Nonsense economics: the rise of modern monetary theory

Is John McDonnell a neoliberal? This sounds almost too obvious for John Rentoul’s famous list of “Questions To Which The Answer Is No.” But for some proponents of “Modern Monetary Theory” (MMT), Labour’s adoption of a “fiscal credibility rule” (based in part on academic work by Simon Wren-Lewis and me), means that “Labour is committed to the thinking which will deliver more austerity.”

MMT has become increasingly popular in some quarters on the left, both in the UK and abroad. Here influential supporters close to the Labour leadership include Paul Mason and Chris Williamson MP; in the US, one of its leading theorists is Stephanie Kelton, who was an economic advisor to Bernie Sanders. Democratic rising star Alexandria Ocasio-Cortez has also expressed interest, suggesting it might help finance ambitious plans for healthcare and a “Green New Deal.” So, MMT has moved away from the fringes and into the centre of the debate amongst those who agree that we need to spend more—perhaps much more—on public services and public investment, but disagree on what that means for borrowing and taxes.

So what is MMT—and what would it actually mean in policy terms for the UK? The UK’s most prominent proponent, Richard Murphy, sets it out here.

“First it says governments can make money out of thin air, at will... MMT then says all government spending is in fact funded by money created in this way, created by central banks on the government’s behalf… MMT logically argues as a consequence that there is no such thing as tax and spend when considering the activity of the government in the economy; there can only be spend and tax.”

The problem with this is that it is either obvious or misleading. The first point—that (fiat) money is ultimately a governmental construct in modern capitalist economies, and central banks can indeed produce as much of it as they want—is not news, certainly not to “orthodox” economists, as MMT proponents might label Wren-Lewis and me.

But it’s the second point that matters. What does it mean to say that “there can only be spend and tax” rather than “tax and spend”? Both from an economic perspective and from a common sense one, taxing and (government) spending happen at the same time. It’s not much help to tell a chancellor trying to write a Budget—setting out her tax and spending plans—that reversing the order would magically solve all their problems.

Richard argues that what it means is “that there is no requirement per se to balance the government’s books”—and that fiscal rules of the sort Labour proposes which, even if they don’t target balanced budgets, impose any constraint on the deficit are therefore damaging and unnecessary.

But again it’s necessary to unpack this. If what MMT is saying is that budget deficits don’t matter because a sovereign government that prints its own currency (like the US, UK, or Turkey, but unlike eurozone countries) can, in principle, never be forced against its will to default, this is broadly correct. Politicians who say that “we risk going the way of Greece” or “there is no money left” are scaremongering: a point made very forcefully by both Wren-Lewis and myself back in 2011.

But MMT goes farther than this. First, it says that deficits are positively necessary for growth. Since it’s government deficits that ultimately create money, without a deficit demand will inevitably be below what’s needed. As Richard puts it: “A government with a balanced budget necessarily denies an economy the funds it needs to function.”

But this isn’t true as a matter of economics, theoretical or empirical. Money is ultimately a creation of government—but that doesn’t mean only government deficits determine the level of demand at any one time. The actions and beliefs of the private sector matter as well. And that in turn means you can have budget surpluses and excess demand at the same time, just as you can have budget deficits and deficient demand. Remember that the UK’s budget was in surplus in 1987, at a time when the economy was in an unsustainable boom. Germany has been running surpluses for years.

Does MMT then argue that governments can simply spend whatever they like? This is perhaps the nub of the issue. There are certainly some who think that MMT is indeed a “magic money tree” and that, for example: “as a sovereign nation, the UK can always afford high quality universal NHS healthcare.”

The problem is obvious. Bangladesh is a sovereign nation just as much as the UK is (meaning, in this context, that it has its own currency managed by a central bank that is under the ultimate control of the government). But, no matter how large a deficit it ran, Bangladesh couldn’t afford universal NHS-quality healthcare for its people. It simply isn’t rich enough—it doesn’t have the doctors, nurses, or hospitals it would need. And this is the crucial point—if it tried to buy them and printed money to do so the result would mostly be inflation, with more money chasing a restricted supply of doctors and so on.

And the same applies to the UK. Yes, the UK can afford a high quality NHS. And education, and welfare system, and so on. But the idea it can do so without raising taxes is for the birds.  Sure, the UK could run very large budget deficits, even with unemployment low. But the result would still be the same as that predicted by conventional economists. Inflation would rise. You can create money out of nothing, but you can’t create doctors, schools, or consumer goods.

And no matter what the Bank of England did, long-term interest rates would rise, as the private sector—not just “markets” or Goldman Sachs, but ordinary businesses and households—observed that we were not just spending more than we were taxing, but that we were consuming, or trying to consume, more than we were producing, and that inflation was the inevitable consequence. We wouldn’t become Turkey overnight—but the logic is the same.

To be fair, the credible proponents of MMT recognise this. Murphy also argues that MMT “has a clear interest in restraining inflation” and this means “taxing sufficient government created money out of existence in a period to secure this goal.”

And this is really the key. For the last 30 years at least, the conventional approach to macroeconomic management has been to use interest rates, not fiscal policy, to control demand and inflation. Wren-Lewis describes this as the “consensus assignment.” MMT reverses this—under MMT, fiscal policy is the main tool.

This may well make sense when interest rates are at or close to zero. But that’s no longer controversial, and was explicitly recognised by government policy during and immediately after the 2008 financial crisis. And it’s an integral part of Labour’s fiscal rule. Equally, it also means that MMT—at least the credible version—does not mean there is no limit to deficits, just a different one, dictated by the potential impact on inflation. MMT isn’t a magic money tree after all. And what does this mean in practice?

Here’s where the proponents of MMT end up tying themselves in knots. Murphy says: “Experience in recent years has suggested that total tax revenues should be less than total government spending or additional money supplies required to ensure the liquidity to permit growth is not present in the economy. The differential expressed as a percentage of GDP might well be close to the desired inflation rate.”

If this means anything coherent at all—there seems to be a misplaced “not,” but even so the logic or economics here baffles me—the implication is that the government’s debt should over time grow broadly in line with nominal GDP, with ups and downs reflecting cyclical movements in the economy. But this is about as orthodox a policy prescription as you can get. It’s certainly entirely consistent with what Wren-Lewis and I have written. So in the end MMT, having begun by arguing that a conventional fiscal rule is a neoliberal plot to entrench austerity, seems to end up in much the same place.

Worse, it’s easy to point to circumstances where on the face of it a naïve MMT-based approach would have pointed you in precisely the wrong direction for the short term. For example, in 2011-12, when inflation rose sharply, even as the economy remained weak.  Wren-Lewis and I argued strongly at the time that deficit reduction should have been slowed, not accelerated. MMT—unless you reintroduce some more orthodox thinking via the backdoor—would tell you the opposite.

So in the end I, like many others who opposed both the dishonest rhetoric and the unnecessary economic damage of post 2010 “austerity,” find the arguments of MMT proponents frustrating. It was easy enough to point to the empirical evidence that showed that many of the justifications for austerity were simply wrong. But MMT is in many respects not wrong: instead, it is a mixture of the tautological, the obvious and the tendentious.

But one thing is absolutely certain. The claim that that MMT means that a future government can dodge hard choices about how to pay for decent public services is just plain nonsense.