Thursday, March 31, 2011
Krugman questions Modern Monetary Theory.
Krugman questions Modern Monetary Theory (MMT). But he does not really attack its FUNDAMENTALS. He simply attacks the claim put about by the more irresponsible MMT advocates, namely that “deficits are never a problem”, to quote Krugman.
For example, Bill Mitchell is one of the leading lights of MMT. He claims that deficits will be the NORM. But he does not say that a country should run a never ending deficit or that it doesn’t matter how big the deficit is.
And Abba Lerner, the founding father (if there is one) of MMT said (p. 39), “The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money……” Note the word “withdrawal”. I.e. is saying that sometimes a surplus rather than a deficit is in order. I.e. his is not is not saying governments should run a permanent deficit, or (put another way) that it should permanently “issue new money”.
And on p.40 he says “In applying this first law of Functional Finance (FF), the government may find itself collecting more in taxes than it is spending, or spending more than it collects in taxes.” In other words he is saying that under FF / MMT, government may run a deficit OR a surplus.
And here, Krugman asks what happens if we have a 6% deficit at full employment, and govt cannot counteract the inflationary consequences because it has lost access to the bond markets. There are several answers to this point.
First, it requires some irresponsible behaviour for a country to lose access to bond markets. Such a country is probably heading for disaster whether it adopts MMT or any other policy.
Second, if a government cannot withdraw money from an economy by voluntary means (i.e. the bond market) it can always resort to brute force: i.e. raise taxes!
Third, a situation where fiscal policy is having too large a stimulatory effect, which is counteracted by an entirely different policy (i.e. monetary policy) is daft, as I pointed out here, here, and here.
So Krugman is saying that given a situation which is daft in several respects, MMT might not work. Well, that’s true. But likewise, if a car driver tries to drive his car with ten times as much alcohol in his blood as is allowed by law, there is liable to be an accident. That does not prove that cars a bad idea.