Hello, Old Friend, Hello
The debt ceiling, which displays the resilience of Freddy Krueger, is back and larger than ever. When we last saw it in February 2018, the spending limit weighed in at a mere $20.456 trillion; the latest version is a whopping $21.988 trillion ($22 trillion would have been such a nice round number, but no, that’s not how Washington works.) After making its unobtrusive return, the ceiling will be put off by a combination of the Treasury’s familiar tricks of not making deposits into the government employees’ retirement plan and the favorable seasonality of the budget (April is the absolute best month for receipts). As a result, we will likely not hear much about our old friend until after Independence Day, when the goalposts will no doubt be moved once more, albeit after much fulminating and grandstanding.
Modern Monetary Theory:
“I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there is nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.”
The hottest financial topic of 2019 has been Modern Monetary Theory, or MMT. Seemingly every financial and economic commentator has felt compelled to share an opinion—which has led to a multitude of ill-considered pithiness and misrepresentations that usually accompany heterodox economic ideas. Since there have been so many people proffering their take on the subject, we felt safe in assuming that one more would not be amiss. What follows is our personal take on this—we have no doubt that both proponents and detractors would find quibbles and objections with much of our elucidation. In our view, MMT encompasses both a statement about how the government is financed and a policy prescription that flows from it. We find the first part much more convincing than the latter.
At the bottom, MMT says that money can be created by governments in any desired amount—as long as that money is denominated in its own currency. This is in contrast to the conventional view that the Treasury needs to borrow or tax in order to get the money which it spends. As a consequence, government spending per MMT is only restricted by the desire (or, more hopefully, the programs on which money can be used wisely) to spend. The limiting factor in budgetary policy is not debt but rather inflation; MMT proponents suggest that we should engage in policies which will promote full employment, and only cut spending or increase taxes if physical resources become constrained and the currency begins to lose value through price inflation.
A first hearing, MMT can sound like pie-in-the-sky lunacy. However, when one begins to look closer, there are distinct similarities between MMT and how the Treasury/Federal Reserve has operated at times in the past. One good example is World War II. When government spending in 1942-45 exploded in order to fund the war effort, short-term interest rates did not rise—they were set at 0.375% for the duration of the war by the Federal Reserve acting under direction from the Treasury. And while the government issued plenty of bonds (which “soaked up” some of its spending) it did not feel constrained by the results of those auctions. The need to win the war overwhelmed considerations of deficits and debt, and the Treasury in essence spent whatever it wanted. Interest rates did not rise and there was no loss of faith in the currency. A second and more current example is Japan, which has run large and persistent structural deficits for the last twenty years without destroying the value of the yen, even with interest rate on Japanese government bonds holding at around 0.1%.
The point is that when modern countries which can create their own currencies are threatened existentially, the “rules” of government finance go out the window. MMT suggests that they could always operate in this manner if they so desired. Whether or not it is a good idea to do so is another question altogether. Many of us would perhaps feel more comfortable if the policymakers in Washington believed they were constrained by deficit considerations, but this does not refute MMT as a framework for viewing government fiscal operations. However, once MMT advances into the area of policy prescription, the argument becomes a bit less convincing. The idea that inflationary pressures would force spending cuts/tax increases on any administration and Congress is difficult to accept. Once the teenagers are given the car keys, it will be difficult to prevent them from joyriding—particularly when all their friends are doing it.
This, in our humble opinion, is the real danger of our “hopeless” deficit situation—not that the American government can be forced to curtail its activities by the “bond vigilantes”, but rather that it will become obvious that MMT is essentially correct in its analysis of the nature of government finance. Quantitative Easing saw the Fed freely admit to creating trillions of dollars in bank reserves “out of thin air” (as the president of the local Fed bank put it during a lunch we attended); people were bound to start wondering why Washington couldn’t do it routinely to fund whatever they as voters desired. On that path lies danger.
In closing, let me just say that the source of the above quotation was none other than Alan Greenspan, taken from his testimony before the House Budget Committee in 2005. MMT might sound like a new and radical idea, but it is not.
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