http://krugman.blogs.nytimes.com/2011/08/15/mmt-again
August 15, 2011 Paul Krugman - New York Times Blog
MMT, Again
In a way, I really should not spend time debating the Modern Monetary
Theory guys. They're on my side in current policy debates, and it's
unlikely that they'll ever have the kind of real -- and really bad --
influence that the Austrians have lately acquired. But I really don't
feel like getting right back to textbook revision, so here's another
shot.
First of all, yes, I have read various MMT manifestos -- this one is
fairly clear as they go. I do dislike the style -- the claims that
fundamental principles of logic lead to a worldview that only fools
would fail to understand has a sort of eerie resemblance to John Galt's
speech in Atlas Shrugged -- but that shouldn't matter.
But I do get the premise that modern governments able to issue fiat
money can't go bankrupt, never mind whether investors are willing to
buy their bonds. And it sounds right if you look at it from a certain
angle. But it isn't.
Let's have a more or less concrete example. Suppose that at some future
date -- a date at which private demand for funds has revived, so that
there are lending opportunities -- the US government has committed
itself to spending equal to 27 percent of GDP, while the tax laws only
lead to 17 percent of GDP in revenues. And consider what happens in
that case under two scenarios. In the first, investors believe that the
government will eventually raise revenue and/or cut spending, and are
willing to lend enough to cover the deficit. In the second, for
whatever reason, investors refuse to buy US bonds.
The second case poses no problem, say the MMTers, or at least no worse
problem than the first: the US government can simply issue money,
crediting it to banks, to pay its bills.
But what happens next?
We're assuming that there are lending opportunities out there, so the
banks won't leave their newly acquired reserves sitting idle; they'll
convert them into currency, which they lend to individuals. So the
government indeed ends up financing itself by printing money, getting
the private sector to accept pieces of green paper in return for goods
and services. And I think the MMTers agree that this would lead to
inflation; I'm not clear on whether they realize that a deficit
financed by money issue is more inflationary than a deficit financed by
bond issue.
For it is. And in my hypothetical example, it would be quite likely
that the money-financed deficit would lead to hyperinflation.
The point is that there are limits to the amount of real resources that
you can extract through seigniorage. When people expect inflation, they
become reluctant to hold cash, which drive prices up and means that the
government has to print more money to extract a given amount of real
resources, which means higher inflation, etc.. Do the math, and it
becomes clear that any attempt to extract too much from seigniorage --
more than a few percent of GDP, probably -- leads to an infinite upward
spiral in inflation. In effect, the currency is destroyed. This would
not happen, even with the same deficit, if the government can still
sell bonds.
The point is that under normal, non-liquidity-trap conditions, the
direct effects of the deficit on aggregate demand are by no means the
whole story; it matters whether the government can issue bonds or has
to rely on the printing press. And while it may literally be true that
a government with its own currency can't go bankrupt, it can destroy
that currency if it loses fiscal credibility.
Now, I am not predicting hyperinflation for the US -- I am not Peter
Schiff! Most of our current deficit is cyclical, and even in the long
run a modest return of political rationality would make the budget
issue eminently solvable. But the MMT people are just wrong in
believing that the only question you need to ask about the budget
deficit is whether it supplies the right amount of aggregate demand;
financeability matters too, even with fiat money.
OK, I have no illusions that this will convince anyone in this area.
(Can you imagine John Galt admitting that he was wrong?) But I thought
I should put it down.
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