By Mark Skousen
“Today, as in the past, a sound money system is the condition of man’s freedom and the key to his future.”
— Jacques Rueff
Three heterodox economists William Mitchell and Martin Watts (both University of Newscastle, Australia), and L. Randall Wray (Bard College, New York) — hereafter referred to as MWW — have written a textbook entitled Macroeconomics, co-published this year by Macmillan International and Red Globe Press. They promise a “comprehensive, university level study course in Macroeconomics from a Modern Monetary theory (MMT) perspective…grounded in real world institutions…and starts by putting the currency-issuing government at the forefront.”
Having analyzed economics textbooks in my career, I found it a valuable exercise to determine what this textbook includes and what it ignores in making the case for MMT.
In the introduction, they acknowledge that MMT grew out of the financial crisis of 2008 and the “cult of austerity” accompanying it. They criticize the “neo-classical” economists for failing to “see it coming,” and wrongly predicting that inflation would accelerate after the monetary crisis due to quantitative easing. MMT “rejects the main precepts of the orthodox neoclassical approach to macroeconomics” (13) and the self-interested “invisible hand” in microeconomics (6).
Thus, MWW see the need for a new Weltanschauung based on the heterodox theories of Marx, Veblen and Keynes. They endorse the United Nations Universal Declaration of Human Rights, including the right to work and protection against unemployment, equal pay for equal work, and a minimum standard of living (9-11).
At times the authors appear nihilistic: “…there is no single ‘right’ way to do economics….…the responsible social scientist is not seeking to establish whether the theoretical model is true, because that is an impossible task given there is no way of knowing what the truth is anyway” (3, 8). And, they assert, “there is no scientific basis for the claim that ‘free markets’ are best” (pp. 3, 9).
“There are no financial constraints”
Despite this caveat, their conclusions are dogmatic: “The most important conclusion reached by MMT is that the issuer of a currency faces no financial constraints. Put simply, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due. For this reason, it makes no sense to compare a sovereign government’s finances with those of a household or firm” (14).
For MWW, the budget and debt constraints that operate for an individual and household do not apply to the government. They reject Adam Smith’s refrain, “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.” To the contrary, “the household budget analogy is false” (124) because unlike households and businesses, government has the power to tax and to print money (318).
They reject the “cult of austerity” (14). Now that advanced countries are no longer constrained by the gold standard or fixed exchange rates, “currency-issuing governments such as those of Australia, Britain, Japan and the USA can never run out of money…for most governments, there is no default risk on government debt” (14, 15).
Furthermore, if a nation operates with a sovereign currency and avoids incurring debt in foreign currencies (a big if), “the national government can always afford to purchase anything…” (16).
The Principal Policy Goal: Full Employment
To what purpose should the government run deficits and monetary inflation? Fiscal policy should aim for full employment of labor and resources and guarantee everyone a job, either in the private or public sector. They call it a Job Guarantee (JG) program. In chapter 19, MWW “elaborate on why full employment should be the key macroeconomic policy goal” (291). Not controlling inflation, not economic growth, not maximizing freedom. But job guarantees for all, the “right to work” at a “living wage” (292, 295, 302).
Figure 1 below illustrates the classic Keynesian case of increasing aggregate demand (AD) to achieve full employment.
If there is chronic unemployment, “the government [can] always put them to productive use…to hire them to perform useful work in the public interest” (16), involving “direct job creation by government” (295).
But there’s more. “There is no financial constraints to stop a currency-issuing government providing first class healthcare and/or pensions in the future” (127).
“An MMT frame considers the $x in the fiscal papers to be of little interest” (130).
They don’t mention it, but how about using government revenues to finance military adventures abroad? At the beginning of World War II, ten million unemployed were suddenly employed as soldiers in the US armed forces.
Does this fiscal nirvana sound dangerous and irresponsible? Is there method to their madness?
In a 5-page section on “mainstream fallacies,” they list eight myths of political economy, including a denial that fiscal deficits cause crowding out of private investments, higher taxes, inflation, or big government, or the need for a balanced budget rule or a “rainy day” fund (124-128). They go out of their way to belittle any government leaders who speak out against “living beyond our means”… “spending like a drunken sailor”… “welfare dependency”… “burdening our grandchildren with the public debt”… or “national bankruptcy” (124).
Three Ways to Pay for Government Spending
There are three ways to finance a new government program. MWW put it in the form of an equation:
G +iB = T + ΔB + ΔM
|iB||=||interest payments on public debt|
|ΔB||=||new borrowing selling government bonds|
|ΔM||=||new base money creation|
The most burdensome and politically unpopular method is direct taxation (T). For them, the best policy is to “spend first, tax later” (323). They ask, “Why not just eliminate taxes altogether?” MWW reject that suggestion because it makes it more difficult for the government to borrow money without the threat of taxation (323), and progressive taxation helps reduce inequality (324). Ideally, according to MWW, taxes should be “countercyclical,” increasing during an expansion and falling during a recession (323).
Deficits and the National Debt: “We Owe It Ourselves?”
The second way to finance government is to borrow the funds to pay for the program (ΔB). It postpones the pain of paying directly through taxation. But there is a price to pay down the road — the government has to pay back the principal to the bond holders and it has to pay interest, usually every six months (iB).
MMT proponents claim that government deficits are self-financing because sovereign nations can issue more debt, raise taxes, or print money. Moreover, government borrowing is also an asset in the form of government bonds held by investors. “The government’s deficit is always mirrored by an equivalent surplus in another part of the economy,” states Stephanie Kelton, economist at Stony Brook University.
This statement is, in essence, the old “we owe it ourselves” argument. Robert Shiller calls it a “half truth.” He states, “The claim would have been accurate only in an extreme, theoretical case: if everyone had identical bond holds and paid identical taxes to cover the interest and principal that were paying themselves. But we are never going to be in that situation in the real world.”
Libertarian economist Murray Rothbard debunked the “we owe it ourselves” argument: “The crucial question is: Who is the ‘we’ and who are the ‘ourselves’?” The bondholders (who tend to be wealthy individuals and institutions) are not the same as the taxpayers (who tend to be middle class.” “For we might just as well say that taxes are unimportant for the same reason.”
National Bankruptcy: False Fear?
Advanced economies have been able to borrow huge amounts of money, more than most economists thought possible.
MWW claim, “The government can consistently spend more than its revenue because it creates the currency” (15). Technically bankruptcy is impossible. “Treasury cheques never ‘bounce” due to insufficient funds” (327).
There is some truth to their statement. American conservatives have cried wolf time and time again about the dangers of deficit spending, that it will lead to national bankruptcy. I’ve heard it all my life, even now that the US federal debt is now over $21 trillion.
Murray Rothbard set the record straight when he debunked this myth about the national debt. He wrote: “Many opponents of public borrowing…have greatly exaggerated the dangers of the public debt and have raised persistent alarms about imminent ‘bankruptcy.’ It is obvious that the government cannot become ‘insolvent’ like private individuals–for it can always obtain money by coercion…by increasing the tax and/or inflation in society.”
Japan as an Example?
MWW point to Japan as an example of a nation where a country can engage in persistent fiscal deficits (pushing the national debt to an astonishing 235% of GDP) without igniting a sharp rise in interest rates or higher unemployment (27-31). Interesting that the authors ignore the fact that accompanying these massive deficits is Japanese’s anemic economic growth rate since 1992 (an average real 0.9% a year) when they started to run massive unproductive federal deficits.
You can also look at the United States in this regard. It is extraordinary that in a world where the largest economy in the world can run deficits of $1 trillion or more a year during times of full employment and strong economic growth and see interest rates continue to decline to historical lows. I don’t know a single economist who predicted it.
Surprise, Surprise! Governments Run Budget Surpluses!
The authors are also correct when they say, “Government deficits are normal, surpluses are atypical” (130). The Keynesians used to favor a countercyclical “balanced budget” policy over time, running deficits during recessions and surpluses during boom times. But as Milton Friedman commented, “Unfortunately, the balance wheel is unbalanced.”
But there are quite a few robust fully-employed economies that are running budget surpluses in an apparent reject of MMT, including:
|Country||Surplus (% of GDP)|
|United Arab Emirates||5.00%|
The third way is the easy way out but also potentially more dangerous in destabilizing the economy — printing money.
How to Deal with the Threat of Inflation
MWW are opposed to “inflation targeting” because it imposes a high price of persistent high unemployment in order to keep price inflation in check (297-98, 315). Instead, they propose an “employment buffer” policy, so that when private demand for labor declines, the federal government increases its job guarantees, and when private demand for labor increases, the government reduces its available job offers. “This targeted approach to sustaining full employment is a powerful stabilizing force for aggregate demand, output, and prices” (302).
MWW introduce the “buffer employment ratio” (BER), defined as:
BER = JGE/E,
JGE = Job Guarantee employment (by the government)
E = Total employment in the economy.
Thus, “BER rises when the JG pool expands and falls when the JG pool contracts” (304).
Why does this “buffer employment” policy control inflation? When inflation threatens, MWW advocate tightening fiscal and monetary policy “to reduce the level of private sector demand. Labour is then transferred from the inflating private sector to the fixed wage JG sector and the BER rises. This will eventually ease the inflationary pressures arising from the wage-price conflict” (304).
Thus, full employment is achieved at all times while price inflation is held in check.
But will it work? There are several potential problems. First, how will labor productivity be affected in a managed economy where unemployment is virtually outlawed? What incentives are there for workers to be efficient when they know they will be hired by the government if they are laid off by the private sector?
Second, wouldn’t workers in the private sector use the JG to demand higher wages? MWW claim, “That would be unlikely,” because “the JG lowers the cost of hiring for firms because the JG workers do not experience the dislocation of unemployment and retain most, if not all, of their general and specific skills” (304). Really? Who’s to say the shifting from the private sector to public sector employment doesn’t involve dislocations and loss of skills? And how easy would it be to shift back from public to private employment when the economy recovers?
Third, MWW assume that inflation is cost-push (wage pressure) rather than demand-driven, a dubious assumption in a managed economy that promises guaranteed employment, a living wage, full medical and retirement benefits.
A sharp rise in BER during a severe recession could create enormous burden on the public sector, as JG soar. How would the government pay for all these JG? Tax, borrow, print?
Finally, can inflation be stopped once it starts? Studies show that once inflation gets started, it’s almost impossible to stop without causing a recession.
Fear of Runaway Inflation
MWW are well aware of the critics who fear MMT might lead to “creeping inflation” and ultimately “hyperinflation” (342).
“We acknowledge that the in the absence of appropriate oversight, a government can maintain an excessive rate of expenditure which leads to rising inflation. But we show that the two popular examples of hyperinflation — the Weimar Republic and Zimbabwe — were the result of increasing aggregate supply constraints rather than being driving by excessive fiscal deficits” (333).
According to MWW, Germany’s inflation problem in the early 1920s was caused by excessive demands of the Treaty of Versailles that could not possibly be paid for out of domestic taxation or exports. And Zimbabwe’s collapse was due to state mismanagement of the commercial farms, which were confiscated by Mugabe’s ruthless regime and turned over to rebels who had “no background in running commercial agriculture” (345).
Still, there’s reason to be concerned that countries adopting MMT might mismanage the economy in other ways. In response to a severe recession, the government would dramatically increase their JG program, which in turn might result in unproductive “make work” public projects. The central bank would be pressured into printing more money even as the real economy shrinks.
Sebastian Edwards of the Hoover Institution did an in-depth study of four Latin American countries (Chile, Peru, Argentina, Venezuela) that had adopted varying aspects of MMT (financing large fiscal deficits and “job guarantee” programs through monetary expansion). He concluded: “The four experiments ended up badly, with runaway inflation, huge currency devaluations, and precipitous real wage declines.”
No Chapter on Economic Growth
One of the surprising sins of omission in MWW’s Macroeconomics textbook is a chapter on growth theory. I don’t know a single other textbook that ignores the importance of economic growth these days. For years, the Keynesian influence after World War II was so strong that the focus in textbooks was on full employment and taming the business cycle based on Keynes’s “General Theory” of unemployed resources and aggregate demand failure. Economic growth theory was a “special case” relegated to the back chapters.
Harvard professor Greg Mankiw created a counterrevolution in the early 1990s by putting the growth chapter up front in his Macroeconomics (Worth Publishers, 1994), and relegating Keynes’s theories to the back pages as a “special” case.
Now MWW want to go back to the good old days of Paul Samuelson “paradox of thrift” and Abba Lerner “functional finance“ theory of “crude” Keynesianism.
Real-World Alternatives to MMT
MWW contend that their textbook Macroeconomics is “grounded in real-world institutions,” yet I was surprised by their failure to cite real-world economies that have achieved strong economic growth and full employment without inflation using more classical economic principles.
Countries can achieve full employment and higher economic growth without inflation by encouraging greater productivity on the supply side, by cutting taxes and regulations, privatizing government-owned businesses and services, and championing saving, capital investment, technology and entrepreneurship.
Figure 2 demonstrates how the supply-side stimulus (AS) can achieve full employment with less inflation.
Note the difference between the Keynesian AD policy (figure 1 above) differs from the Supply-Side AS policy (figure 2 above) — the Keynesian deficit spending model increases output and inflation, while the Supply-Side productive model increases out and reduces inflation.
Here are several case studies that adopted the Supply Side Model (not discussed in MWW’s textbook):
Sweden: In 1992, Sweden suffered a real estate banking crisis, credit crunch, and monetary crisis. In response, the government guaranteed bank deposits and ran significant deficits. After the crisis abated, they engaged in a series of reforms to reduce the size of a bloated welfare state by privatizing various government programs; converting their state pension to a defined-contribution plan; adopting school choice in education; cutting corporate and other taxes; and overall reduced the size of government while maintaining its generous welfare system. Today Sweden has a modest budget surplus. The average real economic growth in PPP (Purchasing Power Parity) terms in nearly 3% a year. Price inflation is low. The unemployment rate is 6.7%, largely due to a generous immigration policy. Sweden’s Economic Freedom Index has risen to #19 most free in the world.
Canada: In 1994-95, Canada suffered from an oversized government, resulting in a budget deficit and currency crisis, with Moody’s downgrading Canadian debt. The Liberal and Conservative parties agreed to severe budget cuts and federal layoffs, despite strong opposition by Keynesian economists. Two years later, the budget was balanced, and the Canadian dollar made a strong recovery. Then Canada adopted a series of supply-side tax cuts. Today the corporate tax rate is only 15%. The size of government has been reduced, economic growth is over 3% a year, inflation is less than 2% a year, but the unemployment is relatively high at 6.7%. The budget did fall into deficit during the 2008 financial crisis, but none of the top five banks suffered serious losses. Canadian budget has improved since then, although the Canadian dollar is weak. Today Canada (#8) is ahead of the United States (#12) in the Economic Freedom Index.
Singapore: Economic growth has averaged 3.5% in the past five years, inflation is less than 1%, and unemployment rate is 2%. Singapore has accumulated substantial budget surpluses ($17.9 billion over the past three years), although it will run a deficit this year. Singapore has the world’s best medical care system, a combination of health saving accounts (Medisave) and universal coverage of catastrophic illnesses (healthcare represents only 4.5% of GDP). They have a flat maximum tax rate of 22% for individuals and 17% for businesses. Singapore has a free-trade zone. Though it is not a democracy, it is ranked #2 in the world’s Economic Freedom Index.
Chile: Since Gen. Pinochet stepped down as dictator and Chile adopted democracy in 1990, Chile’s economy continues to do well. Real economic growth is 2.2% over the past five years, and inflation is at a low 2.2% a year. The unemployment rate is 7%, largely due to the slump in copper and commodity prices. After running a surplus budget in 2011-12, the deficit returned but is a manageable 2.5% of GDP. The maximum tax rate is 44% on individuals and 25% on businesses. It is the highest rated country in Latin America in the Economic Freedom Index (#18 in the world).
These examples demonstrate that countries can achieve reasonable full employment, good economic growth, and low inflation without resorting to risky MMT policies.
There aren’t many cases where a broad range of economists, from Keynesian to Austrian, can agree on something, and MMT is one of them. Vocal critics have included Paul Krugman, Robert Shiller, Kenneth Rogoff, Larry Summers, Steve Hanke and Robert Murphy. All agree that MMT is a bad and even dangerous policy.
It seems that MMT advocates are determined to test the validity of Adam Smith famous refrain, “There is a great deal of ruin in a nation.”
I began with a quote from French economist Jacques Rueff. I will end with his warning: “No religion spread as fast as the belief in full employment, and in this roundabout way, allowed governments that had exhausted their tax and borrowing resources to resort to the phony delights of monetary inflation.”
 Jacques Rueff, The Age of Inflation (Regnery, 1964), translated by A. H. Meeus and F. G. Clarke, p. xiv.
 William F. Mitchell, L. Randall Wray, and Martin J. Watts, Macroeconomics (Macmillan International and Red Globe Press, 2019), preface.
 See Mark Skousen, Economics on Trial (Irwin Publishing, 1991), and my paper, “The Perseverance of Paul Samuelson’s Economics.” Journal of Economic Perspectives (1997), 11 (2): 137-152. https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.11.2.137
 Adam Smith, The Wealth of Nations (Glasgow Edition, 1982), Book IV Chapter II, pp. 456-7, paras. 11-12.
 Stephanie Kelton, “How We Think about the Deficit is Mostly Wrong,” New York Times, October 5, 2017.
 Robert J. Shiller, “Modern Monetary Theory Makes Sense, Up to a Point,” New York Times, March 2, 2019. He concludes, “Though increased spending on infrastructure, education, social welfare and the environment may be wise, and rising deficits may make sense some of the time, we really cannot borrow ceaselessly without risking real harm.”
 Murray N. Rothbard, Man, Economy and State, 2nd ed. (Mises Institute, 2004 ), p. 1027-1028.
 Ibid., p. 1028.
 Milton Friedman, Capitalism and Freedom (University of Chicago Press, 1962), p. 76.
 Sebastian Edwards, “Modern Monetary Theory: Cautionary Tales from Latin America,” Economics Working Paper 19106, Hoover Institution, April 25, 2019. https://www.hoover.org/research/modern-monetary-theory-cautionary-tales-latin-america
 See Mark Skousen, The Making of Modern Economics, 3rd ed. (Routledge, 2016), pp. 445-448.
 J. Rueff, “La Fin de l’ere keynesienne”, in ´Oeuvres completes de Jacques Rueff, vol. 3, Politique ´economique I (Paris, 1979), 178. This article, originally a lecture delivered to the Mont Pelerin Society, appeared in ` Le Monde on 19 and 20–21 Feb. 1976. See also https://dailyreckoning.com/homage-to-jacques-rueff/