the economy

Real Modern Monetary Theory Has Never Been Tried

Photo: Brendan Smialowski/AFP via Getty Images

Over the weekend, the New York Times published a profile of Stephanie Kelton, America’s foremost proponent of Modern Monetary Theory, a.k.a. “MMT.”

A dissident school of economic thought, MMT is composed of a wide range of theoretical premises and policy prescriptions. In mainstream discourse, though, it’s generally invoked as a synonym for the idea that the U.S. government doesn’t necessarily need to offset large-scale spending with tax increases since there is nothing inherently bad about running high deficits. Understood (or perhaps misunderstood) in these terms, COVID-era fiscal policy can look like an “experiment” with MMT.

The Times’s Kelton profile is therefore framed around the question: Did America’s response to the pandemic vindicate MMT by generating a rapid labor-market recovery through massive deficit spending, or did it discredit the doctrine by generating high inflation? The piece’s social-media headline, “Time for a Victory Lap*,” foregrounded the former interpretation, much to the consternation of MMT’s many mainstream skeptics. Larry Summers spoke for this contingent when on Twitter he likened MMT’s ideas to “fad diets, quack cancer cures or creationist theories” and chastised the Times for “publicizing” them.

In truth, the question of whether the COVID era has vindicated MMT has no simple answer. This is in part because MMT means different things to different people. Indeed, as its critics emphasize, not all self-avowed MMTers see eye to eye on every aspect of the doctrine. The term MMT refers variously to a descriptive account of the constraints on spending in a monetarily sovereign nation, a prescriptive program for facilitating full employment and price stability, a meme that posits money printing as sufficient for funding a Nordic-style welfare state, and much else besides. (Importantly, though the meme version of MMT is generally a straw man, the doctrine’s luminaries occasionally flirt with it as when Kelton suggested that implementing Medicare for All might well require tax cuts).

Seperately, it’s unclear what it means for a school of economics to be, in the Times’s phrase, “winning.” Does it just mean that reality hasn’t falsified its premises? Or that policy-makers ignored its teachings and paid a price? Or, if MMT is fundamentally a political project, does vindication (and/or “victory”) require its core policy ambitions to look more realistic today than they did two years ago?

In any case, I think we can say three things about how MMT has held up in the age of COVID:

• MMT’s core descriptive premises about the relationship between deficits and spending have been vindicated by the events of the past two years. These premises are not original to MMT. But those identified with the movement have done a better job of publicizing them over the past decade than most anyone else.

• Congress did not actually try to implement MMT’s policy prescriptions, so the COVID era has neither discredited nor vindicated the school’s most original ideas.

• The fact that the American public overwhelmingly disapproves of the contemporary economy — with the median voter more incensed by moderate inflation than pleased by the strongest labor-market recovery on record — seems inauspicious for MMT’s political project.

What MMT got right.

Evangelists for MMT spent much of the past decade railing against two ideas that have long dominated American political discourse: (1) that the national debt imposes tight constraints on how much new spending the U.S. government can “afford” and, relatedly, (2) that all new public spending must be “paid for,” dollar for dollar, with tax increases or cuts to existing programs.

According to MMT, in a country that can print its own currency, the true constraint on spending is never the scale of sovereign-debt obligations but only the pool of real resources. America cannot run out of dollars because it can print them. It will therefore always be able to pay its debts. Further, Uncle Sam does not actually need to borrow money or raise taxes to increase public spending; the government can simply finance new outlays through money printing if the Federal Reserve is willing to let it. Thus, neither the absolute size of America’s debt load nor the threat of “bond vigilantes” refusing to buy U.S. Treasuries at affordable interest rates constrain Congress’s spending power. The real constraints do not exist in the realm of budgetary abstractions but in that of material realities.

To appreciate this point, it’s worth thinking in concrete terms. Imagine Congress decided that access to Taco Bell’s Doritos Cheesy Gordita Crunch was a basic human right and that it wished to send every American a $200 fully refundable advance Cheesy Gordita tax credit. The fiscal viability of this program wouldn’t hinge on America’s debt-to-GDP ratio; as a financial matter, the federal government can absolutely “afford” to send everyone a $200 Cheesy Gordita voucher. Rather, the macroeconomic wisdom of the policy would depend on the national supply of Cheesy Gorditas. If America’s Taco Bell franchises were sitting on vast surpluses of Doritos Cheesy Gordita Crunch inputs — their freezers full of soon-to-expire seasoned beef and shredded lettuce, kitchens replete with Nacho Cheese Doritos Locos Taco shells — there would be no need to offset the new spending: Pumping up demand for Taco Bell would merely prevent surplus capacity from going unused. But if Taco Bell had been anticipating a decline in Gordita demand and had therefore allowed its stockpiles to run low, the sudden introduction of a “Gorditas for All” policy would trigger bottlenecks and inflation throughout the Gordita sector. In either case, the number on the “national debt clock” tells us nothing about the merits of the policy.

This basic idea — that the constraint on government spending is real resources, not debt loads or revenue levels — is not original to MMT. John Maynard Keynes articulated the same principle in 1942 when he told the British public, “Anything we can actually do, we can afford.” MMT’s detractors are wont to emphasize this point. The economics blogger Noah Smith chastises the Times for suggesting that MMT is unique in claiming “that society should feel capable of spending to achieve its goals to the extent that there are resources available to fulfill them.” Smith rightly notes that this is standard Keynesianism.

Yet the fact that articles in major publications routinely attribute that idea to MMT is an indictment of mainstream economics or, at least, of mainstream economists’ gifts for public communication.

Whatever assumptions undergird orthodox economic models, popular discourse has long suggested that high deficits constrain the governments’ capacity to spend. “Objective” reporters routinely declare that America’s national debt is unsustainable and will force the nation to slash spending or cut taxes in the near future. A decade ago, this conventional wisdom wasn’t limited to news anchors. Rather, it led the Obama administration to deliberately propose a smaller stimulus than the Great Recession demanded.

And mainstream Keynesians such as Summers and Paul Krugman helped to forge this conventional wisdom. In 2003, Krugman warned that George W. Bush’s decision to simultaneously slash taxes and launch a war posed a “threat to the federal government’s solvency” and predicted that “skyrocketing budget deficits” would lead inevitably to high interest rates. MMTers, by contrast, have consistently contested the notion that the federal government could ever become insolvent or that high deficits inevitably lead to high borrowing costs. And they have disseminated these ideas in a manner that has earned the mainstream media’s attention, something more conventional Keynesians consistently failed to accomplish.

Happily, the events of the COVID era vindicated MMT (and/or Keynes) on both these points. Even as multitrillion-dollar COVID-relief bills pushed the national debt past $30 trillion, America’s borrowing costs have remained historically low. This is in part because the Federal Reserve bought up much of the debt that stimulus spending generated, effectively financing public spending through money printing.

Much of this spending served to avert the underutilization of spare capacity. America enacted more stimulus than other wealthy nations and has enjoyed a faster growth rate than its peers as a result. In fact, we are the only G7 country to fully recover our pre-pandemic GDP level by the third quarter of 2021. America’s unemployment rate currently sits at 4 percent; after the 2008 crash, it took a decade for America’s jobless rate to reach such a low level.

In a sense, America’s economic response to the COVID crisis may have been too successful. At the pandemic’s onset, carmakers, semiconductor manufacturers, and other goods producers slashed production in anticipation of a long recession and tepid recovery. When the government managed to prop up consumer spending through stimulus instead, this led to mismatches between demand and supply. And those mismatches were further exacerbated by the pandemic; as consumers spent more time at home, they shifted their spending away from services toward goods. At the same time, the COVID-era stimulus packages replaced more than 100 percent of the income that households had lost to the pandemic recession. Given the bottlenecks in various supply chains and the concentration of demand in the goods sector, this has yielded the highest rate of inflation that America has seen in four decades.

Which is a political problem for the Biden White House. But it isn’t a theoretical one for MMT. Kelton & Co. have always said the real constraint on spending is inflation, not debt sustainability. COVID-era economic policy has illustrated precisely this.

Congress did not conduct an “experiment” with MMT.

MMT’s account of what constrains public spending isn’t original. But the policy paradigm its adherents derive from that account is quite novel indeed.

Many mainstream economists will acknowledge that inflation is the primary constraint on deficit spending. But they tend to dismiss MMTers’ emphasis on that point as pedantic or a mere word game. After all, the basic reality is that, outside of a recession, the government needs to offset large-scale spending with tax increases or it will run out of fiscal space. Talking about inflation instead of debt doesn’t change that.

But this misses the point. By insisting that the government can afford to finance any level of spending and that the real constraint on profligacy is inflation, MMTers aren’t arguing for tax-and-spend liberalism in unfamiliar verbiage. Rather, they’re calling for a much more fine-grain approach to fiscal policy and demand management.

In mainstream discourse, a bill is “fully paid for” if it includes enough tax increases to offset its spending provisions. Yet if the true constraint on spending is scarce resources — not scarce dollars — then fully offsetting new spending with tax increases might not be sufficient to pay for it in a meaningful sense. To see what I mean, consider what would happen if Congress decided to “pay for” $200 billion in cash aid for the poor by imposing a wealth tax on America’s billionaires. Such legislation would add nothing to the federal deficit. Yet it would add to inflationary pressures. This is because taking $200 billion from America’s billionaires will have little impact on their personal consumption; if Jeff Bezos’s net worth falls from $189 billion to $183.3 billion, he won’t be forced to slash his personal spending. Rather, that money will just come out of his idle savings, where it was doing nothing to bid up the price of consumer goods. By contrast, if low-income families see their disposable incomes collectively rise by $200 billion, they are likely to immediately spend almost all of that sum on consumer goods, thereby putting upward pressure on prices. Thus, Congress’s debt-centric approach to analyzing legislation prevents it from paying for policies in the way that actually matters.

MMTers want Congress to put real resources and inflation at the center of its budgetary process. Instead of focusing neurotically on whether a given bill raises as many units of an infinite currency as it spends, MMTers argue that legislators should examine which real resources a new spending initiative will demand, assess the existing supply of those resources, and then, if there’s a gap, attach “pay fors” that will facilitate the necessary expansion in supply.

So in determining the true cost of Gorditas for All, an MMT-pilled Congressional Budget Office might estimate precisely how much taco-shell production would need to expand in order to keep pace with demand. If ensuring universal access to the Doritos Cheesy Gordita Crunch would require diverting large amounts of labor and capital into taco-shell production or dairy agriculture or meatpacking, then Congress would need to formulate policies that would throttle demand for workers and investment in other industries. Meanwhile, a truly comprehensive scoring of Gorditas for All might also account for the policy’s potential to inadvertently increase demand in the toilet-paper and health-care sectors.

More seriously, MMTers argue that Congress’s budgetary process should seek to offset the inflationary risks generated by new spending with a diverse array of tools aimed at addressing discrete price pressures. Among the tools proposed by the MMT proponents Scott Fullwiler, Rohan Grey, and Nathan Tankus: progressive income-tax rates that increase automatically when incomes rise faster than the target inflation rate, tighter financial regulations, encouraging savings by increasing interest rates on savings accounts, direct public investment in in-demand sectors, and environmental regulations that would “disemploy people and resources” in the fossil-fuel industry, thereby freeing them up for redeployment in a less destructive sector, among other things.

In other words, MMTers want a lot more central planning. Needless to say, Congress’s approach to fiscal policy during the pandemic did not remotely resemble what Tankus, Grey, and Fullwiler recommend. The Biden administration’s attempts to address inflation by tackling specific bottlenecks — clogged ports, inadequate chip production, and high energy prices — is in keeping with the ethos of MMT’s prescriptive vision. But like COVID-era economic policy in general, these gestures fall far short of what MMT prescribes and could be justified by plenty of other economic paradigms.

So the pandemic has neither vindicated or discredited MMT as a policy paradigm since real MMT has never been tried.

America’s experiment in prioritizing full employment over inflation hasn’t been auspicious for MMT.

Personally, I find MMTers’ vision of how the economy should be managed intellectually stimulating and somewhat ideologically appealing. But I also find it politically quixotic. MMTers’ proposed budget process sounds a bit like something out of sci-fi utopia. The idea of the U.S. Congress “paying for” a Green New Deal by euthanizing the oil industry is hard to fathom at a time when a unified Democratic government can’t find the votes for funding green-energy tax credits with a 25 percent corporate-tax rate.

In the op-ed in which they laid out their prescriptive vision for inflation management, Tankus, Grey, and Fullwiler acknowledged their project’s political headwinds. “Commenters are not wrong that some of these proposals and tools will be controversial,” they wrote. “What is ignored by this criticism is the fact that our current approach of managing inflation on the backs of a very indebted and underemployed public is also controversial. Indeed, the Federal Reserve has historically been a conservative institution biased against full employment.”

Outrage at the obscenity of involuntary unemployment is at the heart of MMT. A fundamental premise of mainstream economics is that a healthy economy will never provide enough jobs for everyone. In this account, unless there is a significant pool of spare labor on the economy’s sidelines, employed workers will be able to demand wages far in excess of their productivity, and accelerating inflation will ensue. One reason why MMTers demand a high degree of central economic planning is they believe such micromanagement is required to overcome this constraint and ensure genuinely full employment.

And yet in retrospect, it’s not clear that mainstream macro’s failure to deliver jobs for all was especially “controversial.”

During the pandemic, U.S. policy-makers finally prioritized a rapid labor market recovery over the minimization of inflationary risk. As a result, the U.S. economy has been growing at its fastest clip in more than three decades, job openings are near record highs, wages are rising rapidly at the bottom of the income ladder, and the layoff rate is at an all-time low. And yet only 18 percent of voters describe U.S. economic conditions as “excellent” or “good,” trusted gauges of consumer sentiment are at their lowest point in more than a decade, and nearly 60 percent of the public disapproves of Biden’s handling of the economy.

In other words, one arguable lesson of the pandemic is that the political costs of moderate inflation greatly outweigh the political benefits of aggressively pursuing maximum employment, at least in the immediate term. Which makes some sense. Rising prices adversely impact virtually everyone, while a rapid labor-market recovery only directly benefits the minority of Americans who lost their jobs during the COVID crisis. Further, the U.S. population is steadily aging, and retired voters have more use for stable prices than they do for abundant jobs.

To be sure, it’s totally possible that once Omicron is over, supply-side bottlenecks will start to clear, inflation will moderate, and the Biden boom will prove that erring on the side of full employment is politically wise. But at present, it just doesn’t look like there’s overwhelming popular demand for putting the minimization of unemployment above “everyday low prices.” And that seems inauspicious for MMT’s political project. There’s a ton of opposition to the movement’s proposed means of economic management at the elite level of American society. If there isn’t overwhelming support for the movement’s ends at that mass level, it’s hard to see how this economic revolution comes about.

Which isn’t to say it won’t. But given how little affection the public has displayed for a high-growth, moderate-inflation economy, I’m not sure MMT can take a “victory lap” just yet.

Real Modern Monetary Theory Has Never Been Tried