and keeping good, well paying jobs has never been easy. They have a deep personal understanding of what it feels like to do a bad job with employment policy. A government policy of guaranteeing full employment sounds like something that is a critical priority if it can be done in a responsible way. And MMT says it can..
There are MMT solutions to controlling inflation if it looks like it is getting out of hand. And, on paper, there is nothing wrong with what they recommend. The problem is that the political will may be lacking when the time comes.
To see the problem we need only look at the "Fed", the Federal Reserve System. The Fed has a responsibility to manage the economy to avoid extremes of either growth or the lack thereof. Inflation is closely tied to an inappropriate rate of growth. Historically, the Fed has used interest rate manipulation to do this. More recently, it has also used "quantitative easing" (QE) when interest rate manipulation proved inadequate.
Generally speaking the solution to not enough growth or inflation is to increase economic activity. Generally speaking the solution to too much growth or inflation is to decrease economic activity. Lowering interest rates is supposed to result in an increase in economic activity and vice versa. But this assumes the level of economic activity is influenced by interest rates.
Historically, it has been. But our modern income structure means that rich people and large corporations are insensitive to interest rates. We saw in the crash of '08 that driving interest rates to zero was insufficient to get the economy growing. A near zero interest rate was supposed to product more loan origination which was supposed to increase the rate of economic activity. But it is important to understand that this is an indirect effect.
Lowering interest does not in and of itself increase economic activity. Instead it is supposed to change behavior (the low rates cause people and companies to change their behavior by borrowing more money and spending it). This increased spending increases economic activity.
But, for the reasons I outlined above, this indirect effect, which had been completely reliable in the past when wealth was far less concentrated, was missing in action in '09. So the Fed had to resort to adding QE to the mix. Fortunately, that eventually worked. So now the economy is in good shape and the Fed should be recharging its batteries.
This in turn means raising the interest rate so that it will be possible to substantially lower it when a recession looms. It also means unwinding QE so that it too can be wound up when it is needed. But as a result of political influence the Fed has changed course.
Last year they were gradually raising the interest rate and gradually unwinding QE. The interest rate was still below historical norms and by the end of the year a lot of QE had yet to be unwound. The Fed moved slowly and carefully enough in both cases that the economy was still able to do pretty well last year.
But, in a short term effort to goose the economy this year, the White House has pressured the Fed to stop increasing the interest rate and to slow or halt the unwinding of QE. It looks like the Fed is going to go along even though it puts at risk the Fed's ability to deal with future problems. When the next recession looms on the horizon, which it inevitably will at some point, the Fed may not have the tools it needs to manage it.
When it comes to full employment I think New York City's experience with rent control (another idea MMT people like) is very informative. Many decades ago NYC instituted rent control policies in an effort to provide affordable housing for people of modest means. They expanded the program several times over the decades because the problem kept getting worse and worse.
But eventually the whole thing became unsustainable. Without rent control developers build buildings because they think they can make a profit and landlords maintain them so they can keep rents high enough to make a profit. But with rent control maintenance no longer made economic sense (you couldn't get your money back from high rents) and developers only built buildings for rich people because those buildings were exempted from rent control.
So buildings that people could afford were allowed to deteriorate. Over time the deterioration was so severe that they became unsafe and had to be torn down. The only new buildings that went up were targeted at rich people. People couldn't find housing yet buildings were falling apart and eventually were torn down. New buildings that people of moderate means could afford to live in were not built to replace them. Things got worse instead of better in terms of the availability of decent moderately priced housing. Eventually NYC was forced to dismantle most of its rent control regime.
I am worried that the same thing would happen with the MMT people's preferred method of getting to full employment. Instead of continuing to goose the economy until full employment was achieved they envision the government becoming the hirer of last resort. The government would directly hire anyone who wanted to work and couldn't find employment elsewhere. They would be paid (under one formulation) the minimum wage, and presumably be put to work on worthwhile projects. But the Federal minimum wage in now $7.25. That is a ridiculously low number. It is not a living wage in even the most depressed economic areas.
Well, the "reasonable person" solution to that problem is to raise the Federal minimum wage. But it is currently so low because it has proved politically impossible to raise. There is a shortage of reasonable people in Congress. But assume that problem somehow gets magically fixed and the program starts working as advertised. Everybody who wants to work but can't find a job gets a government job on some worthwhile project. So far so good.
But a big concern I now have is with structural problems in the job market. We currently have, for instance, a bunch of unemployed (or underemployed) coal miners. The coal mining industry is contracting so there are less jobs than there used to be. This means they can't even move somewhere else to get a coal mining job. What should the country do? Frankly, we already have too many coal miners. We need to change things so there are fewer coal miners. This means things like retraining programs and not programs that put coal miners to work as coal miners.
More broadly, a big employment problem the economy has is structural. We have lots of people who are ready, willing, and able, to perform jobs that don't need doing. At the same time there are other jobs that go begging because there is a shortage of people with the necessary skills. If a job has only temporarily gone away it makes sense to park people somewhere for a short while and wait for things to right themselves. Then the person can go back to doing what they know how to do.
That's what unemployment insurance does and does well. What it doesn't do is match skills training to actual needs. And an "employer of last resort" system doesn't do that either. This is a problem with the structure of the job market, not with the number of jobs on offer. MMT people have nothing to say about this problem. And even if you are able to create the kind of program MMT envisions, over time it will be subject to the same forces that eventually doomed the NYC rent control system.
The NYC rent control program was initially well suited to the problem at hand. But over time, structural changes kept making it less and less effective. But the will did not exist to make the changes necessary to keep up with these structural changes. It was always easiest to put changes off for another year or so, especially if the changes were unpopular, and they usually were. I am concerned that even an initially well designed jobs program would suffer the same fate over time.
So does that mean that MMT is absolutely useless and should just be ignored? No! I think it has many useful things to say. It is a theory that rests on some simple assumptions. If the assumptions were correct than it makes complete sense. But I think it can be very illuminating to explore exactly how reality and the MMT model world differ.
It is definitely true that, as MMT says, most of the discussion about debt and the deficit is nonsense and should be rejected. And MMT gets us closer to how the real world actually works when it comes to full employment and its economic impacts.
Conventional economic theory says that certain unemployment numbers represent effective full employment. Dropping below them was supposed to immediately result in all kinds of bad things (a big increase in inflation, an immediate economic downturn, etc.). None of those things happened. We are currently are at historic lows when it comes to the official unemployment rate. But, again, the bad things that are supposed to be happening aren't happening. The economy is instead behaving like we are a substantial distance away from full employment.
And there are a number of areas where MMT analysis is valuable and illuminating. The current problems the European countries that use the Euro are having is much easier to understand if you apply MMT to the situation.
I also found what MMT had to say about the ways the Fed and the Treasury department informally work together in a joint effort to make sure both departments can perform effectively in their separate roles, for instance, quite illuminating. I could go on but I won't.
Can MMT help make sense of this and many other things? Definitely yes, in some cases, and maybe in others. I am going to skip over the several other areas I found MMT analysis quite helpful in. So, let's give it a chance. It is no nuttier than other economic theories I have seen.
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