Krugman on MMT

Paul Krugman comments today on Modern Monetary Theory (MMT).  Unfortunately, he gets it wrong.  For example, he says:

Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.

I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right.

The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.

I commented and posted this response to him on his blog:

Paul, you either have an incomplete understanding of MMT or have setup a strawman. MMT does NOT hold that “deficits never matter, as long as you have your own currency.” MMT says that deficits do matter but only if (a) there’s no slack of real resources in the economy and (b) the private sector is choosing to net accumulate debt instead of accumulate net financial assets. In the meantime, however, as long the private sector wants to accumulate net financial assets, deficits are necessary to prevent Aggregate demand from falling.

You apparently prefer to use the interest rate on safe assets as the indicator of whether there’s slack real resources available – hence your emphasis on liquidity trap lingo. MMT emphasizes actual unemployment. If there’s significant unemployment, then there’s slack resources available for the government to purchase and put to use producing incomes for people.

A key insight of MMT is how the real world of banking has changed since the 1970’s when gold and fixed rates were abandoned. In our real world today, reserves do not constrain bank lending and money creation. The fears of inflation based on old equation of exchange theories are unfounded. It’s a shortage of real resources that will drive inflation, not deficits per se.

I’m not the expert on MMT. I’m just a teaching economist with both a lot of teaching and practical applied experience. If you really want to know MMT from the experts, try folks like Bill Mitchell and his Billy Blog, or Randy Wray and company at New Economic Perspectives. For that matter, read Wray’s books or Mitchell’s books.