Sunday, April 21, 2019

Palley on MMT part 1

I'm going to go through Thomas Palley's What’s Wrong With Modern Money Theory (MMT): A Critical Primer page by page and examine Palley's arguments. I won't bother commenting on his descriptions and background material, which seem unobjectionable. All references are to the above unless specifically noted.

Recently, MMT proponents have begun walking-back the idea that functional finance is central to MMT. The purpose of the walk-back appears to be to deny that taxes are needed at full employment to neutralize inflationary excess demand caused by excessive government spending. Three points follow. First, it is fundamentally dishonest to deny the long-standing central role of functional finance in MMT’s argument (see for instance, Kelton, 1999). Second, removing taxes means MMT has now shifted to the arguing that inflation control should be conducted via rationing, price controls, and other administrative measures (Wray, comments at Eastern Economic Association, March 2019). Third, it illustrates the difficulty of understanding and debating MMT as its proponents constantly change their positions. (footnote 2, p. 4)

This is unwarranted well-poisoning. If Pally wants to ascribe a purpose or motive to a body of writing, he should offer an argument in addition to citing the evidence. If he wants to accuse proponents of dishonesty, he should cite their dishonesty. Do MMT proponents really argue that "inflation control should be conducted via rationing, price controls, and other administrative measures"? If so, a written reference, not a reference to an oral presentation seems required.

MMT’s main macroeconomic claim to fame rests on its declaration regarding government’s ability to finance spending without recourse to taxation by issuing money. In fact, government’s ability to create money to finance spending has long been widely recognized by all economists, who have also long recognized that ability gives government considerable extra financial and policy space. (p. 5)

Damned if you do, damned if you don't. How is it a criticism that MMT scholars advocate a position that is "widely recognized by all economists"? And why should I believe Palley that this apparently obvious proposition is MMT's "main macroeconomic claim to fame"? Again, Palley offers no citation to show that MMT scholars believe they themselves have discovered governments' ability to create money.

As regards injecting state money to pay taxes, MMT is strictly wrong with its claim that the public cannot pay taxes until government has first spent. In fact, the central bank is the source of such money. (p. 6)

The Federal Reserve Bank is part of the government. I do not know of a central bank in any industrialized democracy that does not have authority granted by the legislature.

Palley offers as "evidence" a quotation from Wray:
In principle, then, the government first spends fiat money....Once the government has spent, then the fiat money is available to be transferred to the government to meet tax liabilities. As a matter of logic, the public cannot pay fiat money to the government to meet tax liabilities until the government has paid out fiat money to the public. (qtd. footnote 5, p. 6)
But Wray explicitly makes an in principle argument. It is merely a "terminological objection" (see below) to argue about which organ of the government, the legislature directly through spending or the central bank autonomously exercising spending power granted by the legislature, creates the money.

Palley also asserts that Jo Michell "claims MMT does not say government spending is needed to pay taxes" (footnote 6, p. 7). The cited post does not appear to support this assertion. Michell says, "[G]overnment spending comes before taxation . . . is sort of true but also not particularly interesting." What Michell argues is not part of MMT is that "without [government deficits] the means to make settlement would not exist in our economy."

MMT focuses on accounting and stock-flow relations. . . . [T]hose accounting and stock-flow relations have long been understood by Keynesian and neo-Keynesian economists. (p. 7)

Again, it should not be a criticism that MMT scholars agree with orthodox economists.

MMT objects to [the government budget constraint] being called a constraint as if government were a household. However, that is a terminological objection. (p. 7)

Not all terminological objections are created equal. Terminology should clarify, not obfuscate. Palley's terminological objection above obfuscates that the Fed is a part of the government; MMT's terminological objection clarifies: If government is not actually constrained by a budget, it's disingenuous at best to say the government has a budget constraint.

MMT sees the effects of increasing government financial obligations as entirely benign, and policymakers can use the financial space to costlessly boost demand and push the economy to full employment. There are no negative consequences from increasing government financial obligations; no conflicts with other policy objectives; and no policy implementation problems. (p. 7-8)

[citation needed]

As shown below, MMT’s macroeconomic policy assertions follow from its oversimplified and incomplete Keynesian analysis. The lack of a dynamic economic model with behavioral content is a glaring professional failure. (p. 8)

I don't know about this one. My general training in advanced macro is woefully inadequate. Still, the orthodox dynamic macroeconomic models (DSGE models) seems to attract their share of criticism.

Unfortunately, instead of addressing that failure, MMT proponents have responded by claiming critics either do not understand it or have misrepresented it. (p. 8)

Or it could be that critics don't actually understand MMT and are actually misrepresenting it.

The difficulty of confronting MMT about those failings is compounded by its practice of walking back its positions and adopting those of its critics without acknowledgment. (p. 8)

What? MMT scholars might clarify their positions, correct mistakes, or even, gasp! change their minds?!

[M]oney financed budget deficits drive the economy to full employment by increasing wealth and AD. That makes it critical there be institutional arrangements for closing the deficit once full employment is reached to avoid inflationary excess. However, MMT relies on a highly simplified and implausible political economy in its attempt to address that problem. Thus, it assumes taxes can be abruptly and precisely raised at full employment to contain excess demand, when the reality is taxes are politically contested and difficult to raise. Long ago, Friedman (1961) argued that fiscal policy was impractical for “fine-tuning” stabilization policy owing to inside (decision) and outside (implementation) lags. Those lags mean policy implementation is likely to be poorly timed, so much so that it could amplify the business cycle rather than dampen it. (p. 9)

These criticisms are kinda true, especially the latter concerning lags. However, they really amount to the unobjectionable claim that regardless of one's models, managing a large economy is a Hard Problem. Friedman et al. argued against any kind of fine-tuning, not just via fiscal policy but monetary policy as well.

But yes. MMT does need good models concerning how to raise taxes effectively to address inflation. Maybe they have them. I am not at all confident that Palley has made an exhaustive search of the literature to find them.

Absent budget discipline, spending and deficits would tend to ratchet upward owing to the political attraction of money financed deficit spending and the political aversion to higher taxes. (p. 10)

Maybe, maybe not. I'm not at all convinced that the above political attractions and aversions are anything more than artifacts of our dysfunctional political system exacerbated by inequality. And I'm not at all convinced that an artificial budget discipline, denying truths that have "long been widely recognized by all economists, who have also long recognized that ability gives government considerable extra financial and policy space" (p. 5) is the only alternative.

Regardless, part of economics is not just what is feasible in the immediate present but also what is theoretically possible. Taken in that spirit, yes, MMT needs to come up with institutional mechanisms that can use taxes effectively to control inflation, which does not sound like an impossible task.

Another political economy critique (Lavoie, 2014) is that central banks and fiscal authorities are institutionally separated in most economies, but MMT ignores this and treats them as a unified decision maker. The separation is usually justified on public choice grounds that politicians have an inclination to inflationary monetary populism, and separation of fiscal and monetary powers helps prevent that. (p. 10)

This critique is petty. Institutional separation seems inconsequential, and the Fed and Treasury usually coordinate their actions. Regardless, institutional separation is at best one way of avoiding "inflationary monetary populism", but it's hardly the only possible way.

Palley is making a fundamentally flawed argument, which is at least a step up from the beginning of the paper. Anything can be done poorly — White can lose at chess in two moves — so the argument that X might not work is unintersting. The argument needs to be that X cannot work, or be extraordinarily difficult to make work even under favorable conditions.

And heterodox economics is heterodox. That we currently solve certain problems one way is not an argument that that way is the only way, especially when the current way really seems to be failing badly.

Only a third of the way through, and I'm throughly unimpressed with Palley's critique.

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