A reply to Stephanie Kelton

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.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

21 Responses

  1. JT

    “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.”

    This doesn’t seem correct.

    (1) The Fed’s objectives are set by Congress, which comport with MMT objectives: full employment and price stability. (The Fed isn’t really that Independent.)

    (2) At least recently, it’s been the Treasury that’s been the rogue actor. Bernanke was practically begging for the Treasury to support the Fed’s loose monetary policy with expansionary fiscal policy during the Obama administration. MMT economists supported the Fed’s position (not QE per se, but it’s position that the Treasury should have been doing more.

    (3) The Fed’s current mandates severely constrain its actions. It has to ensure the smooth functioning of the financial system to meet its mandates. It’s not going rogue.

    (4) At the end of the day, the Fed is just an agent of Congress. It requires only a simple majority vote for the Congress to tell it what to do, just as it does the Treasury. Both the Treasury and Fed are equally at the whim of Congress.

    • Eric Lonergan

      Independence is not an absolute and is a subtler concept of power than I think you recognise. Congress frequently can’t legislate. That alone gives meaning to the Fed’s ‘independence’.

  2. JKH

    “Let’s be clear about this …”

    The MMT story regretfully is an evolution in clouded analysis

    And more than in relation to CB independence

    The larger and more overarching framing problem is in the so-called consolidation approach

    ALL of the difficulties MMT has in selling it’s story stem from an analytical laziness that inhabits that approach

  3. Steven Craig Hummel

    If we tied monetary policy directly to the point of retail sale with a 50% discount to consumers that was rebated back to the enterprise giving the discount you would slay the two deepest problems of modern economies namely scarcity of individual incomes/business revenue and inflation.

  4. Tony Rooney

    Independent CBs are an extension of neoliberalism, based on the premise that governments are inefficient. Therefore, we should remove the ability of government to affect monetary policy and instead leave it to an unelected group of technocrats. These technocrats believe and practice the same neoliberal policies and show an unwavering belief in neoclassical economics. Given the choice of the 2 give me coordinated monetary and fiscal policy under the direct control of elected governments all day long. After this has been done, MMT should be adopted in the UK and USA and any other sensible sovereign money creator.

    • Eric Lonergan

      Would you make the same claims for the independent judiciary, regulatory agencies, and statistical agencies? The empirical evidence shows that independent central banks are more likely in democracies.

      • normansdog

        this answer inplies that only democracies have functioning economies, perhaps you are not aware of China?
        In any case, before hte 1980’s CB’s nevertargetesd inflation, from 1930 – 1975 they targeted full umployment. Only since then have we had the Regan-Thatcher-Milton Friedman era of 2% inflation targeting.

      • Eric Lonergan

        Great point Norman. In fact what I am arguing in my latest blogs on Europe is in fact directly inspired by what China did in the 1980s!

  5. Jerry Brown

    In my mind, Modern Monetary Theory is a theory that starts with what ‘money’ actually is, and especially what a fiat money is. That ‘money’ is a device created by the state (the authority in other words) in order to provision itself and resolve debts. That device of ‘money’ is ultimately given value by the state’s ability to demand and enforce taxes in it. So this contradicts theories that place the origins of money as a tool devised in order to simplify barter between individuals- and that is pretty important.

    So in a sense MMT is a ‘philosophy of money’ (like the title of your blog here). It attempts to describe what can be done by the ultimate issuers with this institution of ‘money’ that they have created. And especially, MMT focuses on that kind of money that is issued by countries such as the US, UK, Japan, Australia, etc.- floating exchange rate currencies not backed by any promise to convert to any commodity or other currency, issued by the national government.

    So MMT is an attempt to generalize what money is and can do. Across many countries, which have many different laws and institutions in place as to just how money can be created, and who can create it, and how and when and what is taxed, and what it can be spent on and all kinds of different rules and regulations individual to each nation.

    You (and JKH) point out that some institutional rules in place conflict with what MMT says is possible. That is true. And institutions like the Fed, and the politically devised rules they operate under, are very important. But I would point out, like JT here above, that the ultimate institution in the US- the one these rules are all subordinate to- is actually the US Constitution.

    The institutions and rules were actually created by the governments that issue the currencies in question. They are conscious acts of the US Congress in the case of the USA. The Fed hasn’t always existed since the beginning of the US and it hasn’t always operated under the same rules since it has existed either. Nor are these rules some ’emergent’ type phenomena that would always have ended up being the exact way they are. They no more invalidate Modern Monetary Theory than the fact that some countries peg their currencies to the US Dollar does. They do mean we have to consider how these rules in each country interfere with how MMT says money could operate.

    Well maybe that’s what you meant all along?

    Anyway, the time I will consider the Fed to be independent of the US federal government is the day it prohibits the US Congress from spending money on something the Congress thinks important. That will also be the same day the Fed gets a new set of rules to operate under.

      • Jerry Brown

        True. I was trying to put more emphasis on certain points you made and less on others. And I was not 100% sure you were saying what I thought you were. Sorry for the verbosity 🙂

  6. Derek McDaniel

    On fed independence:
    “Stephanie, oddly, chooses either to ignore this, pretend it isn’t the case, or doesn’t mention it because she objects to it.”
    I think you overstated this and are missing the MMT position on the fed. The main argument is, that it ends up not being that important. The fed’s mechanism for imposing constraint on the treasury, adjusting interest rates, doesn’t effectively limit spending, it merely increases payouts to bond holders. The dollar bill has the signatures of both the treasury of the secretary and the us treasurer. If the fed were completely independent, why is the treasury signing the notes it issues?
    Unsustainability in financial terms means something completely different than it does in real terms. It means some kind of financial adjustment is coming down the pipe, like a stock market bubble or a period of higher than average inflation. A difference of just two percent in interest, leads to a difference of 80% over 30 years. If we had interest rates on the debt 2% lower going 30 years back, we would have 80/180 = .44, 44% less debt accumulation. 30 years ago the debt was 2.8 trillion, so we would have 1.5 trillion less debt right now, just from that 2.8 trillion. That’s a big difference.
    People talking about debt sustainability don’t usually recognize how small adjustments are highly divergent over the long run.
    The biggest problem with inflation, is if it is discontinuous: the debt builds up for a long time, and then the “desire to save”, changes suddenly, and you get a price shock. If we want to decrease the debt we should be paying negative real rates on bonds to spur inflation. In my opinion, inflation is the only real tool to put political pressure on the government to reign in spending. If we can’t get inflation to happen, you just keep lowering your bond rate until it skims zero nominal rate, and use base money.
    Providing zero upkeep savings for $20 trillion worth of value is a huge service, that requires a great deal amount of trust, and only the government can securely offer savings at that much volume. All the gold in the world is only $1.8 trillion. When discussing interest rates the fatal mistake is neglecting volume. Higher volumes of wealth always require more maintenance and upkeep, and so should naturally pay a lower rate. If the debt gets really high, rates should be lowered. Paying interest on assets is not a good tool to fight inflation, except in extreme short term situations, because you are actually increasing the total amount of that asset circulating.
    You mentioned dual rates previously, differing the rate between lending and deposits. I am not a believer in uniform rates. Long slow process should have very low rates, quicker cycle processes should have higher rates. The purpose of interest rates is an alternative mechanism to give a fixed profit share to investors, and should be based on the expected gains of the project. Any project with net positive gains over its lifetime is financially viable, and over the long term, projects should not compete with each other based on rates, but rather priority. Money has no opportunity cost for those that issue it, because it’s a non-physical accounting record, so the fed should really facilitate a tiered rate system. Mortgages should have much lower rates than consumer spending.

    Just my thoughts.

    • Derek McDaniel

      Just wanted to correct something. Total gold value appears to be 8 trillion now, I originally got an old statistic. 8 trillion is pretty close to the peak inflation adjusted cap of the highest valued corporation from history: the dutch east india trading company, which was practically a pseudo-state empire.

  7. MigT

    “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”

    More like a Faustian deal with commercial banks, done behind closed doors.

  8. Vassilis Serafimakis

    Yes, I strongly want an independent CENTRAL BANK. I actually demand it.

    Such an institution would be as independent as the Treasury Department of the Department of the Interior are, in that it would answer only and always to the democratically elected government of the land, independently of petty, personal interests and unelected patrons of financial wealth.

    An independent central bank remains, however, something rare.

  9. Daniel

    Lets assume for a moment that congress authorize large budget deficits.

    Lets now assume that the central bank will increase its target rate because its have disagreement with the government.

    In this case the central bank will simply force the government to increase its expenses even more due to hikes in interest servicing and in such case central bank strategy will ne self defeating.

    Unless it will out of spite allow the government to default on its debts and by doing so allow a huge financial and economic crisis to occur.

  10. Clint Ballinger

    “government is to finance – yes, finance – itself by issuing bonds. That is why we have government bonds.” This shows a misunderstanding of accounting. Bonds do nothing (except prop up the interest rate and pay eager savers to save). The accounting is here; most critics just never bother to go through the details of why bonds finance nothing. Bonds are vestigial nonsense. “Treasury Debt Operations” Scott Fullwiler https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303

  11. Gerard MacDonell

    I think Eric makes very good points here, and his emphasis on what things do — as opposed to what they are — is particularly clarifying in this case.

    As usual, there are two MMT perspectives on parade here. The first is the more careful and limited set of claims that you might find in an MMT textbook. The second is the more widely-circulated and casual polemecism that, among other things, takes no account of the institutional arrangements that Eric emphasizes. For example, the leading lights of MMT can often be found making very strong claims for their preferred approach to fiscal policy without any reference at all to the monetary policy assignment.

    Here, Eric correctly holds them to account for this. And “the Fed would never…” is unconvincing, to say the least.

    On the other hand I try to avoid making any comments on MMT without conceding the following point. Whatever we make of their logic, the MMTers got to the currently-consensus relaxed view about the debt/GDP path much more quickly and adamantly than others.

    I find that irritating. 🙂


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