Less than a year before the novel coronavirus spread across the globe, Ray Dalio, Bridgewater Associates founder and billionaire intellectual, published an article on what he saw as the inevitable path for monetary, economic, and fiscal policy. In it, he partially endorsed a view that has emerged since the Great Recession: When monetary policy cannot provide further accommodation after nominal short-term interest rates hit the zero bound, additional fiscal spending is needed as stimulus.
This is not a particularly unusual position. Indeed, over the years, many mainstream Keynesian economists have expressed support for this approach — Harvard economist Lawrence Summers refers to it as “black hole” or “secular stagnation” economics. A year following Dalio’s article, with Covid-19 cases and death tolls mounting, governments in major developed countries around the globe appeared to endorse this view, authorizing deficit-financed spending amounting to between 5% and 10% of gross domestic product (GDP).
Given that government-induced shutdowns designed to combat the spread of the virus contributed to unprecedented levels of unemployment, there was certainly a case for such measures. Dalio’s article, however, put a radical twist on the traditional zero-lower-bound calls for more government spending by endorsing a novel, heterodox economic theory known as “modern monetary theory,” or MMT. The defining feature of MMT — and what distinguishes it from more established, mainstream economic theories — is its insistence that, so long as a government’s debt is denominated in its own currency, there is no upper limit on the state’s monetary borrowing. In other words, public debt is irrelevant; a country’s central bank can always avoid default by printing more money. Such printing, MMT proponents further argue, can go on without any inflationary consequences. They thus call for economists to shed their superstitious fear of debt and for policymakers to unleash the full power of unlimited, risk-free government spending.
It should come as no surprise that some of the loudest support for MMT in the United States comes from the progressive wing of the Democratic Party. After all, if measures of public debt signify nothing beyond future currency-production goals for the U.S. Treasury, then there is no real limit to the amount government can spend on massive programs like universal free college, a Green New Deal, a universal basic income, or a universal jobs guarantee. Moreover, in this moment of profound economic uncertainty, when policymakers are turning to deficit spending in hopes of averting complete financial meltdown, the apparent blank check that MMT advocates offer holds a certain appeal to panicked economists and legislators on both sides of the aisle.
Yet the sudden need for deficit spending in the wake of a global pandemic should not be used as an excuse to embrace MMT. While they may be convenient, MMT’s central claims regarding the harmlessness of deficits, debt, and mass currency production are not only flatly false, they are deeply dangerous. Theoretical considerations and historical examples not only strongly undermine the central tenets of MMT, they also serve as a critical reminder to policymakers — particularly in a moment when deficit spending may truly be necessary — of what happens when governments fail, over long periods, to take responsible measures to balance their checkbooks throughout the business cycle.
GROWING OUT OF DEBT
MMT derives from a heterodox theory known as “chartalism,” which emerged during the early 20th century as a rebuttal to the mainstream prevailing theory of money. According to the latter, money developed spontaneously as a medium of exchange because engaging in transactions through currency is more efficient than bartering. German economist Georg Friedrich Knapp challenged this theory in his 1905 book The State Theory of Money, arguing that money originated with states’ attempts to direct economic activity. A given currency thus derives value not based on its status as a commodity — an object with either intrinsic or exchange value — but because taxes levied by a state are payable in the currency that the state issues.
Knapp’s chartalist theory of money as “a creature of law” was echoed in John Maynard Keynes’s Treatise on Money, in which Keynes asserted that money is “peculiarly a creation of the State.” It appeared again in Russian-born British economist Abba Lerner’s 1947 article bearing the title, “Money as a Creature of the State.” Lerner also drew on chartalist theory to develop the concept of “functional finance,” which suggests that because states can pay their debts by printing money, states with fiat currencies do not face any debt constraints when borrowing in their own currency. The only constraint they face, then, is that of inflation, which he argued is a result not of monetary policy, but of too much government spending. He also believed that inflation could be controlled by higher taxes, which would reduce the amount of money circulating in the economy.
Source: Jonathan Hartley | National Affairs
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