[lbo-talk] Krugman: How to Default in Your Own Currency

Michael Pollak mpollak at panix.com
Tue Aug 16 08:29:28 PDT 2011


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


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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