The crux of the MMT debate
This recent article by Stephanie Kelton is crystal clear and reveals the crux of the ‘MMT debate’. It’s all about central bank independence.
Also listen to this INET interview with Warren Mosler, a well-articulated summary of functional finance. Functional finance explains monetary and fiscal operations like this: the dollar bills in your wallet were created by the state, so the state ran a deficit in order to create money. In that sense, its deficits were self-financed. What happens when the state taxes and issues bonds? It removes the money it has created. It issues bonds to raise interest rates, and taxes to prevent too much money creating inflation. This is a simplification of how things work on many levels. But it is very good pedagogy. It is very clear, and it’s (sort of) correct.
When we map this model onto the real world, its central simplification becomes clear: monetary and fiscal policy are run by separate institutions, and they have been actively separated for very specific reasons. Stephanie, oddly, chooses either to ignore this, pretend it isn’t the case, or doesn’t mention it because she objects to it. She won’t like me saying this, and will probably cite twenty articles where she focuses on institutional structure. But then she says the solution to an unsustainable public sector debt dynamic is to keep interest rates down:
‘Since interest rates are a policy variable, all the Fed has to do is keep the interest rate below the growth rate to prevent the ratio from rising indefinitely. As Galbraith says, “there is no need for radical reductions in future spending plans, or for cuts in Social Security or Medicare benefits to achieve this.”‘
Ok, whether or not this works is debatable. But before one tries it, one has to engage in quite an extreme first move – taking control of the central bank. Central banks across the developed world are, to varying degrees, independent. At one extreme, the second largest economic area in the world has a central bank which is supranational, and legally prohibited from cooperating with national treasuries. But even outside of the Eurozone, central banks have high degrees of institutional independence. Interest rates will not be kept low to accommodate fiscal policy unless the executive takes control of the central bank.
That is in fact policy number one implicit in MMT. It deserves to be explicit, and debated. Stephanie obfuscates on this point:
“Krugman should be wondering why the Fed would ever maintain an interest rate that would put the debt on an unsustainable trajectory. I don’t believe it would.”
There are circumstances where an independent central bank could absolutely be at odds with fiscal policy. The fed tightened in response to Trump’s fiscal stimulus. Central banks across the developed world do not target debt sustainability given fiscal policy. They target what they think inflation might be.
Now you could say, “I don’t agree with this institutional structure. I want to change the law and make the central bank subservient to the Treasury. I want the government to set fiscal policy wherever it wants and the central bank to set interest rates to ensure the debt can be serviced, whatever the implications it thinks there might be for inflation.” But this is a complete reversal of the direction of institutional travel of the past 50 years, and illegal in much of the world economy.
Stephanie then makes an interesting suggestion, ‘if we’re so obsessed with debt sustainability, why are we still borrowing? […] the Fed no longer relies on bonds (open-market operations) to hit its interest rate target. It just pays interest on reserve balances at the target rate. Why not phase out Treasuries altogether? We could pay off the debt “tomorrow.”’
This is intriguing. Anyone obsessed with debt sustainability, has lost the plot for very conventional reasons. But it is worth explaining why we have bond markets! It’s not just that bonds serve a lot of useful functions as financial assets, but also it is precisely because we have separate institutions for fiscal and monetary policy, we have explicitly imposed a constraint on the government. We decided as societies after many decades that we didn’t want politicians to have direct control over the printing press. We want money to be controlled by the central bank. Central government is to finance – yes, finance – itself by issuing bonds. That is why we have government bonds.
It should now be clear why the crux of this debate is in fact about the independence of central banks. Simon Wren-Lewis makes a similar point, here. Let’s be clear about this so we can have a sensible debate. If you want politicians to control the printing press, Stephanie’s MMT is one way to do it. You first take control of the central bank. The second thing to bear in mind is you are not just handing the printing press to your favourite politician, but to all future politicians who take power.