The Critics of Modern Money Theory (MMT) are Right

Abstract

Eric Tymoigne and Randall Wray's (2014) defense of MMT leaves the MMT emperor even more naked than before (excuse the Yogi Berra-ism). The criticism of MMT is not that it has produced nothing new. The criticism is that MMT is a mix of old and new, the old is correct and well understood, while the new is substantially wrong. Among many failings, T&W fail to provide an explanation of how MMT generates full employment with price stability; lack a credible theory of inflation; and fail to justify the claim that the natural rate of interest is zero. MMT currently has appeal because it is a policy polemic for depressed times. That makes for good politics but, unfortunately, MMT's policy claims are based on unsubstantiated economics.

Notes

¹Proponents of MMT tend to be against mathematical modeling. One reason is that economics has become over-mathematical, pushing it to the frontiers of nonsense. I agree with this sentiment, but refusal to model is not the right response. Indeed, by promoting confusion, refusal to model plays into the hands of those who model to excess. The right answer is to use good judgment so that modeling clarifies but resists mathematical excess. A second reason for MMT opposition to modeling is that proponents do not believe in models. That reason is entirely specious as textual arguments also embed models. However, the assumptions, logic, and implications tend to be less transparent.

²The debate over consolidation also raises a policy question. There is an orthodox macroeconomic literature (see Fischer, 1995) that claims independent central banks deliver superior macroeconomic performance. This is a literature I am not convinced by, but it does raise a yellow flag. MMT argues for a consolidated central bank that puts its ability to money finance spending at the disposal of a fiscal authority. If it turns out that such an arrangement does not deliver best outcomes owing to political economy problems in the conduct of fiscal policy, it is a problem for MMT because those political problems are part of the real world. They are not going away and must figure in policy analysis that claims to be serious.

³Variables can be expressed in real terms by deflating with the price level.

⁴There is an equilibrium and disequilibrium statement of this relation. Total investment consists of planned investment in equipment and structures (I_K), planned equipment in inventory (I_P), and unplanned inventory (I_U) so that I = I_K + I_P + I_U. Substituting in Equation (12) yields D = S − I_K − I_P − I_U. In equilibrium, plans are met so that I_U = 0 and D = S − I_K − I_P. In disequilibrium plans are not met so that either I_U > 0 due to an unexpected demand shortfall or I_U < 0 due to an unexpected increase in demand. These disequilibrium effects induce firms to increase output if I_U < 0, and decrease output if I_U > 0.

⁵MMT credits Godley's (1999) sector balances approach with identifying this relation. In fact, the eminent old Keynesian economist James Tobin (1963) explicitly identified and analyzed this relation 50 years ago and decades of Yale students learned about it. It is also noteworthy that (Godley & Lavoie, 2007) explicitly pay tribute to the stock-flow consistent IS-LM model of Tobin (1982), whereas MMT is vituperative about the IS-LM model.

⁶Similar relations can be derived for an open economy by using the national income accounting identity for an open economy and adding a trade balance financing equation.

⁷Aspromourgos (2000) is another critic who has produced a Keynesian model-based analysis and finds MMT wanting.

⁸This, by the way is part of the old Keynesian IS-LM story (Blinder & Solow, 1973), again showing how little there is to MMT. However, old Keynesians recognized there were additional constraints on policy which limited policy makers' ability to attain non-inflationary full employment.

⁹In a growing economy there can be persistent budget deficits, but to avoid inflation the high-powered money stock must grow at the rate of growth.

¹⁰It is a pity T&W did not comment on asset-based reserve requirements as it is a policy MMT should endorse.

¹¹If ELR jobs have superior characteristics to minimum wage private sector jobs, they would require a lower wage to compensate for these positive differences. Conversely, if ELR jobs have inferior characteristics, the compensating wage differential could theoretically be positive.