Three Big Questions About Modern Monetary Theory

Published on: 16:07PM Apr 20, 2019

As Modern Monetary Theory (MMT) seems to be underlying a lot of policy debate going into the next election (its the underpinning theory of fiscal policy supported by the likes of Alexandria Ocasio-Cortez), I'm left with a lot of questions as a non-macro economist and a lay economist at that. (for a lite intro to MMT try this NPR Planet Money podcast).

1) What about inflation and central bank independence? In Frederick Mishkin's The Economics of Money, Banking, and Financial Markets  text he devotes quite a bit of material to the empirical evidence and theory relating central bank independence to positive economic outcomes and controlled inflation. It seems that under MMT, the Fed is not very independent at all, and when it comes to fiscal policy, the Fed becomes the government's right arm. If one of the themes of MMT is that government should not be constrained by public debt, but should spend as required to achieve its goals and promote high employment, then an independent fed deliberating over monetary policy would seem to be a bottleneck. Does MMT mean a less independent federal reserve?

2) Okay, what about inflation then??? One of the ideas from MMT it seems is that if money creation and spending begins to generate inflation is that the government can take some of that pressure off by raising taxes. Higher tax rates would reduce spending and investment and cool the economy. I suppose if that works out, the issue of an independent fed would be moot. Taxing, spending, money, and inflation is all handled in a one stop shop - via fiscal policy.

3) Okay.....but again....what about inflation? Who is running the (print) shop? What does the public choice theory say about how this will actually work?  If MMT implies a one stop shop for fiscal and monetary policy, where is this authority held? Unless we are talking about drastic changes to the constitution, this has to be worked out between the president and congress with congressional approval. We've seen how that works recently. Beyond the mechanics laid out in our constitution, more importantly is how does this change impact incentives in the overall economy? Sure existing programs might get more funding but what about new funding?  How might we envision a spending plan executed under an MMT regime? One example could be the Green New Deal. As Economist Noah Smith Explains:

"So this quick, rough cost estimate adds up to about $6.6 trillion a year. That’s more than three times as much as the federal government collects in tax revenue, and equal to about 34 percent of the U.S.’s entire gross domestic product. And that’s assuming no cost overruns — infrastructure projects, especially in the U.S., are subject to cost bloat. Total government spending already accounts for about 38 percent of the economy, so if no other programs were cut to pay for the Green New Deal, it could mean that almost three-quarters of the economy would be spent via the government."

Given conventional views of monetary and fiscal policy, this could be problematic, but under MMT this level of spending might (easily?) be maintained via a combination of money creation and an optimal level of tax rates which could be raised if necessary to dampen inflation if it rears its head as a result. But what about contemporary angst over getting money out of politics? This seems like throwing kerosine on the fire.  Are rent seekers and special interests salivating over this? Recall the Waxman-Markey climate proposal? Rent seekers and special interests flocked in droves according to the Washington Post:

"as the legislation's chances improve, corporations, environmentalists and other interest groups have worked to put their imprint on the bill. The Center for Public Integrity said its review of Senate disclosure records showed that more than 880 businesses and interest groups have registered to lobby on climate change in the first quarter of 2009 -- up more than 14 percent over the same time last year. The groups include coal companies, investment banks, wind and solar firms, state governments, auditing firms and technology companies that might be part of the proposed trading system for carbon." 

As Economist Lynne Kiesling sarcastically commented about this on her blog back in 2009 "I feel really confident in political processes. I’m sure that this political process will serve the interests of science, economic efficiency, and the environment. And I feel really, really well-represented in this process."

This is just one example of one government program illustrating the problems related to policies on government spending, taxes, and subsidies. MMT seems to inject money into politics and make it potentially more pernicious than any other time in history.

If we go back to the 70's and 80's, government tried managing the economy and unemployment by expanding the money supply. This led to crazy inflation and high unemployment. One bad government policy led to another and we had price and wage controls to boot. The lesson being it led to a scary level of government intervention in the economy and basic levels of individual decision making. Are we looking at another Economic Stabilization Act of 1970? Payboards and price commissions? Fixing this mess meant a lot of pain and sacrifice going into the 80's. (remember inflation and interest rates and farm bankruptcies back then!)

I need better answers to the questions above, how will this impact inflation and central bank independence, and how does MMT navigate the public choice implications of such a massive change in fiscal and monetary policy?