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Rep. Alexandria Ocasio-Cortez has said it “absolutely” should be part of our conversation about the economy. During the presidential campaign, Sen. Bernie Sanders’ chief economist was an adherent. But what the heck is Modern Monetary Theory? On this episode, economist and AEI scholar Stan Veuger breaks it all down, discussing his latest article for AEI Economic Perspectives titled Modern Monetary Theory and Policy.
Stan Veuger is a resident scholar here at AEI where he specializes in political economy and public finance. What follows is a lightly-edited transcript of our conversation. You can download the episode by clicking the link below, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.
PETHOKOUKIS: Modern Monetary Theory is an economic idea that’s sort of been bubbling around for a while on Twitter, I mean that’s where I saw it but it’s sort of now entered the political landscape. There are politicians talking about it now with greater or lesser specificity, they may not call it MMT, Modern Monetary Theory, but they seem to like the idea. What is the idea — what is it, and what isn’t it? What is its central claim?
VEUGER: The central claim of MMT is that if you have borrowed money in your domestic currency, in your own currency, the currency that you as the government create, then you can always pay back those claims.
Right, that’s what we do in the United States.
It is. Yes, so it is the idea is that the US government can create more dollars and then it can use those dollars to pay its debt. That’s the central idea.
That does not sound very interesting. That sounds like something that’s not a controversial statement. So why are folks on the left and Democratic politicians talking about this theory if that’s the central claim?
Because there’s a few economists and other people who have turned this relatively uncontroversial claim into a broader political agenda. And so what they say is, because you can always live up to the financial obligations you incurred in your own domestic currency, that means that there are no real borrowing constrains that you have to take into account. That is, I think, a fair representation. Now, some of the people who associate with this movement will push back and say no, we do believe in resource constrains and things like that — but only when they receive push back. They typically do frame the idea as allowing for extrapolation from we can pay back what we owe in our own currency to we can take on significant additional spending programs without running into any kind of macroeconomic constraint. Now, one thing to keep in mind is that part of why this theory, if you want to call it that, is poorly defined is that it’s never really been spelled out.
There are very few explicit academic style articles on the topic. There are no real articles in serious academic journals. You know, there’s a book titled “Modern Monetary Theory” that’s by one of the proponents, someone who’s at the University of Missouri-Kansas City. But, that book also contains some content that other people who, on Twitter, identify as MMT proponents would not necessarily accept.
And so I think it’s hard to move in specific terms beyond one, the undisputed idea that you can pay off debt owed in your local currency, and two, that a lot of the proponents of the theory as a broader concept would like to see more public spending and are not worried about paying for it.
Do you have a sense of the path this idea has taken? Now you have politicians like Rep. Alexandria Ocasio-Cortez talking about it, and I also see other people talking about it. Again, they may not use the phrase. They seem to have heard the idea that there’s a way that we can get our spending agenda through without having to raise any taxes anytime soon. So how did this emerge?
Yes. I think it moved from a couple of heterodox economics departments to the policy sphere in a couple of ways. So there’s some blogging about it, certainly since the fiscal policy changes induced by the Great Recession and one of the leading PhD economists, who was a proponent of MMT, has long been a Democratic political operative. Stephanie Kelton worked for the Senate Budget Committee and then she was chief economist on Bernie Sanders’ presidential campaign. So she is really an important link between the few academic economists who think that these ideas are important, and the policy dialogue, and then for some reason it is also very popular on Twitter.
But was this idea sort of out there 10 or 20 years ago and no one paid attention to it, and then because of the Great Recession, because there is a huge debt, and because there was much questioning of traditional economics, their idea was given space to emerge? Or, is there something newer about it?
No, actually the MMTers, the movement claims much older intellectual origins. Origins that go back to before the neoclassical, the new-classical economists, and the new-Keynesian economists. So they go back to the 50s and the 60s when people still believed in an unmovable Phillips curve, those kind of neo-Keynesian economists are ones they often refer back to. So, you know, at least the lineage they claim goes back pretty far. The uptick in popularity is certainly related to the fiscal austerity policies we’ve seen since the Great Recession. I think some of the pushback on calls for tighter fiscal policy, and certainly tighter monetary policy, since the Great Recession has been justified.
I just don’t think that the jumps they’re making are particularly useful. Obviously, there’s been pushback from mainstream monetary doves too. People who think, even now, that the Federal Reserve shouldn’t be tightening, and there were people in 2010 who thought that European countries and the US should run larger fiscal deficits. I mean that’s fine. That’s a position a lot of people held. None of that has as much to do with what the MMT people specifically claim as arguments for those policy stances.
Right, so you’ve sort of had this environment where people were unsatisfied with the answers and policies they were given: worry about debt, worry that the big deficits are going to cause high inflation. So there has been a pushback, which has now resulted in a different way of looking at those issues. But again, what I’m trying to get at is, is it really just the framing device that’s new, and this is just another way to justify looser monetary policy or more spending? Or is there a new kind of economics? You were talking about how it really all goes back to the 50s and it’s Keynesian. Is that really all it is?
No, so that’s the lineage the MMT claims. I think there’s less to it than that. So if you look at the book I mentioned earlier by L. Randall Wray, who’s at the University of Missouri-Kansas City, 80 percent of the book is account balances. So, it shows how the money goes from the Central Bank to the Treasury. There are some assets in the private sector, there are some assets abroad. It’s a lot of moving things around on balance sheets. The only really substantive economic point there is, again, that governments can pay off debt they owe in the currency they create. And so, it feels like there is a lot of thinking going on, but in terms of economic substance it’s very little.
Do you think the proponents felt the need to sort of drive that point home, since after the Great Recession you heard a lot of concern that the US was going to go bankrupt, that it couldn’t borrow, that credit markets were going to shut down because of these huge trillion-dollar deficits? Is what we’re seeing kind of like an overkill to remind people that, hey that’s not what economics says, and here’s why?
Yes, I think that would be a generous interpretation, but I think that’s true. I don’t know, there probably are people who believe that you can’t just create money to pay off your domestic currency denominated public debt. I don’t really understand why you wouldn’t believe that and I don’t really see a counter-argument to that very narrow point.
But, this is sort of basic economics, that if you have debt in your own currency, you can print money. Is that a concession you’re making? I think MMTers view that as a concession.
I think it would be a concession if I said that there were no potential downsides to printing money. And there are many potential downsides to that. So, let’s talk about two. The first downside, which is particularly important for the US context, is that if you create enough new money, at some point inflation will go up. That was a big issue in the 70s and it is precisely why much of modern economics kind of ditched the intellectual predecessors of the MMT movement because we ran into stagflation. The second point I would make is that policy makers are aware of the fact that they can just create more money and pay off their domestic currency denominated public debt, but in some situations they don’t do that precisely because there are downsides to it. So there’s work by Wenxin Du at the Federal Reserve Board, Jesse Schreger at Columbia, where they simply show that if you look even at domestic currency denominated sovereign debt, markets price at a default risk. And we’ve seen situations in the past where countries have chosen to default on their domestic currency denominated public debt. For example, in Russia in ‘98, Mexico in ’94. And there are good reasons for that. One clear one is that if you created a lot more new domestic currency, your exchange rate may depreciate. Now, if there are domestic firms who have a lot of foreign currency denominated debt and their balance sheets are confronted with this depreciating exchange rate, then they will not be able to pay to live up to those foreign currency denominated debt obligations. And so there are real downsides to just cranking up the printing presses, and if you don’t acknowledge that then your theory is incomplete.
Do you feel that’s not being acknowledged?
Well, it’s certainly not something they’re open about, which is remarkable for something that refers to itself as a monetary theory, right? You’d think there would be a theory of the price level which is something that monetary economics is often very concerned with. And so, what they try to do is avoid talking about how they would deal with problems like that. Because, sometimes they’re pushed on it and they will say yeah sure, if that happens we’ll just raise taxes and that will, as they say, remove the money from the economy. But at the same time they try to be a bit slippery about that and say no, actually that’s not what we’re going to do.
Are they saying something different about inflation at all? Because it seems to me that they point to the current inflation rate and the fact that we’ve had big fiscal deficits, and say inflation has remained very low. Are they saying something different maybe building on this secular stagnation idea, does that come into play here?
Well, they do say those things. That’s their first line of defense when you say, ‘well look we can’t just create as much money as we want and use it for public spending programs.’ The first line of defense is that, rather than that inflation is low, but that’s not different from what other more mainstream monetary doves say, right? At this point it’s not even different from what most former monetary hawks say. So I don’t think that the theory as such adds any anything new to that. Where they have — and I think this is a reasonable interpretation from the writing of at least a good subset of the MMT proponents — a different view on inflation and how to deal with it is when that first line of defense is removed. You say, sure fine but what if we do get inflation, and then they say okay then we use tax policy, fiscal policy. Right, which is different from the sort of more mainstream view where the monetary authority is in charge of controlling inflation.
So it’s kind of a “world turned upside down” approach to macroeconomics right, where you have the Federal Reserve in charge of financing these programs, whether it’s Medicare for All or a job guarantee. So they will print the money to finance those programs and then it will be up to Congress — if somehow inflation isn’t forever and always low — to drain the system of that money through tax increases?
That’s right. The House Ways and Means Committee and Senate Finance.
Well that seems novel, is that novel? Is this what excites them?
Yeah, yeah, that’s novel. I would say this is the core of the substantive novelty, right? I think that is a very bad idea to make that swap and put elected officials in charge of price stability while putting the monetary authority in charge of financing large public programs. But I do think that that’s really at the heart of what they’re thinking get at — the problem is that they’re never particularly explicit about this part of the Modern Monetary Theory. In part, of course, because this is not the popular part.
The popular part is the ‘we have a way to get your program to spend a lot of money and we don’t have to go through the difficult process of raising taxes?’
That’s right. The unpopular part is when inflation escalates we’re going to raise your taxes and if Congress isn’t fully functional, then we’re not going to deal with inflation. That seems like a bad institutional design.
Under such a system what do you really need a Federal Reserve for? Why don’t you just have, merge it with the Treasury Department?
I think that’s what they have in mind. The Federal Reserve would, I guess, do the equivalent of open market operations but to Medicare providers.
Yeah, or financing the checks going to the job guarantee people. So that is not a central bank as we currently envision it, right?
So there’s a weird line of logic that I don’t understand at all among MMTers, much less so than this ‘okay, we’re going to use taxes to ensure price stability.’ Sometimes some of the proponents of Modern Monetary Theory say that actually the job guarantee program, The universal job guarantee program, is what will keep the price dynamics from spinning out of control. It’s very unclear how this works, but the logic is, okay, well you give everyone a guaranteed fifteen dollars an hour job, and that fifteen dollars an hour, that somehow fully determines the price level. I don’t understand how that works at all, but that’s the only alternative I’ve really seen them spell out, the only alternative to the previous two options we’ve mentioned. One, we just don’t believe that inflation is going to be an issue, and two we’ll use tax policy to ensure price stability. The only alternative to those two options that I’ve heard is this, that somehow the job guaranteed program will ensure price stability. I don’t really understand how that would work. You would think that if that works, then surely what we have now, which is Medicare fee-for-service payments, that would also ensure price stability, and yet no one believes that.
So where does the confidence come from that politicians in Congress will take this kind of unpopular action, that they will do that? Especially when we’ve seen central banks, at the behest of politicians, make very bad decisions — which is why we try to have independent central banks — where does the confidence come from that flipping that around is going to work better?
Well, so I think this is why they are often hesitant to talk about this backstop.
Is this like an anti-technocrat kind of populist thing? Or intellectual cover for it?
I’m not even sure that’s the case, I think that they just want the additional social spending and MMT provides I guess the intellectual veneer for doing that. I think this is why the proponents become a little evasive when you press them on how to deal with inflation, and how they sometimes contradict themselves. It’s precisely because I don’t think they’re super confident that having the House Ways and Means Committee in charge of ensuring price stability is a good institutional design.
Well, couldn’t you create some sort of independent body?
So you could have an independent fiscal authority instead of an independent monetary authority. The concern there has typically been that fiscal policy choices often include many more direct distributional choices than monetary policy does.
The idea we’re going to have a panel of unelected technocrats and they’re going to figure out who pays what tax rate and what tax credits maybe get reduced. That does seem like the job of Congress, right?
Yeah, those choices are much more inherently political than the monetary policy choices, whatever concerns you may have about those. But, I think if you had to rank order them by what are the more politically sensitive choices, I’d say tax choices are more politically sensitive than setting the federal funds rate. That’s what it would come down to. So the thing is they don’t want to go down this route this far. So I’ve never seen an explicit institutional design featuring an independent fiscal authority.
Alright, do they have a point? Because I’ve seen some more traditional left-of-center economists and they’ll say, ‘well listen one thing this does, it does kind of reframes the issue a little bit and we’ve been too worried about debt.’ I mean we’ve seen the debt-GDP ratio double over the past decade with no apparent impact on inflation or ability to borrow. So to the extent that this trend nudges policy in a direction that seems to worry a bit less about debt, it’s a good thing. So do the MMTers have it more right than the people who were pushing for Simpson-Bowles and who were saying we need to dramatically reduce the deficits? Is their story, given what we’ve seen the past, more right than that story?
No. Well, I wouldn’t say so because again, I don’t think their story — in the parts that are useful — adds much to what people have been saying. People have pointed to Japan and said ‘look they have a massive amount of debt and they’re doing just fine.’ You know, I don’t think the US itself — we’re running at 3.7 percent unemployment and we’re a running 5 percent of GDP fiscal deficits. I don’t think in that debate, that the people who say deficits don’t matter and that we can just go ahead and spend need more help. I think they’re doing fine just by themselves.
As you look at what the left and the right have been saying about debts and deficits, has the fact that folks on the right have their own theory of supply-side economics, which says, debts and deficits don’t matter, we should cut taxes, tax cuts will in many cases pay for themselves, and in more extreme versions, all tax cuts seem to pay for themselves, given space for this idea to percolate?
Well yes, I do think in many ways it’s the left-wing equivalent of the ‘we’re always to the right of the peak of the Laffer Curve’ thinking, which we’ve seen on the right in the US over the past couple of decades. For example last year when the Tax Cuts and Jobs Act passed, basically every senior Republican elected official said, ‘no, it’ll pay for itself.’ Say what you will about the world which derived the Laffer Curve guys. They’ve definitely convinced a lot of elected officials. I think that’s bad, I don’t think that’s good. And so I’d be disappointed if the MMT guys succeed in doing the same thing to the center-left.
Do you think that current federal debt levels are anywhere close to being a problem? Whether it’s the debt or the deficits, which are also supposed to rise. People always ask me what is the danger zone? Is it that debt as a share of GDP, is it 100 percent, is that the danger zone? Are we anywhere near that danger zone?
Well, I think one of the issues is that we don’t really know where the danger zone is, and I’d say lower is better than higher. We also have to remember that whatever the danger zone is, higher federal debt levels crowd out private sector activity, whether or not you’re worried about an immediately looming financial crisis. Think of this past year. I think there’s pretty broad agreement that without the increased deficits from the tax bill, fiscal stimulus, and the spending bill fiscal stimulus, I don’t think we would have seen interest rates rise as much, and so we wouldn’t have seen that much crowding out of the private sector.
Again, is that a theory that’s in dispute at all, the impact of deficits on the crowding out of private enterprise — and do MMTers challenge that?
So, it’s hard to think of how they think of interest rates because their theoretical framework is balance sheets, right? So there are no dynamics. In the end, the interest rate is the relative price of consumption in one period and another, and that there are no multiple periods in their economic thinking. So I wouldn’t be confident saying one way or another, whether they are concerned about that just because I’ve never really seen them develop a theory of how investment works. So this is a in a sense a big difference with sort of other modern macro-economic theories, right? So their models are basically accounting balance sheets, whereas all modern mainstream economics starts from optimizing agents and firms who plan ahead, who try to invest so as to reap benefits in future periods. None of that is in their work. I don’t really find it easy to think of interest rates in the context of their theories.
I think some proponents would say that if you look at what the economy has done over the past decade, that the performance and particularly what we’ve seen with inflation should cause mainstream economists to take pause and think hard about whether they have the story right. Have you done that? Does anything, whether it’s persistently low inflation changed your thinking at all? Because there have been a variety of theories that have popped up to say that we had it wrong and now we’re suffering from secular stagnation and persistent lack of demand, and we need to do something different. Has anything happened in the past 10 years about how you think about these issues?
Well, I haven’t been particularly worried about inflation over the past ten years, and I think that the people who were worried have indeed changed their minds. We’ve seen that even in practice, the European Central Bank basically made a 180 on its monetary policy stance after they realized and that there was no reason for them to be as concerned about inflation as they were right after the crisis hit. So I do think we’ve seen people reconsider really how large the inflation threat was in the early recovery from the financial crisis. I don’t think that has required a fundamental reshaping of their theoretical framework. I think they’ve just learned more about the way the economy works. And I think that’s been helpful. I don’t think that the MMT framework would have helped them much in 2009 because there’s nothing even approaching empirical implementability.
So say it’s 2008 and if we were all MMTers, what does the government do in reaction to an economy that seems to be collapsing?
I don’t know I would imagine it implements a universal jobs program. And so then we get to 2012, the federal government now employs an additional, maybe 20 million people, and those people are going to be employed by the federal government. It’s really hard to think of that kind of counterfactual — especially if you implement it right when lots of people are losing their jobs. Presumably, they will all get hired by the federal government. It’s not clear what they will do. They’ll be employed at fifteen dollars an hour. It’ll take a long time for the private sector to want to rehire them. It’s tough. Again, there isn’t much in terms of quantification in the theoretical framework. I don’t really know how to think about that. But I think that would be the first order impact, that the federal government would employ a lot more people than it did otherwise.
It’s a question I get asked a lot, I’m not sure I give a very good answer, but why is inflation still so low? It seems unemployment is very low, there’s all this stimulus in the system, and yet inflation seems low too.
Well, I think it’s about where it is because that’s what the Federal Reserve’s inflation target is and so when inflation threatens to rise above 2 percent, the Federal Reserve raises interest rates as it has been doing consistently for a couple years now.
The Fed has not been proven powerless. In fact, it’s been proven effective at keeping inflation down, right?
Yes exactly, and it took really drastic measures during the Great Recession. I don’t really understand why the MMT people aren’t giving them credit for it. They took extraordinary measures that I don’t think anyone could have predicted in 2005 and so in that sense they did what they were supposed to do. But again, the reason why inflation now is low is because the Fed sets an inflation target and they’re trying to stick to it.
Right, does part of this stem from the fact that this appears to be a novel way of looking at the world, and a number of things have happened. For example, there have been a number of theories proposed over the past decade to explain what we’ve seen in the job market and why the recovery has been weaker than what some people might have expected, including this secular stagnation theory from Larry Summers. These theories often point to corporations not investing because they’re all short-term oriented, or that the labor market has changed and we now have a gig economy, or that there’s too much monopoly to explain what many people view as a malfunctioning economy. Is the right answer or simple answer still that we had a banking crisis, housing crisis, and financial crisis all rolled up in one 10 years ago and boy, it’s taking a while to heal.
Yeah, I think that’s right. And so, a bunch of the theories — a few of the things you mentioned are a little more recent vintage — that people were very worried about earlier on during the depth of the Great Recession, have bit-by-bit been proven not that concerning. You don’t hear people talk about the work disincentives in the Affordable Care Act as much anymore. Even though Casey Mulligan used to argue that that was basically what explained all the job losses during the Great Recession.
The idea that uncertainty about Obama economic policies was a depressant?
Yeah, I think that policy uncertainty is still not very helpful. I think we now see on the trade side that that’s still an issue, but it is certainly not the only thing that explained the depth of the Great Recession. I think recovery just takes a while. Recovery from financial crises has always been slow.
And then just as we wrap up, MMTers, again they’re not happy with the Fed. Do we need a new — and maybe it isn’t Modern Monetary Theory that we’re getting — theory of monetary policy? Or do the central bankers already have it right?
What I would like is a more explicitly developed version of Modern Monetary Theory. If that is what we’re going to engage with, then I would like for them to answer questions about the institutional design they have in mind, I would like to see them try and quantify some of the mechanisms in their work, that kind of stuff. That seems like a good way for them to spend some of their intellectual energy.
I’m going to end our chat the same way you end the paper, which is a concern that MMT could lead to hyperinflation, which doesn’t necessarily mean wheelbarrows full of money, but it does mean much higher inflation than we’ve seen in this country in a long time. Do you think that’s a genuine risk? And what do you mean by hyperinflation?
What I mean is that if you take MMTers at their word in the most aggressive sense, then what you would see is a massive debt finance expansion of the welfare state with Medicare for All, with a jobs guarantee, and with concerns about inflation being deferred entirely to elected officials who would have to raise taxes to keep it under control. I think in a scenario like that, we do run a risk of going back to the 1970s pre-Volker style macroeconomics and I think that would be bad.
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