Nice piece here from Gareth Hutchens at the ABC:
We may be on the cusp of a revolution.
What if everything we thought we knew about public finance over the past 40 years has been wrong?
A new economic theory has emerged that could rewrite our understanding of how governments create and spend money and what type of society we can afford to build.
And if it is correct, people may be furious.
Because it could show that Australia’s political elite can afford to spend far more than they are on public health and education, social housing, scientific research and green energy schemes, while eliminating unemployment.
And yet they’re not — either from a misunderstanding of government finances or because they don’t want to.
However, to embrace this radical economic theory you will have to forget what you’ve learned about budget deficits (that they’re bad) and government debt (that it burdens future generations).
Why?
Because proponents of the theory say that far from being a problem, budget deficits are often a good thing — they can be the source of healthy economic growth.
They argue a country like Australia that controls its own currency doesn’t need to tax or borrow before its national government can spend money — the government can create all the money it needs to fund itself … within limits.
It all sounds too good to be true, which is why critics warn the theory is naive, simplistic and potentially dangerous.
But supporters of the theory — who are growing in number — say many of the world’s problems today (extreme wealth inequality, poorly funded public hospitals and schools, chronic underemployment, stagnant wages) are a consequence of misunderstanding government financing.
They say macroeconomic theory — which looks at the bigger picture of how the national economy works — has got too many major questions wrong.
So what are we talking about? Let’s take a closer look.
MMT is challenging the orthodoxy
The theory is called Modern Monetary Theory (MMT).
It is challenging the neoliberal economic orthodoxy that has dominated policymaking in Australia, the United States, the United Kingdom and many other countries since the mid-1970s.
The reigning orthodoxy assumes a couple of things.
Firstly, it assumes every country has a “natural rate” of unemployment and it’s unwise to try to force the jobless rate below the natural level because inflation (and wages) will rise too quickly. Therefore, it assumes it’s better to accept a certain amount of unemployment to keep prices stable (and to keep wage demands weak).
At the moment, Australia’s natural rate of unemployment is assumed to be somewhere between 4 and 5 per cent.
Secondly, the economic orthodoxy holds that the national government needs to collect taxes, or borrow from savers, before it can spend money.
Politicians repeat this point incessantly.
When you hear a politician saying the government must “live within its means,” what they’re really saying is the government mustn’t spend more than it collects in taxes or borrowings.
However, MMT economists want to turn these orthodoxies on their head, among others.
What is MMT?
MMT is a school of economic thought and a political project (more on this later).
Its proponents are not shy about their intentions to shake up the establishment.
The people who developed it have been working on the body of theory for decades, quietly, in countries such as Australia and the United States, but their ideas have recently burst out into the open as global leaders search for fresh ideas to deal with the unprecedented economic crisis of 2020, and the lingering effects of the global financial crisis in 2008-09.
MMT economists make several claims:
Firstly, they say we’ve been thinking about budget deficits incorrectly.
They say budget deficits are not always bad. In fact, deficits are often necessary and beneficial. A budget deficit is merely evidence of extra government spending, and government spending boosts the wealth of private sector businesses and households.
They say it depends what deficit spending is used for. Increasing the deficit to finance a war is not the same thing as increasing the deficit to build more hospitals and schools.
They argue investments that will enhance productivity through better health, greater knowledge and skills, improved transport and the like are worth funding, even if it results in a budget deficit.
Secondly, MMT economists say we’ve been thinking about government spending incorrectly.
They say the argument (promoted famously by British prime minister Margaret Thatcher) that national governments must tax or borrow before they can spend is wrong.
MMT argues it’s the other way around — national governments have to spend money into the economy before they can tax or borrow. Government spending actually precedes taxation.
Accepting this proposition is key to embracing MMT.
Thirdly, they say taxes are necessary, but not for the reasons you may think.
They say government taxes can be used to keep inflation under control, to control our behaviour (via fees and levies and rates), and to get us to produce things the government needs.
MMT economists draw on the ideas of chartalism to make this last point. They say governments use taxes to create demand for their own currency — that is, if a citizen has to pay tax then they’re going to have to work to earn the currency to pay the tax in that currency.
Essentially, governments use taxes to put everyone to work.
“At the end of the day, a currency-issuing government wants something real, not something monetary,” writes Professor Stephanie Kelton, one of the highest-profile MMT economists and a senior adviser to Bernie Sanders in both his 2016 and 2020 Democratic presidential primary campaigns.
“To get us to produce things for the state, the government invents taxes or other kinds of payment obligations.”
Fourthly, MMT economists say countries that issue their own fiat currency can afford to buy anything that’s available for sale in their own currency, and they can never go bankrupt in their own currency.
“Fiat” money is government-issued currency that isn’t backed by any commodity, such as gold. It’s paper or digital money that has no intrinsic value. We’ll return to this point later too.
Fifthly, MMT economists say “full employment” is not only possible, it’s a moral imperative. Anyone who wants a job should have one.
They say we must prioritise genuine full employment and governments should spend whatever is necessary to achieve it — no matter the debt or deficit.
Sixthly, MMT economists say the national government should run a permanent “Job Guarantee” (JG) program to provide a job to everyone who wants one.
They say it could be linked to other economic and social programs, such as a “Green New Deal” — a policy advocated by MMT proponents linked to the US Democratic senator Bernie Sanders, to create jobs by shifting to zero-emissions technologies.
Which countries could MMT apply to?
MMT’s principles couldn’t be applied everywhere immediately.
MMT economists say they’re specifically talking about countries with floating exchange rates that issue their own fiat currencies — countries like Australia, Japan, the UK, Canada and the United States.
The theory couldn’t be applied as easily in European Union nations, for example, because those countries have ceded currency sovereignty by all agreeing to use the same currency, the euro.
There would be many hurdles to jump for MMT principles to work in the EU.
What’s so special about fiat currencies?
MMT’s theorists say world leaders still haven’t come to terms with the demise of the Bretton Woods monetary system in 1971.
During that era (1945 to 1971), certain currencies were pegged at agreed fixed rates against the US dollar, and the US dollar was supposed to be backed by gold reserves so it could be exchanged on demand for a fixed amount of gold held by the US government.
But that system was abolished by US president Richard Nixon in 1971 when the US admitted it did not have enough gold to back its currency.
After that, the US and other major sovereign currency issuers (including Australia) adopted “fiat” currencies — currencies with no intrinsic value, that aren’t backed by gold — with floating exchange rates.
MMT economists say this is significant because it means those countries (such as Australia, the US, Canada, the UK, Japan) no longer have to fear a shortage of gold, and that leaves them free to print as much money as they need to fully employ their “real” resources — workers, factories, machines, raw materials — within limits.
That insight is not new, nor particularly radical.
In a speech in 1997, then-US federal reserve chairman Alan Greenspan said central banks in the modern era could issue currency without limit.
“When there is confidence in the integrity of government, monetary authorities — the central bank and the finance ministry — can issue unlimited claims denominated in their own currencies and can guarantee, or stand ready to guarantee, the obligations of private issuers as they see fit,” Greenspan said.
MMT economists say the reality of this situation seems to have been forgotten, but policymakers should remember it.
Does MMT apply to all levels of government?
No.
MMT only applies to the national government level, because that’s the level of government with the power to issue the sovereign currency.
Local governments must behave like households when making spending decisions because they’re currency users, not currency issuers like the national government.
What exactly is the Job Guarantee?
The Job Guarantee is a central component of MMT.
MMT economists say the national government should ensure that everyone who wants a job has a job.
Why? Because unemployment is socially destructive and wasteful.
They say “full employment” should be a national priority, like it used to be in Australia: between 1945 and 1975, full employment was an official part of Australia’s national economic program, and the Federal Government felt obliged to ensure it.
However, full employment was abandoned in the mid-1970s. It was replaced by an acceptance of the so-called “natural rate” of unemployment, which is assumed to be around 4 or 5 per cent unemployment.
MMT economists say the idea of a job guarantee is not radical. The basic human right to a job is outlined in Article 23 of the UN Declaration of Human Rights and in former US president Franklin D Roosevelt’s call for an economic bill of rights.
Australian economics professor Bill Mitchell is one of the founders of MMT and one of the originators of the Job Guarantee idea.
Mitchell says it would work like the “Wool Floor Price Scheme” introduced by Australia’s government in 1970.
The Wool Floor Price Scheme was used to stabilise the incomes of farmers by ensuring a steady price for wool each year, irrespective of the volume of wool farmers could deliver to the market after each clip.
Under the system, the Australian Wool Corporation would purchase stocks of wool from auction markets when demand was low and sell them when demand was high — helping to keep wool prices stable.
“By being prepared to hold ‘buffer wool stocks’ in times of low demand and release them again in times of high demand, the government was able to guarantee incomes for the farmers around the stable price,” Mitchell has explained.
Have you noticed those old red-brick woolsheds near the wharves in Australia’s cities and towns?
Many have been turned into apartments or offices. But that’s where surplus wool stocks used to be kept under the wool floor price scheme.
A job guarantee program would work similarly to the woolsheds.
It would play the role of an “automatic stabiliser” in the economy by employing more people during downturns and fewer people during boom times.
In downturns, it would provide jobs for whoever wanted one — soaking up surplus workers who had lost their jobs — helping to prevent incomes falling below a living wage.
Mitchell says in an economy that adopted the MMT policy framework, the Job Guarantee would give rise to a “Buffer Employment Ratio (BER),” which is the ratio of Job Guarantee employment to total employment, which economists could use to track inflationary pressures and keep their eye on the capacity of the economy.
How would the Job Guarantee work?
Advocates say the job guarantee program should be federally funded, but administered at the local level by municipal governments, non-profits and social enterprises.
Professor Kelton, who has written a best-seller on MMT called The Deficit Myth, sees it working this way:
“Because the job guarantee allows workers to transition into alternative employment rather than joining the ranks of the unemployed, the program helps to cushion the overall economy by supporting wages and preserving (or enhancing) skills until the economy recovers and workers begin to transition back into private sector jobs,” she writes.
“The federal government guarantees the financing, establishes the broad parameters that define the types of jobs the program aims to support, and provides oversight to ensure compliance and accountability.
“Virtually everything else is handled in a decentralised way, bringing decision-making as close as possible to the people and communities who will benefit most directly from the tasks that will be performed.”
Kelton says the job guarantee isn’t about creating any old job.
“This isn’t a make-work scheme, aimed simply at giving the unemployed a shovel in order to justify paying them a wage,” she writes.
MMT economists argue there is no financial constraint on the amount a government should spend to achieve full employment, so the deficit should be set at whatever level is necessary.
What does MMT think of universal basic income?
Unlike a Job Guarantee, where only those who work get paid, a universal basic income would see the government pay everybody a modest amount with no strings attached.
Advocates of the UBI say it would reduce or eliminate the bureaucracy around welfare and government work programs and, if set high enough, would provide everyone with a basic income safety net to avoid poverty.
People could then choose to top up that very modest lifestyle through paid work, or live off the UBI while doing volunteer work, social and community activities, artistic pursuits or other unpaid work such as caring responsibilities.
However, MMT advocates don’t like the idea of a UBI.
They say the Job Guarantee idea is superior to universal basic income because of the economic and social function it provides — a JG would supply everyone with a job, which is socially beneficial, and JG workers could be used as a “buffer stock” against inflationary pressures (while still providing everyone with a job).
MMT’s view of budget deficits
This area of MMT attracts much criticism (and misunderstanding).
According to MMT economists, we’ve been thinking about government spending and budget deficits the wrong way.
They say Margaret Thatcher’s dictum that federal governments must tax or borrow before they can spend is fundamentally wrong, and it’s the other way around — federal governments have to spend money into the economy before they can tax or borrow.
It’s a crucial point.
They say when Thatcher argued that government finances were constrained in the same way as household budgets, she committed the “household fallacy” — and that fallacy has had a deleterious impact on politics and society.
They say national governments are not the same as households — national governments have the power to print money and impose taxes, households don’t.
Thatcher wasn’t comparing apples with apples.
They argue another former British Conservative prime minister, Theresa May, made the same mistake when she told a nurse that wages for British nurses hadn’t increased for years because the UK government didn’t have a “magic money tree.”
MMT economists say the “household fallacy” leads to socially destructive outcomes.
Why? Because it makes politicians think they can’t afford to spend more on socially important programs until they “find the money” to pay for them.
According to MMT adherents, that view is misguided — because a sovereign government that issues its own currency can print as much money as it needs to pay for all the goods and services it needs in its own currency — within limits.
Mr Greenspan, again, made a similar point in 2005 when he admitted that the US Social Security system couldn’t run out of cash.
“There’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody,” he said.
The fundamental question was whether the US economy had the ability to soak up any extra cash the government printed, he said.
What about inflation?
This is an important topic.
For many people, the thought of governments printing unlimited amounts of money conjures images of shoppers pushing wheelbarrows of cash in Weimar Germany, or the hyper-inflation of more recent times in Zimbabwe or Venezuela.
Some of MMT’s critics like to draw that comparison deliberately.
But MMT economists say that’s a caricature.
Why did hyperinflation occur in Zimbabwe? Because when you damage the productive capacity of an economy, as Robert Mugabe did, it can’t produce the same volume of goods and services. When you have households fighting over a shrinking amount of goods, prices soar. If you start feverishly printing money in that situation, you’ll make things even worse.
MMT economists say inflation would only be a problem (in a country like Australia) if the federal government spent too much money into an economy that was already running at, or close to, full capacity.
If your economy’s “real resources” are underutilised — its workers, factories, machines, land and raw materials — government spending won’t create concerning inflationary pressures, they argue.
They say if inflationary pressures start building, the federal government could raise taxes or reduce government spending to take money out of the economy.
Essentially, MMT asks people to look around to see how government spending works in reality.
“You’ve probably already seen MMT’s central insights in action,” Kelton writes.
“I saw them up close when I worked in the US Senate.
“But have you noticed this never seems to be a problem when it comes to expanding the defence budget, bailing out banks, or giving tax breaks to the wealthiest Americans, even when these measures significantly raise the deficit?
“As long as the votes are there, the federal government can always fund its priorities. That’s how it works.”
Criticisms of MMT
There are many criticisms of Modern Monetary Theory.
But at this point, it’s difficult to tell how many mainstream economists are making criticisms in good faith.
MMT has ruffled lots of feathers. It’s clear some orthodox economists don’t want to cede territory to the upstarts. Others won’t have wrapped their heads around the MMT logic yet. And there’d be some professional jealousy and rivalry behind the scenes.
However, some economists have scrutinised MMT seriously. Stephen Grenville, a former deputy governor of the RBA, being one of them.
While open to some of its ideas, he, like many other mainstream economists, argues it has fundamental flaws.
There’s no free lunch: Grenville says the chief vulnerability of the MMT narrative, and where MMT economists “are a little vague, even slippery,” is the MMT assumption, sometimes implicit, that budget deficits can be funded without adding to official debt.
“The government might get the cash to spend in its deficit by giving the central bank a bond in return for the cash,” Grenville wrote in the Eureka Report.
“But the bond is just a government debt which it owes itself, so in the view of many MMT supporters, the bond could be deleted from the central bank balance sheet by offsetting book entries in the accounts of the government and the central bank.
“In spending the cash to implement its deficit, the government shifts the economy to full-employment … GDP has increased without either debt or interest rates rising. This seems to be ‘free money’,” he said.
“It’s hardly surprising that this is an attractive narrative […] [but] this is clearly wrong.”
Human Behaviour: A major criticism of MMT has to do with the assumptions it makes about human behaviour, particularly about the way politicians “should” behave.
Professor Kelton, in her book The Deficit Myth, says unelected central bankers shouldn’t have so much control over the economy, and the responsibility for economic management should rest with elected representatives.
“We must end the cruel and inefficient practice of relying on democratically unaccountable central bankers to target the ‘right mix’ of inflation and unemployment,” Kelton wrote.
“To build an economy for the people, responsibility for maintaining full employment and income security must become the responsibility of elected representatives of the people.
Cynics say handing that type of responsibility to politicians could be a recipe for disaster.
Would politicians have the ability to know when the economy has reached full capacity?
Would they have the backbone to raise taxes, perhaps during an election year, to keep inflationary pressures down? Would they have the discipline to stop spending?
Recent Australian history demonstrates this point, when the Howard government pressed ahead with tax cuts ahead of the 2007 election (promises matched by the Rudd opposition) even as the Reserve Bank was hiking interest rates to temper rising inflation during the mining boom.
A few years ago, the economist Thomas Palley said one problem with MMT was that it “assumes away the problem of fiscal-monetary conflict.”
By that he meant MMT assumes that fiscal and monetary authorities behave as a single entity for the good of the country. Is that politically practical?
Interestingly, a former vice-chairman of the US Federal Reserve, Stanley Fisher, has suggested that responsibility for overseeing massive deficit-financing could be handed over to a central-bank-like independent committee. That type of institution could prevent uncontrolled spending by politicians (Fisher was not arguing for MMT, however).
Grenville says in an MMT context, “perhaps this all-wise committee could just set the budget deficit size, and leave it to parliament to make the hard decisions on distribution and on the size of the public sector by setting taxation rates.”
Bond market vigilantes: Another concern about MMT regards how participants in bond markets, credit markets and foreign currency markets might react if a country adopted its principles.
What’s to stop traders from deciding that your currency will become nearly worthless if your leaders start printing money and expanding the budget deficit, and trying to punish you accordingly? Financial market participants may take a lot of convincing.
Tax policy: According to MMT, the government could use changes in the level of taxation to control inflation. However, would the uncertainty surrounding the shifting level of taxation make it harder for businesses and households to make investment decisions?
What do MMT economists say about themselves?
On one hand, they say MMT is not a political project, it’s simply a way of looking at the world.
According to Mitchell, anyone — left or right — can view the world through an MMT framework and you can use MMT principles to pursue a leftist or rightist agenda.
On the other hand, MMT’s supporters advocate for a framework that would overhaul politics. It would take the responsibility for price and employment stability away from the central bank and put it back into the hands of politicians.
The Job Guarantee idea is also a central component of MMT, and it would be the government’s responsibility to run it.
What schools of economic thought does MMT draw on?
MMT has several moving parts.
The MMT project is a synthesis of economic theories, some of them decades old — so some opponents mock MMT for offering nothing new at all.
Theoretically, it draws heavily on Abba Lerner’s functional finance, Wynne Godley’s sectoral balances and Hyman Minsky’s financial instability hypothesis (Minsky also theorised about a job guarantee).
It provides a neo-chartalist analysis of the relationships between the private banking system, the central bank and treasury. That’s also where it’s uncommon view of taxation comes from.
It also has a strong overlay of Keynesianism, by advocating for central governments to actively use their budget balances to manipulate macroeconomic outcomes, the key tenet of John Maynard Keynes’ Depression-era policy prescriptions.
Who are the main figures in MMT?
Some of the main personalities include:
- Bill Mitchell, emeritus professor of economics at the University of Newcastle and Director of the Centre of Full Employment and Equity
- L Randall Wray, professor of economics at Bard College, United States, and senior scholar at the Levy Economics Institute
- Warren Mosler, economist and co-founder of the Centre for Full Employment and Price Stability at the University of Missouri-Kansas City
- Martin Watts, emeritus professor of economics at the University of Newcastle and a Research Associate at the Centre of Full Employment and Equity
- Stephanie Kelton, professor of economics at Stony Brook University and a former economics adviser to US Democratic senator Bernie Sanders
- Steven Hail, professor of economics at the University of Adelaide
The problems are minor and benefits are obvious in a world of secular stagnation. How else are you going to deleverage while still growing? How else will you lift interest rates and give capitalism back its primary driver, the cost of capital? Keep pumping money into asset prices until wealth inequality delivers a revolution?
The major roadblock is political. Conservative politics doesn’t like MMT because without the budget they have nothing left with which to claim better economic management. Creditors don’t like it because it inflates away their assets even as it enriches the broader population. The creditors have the ear of government.
These days, the left has swallowed that dogma as well (see Kouk for instance) so it resists because it does not have the imagination to shift the battleground of politics onto ground clearly more favourable to itself.
Like all such bright ideas, if MMT does come, Australians will be last to get it.
