MMT Misconceptions part 1

I will skip the pure bad faith propaganda in Doug Henwood's essay, Modern Monetary Theory Isn’t Helping: As the saying goes, "Never wrestle with a pig. You both get dirty and the pig likes it." However, Henwood reproduces many misconceptions about MMT (and basic economics). Whether he reproduces them out of ignorance or bad faith is irrelevant; my task here is to link correct the misconceptions.

Note: For clarity, I've added the label "Misconception:" to the boldfaced titles.

Misconception: "Cool[ing] things down" means "creat[ing] a recession".

Since there is a risk that too much government spending would spark inflation, the government might need to cool things down, meaning create a recession — though Wray shies away from using the word — by raising taxes.

Strictly speaking, this statement is a misconception not about MMT but about basic economics.

I don't know what Henwood actually means by "cool things down"; it's not a precise economic term; Henwood is paraphrasing without a citation, so I can't look at what Wray actually said. It is certainly the case that raising taxes is neither synonymous with creating a recession nor do tax increases necessarily or even usually cause recessions. Tax increases are contractionary, but contractionary fiscal policy is recessionary only if long-run economic growth is near zero. In standard undergraduate macroeconomic theory, when actual output exceeds potential output, some people are working harder than they want to, and they demand more for their loss of leisure than they are producing. The economy will (and should) contract (the short-run rate of growth will at least slow) no matter what the government does; all raising taxes does is to change how the contraction takes place. Without taxes, the contraction will take place through an increase in the general price level; with taxes, the government just takes the excess money out of the economy.

(Of course, if someone doesn't use a word, and Henwood explicitly says that Wray "shies away" from using recession (because contraction is different from recession), basic honesty generally requires some evidence for the imputed usage. The evidence is definitely not to be found in basic macro.)

Misconception: Reserve accounting is irrelevant

Much of the MMT literature is an elaboration of the arithmetic of bank reserves . . . Reserve accounting is important if you’re a financial economist or a central banker, but it’s of limited relevance to anyone concerned with big-picture economic questions.

Wait, what? Central bankers are most definitely concerned with big-picture economic questions. Any intro macro textbook will tell you that reserve accounting is the foundation of orthodox monetary policy. In my principles class, I spend an entire 110 minute lecture on reserve accounting. And it's not that hard; mostly just arithmetic and a little simple algebra, but it does scare some people with deficient education.

More importantly, MMT scholars want to prove that money does not work in the way we think it works, so they have to talk at length about how it actually works. Perhaps they're not correct, but a blithe math-is-scary dismissal is not a critique.

Misconception: MMT should be a theory of everything

Absent from Kelton’s paper, Wray’s book, and much of the subsequent MMT literature, is any sense of what money means in the private economy, where workers labor and capitalists profit from their toil and compete with each other to maximize that profit, a complex network of social relations mediated by money.

Nor does MMT literature address the heartbreak of psoriasis. So what? MMT is not intended to be a theory of everything, to rethink how a capitalist economy works at a fundamental level. Why should it be? Marx already did most of that work.

Misconception: Fiscal policy is impossible

[Abba Lerner's] proposed doctrine of functional finance held that “government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound.” In other words, if unemployment is rising, loosen policy (boost spending, cut taxes, lower interest rates), and if inflation is rising, tighten policy (the reverse). On first glance, this sounds completely reasonable. But on second, it’s a lot more complicated.

For one thing, it often takes time to understand what’s going on in the economy, and it takes even more time to change policy — and sometimes, like in the 1970s, unemployment and inflation are both rising, and it’s not obvious what policy should do in response. Anyone who’s watched Congress struggle with tax and spending policy has to wonder how anyone could believe that fiscal policy could be fine-tuned with requisite speed and precision.

MMTers extend this hubris about the precision and power of policymaking

A lot to unpack and explain here. Please bear with me. Note that I'm going to hold off talking about macro stabilization techniques, both mainstream and MMT, until later.

First, Henwood commits a subtle non sequitur fallacy. They're not completely unrelated, but there's a big gap between how we should measure or evaluate policy goals, and the specific techniques we use to achieve those goals. Saying that we should evaluate policy by its results rather than its soundness does not by itself entail that any specific policy measures, i.e., "if unemployment is rising, loosen policy, . . . if inflation is rising, tighten policy." Henwood's use of "[i]n other words," is absolutely dishonest, as if he were rephrasing Lerner instead of drawing a conclusion.

I'm not saying socialists should never talk about fiscal policy lags, but this trope is such a pro-austerity conservative laissez-faire bourgeois talking point that an honest socialist must handle it with full hazmat gear. Indeed, Henwood's use of hubris, plus the connection of functional finance to policy lags to hubris, is a direct invocation of bourgeois arguments against socialism: it is hubris to believe that the government could have any role in managing anything as complicated and subtle as a market economy. I'm a socialist, so that's not an argument that I want to get anywhere near my own lips.

Fiscal policy is indeed difficult, which is why principles of macro by itself (where I teach my students about fiscal policy lags) is not a sufficient qualification for holding the Fed chair. But thinking that a lot of smart well-educated people can do something merely difficult is hardly hubris.

Although taxes do work reasonably well as an "fine tuning" automatic stabilizer, literally no economist anywhere — including MMT scholars — thinks that using conventional fiscal policy (building bridges, airports, etc.) is an effective tool for fine tuning an economy for exactly the reason that Henwood lifts out of a dimly remembered or badly garbled sophomore economics class. So what? That's not the argument that anyone is having, and that has nothing to do with functional vs. sound finance.

I can tell a lot about a firm (or a household) just by looking at their books and not their real business. Specifically, I'm looking at things such as cash flow, net profit, and debt to income ratio. I know what those numbers should look like, and if they don't look the way they should, the firm is in real trouble.

Sound finance says that to some degree or another, we can tell how a government is doing just by looking at its books, or at least that we should pretend that ordinary accounting criteria that are important to households and firms are just as important for a government.

Functional finance says that we can tell very little, if anything at all, just by looking at the government's books; instead, we must look at the real economy, i.e. at GDP, inflation, employment, investment, etc. to determine how well the government is doing. If a firm is running up a lot of debt, that's troubling by itself. For a government, we don't know: is the debt causing inflation? If not, well, the government is all right for now. If a firm has positive cash flow, that's great. For a government, we don't know: is the positive cash flow causing unemployment? If so, the government is in trouble. Functional vs. sound finance is about what we should look at to determine what to do; neither offers a specific prescription on what to do about what we see.

There's a deeper economic philosophy in play. Sound finance is the position that the government should be (or should pretend to be) part of the market economy, subject to the same market discipline that capitalists apply (or pretend to apply) to themselves. Functional finance says that the government is not part of the market economy, it manages the market economy. Naturally, the capitalist class prefers sound finance.

(Yes, as a socialist, I'm against markets in general. The socialist point here is that I argue that positioning the government as not a part of but the manager of a market economy is a useful step towards socialism. And there is an argument that a capitalist government cannot effectively manage a capitalist economy not because that task is too difficult but because it is a capitalist government. Henwood does not make this argument.)

Misconception: Monetary policy is just like fiscal policy

To extend (in bold) the ellipses at the end of the last quotation:

MMTers extend this hubris about the precision and power of policymaking to the realm of interest rates . . .

Wait! Stop! Monetary policy, i.e. interest rates, is completely different from fiscal policy, and is subject to fewer and very different lags. Conventional macro already holds that the central bank can fine tune the economy.

Misconception: MMT holds that monetary policy can fine tune the economy

To finally complete (in bold) the ellipses above:

MMTers extend this hubris about the precision and power of policymaking to the realm of interest rates, which they think the central bank is completely in control of and should be kept as close to zero as possible.

Sigh. One of the points I learned to look for when I debated religion (and especially creationism) on the internet was when a writer contradicted him- or herself in the same paragraph. Henwood manages to contradict himself in a single sentence. If MMT economists want to keep interest rates near zero without qualification, then they do not want to use interest rates for fine tuning.

And indeed MMT scholars argue not that we should not but that we cannot fine tune the economy with interest rates. MMT scholars argue that businesses' expectations of profit determine most investment; interest rates by themselves do very little. Moreover, because people hold bonds for income, interest rates have the opposite effect on consumption than they do on investment.

Misconception: MMT economists do not understand interest rates

Although MMTers tend to talk casually of “the” interest rate, in fact there are many. Long-term government bonds, for example, are almost always going to carry higher rates than short-term ones, because so many more unpredictable things can happen before the bond reaches maturity. And either is going to yield less than a bank loan of similar maturity to an oil wildcatter or the corner bodega, because of the higher risk of default.

Thank you, Mr. Henwood, for explaining to a bunch of people with PhDs in economics what I teach my sophomores about interest rates. I'm sure they are most grateful for lesson. </snark>

Talking about the imaginary singular interest rate is endemic among economists in general, for a lot of boring technical reasons, sometimes just laziness. For one, risk- and maturity-adjusted interest rates should all be about the same, because that's how markets usually work. But because people are exceptionally bad at judging risk (not to mention uncertainty), markets don't always work the way they're supposed to.

When MMT economists talk about the interest rate, they usually talk explicitly about the Federal Funds rate, the rate at which banks loan each other reserves overnight, which is indeed singular and which the Federal Reserve can indeed completely control, and which does indeed influence other interest rates at least a bit. If any MMT economist has said that all interest rates should be near zero regardless of risk or maturity, I would like to see a citation, because that economist should be stripped of their PhD and forced to repeat their sophomore principles classes.

Misconception: MMT scholars don't understand inflation

MMTers are coy about [inflation] — they never say how much is too much, and they profess great confidence in their ability to control it.

Ok... How fast is too fast? It depends. On what? A lot of things; I can't put it in a soundbite for you. But let's proceed.

In a paper criticizing MMT, the left-Keynesian economist Thomas Palley says he’s heard a “leading” MMTer say inflation less than 40 percent is “costless.”

Objection! Hearsay! Sustained. Move on counselor.

<snip long discussion about hyperinflation> Weimar Germany may be an extreme case, but since it’s often brought up by critics of MMT — “won’t all that keystroking lead to inflation, like Argentina or Weimar?” — it’s one for which they need to have a good answer. Wray’s reluctance to face head-on the risks of printing money makes you wonder how confident he really is of his own theory.

Printing "too much" money is only the proximate cause of hyperinflation, in just the same sense that turning on the heat is only the proximate cause carbon monoxide poisoning. It's a bugaboo, moreover a bugaboo hysterically promoted by capitalist economists against Allende Chavez socialism. Hyperinflation is just not a risk in a country with an otherwise well-functioning government that can effectively collect taxes; if its government is dysfunctional, the country has worse problems than just hyperinflation.

MMT scholars talk how to control inflation all the time. It's really not that difficult. You suck money out of the banking system and the economy by selling bonds, or you (gasp! horror!) raise taxes.

But raising taxes is hard! No shit, Sherlock: economics is hard. Running a government is hard. People go to school for years just to start to learn how to do it.

(Maybe they should just go to journalism school and write dishonest hatchet jobs. Hell, it works for David Brooks and Thomas Friedman, maybe it'll work for Henwood; perhaps he'll go all James Burnham on us and join the AEI.)

But people hate taxes! Really? You don't say! Do they love recessions? Because that's how to control inflation without raising taxes.

Actually, people don't hate taxes, capitalists hate taxes, and they tell the people what to think. Henwood approves of taxes, and good on him, I do too, and so do MMT scholars.

Damn! This is getting long, and we're only about a third of the way through Henwood's mess. Let's take a break here and pick up where we left off in a day or so.