Making Sense of Modern Monetary Theory, Part 2
In Part 1 we took a look at Modern Monetary Theory’s historical precedents, and illustrated the ideological basis of MMT’s disagreement with various components of present-day fiscal and monetary policy. We will now take a look at the uncertainties and seeds of promise that underlie MMT’s alternate vision for the future of macroeconomics.
We are now at a major crossroads in the future of monetary policy.
As the Federal Reserve begins to dutifully raise rates and sell its Treasury and QE-era securities (shrinking the bank’s balance sheet), it faces attacks from both sides of the political spectrum: President Trump has vocally advocated for a return to low rates, while the rise of MMT seeks to challenge the traditional role of the Fed altogether.
Based on the activity of the Fed as a guarantor of US government debt following the crisis, MMT practitioners believe that, because of their aforementioned belief that the government can support much higher levels of debt over a long period of time, fiscal policy should be the prime tool of the government in maximizing the country’s economic output, not monetary policy. In this way, MMT paints an attractive picture: the government, free to take on as much debt as it feels it needs, uses the Federal Reserve (newly-relegated to the role of full-time government bond guarantor) to ‘print money’ at no charge, leaving it free to engage in large-scale projects and expenditures it could not pursue if it was concerned with balancing its budget. Because this money, when spent, would reach the private sector more directly than it would through liquidity extended to commercial banks (which must then choose how and where to lend that money at the greatest rate of return), it could stimulate harder-to-reach areas of the nation’s economy faster than traditional monetary policy. Should Inflation begin to rise, the government would respond by raising taxes, but because it is no longer compelled to balance the budget, it would only need to ensure that the overall taxation rate covers interest payments on the debt. As long as taxes (represented by a percentage of the country’s GDP) matched the overall GDP growth rate of the country’s economy, they would work to rein in inflation in the same manner as interest rates do under the current monetary system. With interest rates thus free to remain at near-zero levels, liquidity would remain broadly accessible, theoretically avoiding the kind of tight-money credit-squeeze seen in 2008.
This is the narrative that prominent Democrats invoke in support of expensive initiatives, such as Universal Healthcare and the Green New Deal, and which has, ironically, been inspired in part by the effects of the Trump administration’s counter-cyclical tax cuts and the President’s vocal attacks on the Federal Reserve’s interest rate increases. Now, however, we must again consider the question posed at the very beginning of this article. What unknown factors underlie this optimistic vision? And which among them have the potential to cause economic consequences as yet unforeseen?
There are many, and together they form a serious counter-argument to the heedless adoption of such a radical change in our economic system as Modern Monetary Theory. First and foremost is a fundamental truth of market behavior: past performance is no guarantee of future results. MMT is built on the concept of the dollar’s perpetual dominance as the world’s reserve currency, but it already faces threats from abroad. China has already begun to resist the dollar’s dominance as the world’s reserve currency, and regional confederations like the EU continue to consolidate economic heft in the global arena. Adoption of MMT, with its open embrace of greatly-increased debt and its associated costs, could itself drastically undermine the dollar’s current strength, and status as the world’s reserve currency, in the eyes of investors around the globe. There is no guarantee that investors will continue to perceive the dollar as the bastion of strength it has become if the policies and practices that put it on top are abandoned in favor of something radically new.
Secondly, the low interest rate and deficit-spending conditions that the US has sustained with sizeable growth since 2008, and which MMT seeks to expand on throughout future expansionary cycles, are not guaranteed to produce higher productivity in the long term. Indeed, its is almost impossible to be certain of exactly how directly they are correlated to long-run economic performance, given the variety of logistical and psychological variables. Japan is a prime example of easy money policies and deficit spending (at levels even more aggressive than those seen in the United States) which have failed to grow the nation’s GDP in the long-run since the 1980s, despite the introduction of sub-zero interest rates following 2008. Even if the transition to MMT in the US went off without a hitch, there is no guarantee that the long term results would be positive for the nation’s economy.
MMT’s attempt to minimize taxes could backfire in the long run, too, as interest expense on the national debt are already the fastest-growing component of the Federal budget. At a certain point in the future, taxes would likely need to rise in tandem with the growth of interest payments, even if inflation has not yet risen sufficiently to support taxation’s negative impact on output.
This leads to the final major unknown factor central to Modern Monetary Theory that calls in to question its viability: its politics. Although today’s monetary policy and Federal Reserve-set interest rates may lack the directness and immediacy of broad fiscal spending changes, they have been crucially free from the gridlock formed by opposing political ideologies that trips up efforts to pass meaningful legislation. In the event of a downturn, today’s Fed can act quickly and decisively, with an established mathematical approach that links the goals of successive monetary policymakers to agreeable targets. In MMT, this decision-making agency is given to the notoriously bickering-prone and less technically-apt congress. Even if a large majority passed legislation to initiate MMT practices and spending plans, nothing could stop a successive congress from making further, sweeping changes, stirring up uncertainty and destabilizing the trustworthiness of the US credit system. In the event of a confluence of factors resulting in a Japan-like lack of growth and sudden inflation (creating a 1970s-like stagflation spiral), it would be up to Congress to make the unpopular decision to raise taxes to rein in inflation under MMT doctrine, penalizing an already-stagnant economy.
For these and other reasons, Modern Monetary Theory is clearly not the final answer to the question of ensuring America’s continued productivity and economic growth. Neither is its implementation truly justified by the changes wrought in the country’s fiscal and monetary landscape following the 2008 crisis. Rather, MMT’s greatest promise lies in is its ability to contribute to our understanding of how to improve the economic system we already have. It has already influenced discussions about increasing the term-length of US debt, which could prove an effective alternative for securing lower interest costs on debt in times of recession. Furthermore, the evolving role of digital technology in defining the very form of currency itself opens up several new avenues in which MMT’s support for lower interest rates could be selectively applied.
Modern Monetary Policy should be handled with clear-eyed pragmatism, but it does show us that we still have much to discover about the way our current economic system works, and how it can be improved to produce ever-increasing efficiency. Its popularity demonstrates that there is a real need to increase spending in the poorest parts of America’s economy, whether it comes from the public sector, private industry, or some combination of the two. More often than not, this has been best achieved in the past through compromise: by setting aside our political entrenchments and committing to bipartisan economic activity that improves upon the system we already have.
Now, in this age of historic political polarization, it is more important than ever that we seek a middle ground amidst the fiery rhetoric of extremes from both sides of the political spectrum that threatens to overwhelm the national discourse. Undue haste in the adoption of radical changes to our economy only opens the door to future trouble, often from the very circumstances we were too short-sighted to see coming in the first place.
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