So, this happened.
Some people are frustrated about the surrender on the minimum wage, the scaled-back unemployment insurance, the child tax credit that should have been a universal child allowance, the fact that most of the good things phase out over the next year or two.
On the other side are those who see it as a decisive break with neoliberalism. Both the Clinton and Obama administrations entered office with ambitious spending plans, only to abandon or sharply curtail them (respectively), and instead embrace a politics of austerity and deficit reduction. From this point of view, the fact that the Biden administration not only managed to push through an increase in public spending of close to 10 percent of GDP, but did so without any promises of longer-term deficit reduction, suggests a fundamental shift.
Personally, I share this second perspective. I am less surprised by the ways in which the bill was trimmed back, than by the extent that it breaks with the Clinton-Obama model. The fact that people like Lawrence Summers have been ignored in favor of progressives like Heather Boushey and Jared Bernstein, and deficit hawks like the Committee for a Responsible Federal Budget have been left screeching irrelevantly from the sidelines, isn’t just gratifying as spectacle. It suggests a big move in the center of gravity of economic policy debates.
It really does seem that on the big macroeconomic questions, our side is winning.
To be clear, the bill did not pass because some economists out-argued other economists. It was a political outcome that was driven by political conditions and political work. Most obviously, it’s hard to imagine this Biden administration without the two Sanders campaigns that preceded it. (In the president’s speech after signing the bill, Bernie was the first second person credited.) If it’s true, as reported, that Schumer kept expanded unemployment benefits in the bill only by threatening Manchin that the thing would not pass the House without them, then the Squad also deserves a lot of credit.
Still, from my parochial corner, it’s interesting to think about the economic theory implied by the bill. Implicitly, it seems to me, it represents a big break with prevailing orthodoxy.
Over the past generation, macroeconomic policy discussions have been based on a kind of textbook catechism that goes something like this: Over the long run, potential GDP grows at a rate based on supply-side factors — demographics, technological growth, and whatever institutions we think influence investment and labor force participation. Over the short run, there are random events that can cause actual spending to deviate from potential, which will be reflected in a higher or lower rate of inflation. These fluctuations are more or less symmetrical, both in frequency and in cost. The job of the central bank is to adjust interest rates to minimize the size of these deviations. The best short-term measure of how close the economy is to potential is the unemployment rate; at any given moment, there’s a minimum level of unemployment consistent with price stability. Smoothing out these fluctuations has real short run benefits, but no effects on long-term growth. The government budget balance, meanwhile, should not be used to stabilize demand, but rather should be kept at a level that ensures a stable or falling debt ratio; large fiscal deficits may be very costly. Finally, while it may be necessary to stabilize overall spending in the economy, this should be done in a way that minimizes “distortions” of the pattern of economic activity and, in particular, does not reduce the incentive to work.
Policy debates — though not textbooks — have been moving away from this catechism for a while. Jason Furman’s New View of Fiscal Policy is an example I often point to; you can also see it in many statements from Powell and other Fed officials, as I’ve discussed here and here. But these are, obviously, just statements. The size and design of ARPA is a more consequential rejection of this catechism. Without being described as such, it’s a decisive recognition of half a dozen points that those of us on the left side of the macroeconomic debate have been making for years.
1. The official unemployment rate is an unreliable guide to the true degree of labor market slack, all the time and especially in downturns. Most of the movement into and out of employment is from people who are not officially counted as unemployed. To assess labor market slack, we should also look at the employment-population ratio, and also at more direct measures of workers’ bargaining power like quit rates and wage increases. By these measures, the US pre-pandemic was still well short of the late 1990s. More broadly, there is not a well defined labor force, but a smooth gradient of proximity to employment. The short-term unemployed are the closest, followed by the longer-term unemployed, employed people seeking additional work, discouraged workers, workers disfavored by employers due to ethnicity, credentials, etc. Beyond this are people whose claim on the social product is not normally exercised by paid labor – retired people, the disabled, full-time caregivers – but might come to be if labor market conditions were sufficiently favorable.
2. The balance of macroeconomic risks is not symmetrical. We don’t live in an economy that fluctuates around a long-term growth path, but one that periodically falls into recessions or depressions. These downturns are a distinct category of events, not a random “shock” to production or desired spending. Economic activity is a complex coordination problem; there are many ways it can break down or be interrupted that result in a fall in spending, but not really any way it can abruptly accelerate. (There are no “positive shocks” for the same reason that there are lots of poisons but no wonder drugs.) It’s easy to imagine real-world developments that could causes businesses to abruptly cut back their investment plans, but not that would cause them to suddenly and unexpectedly scale them up. In real economies, demand shortfalls are much more frequent, persistent and damaging than is overheating. And to the extent the latter is a problem, it is much easier to interrupt the flow of spending than to restart it.
3. The existence of hysteresis is one important reason that demand shortfalls are much more costly than overshooting. Overheating may have short-term costs in higher inflation, inflated asset prices and a redistribution of income toward relatively scarce factors (e.g. urban land), but it also is associated with a long-term increase in productive capacity — one that may eventually close the inflationary gap on its own. Shortfalls on the other hand lead to a reduction in potential output, and so may become self-perpetuating as potential GDP declines. Hysteresis also means that we cannot count on the economy returning to its long-term trend on its own — big falls in demand may persist indefinitely unless they are offset by some large exogenous boost to demand. Which in turn means that standard estimates of potential output understate the capacity of output to respond to higher spending.
4. A full employment or high pressure economy has benefits that go well beyond the direct benefits of higher incomes and output. Hysteresis is part of this — full employment is a spur to innovation and faster productivity growth. But there are also major implications for the distribution of income. Those who are most disadvantaged in the labor market, are the ones who benefit most from very low unemployment. The World War II experience, and the subsequent evolution of the racial wage gap, suggests that historically, sustained tight labor markets have been the most powerful force for closing the gap between black and white wages.
I’m not sure how much people in the administration and Congress were actually making arguments like these in framing the bill. But even if they weren’t explicitly argued for, some mix of them logically follows from the willingness to pass something so much larger than the conventional estimates of the output gap would imply. Some mix of them also must underly the repeated statements that we can’t do too much, only too little, and from the recognition that the costs of an inadequate stimulus in 2009 were not just lower output for a year or two, but an extended period of slow growth and stagnant wages. When Schumer says that in 2009, “we cut back on the stimulus dramatically and we stayed in recession for five years,” he is espousing a model of hysteresis, even if he doesn’t use the word.
On other points, there’s a more direct link between the debate over the bill and the shift in economic vision it implies.
5. Public debt doesn’t matter. Maybe I missed it, but as far as I can tell, in the push for the Rescue Plan neither the administration nor the Congressional leadership made even a gesture toward deficit reduction, not even a pro forma comment that it might be desirable in principle or in the indefinite long run. The word “deficit” does not seem to have occurred in any official statement from the president since early February — and even then it was in the form of “it’s a mistake to worry about the deficit.” Your guide to being a savvy political insider suggests appropriate “yes, buts” to the Rescue Plan — too much demand will cause inflation, or alternatively that demand will collapse once the spending ends. Nothing about the debt. Things may change, of course, but at the moment it’s astonishing how completely we have won on this one.
6. Work incentives don’t matter. For decades, welfare measures in the US have been carefully tailored to ensure that they did not broaden people’s choices other than wage labor. The commitment to maintaining work incentives was strong enough to justify effectively cutting off all cash assistance to families without anyone in paid employment — which of course includes the poorest. The flat $600 pandemic unemployment insurance was a radical departure from this — reaching everyone who was out of work took priority over ensuring that no one was left better off than they would be with a job. The empirical evidence that this had no effect on employment is informative about income-support programs in general. Obviously $300 is less than $600, but it maintains the priority of broad eligibility. Similarly, by allowing families with no wages to get the full benefit, making the child tax credit full refundable effectively abandons work incentives as a design principle (even if it would be better at that point to just make it a universal child allowance.) As many people have pointed out, this is at least directionally 180 degrees from Clinton-era “welfare reform.”
7. Direct, visible spending is better than indirect spending or spending aimed at altering incentives. For anyone who remembers the debates over the ARRA at the start of the Obama administration, it’s striking how much the Rescue Plan leans into direct, visible payments to households. The plan to allow the child tax credit to be paid out in monthly installments may have some issues (and, again, would certainly work better if it were a flat allowance rather than a tax credit) but what’s interesting here is that it reflects a view that making the payments more salient is a good thing, not a bad thing.
In other areas, the conceptual framework hasn’t moved as far as I would have hoped, though we are making progress:
8. Means testing is costly and imprecise. As Claudia Sahm, Matt Bruenig and others have forcefully argued, there’s a big disconnect between the way means testing is discussed and the way it actually operates. When the merits of income-based spending are talked about in the abstract, it’s assumed that we know every household’s income and can assign spending precisely to different income groups. But when we come to implement it, we find that the main measure of income we use is based on tax records from one to two years earlier; there are many cases where the relevant income concept isn’t obvious; and the need to document income creates substantial costs and uncertainties for beneficiaries. Raising the income thresholds for things like the child tax credit is positive, but the other side of that is that once the threshold gets high enough it’s perverse to means-test at all: In order to exclude a relatively small number of high-income families you risk letting many lower-income families fall through the cracks.
9. Weak demand is an ongoing problem, not just a short-term one. The most serious criticism of the ARPA is, I think, that so many of its provisions are set to phase out at specific dates when they could be permanent (the child tax credit) or linked to economic conditions (the unemployment insurance provisions). This suggests an implicit view that the problems of weak demand and income insecurity are specific to the coronavirus, rather than acute forms of a chronic condition. This isn’t intended as a criticism of those who crafted the bill — it may well be true that a permanent child tax credit couldn’t be passed under current conditions.
Still, the arguments in support of many of the provisions are not specific to the pandemic, and clearly imply that these measures ought to be permanent. If the child tax credit will cut child poverty by half, why would you want to do that for only one year? If a substantial part of the Rescue Plan should on the merits be permanent, that implies a permanently larger flow of public spending. The case needs to be made for this.
10. The public sector has capacities the private sector lacks. While Biden’s ARPA is a big step forward from Obama’s ARRA in a lot of ways, one thing they have in common is a relative lack of direct public provision. The public health measures are an exception, of course, and the aid to state and local governments — a welcome contrast with ARRA — is public spending at one remove, but the great majority of the money is going to boost private spending. That’s not necessarily a bad thing in this specific context, but it does suggest that, unlike the case with public debt, the institutional and ideological obstacles to shifting activities from for-profit to public provision are still formidable.
My goal in listing these points isn’t, to be clear, to pass judgement on the bill one way or the other. Substantively, I do think it’s a big victory and a clear sign that elections matter. But my interest in this particular post is to think about what it says about how thinking about economic policy is shifting, and how those shifts might be projected back onto economic theory.
What would a macroeconomics look like that assumed that the economy was normally well short of supply constraints rather than at potential on average, or was agnostic about whether there was a meaningful level of potential output at all? What would it look like if we thought that demand-induced shifts in output are persistent, in both directions? Without the assumption of a supply-determined trend which output always converges to, it’s not clear there’s a meaningful long run at all. Can we have a macroeconomic theory that dispenses with that?
One idea that I find appealing is to think of supply as constraining the rate of growth of output, rather than its level. This would fit with some important observable facts about the world — not just that demand-induced changes in output are persistent, but also that employment tends to grow (and unemployment tends to fall) at a steady rate through expansions, rather than a quick recovery and then a return to long-run trend. The idea that there is a demographically fixed long-run employment-population ratio flies in the face of the major shifts of employment rates within demographic groups. A better story, it seems to me, is that there is a ceiling on the rate that employment can grow — say 1.5 or 2 percent a year — without any special adjustment process; faster growth requires drawing new people into the labor force, which typically requires faster wage growth and also involves various short run frictions. But, once strong growth does generate a larger labor force, there’s no reason for it to revert back to its old trend.
More broadly, thinking of supply constraints in terms of growth rates rather than levels would let us stop thinking about the supply side in terms of an abstract non monetary economy “endowed” with certain productive resources, and start thinking about it in terms of the coordination capabilities of markets. I feel sure this is the right direction to go. But a proper model needs to be worked out before it is ready for the textbooks.
The textbook model of labor markets that we still teach justifies a focus on “flexibility”, where real wages are determined by on productivity and a stronger position for labor can only lead to higher inflation or unemployment. Instead, we need a model where the relative position of labor affects real as well as nominal wages, and in which faster wage growth can be absorbed by faster productivity growth or a higher wage share as plausibly as by higher prices.
Or again, how do we think about public debt and deficits once we abandon the idea that a constant debt-GDP ratio is a hard constraint? One possibility is that we think the deficit matters, but debt does not, just as we now think think that the rate of inflation matters but the absolute price level does not. To earlier generations of economists, the idea that prices could just rise forever without limit, would have seemed insane. But today we find it perfectly reasonable, as long as the rise over any given period is not too great. Perhaps we’ll come to the same view of public debt. To the extent that we do care about the debt ratio, we need to foreground the fact that its growth over time depends as much on interest, inflation and growth rates as it does on new borrowing. For the moment, the fact that interest rates are much lower than growth rates is enough to convince people past concerns were overblown. But to regard that as a permanent rather than contingent solution, we need, at least, to get rid of the idea of a natural rate of interest.
In short, just as a generation of mainstream macroeconomic theory was retconned into an after-the-fact argument for an inflation-targeting central bank, what we need now is textbooks and theories that bring out, systematize and generalize the reasoning that justifies a great expansion of public spending, unconstrained by conventional estimates of potential output, public debt or the need to preserve labor-market incentives. The circumstances of the past year are obviously exceptional, but that doesn’t mean they can’t be made the basis of a general rule. For the past generation, macroeconomic theory has been largely an abstracted parable of the 1970s, when high interest rates (supposedly) saved us from inflation. With luck, perhaps the next generation will learn macroeconomics as a parable of our own time, when big deficits saved us from secular stagnation and the coronavirus.
“The balance of macroeconomic risks is not symmetrical. We don’t live in an economy that fluctuates around a long-term growth path, but one that periodically falls into recessions or depressions.”
That sounds like Milton Friedman’s “plucking model”. And I would note that Friedman was arguing that the central bank’s primary responsibility was managing inflation when people were wearing “Whip Inflation Now” and resorting to price controls, rather than giving an after-the-fact justification.
From the perspective of today, Friedman was much closer to Keynes than he seemed at the time.
I don’t understand how an economy can be above a “supply” constraint.
How can I produce more shoes that I can materially produce? It sounds like a logical contradiction.
An economy above its “supply” constraint can only mean an economy where unemployment is so low that workers can demand an excessive wage. But excessive relative to what?
If we say that it is excessive relative to what employers are willing to pay, so that they stop investing, it seems to me that we are using a circular definition of “supply” constraint, we should instead call it “optimal from the point of view of employers” constraint.
The idea that the economy can run above a supply contraint already implies that the economy never reaches maximum output.
Maybe it’s not good to reach maximum output, but still it is the case that full employment in theory is maximum output, so we should at least redefine the concept of “full employment”.
“How can I produce more shoes that I can materially produce?”
In the current period you can’t. (Assuming full employment of resources in the current period.) But if there has been investment in shoe production capital in the current period then in the next period shoe production can be increased.
“The idea that the economy can run above a supply contraint already implies that the economy never reaches maximum output.”
If this wasn’t so we would still be in the caves.
Yes but this is based on a constraint capital goods, whereas the argument is that there is a labor supply constraint that makes the production of additional capital goods useless.
My point is that a soft constraint (wages are too high according to some unspecified parameter) is treated as a hard technical constraint when defined as a “supply” constraint.
This is a good question. The usual answer is that potential reflects what the economy can “sustainably” produce, but that just pushes the question back to what’s sustainable.
Milton Friedman’s answer is that potential output is the level of output people would choose on the basis of real costs of production. A higher level fo production happens when people are fooled by money illusion into production that is socially wasteful. Inflation makes people think that their real wages will be higher than they are; the real wages they actually receive are worth less to them than the leisure people forego to produce it.
This is a logical story but I don’t think there’s any reason to think it’s a thing that actually happens, and it certainly isn’t what people mean by output above potential today.
There’s some implicit suggestion in the way it’s sometimes presented about plant and equipment being overworked, stocks of materials being run down, etc., but that doesn’t play any role in the way it’s formalize and, again, isn’t a thing that actually happens.
What it means in practice is a level of output associated with rising inflation. I.e. the statement “output aovbe potential will cause inflation to rise” is tautological. Why this link between output and inflation should exist is a different question, but unlike the previous stories this is something that we sometimes do seem to see.
While it indeed seems to be the case that economic thinking has changed, economists of all stripes remain obsessed with *employment*. I recommend a big dose of Andrew Yang: due to automation and AI, a great many jobs are going away and not coming back. Before long, the nominal unemployment rate will become an irrelevant relic of history. Why do economists refuse to contemplate this obvious reality? How about we start thinking about it and planning for it now?
“Perhaps we’ll come to the same view of public debt.”
My concern is with the cost to service the debt as a percentage of the federal budget. That is, as the debt to GDP ratio rises, the potential for a greater percentage of the federal debt being devoted to having to service that debt also rises.
While today we’re at near historic lows (over the past 50 or so years) in terms of the percentage of the federal budget being used to pay the debt–that’s because we’re also near historic lows in terms of the interest rate. And note the 10 year treasury is used as a proxy for the risk-free rate of return–which implies that the rate of return on investments need to be riskier in order to pay for those public union pension funds.
That implies, as the debt to GDP ratio rises, that one of three things will happen:
(a) We’ll encourage the government to keep interest rates low, which will cause a lot of risk taking in investment markets as people seek to improve yield on investments. And a few of those–including some public pension funds–may fail (or at least have serious setbacks) as a result.
(So you may never retire. But at least you can get a 3% home mortgage.)
(b) Interest rates will naturally start rising again as the economy recovers–and the government finds itself in a squeeze, being forced to spend a greater and greater percentage of the federal budget to treasury holders. That then creates a situation where the government either (1) risks significant inflation by continuing to drive the debt even further up, continuing this vicious cycle, or (2) goes on a diet, and the federal budget turns into a massive wealth transfer from taxpayers to bond holders.
And we’ve seen (1) in the past with hyperinflation caused by spiraling government debt. I believe we are a thousand miles away from that outcome–but it doesn’t mean we want to go on the road trip.
(c) The Federal Reserve figures out a way to permanently bury all that debt in someone’s back yard and pretend the huge implicit imbalances don’t exist. (Already Federal Reserve holdings of the debt have leaped well beyond the holdings purchased during QE2–with current debt held by reserve banks nearly at $5 trillion.
https://fred.stlouisfed.org/series/FDHBFRBN
And in a sense, that permits the federal government to “borrow” money without that money going into circulation, causing inflation.)
But I’m not entirely copasetic about (c) as a long-term option.
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None of this implies a hard debt to GDP limit. But it does imply that there is a brick wall behind all that foam…
Couldn’t the government just print money? I don’t see why printing money should be more inflationary than printing debt.
This would likely keep the interest rate very low, I suppose.
Great stuff but why the immature “our side is winning” and “I am reveling in the wailing of [insert mythical right wing bogeyman]” rhetoric?
It cheapens what it otherwise a thoughtful and well worked essay considerably. Look to the beam in your eye first.
Depends on the audience and the purpose of the piece. Part of my goal here was to help people on the left to see ARPA as consistent with a broader, more transformative agenda, even if the bill itself falls short in various ways. A certain amount of go-team rah rah is useful for that. With a different audience in mind I’d write it differently.
I actually agree with Summers that this stimulus will lead to asset price inflation. So with respect to the stimulus we should have paid reparations to descendants of American slaves because that group just happens to be a group that lives paycheck to paycheck, high % the group in low wage jobs, has little savings, relatively high birth rate, most don’t have passports, and thus a helicopter drop focused on this group would inject dollars most quickly into the economy increasing aggregate demand.
So a reparations package would give $40k to every American that has a Black citizen ancestor in 1960 ages 30-50 that makes less than $70k. Those younger would get 2 years free tuition at a community college followed by 2 years everything paid for a regional state university. Upon graduating or serving 4 years in the military or getting a certain number of SS credits they would get $10k. Those older get $10k plus an extra $200/month in SS from ages 62-72.
In addition every American would get access to a $150k interest free mortgage. So if a house costs $200k it doesn’t qualify. Cities with affordable housing would be encouraged to offer incentives to attract new residents just like they offer incentives to attract Amazon and Tesla. The interest free mortgage would have the short term effect of reducing the unemployment rate as people focus on moving, and then the newly flush descendants of slaves would re-enter the labor force from a position of strength.
Bottom line: 2021 just happens to be the best time to pay reparations to descendants of American slaves because it would benefit all Americans. Furthermore, in 2020 Trump essentially paid reparations to retired West Virginia coal miners for very similar reasons…so everyone should understand that the true beneficiaries of reparations are productive Americans that will end up with the dollars.
‘ Both the Clinton and Obama administrations entered office with ambitious spending plans, only to abandon or sharply curtail them (respectively), and instead embrace a politics of austerity and deficit reduction.’
Almost the entire piece is dependent on this false statement. The pre-recession deficit in 2007 was 141 billion and 1.1% of GDP, the 2008 deficit was 459 billion and 3.1% of GDP which occurred with the full year in recession with the first stimulus package. The Obama administration’s deficits ran between $1.09 and $1.41 trillion and 6.7% and 9.8% of GDP for his first term and of his 8 years zero deficits were as small by % of GDP or dollar amount as the ‘07 deficit and only 2 were smaller by % of GDP and 1 by dollar amount than the 2008 year and 2008 was the largest nominal deficit in history to that point and was the 3rd largest by % of GDP over the previous 15 years.
Austerity does not mean ‘spend less than I would with zero constraints’ it means to spend less to bring down debt. The Obama administration did neither of those two things- the first four deficits under Obama were the 4 largest by % of GDP since 1947 with the smallest of those deficits being 17.5% larger than 5th place in that span and the largest being 72% larger.
Attempts to frame the Biden administrations as qualitatively different from the Obama (or even Trump) administrations in terms of their approaches to spending, debt and deficits are dishonest.
I’m glad to have an active comments section so I can’t complain about the, let’s say, diversity of views here. But a link from Tyler Cowen does bring in a different crowd.
Do you have a legitimate response to his argument? I am new here and genuinely curious as to what the counter argument is.
What if we had an incredibly ignorant failed casino operator who ran for President with the austerity party and proclaimed on the campaign trail that he “loves debt”. Then this guy gets elected and goes on to cut taxes and significantly raise spending despite “full employment” and the shrieks of the WSJ editorial page?
Toward the end of his first term this loathsome leader is well on his way to re-election as unemployment drops to unheard of levels and interest rates and inflation remain subdued and all in his party forget everything they had been preaching for the last four decades. Might this experience trump all the macro papers written over the last few decades?
Agree with direct checks; so now, why don’t we see more on budget spending for all to see and why don’t we for example not raise the minimum wage, but write checks to those who are not earning enough instead recognizing there may be a lag period involved.
Yes, this was politics over economics and to think many in the US Congress have an understanding of economics , well, that is hard to accept if you have ever listened to some Congressional hearings with the Fed or bankers presenting to the members.
Debt capacity is a tricky thing and all too many view the debt load as an absolute number. The large increase we are seeing and whether it proves to be an issue is dependent upon US growth, overall world growth and how high the debt is relative to other countries. If the world is truly in slow growth mode, it is likely higher levels of debt will be ok. Solving for the equilibrium in a mathematical way is unlikely; this is feel territory and the market will let all know.
Yes, macroeconomic management is undergoing a real live test.
Terrific post. Interesting how the politicians have decoupled from the economics establishment. We are living through a natural experiment in macroeconomics.
I would have put something in about the need to overshoot the inflation target in order to reverse any hysteresis effects, as we have discussed, but not complaining. On this, Powell and Brainard are ahead of the economics establishment with inflation averaging, another decoupling.
Yes to all! And what about the potentially powerful role of public investment in care, greening our economy, education and health, as well as in what we more conventionally think of as “infrastructure?”
The economic theory is called Modern Monetary Theory or MMT.
The textbook you need to read is The Deficit Myth by Laurel Sheldon ( may have name incorrect ), an American economist.
She sets out 6 common myths and then recommends the policies to be implemented.
Wholehearted believer in the theory ( a theory is an explanation of a number of facts, nothin.g more and nothing less).
Read it and see if you agree with the explanation
*Stephanie Kelton is the author and her book is great.
I agree with many of her conclusions but not so much with the arguments by which she reaches them. See my review here: https://prospect.org/culture/books/mmt-can-we-create-all-the-money-we-need/
MMT is a crock. I recommend Palley.
I read your linked review of Kelton’s book, and find your two main criticisms of MMT therein to be odd. I didn’t read the book, so perhaps Kelton is at fault for poor explication, but MMT does not have the two obvious “holes” in its foundation you cite.
First you say that its claim that the government creates all money ignores the existence of banks. But MMT has done more voluminous and explicitly detailed analysis of the actual mechanics of bank lending than almost any other school of economics–they were in the lead in incontrovertibly debunking the mainstream “loanable funds” theory. What they point out is that when a bank loan’s borrower spends the “new” funds, the bank’s Fed reserve account is debited by exactly that much–it’s a wash, no new money created. The bank has less money–just like when I loan my brother $100 in cash I had stored in my mattress, he has more, but I have less; a wash, overall.
EXCEPT when debiting the bank’s reserve account would take it below its minimum reserve requirement (currently $0)–in which case the Fed automatically loans it enough to keep it above the minimum. But of course, in this case it is the FED that is creating that “new” money loan (to the bank) by making a keystroke “ledger entry” in the bank’s reserve account. Only the Fed/govt. can do that money creation, “out of thin air”, not the bank.
Note that if banks really could create money out of thin air, to give to borrowers, why wouldn’t they just create it and give it to…themselves! Their bank’s (and its stockholders’) net worth would skyrocket! Any banker worth her salt would do this in a heartbeat, except…this can’t happen–thank god; only the Fed can give new money to banks. Whether they need it or not… 🙂 Other than in bank bailouts, the Fed doesn’t do this except on a temporary basis.
AND, if the Fed, under routine conditions, has to consistently loan a bank too much reserve money like this, it will require the bank to sell (pre-existing) capital to raise its reserve account higher above the minimum required. Again, a wash–less capital, more reserve balances for the bank.
If you want to claim that this (MMT’s) “foundational” account of how money is created is in error, that’s fine, but no actual bankers believe it’s in error; and the explicit, Fed-clearing reserve account details of such purported errors would be nice to see–again MMT has many pieces tracing these mechanics in mind-numbing detail, which is probably what Kelton declined to bore her readers with.
The other criticism was that the govt. deficit does not tautologically equal the increase in net private sector financial asset wealth, contrary to MMT’s claim. Again, Kelton may have been unclear, but I’ve never seen that claim, in the proper temporal context, made by MMT’ers. They would of course agree that it is only true at the instant the deficit amount is spent/”created”–when the $1400 Fed stimulus check hits my bank account, my financial assets go up by $1400. If, next day, I cash it into $100 bills, then burn the bills, my wealth obviously goes back down by $1400–but how is this trivial fact important for the point MMT’ers wish to make about the deficit?
That point–which is not diminished by the fact that wealth (and its nominal valuation) can change AFTER the wealth is created–is that the deficit is seen by mainstream economists as nothing BUT a drag on the economy. Rather, MMT points out that it has a huge benefit: creating additional private sector wealth, little of which will be frivolously destroyed, much of which can be used for productive/investment spending, and changes in the nominal valuation of which, like all wealth, are subject to illusory bubbles and runs, which don’t affect the underlying “real” value nearly as much as they appear to. And against which benefit, the drag of paying it back (in later years) may be fairly low, especially since the govt. can create more money from thin air with which to do so!
It would be just weird if MMT had overlooked the two “obvious” points you cited–and they haven’t. MMT is very rare in economic theory, in that it routinely and carefully calibrates its ‘theory’ against actual banking and accounting practices. While any popular explication can of course be un-carefully or incompletely presented, the body of work itself does not have such obvious, glaring errors. It can still be wrong about any particular conclusion, but claiming it’s overlooked something totally obvious just reduces the credibility of such critiques.
While an 80 year old CEO of a relatively small group of private investment companies educated by personal experience more than economic literature, I was mesmerized by Stephanie Kelton’s book and later enthralled by a lunch with her collaborator Warren Mosler: MMT provided me with context with which to logically organize my experiences in the real world. As pleased as I am to see the growth in acceptance of the analytical tool that is MMT, I worry a bit about linking MMT to what we are seeing developing in the Biden Administration and the surrounding establishment: given the virulent objections and criticism discussion of MMT generates, might we be better off just letting the proof be in the pudding? So much of what MMT suggests as good policy is what Republicans have been practicing while blithely subduing their comments regarding the horrors of deficit spending and levels of National Debt, perhaps we shouldn’t call their attention to their willing participation in the Grand Experiment?
“…perhaps the next generation will learn macroeconomics as a parable of our own time…”
You seem to be saying that macro policy/economic theory making is dependent on the secular state of the economy – if its inflationary, supply side economics should apply – if it’s disinflationary, demand side economics should apply. To some extent this is born out by history. Classical theory seemed to be incapable of explaining the Great Depression, hence the rise of Keynesianism and fiscal policy solutions. The 1970s hyperinflation was treated as a supply side phenomenon, hence the emphasis on monetary policy. (This accounted for the supply side shock of the oil price rises – the inflation – but ignored the demand side shock of a massive transfer of income – the stagnation – from the West to the oil producing countries.)
Since the time of Keynes and the GT hasn’t there always been a tension between macroeconomic theories which stress the supply side (classical economics and derivatives) on the one hand and the demand side (Keynesian economics) on the other? For instance, the classical economists continued to emphasis supply side solutions during the Great Depression (“free markets will prevail in the end” and eventually return the economy to the long run trend). Hardly a novel observation, I know.
You seem to be saying that textbooks should be written to emphasize the demand side economics.
Is this healthy? Is this just as inadvisable as the emphasis on supply side economics that has occurred over the last 40 years and which has driven macroeconomics in to a backwater and morass?
I think of myself as a Keynesian (as much as I think I understand Keynesianism anyway) yet to discard the other brands of macroeconomic discourse seems to be not a wise move.
The “macro theory for our time” epithet might be as troubling as was the “peace in our time” epithet of the late 1930s. 🙂
That’s quite a compendium of economic error you’ve produced there, Josh. I feel sorry for you students – and I straighten them out whenever any of them come to me. (I straighten them out about public pensions as well: you’re utterly wrong about that too.)
All part of life’s rich tapestry. How’s life at IBO these days?
Very insightful and I buy nearly every argument.
Let’s say we do disregard debt/gdp and focus on a deficit rule based on yield vs growth, inflation, slack in labor markets etc. We will probably run economic policy that is more appropriate than the past decades.
But what happens when debt/gdp is, say, 300% and we are hit by an exogenous shock that pushes yields 5%-points higher?
It seems to me that we will risk more boom and bust cycles? With such a high debt / gdp ratio, there is further to fall, much greater dependence on financial market appetite for our bonds, and much more damaging consequences of unexpected rise in inflation. Inflation scares will trigger expectations of austerity and higher rates. Higher yields and austerity will be a double whammy to the “yield vs growth” parameter. Deficits will have to be cut further, and debt service swallows more of the remaining budget. Gdp falls and the the debt / gdp ratio balloons. Investors get more nervous. And so on.
Are such scenarios s a concern to proponents of this framework? If not, how are such risks managed?
It doesn’t make sense to talk about an exogenous shock to yields. The interest rate on Treasury debt is under the control of the Fed. One of the major lessons we’ve learned over the past decade-plus is that “financial market appetite” is not relevant for public debt.
“Inflation scares” may well occur. But the only way they translate into something like your scenario is if the Fed validates them. So the answer is, don’t do that.
Just to chime in on macro for these times. This is looking more and more like a teachable/learnable moment with regard to supply constraints. Large fiscal stimulus, Fed willing to overshoot 2 per cent. Loose/loose fiscal/monetary policy mix. Macro for these times may involve ditching the idea of potential GDP in favor of some version of path dependence/multiple equilibria. In fact, that should already have happened after the GFC. Why are Summers, Blanchard, etc., resisting? Maybe because they are policing the left flank of the Overton window. The challenge here is to resist the inflation hawks so that we can let this natural experiment play out. I don’t see the working class losing from that. The outcome will be a high-pressure labor market. Its not so much Keynes or the classics (here I mean Marx, not Marshall), demand or supply. Its Keynes and the classics.