President Donald Trump and newly elected New York Congresswomen Alexandria Ocasio-Cortez have exactly the same monetary policies. What I hear you say, Trump is a Republican and AOC is a socialist, according to her own description.
It was Franklin Templeton’s Michael Hasenstab, who said that despite the polarisation of American politics, one thing that brings the two parties together is the government debt. He went on to note that, it used to be the case that Republicans were concerned about the level of government debt and took actions to reduce it, the Democrats on the other hand typically expanded government debt. These days both parties just expand the debt position.
Both the President and congress women Ocasio-Cortez are big supporters of Modern Monetary Theory or MMT for short. MMT basically posits that a government can pay its bills by creating money the old fashioned was – printing it.
If you think the whole idea sounded like lunacy, you are “old school” and maybe right, but then again. Nevertheless President Trump amd Ms Ocasio-Cortez belive in it. How do we know, well the President’s policies are based on MMT and Ms Ocasio-Cortez has said she believes in it.
The President’s addition to debt is staggering and while Republican’s criticised President Obama record on debt, Obama can rightfully point to the worst economic conditions since the 1930’s. Faced with a strong economy the Republicans have engaged in a debt expansion.
So why is MMT, as it is known for short, generating such intense interest now?
First, let’s start with the confusion over what it is. The answer seems to depend on which advocate of MMT is being asked. It is sometimes a theory of money. MMT is also being discussed in the context of a political program to justify huge increases in social spending. Then there is its role as a prescription for macroeconomic policy.
MMT is in its early days as an economic theory, it is not settled or fully developed. This makes engaging with it challenging — even, at times, frustrating. Nobel Economics Prize winner Paul Krugman has been writing about MMT since 2011. Krugman like many other economists have warned that MMT could lead to hyperinflation. They rightly point at reckless fiscal policy that generated rampant inflation in Zimbabwe, Argentina, and Venezuela, where central banks are far less independent than the US Federal Reserve.
Supporters of MMT might respond that what they are calling for in the US is nowhere near what the governments in Zimbabwe, Argentina, and Venezuela have done, so it’s unreasonable to claim that we’d see similarly high inflation. Indeed professor of public policy and economics at Stony Brook University Stephanie Kelton argues that MMT is not a recipe for doom, because:
- If you keep interest rates low there’s no problem. Economist James K. Galbraith has explained. Preventing a doomsday scenario is not difficult, he says “the prudent policy conclusion is: keep the projected interest rate down.” Since interest rates are a policy variable, all the US Federal Reserve has to do is keep the interest rate below the growth rate to prevent the ratio from rising indefinitely. Galbraith points out “there is no need for radical reductions in future spending plans, or for cuts in Social Security or Medicare benefits to achieve this.”
- If we (including Australia) are so obsessed with debt sustainability, why are we still borrowing? Well an answer maybe in part because the US Federal Reserve no longer relies on open market bonds operations to hit its interest rate target. It just pays interest on reserve balances at the target rate. In reality why not phase out Treasuries altogether? That would pay off the debt quickly. That may seem radical so what if the US debt duration was restricted to the three month T-bill rate. Interest rates would then always sit within a hair of the overnight rate. If the US needed to embark on a World War II like mobilisation, Congress could instruct the Fed to cap interest rates the way it did during the actual mobilisation for WWII.
- Paul Krugman, like most of the economics profession, appears to assume that the short term interest rate is the only tool available to the Fed to slow the economy. MMT disagrees, and many central banks around the world do, too. As just one possible alternative, the US Federal Reserve could mandate a lower maximum loan-to-value or higher debt service-to-cash flow ratios. Less credit would be extended, consistent with the Fed’s goal of slowing the economy, while the interest rate on the national debt would not rise. A potential benefit to raising margins of safety, compared with raising short-term rates, is that credit extended could come with reduced risks of default.
There is a fourth answer to slow the economy and bring the budget back into balance, increase taxes, demand will fall, inflation follows, the economy contracts and debt can be paid down. This one in reality does not really appeal to our political masters and the voters.
Nevertheless the bedrock observation of MMT is correct, that being any government that issues its own currency can always pay its bills. This observation allows policy makers to show less concern about the budget deficit than is typically the case.
In fact, MMT is growing in prominence precisely because of its relative lack of concern about the size of the US deficit. In a short review of MMT, on its face it Ms Ocasio-Cortez policies are not all that different from President Trump’s current policies that deliver benefits today and cost tomorrow. The President signed off on deficit financed 2017 tax cuts, which have increased debt and only delivered a short term sugar hit to GDP which is fading quickly.
Political progressives like Ocasio-Cortez who are showing sympathy for MMT are also being short sighted. If we further loosen the shackles tax revenue has placed on federal spending, then Democrats may get Medicare for all the next time they control the government. But, in turn, when the Republican’s next in the White House, what might it do with its newfound fiscal freedom?
Both parties claim to care about the deficit, but once in power they often act as if they care more about putting their preferred policies in place, whether these are tax cuts in the case of conservatives or new spending programs in the case of liberals. Further loosening political constraints on deficits is reckless, no matter which party is doing it.
MMT is seductive in its promises, but if continued it could cause great harm to the US economy. Like Medusa, it may seem beautiful. But look it in the eye you will turn to stone.