This is the second and final part of this cameo set, which aims to clear up a few major blind spots in peoples’ embrace with Modern Monetary Theory (MMT). This is all repetition. I don’t apologise for that and it does not reflect a slack or bad editorial approach from yours truly as some critics have claimed. Repetition is how we learn. Reinforcing things in different ways (aka repetition) helps people come to terms with concepts and ideas that give them dissonance. MMT is certainly about dissonance as the current level of hostility towards our work is demonstrating. It is also challenging existing ‘fiefdoms’ in the academy and beyond, which also creates aggression and retaliation. The problem is that most of the current criticism merely rehearses the same tired lines of inquiry. A stack of mainstream (New Keynesian) economists now regularly claim they ‘knew it all along’. The short and truthful response is – ‘no they didn’t. The standard mainstream macroeconomic theory cannot accommodate MMT principles unless it jettisons its core propositions and becomes something else. At any rate, as noted in – Operationalising core MMT principles – Part 1 – I am happy to help clarify quandaries that newcomers have with MMT if they are genuinely trying to work out what it is all about. I have no desire to interact with ‘critics’ who are just defending mainstream macroeconomics in its death throes and have no genuine interest in really understanding MMT beyond the superficial and no penchant for reading the now lengthy body of work we have generated in the academic literature. Yesterday, I considered a typical inquiry about an important operational detail of implementing a Job Guarantee. Today, I consider a related topic. If a government is facing a situation where it needs to shift workers to the Job Guarantee pool to stabilise inflation, how does it do that? The ‘critics’ often claim we only advocate tax increases to fight inflation and because they are politically tricky to engineer MMT essentially fails to have an effective price anchor. Today, I bring together many past blog posts to summarise the MMT position on counter-stabilising fiscal policy for those that might be struggling to put it all together.



Some background reading

By way of background and more detailed reading of the topics for this series:

1. An MMT response to Jared Bernstein – Part 1 (January 8, 2018).

2. An MMT response to Jared Bernstein – Part 2 (January 9, 2018).

3. An MMT response to Jared Bernstein – Part 3 (Jamuary 10, 2018).

4. Planning public works – history has a lot to say if we listen properly (January 30, 2018).

5. Functional finance and modern monetary theory (November 1, 2009).

Exactly how might a currency-issuing government fight inflation?

This question keeps arising even though MMT writers regularly deal with it.

The latest assertion doing the rounds of Twitter and elsewhere is that MMT just advocates tax rises to fight inflation and fails to specify what taxes.

I often wonder where people get these sort of ideas from. And I also am often astounded that they feel privileged enough to make all sorts of assertions (accusations) without fully reading our work.

When that is pointed out to them, they turn around and say it is not their responsibility to read everything – we should be clearer.

And, this accusation is usually accompanied with some spleen about there being too much MMT writing to wade through.

I don’t expect a lay person to have trawled through all the academic literature, much of which is behind expensive paywalls – given the greed that many publishers entertain.

But in the case of MMT, we have assiduously built a huge social media (blogs, Op Eds, etc) vault of the ideas. I have summarised all of my academic papers and books into readable form through the last 14 years of blog writing.

Sure enough I have left out a lot of technical discussion about the econometric techniques I have used and the advanced empirical analysis, and, whatever, but the essential ideas and the body of MMT (both theory and practice) now exists outside of the academic literature.

So I do think that to participate in informed debate, no matter what one’s background might be, places an onus on each and every one of us to understand as best we can the material we desire to discuss.

And where we don’t fully understand things, asking questions is good. But shouting that people are cranks because you don’t like what you read or can’t be bothered reading is bad.

Anyway, here is a pithy summary of the types of options a currency-issuing government has at its disposal in terms of counter-stabilisation (addressing the economic cycle) and in terms of longer-term remedies that can attenuate the amplitude and frequency of economic cycles.

The crude view that ‘MMT just argues for tax increases’ to stifle aggregate spending.

MMT clearly does suggest that as taxes reduce the purchasing power of the non-government sector and increasing taxes can stifle total spending in the economy.

But MMT argues that taxation changes are just one of several fiscal instruments that can be used to moderate or stimulate total spending in the economy, which then allows the government to regulate price pressures that arise from nominal demand outstripping the capacity of the economy to respond in real terms (producing goods and services).

Shifting workers into the Job Guarantee pool

Let’s make it clear and simple.

At present, governments shift workers from employment (in the non-government sector or the standard public sector) into unemployment as a way of reducing spending pressures in the economy. They do this with a combination of spending cuts, tax hikes, cutting direct public employment, among other means.

Monetary policy may, under some circumstances, also reduce overall spending, although this option is far from reliable or predictable.

But, however they do it, government’s use an unemployment buffer stock to suppress bargaining power.

The Job Guarantee is an unconditional job offer at a fixed wage at the bottom of the acceptable non-government wage structure to anyone who cannot find a job elsewhere and wants to work.

So from a social well-being perspective, the continuous availability of these job opportunities (the ‘buffer stock of jobs’), means that a worker never needs to endure unemployment again and can always find a job with a socially-acceptable wage that guarantees they can participate fully in their communities and society in general.

In other words, the Job Guarantee provides a much stronger safety net for disadvantaged workers than the unemployment buffer stock approach.

But we should never forget that the Job Guarantee also provides government with a mechanism to reduce spending pressures in the economy in more or less the same way as if it was using the unemployment buffer stock option.

Although, from this perspective, instead of shifting workers (in the non-government sector or the standard public sector) into unemployment when there is a need to rein in total spending in the economy, the Job Guarantee shifts them into the Job Guarantee pool of jobs.

By buying labour resources that have no alternative bid for their services the government shifts workers from the inflating sector to the fixed price sector and eventually price pressures stabilise.

So the Job Guarantee used as a counter-stabilising force on the upside of the cycle is not Shangri La! It is a coercive mechanism that creates job losses, but, substitutes those losses with a Job Guarantee job instead of unemployment.

In the downside of an economic cycle, it acts as a safety net.

The question then is how does the government go about shifting workers into the Job Guarantee pool should it desire to do so?

Foundations of the MMT counter-stabilisation approach

Modern Monetary Theory (MMT) draws, in part, on the work of Abba Lerner’s Functional Finance. Please be clear – MMT is not Functional Finance. It just draws on some of the thinking that Abba Lerner presented.

I considered that part of our heritage in the blog post (5) cited at the outset (above).

The point is that a currency-issuing government is not financially constrained and thus is free to adopt the principles of functional finance in its spending, taxation and debt-issuance decision-making.

In that sense, all initiatives should be evaluated by their ‘functionality’ (against stated goals such as well-being or environmental sustainability) rather than asking irrelevant questions such as whether the government ‘has enough money’.

Restricting our appraisal of policy options based on perceived ‘financial ratio’ acceptability, is the driving force in what is known as ‘sound finance’, where the government is envisaged to be a ‘big’ household and financially constrained in much the same way.

Functional finance rejects ‘sound finance’ as a means of policy appraisal and government conduct and so does MMT.

We should be careful not to follow the ideas in functional finance slavishly though because as I explained yesterday the standard ‘progressive’ interpretation of functional finance (which appears in Post Keynesian arguments) advocates ‘generalised expansion’ to generate full employment, which, of course, dispenses with an effective inflation anchor.

The upside risk of that implementation is an inflation outbreak, which makes the approach prone to ‘stop-go’ dynamics.

That point marks a divergence between MMT and other progressive (Keynesian) approaches.

Even Abba Lerner abandoned functional finance (and became a Monetarist) because he developed a fear of its inflationary consequences.

If you have any doubts on this, please read his 1997 paper – From Pre-Keynes to Post-Keynes (full reference to follow). If you have library access you can get it from JSTOR as below.

[Reference: Lerner, A.P. (1977) ‘From Pre-Keynes to Post-Keynes’, Social Research, 44(3), 399-415. https://www.jstor.org/stable/40970292]

MMT is concerned with what and how the government injects net spending into the economy in addition to how much it should spend to achieve full employment.

And so we need to be cautious in how we draw on the ‘steering wheel’ analogy that Lerner initially presented in his 1941 article The Economic Steering Wheel, which said that macroeconomics was all about “steering” the fluctuations in the economy.

In that time, Lerner held out that fiscal policy was the steering wheel and should be applied for functional purposes.

Laissez-faire (free market) approaches (‘sound finance’) was akin to letting the car zigzag all over the road and if you wanted the economy to develop in a stable way you had to control its movement.

What are the ‘steering wheel’ tools available to government confronting inflationary pressures?

1. Taxation – to reduce the purchasing power of the non-government sector, which indirectly, reduces total spending.

2. Spending – to withdraw direct spending impulses.

3. Industry policy – to stimulate higher productivity growth and lower cost technology.

4. Incomes policy – to create consensual charters among income recipients to moderate income share demands.

5. Trade policy – import substitution, export enhancement strategies, and capital controls – the latter to prevent damaging speculative runs on currencies, which then result in exchange rate movements that introduce price pressures.

Fiscal policy is usually confined to (1) and (2), although clearly the other tools often require accompanying taxation and spending initiatives.

Lerner’s general principle, espoused in his 1943 article – Functional Finance and the Federal Debt (p.39), was:

Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability

[Reference: Lerner, A.P. (1943) ‘Functional Finance and the Federal Debt’, Social Research, 10, 38-51.]

To answer the question – how does a government intervene to curb an inflation – depends on what is driving the inflationary process.

The background blog posts that will help here are:

1. Modern monetary theory and inflation – Part 1 (July 7, 2010).

2. Modern monetary theory and inflation – Part 2 (January 6, 2011).

Typically, the criticism that people have of MMT is based on what we consider to be ‘demand-pull’ inflation which arises from nominal demand (spending) growth outstripping the real capacity of the economy to react to it with output responses.

The crude criticism is that governments will spend willy-nilly once they accept they are freed from financing constraints. This is a political issue – and the criticism is really about the quality of the polity.

Imposing artificial constraints to negate the status of the currency-issuing government is a weird way of improving the quality of government.

Conversely, ‘cost-push’ inflation arises from supply shocks – such as a rise in an imported raw material (for example, oil).

Where an economy is exposed to imported cost pressures, using ‘demand pull’ options (restricting total spending growth) will not be a very effective means of reducing inflation.

In that context, arrangements have to be put in place to facilitate a ‘sharing’ of the overall real income loss (arising from the higher import costs) among the domestic income recipients.

If such a sharing arrangement breaks down and these claimants on national income attempt to make up their real losses by increasing their nominal income aspirations (workers pushing for higher nominal wages growth, bosses pushing their nominal margins) then an inflationary spiral can begin.

In this context, cost-push inflation is sometimes linked to the ‘conflict theory of inflation’, where a ‘battle of the mark-ups’ drives the inflationary process.

Firms and unions are considered to have some degree of market power (that is, they can influences prices and wage outcomes) without much correspondence to the state of the economy. They both desire some targetted real output share.

In each period, the economy produces a given real output which is shared between the groups with distributional claims.

If the desired real shares of the workers and bosses is consistent with the available real output produced then there is no incompatibility and there will be no inflationary pressures.

But when the sum of the distributional claims (expressed in nominal terms – money wage demands and mark-ups) are greater than the real output available then inflation can occurs via the wage-price or price-wage spiral noted above.

The ‘battle’ might begin with workers trying to get more real output for themselves by pushing for higher money wages and firms then resisting the squeeze on their profits by passing on the rising cost – that is, increasing prices with the mark-up constant.

Or vice versa, firms push their margin up and workers resist.

In thinking about solutions to these sources, we should understand that there is a close link between ‘cost push’ and ‘demand pull’ notions of the inflationary process.

Conflict theories of inflation note that for this distributional conflict to become a full-blown inflation the central bank or the government has to ultimately ‘accommodate’ the conflict. What does that mean?

If the central bank pushes up interest rates and makes credit more expensive, firms will be less able to pay the higher money wages (the conceptualisation is that firms access credit to ‘finance’ their working capital needs in advance of realisation via sales). Production becomes more difficult and workers (in weaker bargaining positions) are laid off.

The rising unemployment, in turn, eventually discourages the workers from pursuing their on-going demand for wage increases and ultimately the inflationary process is choked off.

Alternative, if the government maintains its current fiscal position, the higher nominal income demands can easily outstrip the real capacity of the supply-side to respond with production of real goods and services.

So, if the central bank doesn’t tighten monetary policy and the fiscal authorities do not increase taxes or cut public spending then the incompatible distributional claims will play out and inflation becomes inevitable.

The solution to both sources of inflation thus is not that dissimilar although additional measures might be brought to bear to handle the case of a price hike in an imported raw material (incomes policies, technology substitutions etc).

In the latter case, back in 1973, the standard Australian cars were big 6-cylinder vehicles and homes used big oil heaters. In the year that followed (after the OPEC price hikes), one saw the big oil tanks on the nature strips waiting to be collected by the local council rubbish throwouts and, soon after, smaller 4-cylinder cars started to appear.

Substitution. These are structural shifts rather than cyclical shifts.

But, in the context of the economic cycle, MMT economists have a preference for fiscal policy counter-stabilisation rather than rely on interest-rate movements (monetary policy), given the latter are indirect and uncertain in their impact.

A reliance on policy settings determined by unelected and unaccountable technocrats is also counter to notions of democratic accountability.

So, an understanding of the context is important. If inflation is accelerating as a consequence of excessive spending yet unit cost pressures are not present, then the basic principles of functional finance remain valid.

I recommend Mathew Forstater’s Levy Working Paper No. 254 – Toward a New Instrumental Macroeconomics: Abba Lerner and Adolph Lowe on Economic Method, Theory, History and Policy – for an excellent account of the way in which fiscal policy can work in this context.

Manipulating tax rates is one of many options available

Raising taxes to stifle such excessive nominal spending is one option only but not necessarily the preferred MMT option.

Typically, a mix of fiscal responses will be required depending on the circumstances, the existing tax and spending structure, the state of income and wealth distribution in the particular country, how fast inflation is accelerating, and more.

Governments have shown they can cut spending quickly and still prosper politically, if the political forces are aligned.

There are many areas of government spending that can be wound back without impacting significantly on the well-being of most of us or invoking distributional consequences that would have negative impacts at the lower end of the income distribution.

For example, consider the incidence of Corporate Welfare, which includes “a government’s bestowal of money grants, tax breaks, or other special favorable treatment for corporations”.

The so-called “Socialism for the rich, capitalism for the poor” or “privatising the gains and socialising the losses” is rife in most fiscal systems, especially in this neoliberal period.

While conservatives rail against governments spending on public health and education or income support for the poor, the reality is that corporate welfare spending often dwarfs these progressive targets.

The 1993 article by Daniel Huff and David Johnson – Phantom Welfare: Public Relief for Corporate America – published in the Social Work journal [38(3), pp.311-16)] – quantified the extent to which federal subsidies in the US benefit the corporate sector.

The pattern is common in most countries.

In 1993, they estimated this largesse to be “in excess of $150 billion a year”, which “represent a major redistribution of wealth that partially accounts for the growing gap between the rich and the poor”.

There are huge opportunities within the military-industrial complex in the US to make cyclical cuts, which will attenuate nominal demand growth and multiply through the economy.

A social democratic government elected on a broad progressive consensus and a willingness to acknowledge MMT principles would be in a position to resist the neoliberal aspirations of those corporate interests who would fight “tooth and nail”.

Forward planning essential

We often think of infrastructure spending as ‘lumpy’ – big amounts are expended on some large project – like a new metro system.

But a properly organised government views public infrastructure provision as a continuous process requiring constant attention and varying amounts of financial support.

In that sense, significant forward planning is required which enhances the capacity of fiscal policy to be relatively responsive to the cycle in both directions.

MMT economists are fully aware of the technical, legislative and implementations lags that can accompany large-scale public spending.

But well thought out preparation and well planned projects can allow the government to turn spending on fairly quickly in a downturn and turn it off (or restrict it) in times of high pressure.

For example, the decision by Norwegian authorities to fast-track the construction of Oslo Airport at Gardermoen was a highly effective fiscal intervention to ease the pain of the 1992 recession.

While the location of the airport was controversial, the intervention was effective and finite. It also carried scale such that components could be expanded or restricted at fairly short notice to meet with the changing cyclical conditions.

Another good example is the highway projects in Japan. The Japanese government has a well-designed infrastructure plan in place that allows it to expand and contract government spending to extend the highway and related infrastructure (bridges, waterways etc) to suit cyclical conditions.

This type of spending can be highly responsive with minimal lags if the planning processes have been completed.

There are many other examples.

Governments can also offer coherent vocational training capacities – apprenticeship schemes – depending on the way the public sector is constructed.

While these functions should be oriented towards providing skills to suit the medium- to long-term trajectory of the economy, it is true that the government can expand or contract the intake into these schemes whenever they like – say monthly.

In terms of planning functions, the neo-liberal era has also been marked by a major reduction in Departmental capacity to design and implement fiscal policy – given the obsession with monetary policy and the major outsourcing of ‘fiscal-type’ government services to the private sector.

Many of the major government policy departments in the advanced nations are now just contract managers for outsourced service delivery.

So this diminution in the overall capacity of the government machine to implement efficiently and speedily complicated nation-wide infrastructure programs has to be addressed as a matter of urgency by progressive politicians.

In that context, governments must develop forward-looking capacity to ensure that it has project implementation skills when they are required.

Please read my blog post – Planning public works – history has a lot to say if we listen properly (January 30, 2018) – for more discussion on this point.

Tax changes are less powerful than spending manipulation

Further, MMT economists realise that the expansionary and contractionary capacity of tax changes are dollar-for-dollar less than for public spending changes.

Tax cuts in a downturn are in part saved and are subject to longer lags than government spending injections. The reverse occurs in an upturn with tax hikes.

Tax changes operate through shifting private spending decisions as disposable income is impacted. Those behavioural shifts take time.

Whereas government spending shifts are direct and can add or subtract dollars to and from the economy virtually immediately.

So to claim that MMT economists are biased towards the use of tax hikes to pull back an overheating economy is more than inaccurate.

Other sources of inflation

Finally, MMT economists also recognise that inflation can come via exchange rate movements, which may require specialised policy responses.

For example, if there are speculative capital outflows which put downward pressure on the currency in the foreign exchange markets then MMT economists would suggest capital controls are an effective way to stabilise the currency and prevent the inflationary impacts emerging.

Iceland’s recent use of capital controls demonstrates the effectiveness of this strategy.

Conclusion

I could go into more detail of the actual design of public infrastructure projects that facilitate a ‘continuous’ investment concept – where the government see these large projects in modular form and progressively adds to the capacity.

But the point is that there is considerable flexibility on the spending side of fiscal policy – probably more so than on the revenue side.

Which is why it is ridiculous to try to mount a criticism of MMT by claiming politicians would not be able to control inflation because they would not be able to introduce tax increases quickly enough and/or at a sufficient magnitude to create the required spending curbs (in the case of a ‘demand pull’ inflation episode).

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.