Saturday, July 04, 2020

The fundamental problem with MMT

Robert P. Murphy has a mostly negative review of Stephanie Kelton's The Deficit Myth. Murphy appears to be a member of the Mises Institute, so I assume he believes that the government cannot do anything good, other than to protect the property of the wealthy. Even before reading, I was pretty sure he would disapprove in principle of the whole MMT project of making it easier for the government provide for social welfare. Still, Murphy avoids the OMG! hyperinflation hysteria so common to vulgar critics of MMT, and ideological bias is no guarantee of error, so I want to look at his criticism in more detail.

Murphy presents a laundry list of mostly unconnected objections to MMT, so I'll just present a corresponding list of rebuttals over at least a couple of posts, perhaps more.

The Fundamental Problem of MMT

Murphy begins his objections by stating MMT's "fundamental problem":
regardless of what happens to the "price level," monetary inflation transfers real resources away from the private sector and into the hands of political officials. If a government project is deemed unaffordable according to conventional accounting, then it should also be denied funding via the printing press.
I'm still really struggling to understand this objection. Clearly, Murphy thinks that monetary inflation is something different from a general increase in the price level, the usual definition of inflation. But I don't know what that is. (Murphy kind of expands on the point below.) Presumably, because MMT is all about the government creating currency as needed, I think Murphy considers the creation of additional currency by itself to constitute monetary inflation.

Now it is definitely true that when the government creates money to purchase goods and services from the population, it is transferring real resources from the private sector to the government. That's pretty much the whole point of a government, and what governments have been doing for about 7,000 years. I get it, Libertarians are completely against governments except to protect their own privilege, but this objection seems misplaced and has nothing to do with MMT per se.

Murphy continues with another opaque objection: "If a government project is deemed unaffordable according to conventional accounting, then it should also be denied funding via the printing press." But what does Murphy mean by "unaffordable" and by "conventional accounting"? Affordability precedes accounting: spending is affordable if a firm or household can get the money; once it has the money, firms and households account for how they spend it. But where does the money that firms and households need to get ultimately come from? Well, in every large economy since 1971, the government creates the money*. All government spending is "funded" by created money. Although MMT scholars are exceptional in that they don't try to pretend that governments don't create money, this objection has nothing to do with MMT. Libertarians might pine for a return to the gold standard, but the world abandoned the gold standard because it just doesn't work. Go back 50 years and argue with Richard Nixon, not Stephanie Kelton.

*The Eurozone is a Hot Mess and has suffered several financial crises precisely because the European Central Bank is not part of any national government.

I will concede one point to Murphy: if the government wants to appropriate real resources away from private production, it should ensure that the citizens believe that benefit of the government spending exceeds the benefit of alternative private employment of those resources: to avoid price inflation, the government should collect enough taxes (after, of course, it spends the money) to reduce private demand by as much as it reduced private production. But every MMT scholar agrees with this concession. The whole point of MMT is about how to employ unused resources, i.e. available labor not employed by the private sector.

Murphy expands a bit, presumably on "monetary inflation". Government spending to employ real resources increases the price level. If the price level would have otherwised decreased, so that spending keeps the price level stable, then those with financial assets are poorer than they would have been had the government permitted deflation.

The easiest rebuttal is simply: yes, but so what? That's how the money system works. Instead of permitting deflation, investors increase their real wealth by collecting interest, which requires increasing the money supply. We might have chosen to keep the money supply constant and let price levels decline instead, but we didn't; which method is correct is beyond the scope of this post. Regardless, investors can't have it both ways: investors cannot be both entitled to interest, increasing their real wealth holding the price level constant, and entitled them a decrease in the price level, increasing their real wealth holding the money supply constant.

But it also matters why the price level decreases. There are two ways the price level can decrease. The price level will decrease if real production increases holding the money supply constant. That's the trade-off above: presently, the government increases the money supply, supplying all holders of financial assets with interest. However, the price level can decrease when real output decreases. In this case, an increase in real wealth for holders of financial assets is at best illusory. If financial asset holders were to increase their consumption, that spending would simply drive prices back up. Even worse, if the decrease in real production were to become permanent (as equipment rusts and workers forget their skills), then an attempt to convert financial assets to consumption will increase the price level above its original point, causing a decrease in asset holders' real wealth.

Murphy argues directly against employing unused resources at all. Murphy cites Mises' malinvestment argument: unused capacity is the result of earlier bad investments; employing that unused capacity will just perpetuate the bad investments. If, for example, we have a thousand factories and a million workers making Pet Rocks that nobody wants anymore, it's a pointless waste of real resources for the government to print the money to keep the Pet Rock factories operating and employing those workers. MMT theorist agree that the Pet Rock factories should not operate (and investors would lose financial claims to their revenue), but what about the workers?

Even taking the malinvestment theory at face value, what do we do with the million workers? We have four choices: pay them to continue to make Pet Rocks, let them starve and die, pay them while they're not working, or pay them to do something else useful. In theory, the private sector should be able to pay them to do something else useful, probably building more factories for products that people do want. Not that Libertarians care much about evidence, but the evidence shows that's not what happens in real life. Instead, if we abandon too many bad investments at once, those workers are not reaborbed into the workforce. Even worse, the workers that provided the newly unemployed workers with consumer goods also leave the private labor force. We end up losing useful productivity for years and sometimes decades.

Murphy continues with some more MMT-specific objections. I'll cover those in a later post.

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