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.


5 thoughts on “Krugman on MMT

  1. It is good to hear that you have taken the initiative to try to explain the fundamentals of MMT to PK; hopefully, some of the other commentators (sic) will either read and investigate further or pose insightful questions. I have been struck with the apparent shallowness of most economists/wannabes who don’t understand why/how economics is of importance to society. By the way, I have wondered whether you may have a reference to a source which would explain what led to the decision of Nixon to believe that going off a precious metal standard would work and whether the economists of that period had anticipated any of the consequences which led the MMT proponents to recognize the ideas underpinning this proposed money/economic system. I suspect that the originators of the proposal were familiar with Chartism; were they also familiar with/refer to A Lerner’s ideas. I am looking for explanations/references.

    • I don’t know enough about the background of the decision in Nixon’s time to say. I do know they were largely forced into it because US gold reserves were depleting under the old rules. A lot of the Nixon advisors were actually Chicago school types – Milton Friedman, Schultz, others. They may have been interested in floating exchange rates simply as a way to elevate “markets” over fixed prices without thinking through the implications. Nixon and Kissinger didn’t really abandon the idea of a commmodity-backed U.S. dollar though. They only abandoned the official gold backing and fixed rates. Gold was replaced with an implied backing by oil at whatever the world oil price was/is. This was managed through the deals Kissinger brokered whereby OPEC, especially the Saudi’s and oil emirates, committed to always and only sell oil on the world for US dollar-denominated prices (in return for security protection). Thus, the rest of the world was committed to always needing/wanting US dollars since it was the only way to buy oil. Thus, the US dollar has an implicit commodity value or convertibility in the form of it can be used to buy oil. Euros, yen, etc cannot do that.

      It’s interesting that 3 major oil exporters have at various times sold oil for something other than dollars. Iraq in 2001-2003 sold some for Euros. Venezuela has bartered oil for real goods/services under Chavez. And Iran supposedly is currently selling for yen or reminbi. It is an exercise for the reader to decide what those three countries have in common.

  2. When I checked PK’s article at the link you provided:
    I noticed that the comments have yet to be published. I suspect that comments from a variety of individuals who also wanted to try to explain MMT to the nobel prize winner. See comments at other sites today:
    There is obviously a communication problem when the MMT proponents cannot appear to get the message thru to someone with the credentials of PK; this relates to my earlier comment that it would be very helpful to use well thought-out videos with accompanying explanations/references so that non-economists, as well as those more qualified, could get the message.

    • Part of the problem in getting through to PK or similar folks is that they really don’t do much fundamental research anymore at their stage of life. Much of what they read is stuff written by either their fellow-thinkers or their known “adversaries” such as the Chicago school types. The fundamental research, the going and reading stuff that’s pretty different or newer at a fundamental level than what they learned in grad school 2 and 3 decades ago doesn’t happen. I’m sure PK thinks he knows what MMT says, but I’m also sure he hasn’t really read that much of it. When he has read it, he’s probably read it with a mind towards argumentation/refutation, not open learning.

      In my own case, I used to think much the same way. Then 3 years ago two things happened. My teaching load shifted to macro from micro and the global financial crisis hit. I started reading fundamental stuff, like what’s the exact process by which the govt spends money in the sense of where does the check go, who cashes it, what accounts are changed, etc. One of the eye-openers for me was learning that banks really are not constrained by reserves. In reality, at least for the last 3 decades, banks make loans first. Then 2 weeks later (approx), they report the reserve position. If it’s short, Fed or other banks provide the reserves. This is one idea is fundamental. If banks are not reserve constrained, then the entire edifice of monetary policy-as-preferred-policy collapses. The whole inflation is the result of too much reserves creation collapses. I started going and looking at empirical data. In the end, I changed my thinking and realized that the world simply doesn’t work the way I was taught (I went to school around the time Krugman did). Part of it is because I was taught was ideologically biased. But part of it is because the world changed since then. Gold standard is gone. Fixed exchange rates are gone. But the reality is that the theories/models/thinking that the mainstream folks use (both “liberal” types like Krugman and conservative types like Chicago) don’r reflect reality anymore.

  3. Pingback: Krugman Is Still Wrong About MMT – and with it still wrong on deficit « EconProph

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