In both physics and monetary policy, common sense is not always a perfect guide.
The idea that time passes at different rates depending on your velocity, as Albert Einstein’s Theory of Relativity tells us, is hard to grasp intuitively. That light emitted from the front of an accelerating object still travels a constant speed seems absurd.
And when new concepts, such as Modern Monetary Theory (MMT) — the idea governments which control their own money have little need for fiscal austerity — come along, it seems normal that the first intuitive reaction will be: “Nonsense!”
That is certainly how U.S. Federal Reserve chair Jerome Powell responded when asked about MMT at congressional hearings earlier this week.
“The idea that deficits don’t matter for countries that can borrow in their own currency, I think, is just wrong,” said Powell. “U.S. debt is fairly high to the level of GDP, and much more importantly, it’s growing faster than GDP — really significantly faster. We are going to have to spend less or raise more revenue.”
Intuitively, that sounds right. Just as with our household accounts, once we are deeply in debt, the only way out is to spend less or earn more.
At some point, lenders will stop lending and interest payments will become prohibitive; the only alternative to austerity is bankruptcy and, perhaps, poverty.
But just as special relativity does not apply when we are rushing to an appointment (no matter how fast), it is an absolute fact that government finances, and the ability of central banks to create money, has very little to do with the way you manage your personal budget.
In some ways, Einstein’s special relativity — discussed with various levels of exactitude in popular science fiction — is more accessible than the principles of monetary theory. As a popular genre, monetary theory fiction does not exist.
Not only that, but monetary theory — like economics as a whole — may also be harder to tie down and examine.
Whereas the vast majority of scientists, guided by theory and experiment based on a common data set, have the same basic idea of how relativity works, any two economists are likely to disagree.
As Noam Chomsky reminded us, complex, unfamiliar concepts do not lend themselves to capsule explanation.
But, in essence, MMT is the idea that a government’s debt-to-GDP ratio, even when it rises to 200 per cent, need not create inflation in an economy that controls its own currency.
Keep on spending
MMT’s idea is instead that governments should keep on spending until such time as every person is employed and inflation finally kicks in. The government then can take action of some kind — raising taxes, for instance — to arrest that inflation.
For most of us, a new brilliant and complex way of understanding economics (or science) is impossible to distinguish from bafflegab. But in a clear and excellent piece on the Financial Times site Alphaville, Brendan Greeley writes that MMT “is neither Marxist, nor is it bullshit.”
But the theory’s critics do not just include traditional anti-tax think-tanks and Republicans. Centre-left economist Paul Krugman, writing in the New York Times, has been a vociferous opponent of MMT, prompting counter-arguments from the current high-profile proponent of the idea, Stephanie Kelton, a professor of public policy and economics at Stony Brook University in New York.
The debate will clearly not be resolved here. But for those who are interested, there has been plenty of ink spilled and breath expended on the subject, including this long interview with Kelton on the podcast Left Out.
Basing her argument on the writings of illustrious economic thinkers, such as John Maynard Keynes and Adam Smith, and using the example of the U.S. funding of the Second World War and Japan’s current economy, Kelton says people like Powell and Krugman are trapped in old, conventional thinking.
Radically new ideas in economics, as in science, are almost universally opposed at first by the old guard. And there is logic in that response: An untried idea that didn’t work could bring an entire economy crashing down.
But even ideas that turned out to be successful were attacked when they were proposed. Exchanging the gold standard for the U.S. dollar in 1944, and then the ending of the convertibility of dollars for gold in 1971, both led to predictions of doom. I’ve spoken to scholars who feel the danger isn’t yet over.
In the aftermath of the 2008 financial meltdown, plans for central banks to inject money, imagined into existence with quantitative easing, and other schemes to cut interest rates below zero, or to distribute cash to the public using helicopter money all had traditionalists twisting their shirt tails with worry.
It is no wonder that the idea of changing the conventional rules — about spending, inflation, government bonds and interest rates, as it seems MMT would — would leave those of us who have long considered those things to be real and solid facts baffled and a little lost.
But that doesn’t prove it wouldn’t work.
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