Policy Aspects of MMT

By Eric Tymoigne and L. Randall Wray

[Part I] [Part II] [Part III] [Part IV] [Part V] [Part VI]

From the theoretical framework discussed in the 5 previous installments, MMT draws specific policy conclusions about fiscal, monetary and financial policy. In this final post we address the policy implications.

In line with Keynes and Minsky, MMT recognizes that unemployment, arbitrary distribution of income, price instability and financial instability are central problems of market economies that require some government involvement for resolution.

The nature of this involvement is, however, very different from the Bastard/IS-LM Keynesian approach that focuses on fine-tuning. The fine tuning takes the form of discretionary, temporary, and limited fiscal and monetary policies to deal with slumps and booms through proactive change in government spending, tax rate, and interest rate. The philosophy behind this orthodox approach of government intervention aims at avoiding direct intervention to achieve the goal (e.g. hiring to achieve full employment, or price controls to achieve low inflation), but rather using indirect “tools” while letting market participants push the economy toward desired goals by tweaking their incentives.

MMT does not agree with this approach. The government should be directly involved– continuously–over the cycle, by putting in place structural macroeconomic programs that directly manage the labor force, pricing mechanisms, and investment projects, and constantly monitoring financial developments. Because those programs would be permanent and structural, rather than discretionary and specific to one Administration, they would be isolated from the political cycle and political deliberations.

All this eliminates problems of lags, credibility, and time inconsistency that Friedman and others have complained about.

However, this does not mean that the government should apply a rule blindly when implementing its policy; discretion is still possible within each program to make sure that it works. For example, Social Security is a structural program but government employees still have large discretion to determine if someone qualifies for benefits. Human discretion is still possible within the set of rules and structures.

The Job Guarantee program is another example of this type of policy. But MMT goes beyond full employment policy as it also promotes capital controls for open economies, credit controls, and socialization of investment. Wage rates and interest rate management are also important.

More generally, it is not correct to associate MMT with textbook Keynesianism of the 1960s in the way Palley does.

MMT discards the interest rate as an instrument of policy and relies on fine tuning of government spending to maintain full employment and taxes to maintain budget balance […] Yet long ago, Milton Friedman (1961) raised the problem of inside and outside policy lags. The former represent lags regarding time taken to decide and enact policy change (Palley 2013, 27)

MMT does not promote fine tuning, but rather recognizes the role of a “rightly distributed” demand in addition to the level of aggregate demand (Keynes 1937), and aims at combating the inherent instability of market mechanisms.

More importantly, MMT does not rely on increasing aggregate demand in order to reach full employment; it disconnects full employment from economic growth and makes work a right.

The following discussion focuses on two specific aspects of policy advocated by most proponents of MMT, the Job Guarantee program and the central bank policy of a permanently zero or near-zero overnight interest rate.

MMT’s JG/ELR[1] proposal is not the Bastard Keynesian fine-tuning policy to which Palley refers. We are quite surprised that Palley still promotes a rather orthodox version of the Phillips Curve trade-off. Yet, his belief that full employment must generate rising inflation cannot apply to the JG program. Let us first look at the “labor market” effects of putting in place a JG program. We then turn to the “aggregate demand” effects.

According to Palley,

MMT proponents can be labeled “fiscal policy optimists”. The same holds for neo-Keynesians. Both believe that expansionary fiscal can shift the economy to full employment and keep it there, regardless of such outside factors as the distribution of income. This fiscal policy optimism is open to question. […] In the short-term, as in the Keynesian model, expansionary fiscal policy can increase demand and remedy the problem because government spending is a perfect substitute for private spending. However, higher government spending implies higher taxes to balance the full employment budget and that may have adverse supply-side tax effects that are not present in either Keynesian or Kaleckian models. […] The argument is full employment requires not just Keynesian demand management, but also structural policies that address labor market bargaining power concerns. (Palley 2013, 23-24)

As we will show, the JG program does not focus on stimulating aggregate demand to move the economy to full employment. Nor does it see government spending as a “perfect substitute” for private spending.

Rather, the JG is targeted spending that is designed to improve the structure of the labor market by developing a pool of employable labor while at the same time ensuring continuous full employment of those ready and willing to work. While it might be a policy option to increase taxes in step with government spending on wages in the JG program, this should be done only if inflation pressures arise. Inflationary pressures will already be dampened by the rise in taxes that occurs through the automatic stabilizers so a further increase of taxes (i.e. raising tax rates and/or imposing new taxes) may not be necessary.

Since most readers will by now be familiar with the structure of the JG program, we will be brief. The national government agrees to provide wages (and some non-wage funding) to employ anyone who is ready and willing to work at the program wage (plus non-wage benefits). We will leave to the side a full discussion of the setting of the compensation, but wherever that is set, it will become the de facto minimum compensation level since private employers would have to at least match it to retain employees. To minimize (temporary) disruption to the structure of private wages, government can set the JG at the current legal minimum wage.

We will also leave to the side a full discussion of the administration of the program, which could be run by the national government, or decentralized to state and local governments or to NGOs such as not-for-profit community service organizations. What is important is to embrace principles of democratic governance, transparency, and accountability—so the level of decentralization will depend on how best those principles can be put into place.

The JG program is quite explicitly a “rightly distributed” spending program in which government spending is directed precisely to those who want to work but cannot find a job. This places no direct pressure on wages and prices because the workers in the program were part of the “surplus” or “redundant” labor force and are still available for private employers (at a small mark-up over the JG program wage—the minimum wage).

For that reason, employing workers in the JG program is no more inflationary than leaving them unemployed. Indeed, the JG should lower recruiting and hiring costs as employers would have an employed pool of workers demonstrating readiness and willingness to work, which should reduce inflation pressures.

Turning to effects on aggregate demand, many critics worry that if, say, 10 million people obtain jobs and thereby increase their incomes above their pre-employment levels, consumption would increase and drive up inflation. This seems to be a major concern of our critics.

By logical extension, they would also worry about a private-sector led expansion that created minimum wage jobs in the fast food sector. We find such a position to be overly defeatist—a “let the poor eat cake” response to unemployment and poverty.

This criticism is also often combined with the claim that workers in the JG would just “dig holes”, adding nothing to national output. Again, we see that as overly pessimistic—since a jobs program can be designed to produce desirable output, as the New Deal’s jobs programs did.

However, let us imagine that the JG program is extremely successful at creating jobs and income, so much so that the economy moves from slack to full employment of all productive capacity, resulting in rising prices. The presumed problem is that while JG workers get wages (and thus consume) they do not contribute any production that is sold (hence, does not absorb wages). The “excess” wages from newly employed workers induces spending to rise.

What could government do in that case? It would have at its disposal the usual macroeconomic policy tools: raise taxes, lower government spending on programs other than the JG, and tighten monetary policy.

Indeed, this is what it would do in the absence of the JG if the private sector achieved full employment through creation of 10 million new minimum wage jobs in the private sector. The only difference is that government would not be able to fight inflation by increasing unemployment—because the macro policies used to fight inflation would dampen demand but any worker losing a job could turn to the JG program for work.

What this means is that with a JG in place, the inflation-fighting adjustments to spending will occur among the employed rather than by causing unemployment and poverty. In other words, the costs of fighting inflation can be made to be borne at higher income levels.

We are surprised that our critics appear to prefer to use unemployment and poverty to fight inflation, which forces the least able to bear more of the costs.[2]

Our position is similar to Keynes’s: “No one has a legitimate vested interest in being able to buy at prices which are only low because output is low.” (Keynes 1964 p. 318) So while Palley argues against creating jobs on the argument that those with jobs would have more income, and this could cause what Keynes called “semi-inflation” (increased demand drives up prices in those sectors with an elasticity of output below one), that is not a defensible position.

Normally, as Keynes said, a rise of effective demand “spends itself, partly in affecting output and partly in affecting price” and only if the elasticity of output approaches zero does a rise of effective demand cause “true inflation”. (Ibid p. 285) Below that point, there is no “legitimate vested interest” in keeping labor unemployed. Instead, inflation must be fought by alternative means.

It must be recognized that increasing the number of private sector workers in the fast food industry will cause the same sort of “semi-inflation”, raising prices in the same sectors that consumption by new workers in the JG program would affect.

It does no good to argue that hamburger flippers are “productive” (they flip burgers) while JG workers are not (they provide, for example, public services to the aged), because the “semi-inflation” will occur in all sectors where increased spending faces anything less than perfect output elasticity.

Hence, if our critics were consistent, they would always fight against job creation if any sectors that would experience increased sales to workers had less than perfect output elasticity. Their argument against the JG is a red herring.

Note also that with a JG, the government’s budget would be made more strongly countercyclical, as government spending increases in the slump when workers move from higher-paid employment to the JG; the process is reversed in a robust expansion, where when the private sector hires out of the JG pool. These stabilizers might be enough to stabilize aggregate demand. After all, most unemployment in developed countries is cyclical in nature so unemployment is largely due to a lack of aggregate demand. The JG pool raises that demand (by paying wages) and so will encourage hiring. If not, government can use discretionary policy interventions.

In terms of the central bank policy, MMT does see a role for a central bank, not in terms of fine tuning the economy but rather in terms of promoting financial stability. Using interest-rate manipulations to influence economic activity is problematic for at least three reasons.

First, the sensitivity of economic activity to interest rates is low overall, and declines as an economic boom emerges. This sensitivity is even lower now that gradualism and transparency have made it much easier for economic units to anticipate adverse changes in interest rates and to protect themselves against them.

Second, as Minsky notes, using the central bank for fine tuning and for financial stability are two incompatible purposes. Increasing interest rates during an expansion promotes financial fragility, and moving interest rates widely up and down to fine tune the economy creates instability in the refinancing operations of banks. The ultimate example of this is the Volcker experiment that killed the thrifts and promoted the growth of securitization and the originate-to-distribute model.

Third, changes in the policy rate affect the cost of borrowing, which affects costs of production and so prices. As such rising interest rates may lead to inflation if their growth is too rapid. Thus, MMT does not believe in the natural stability of financial market as Palley asserts:

Analytically, MMT’s “park it” approach to interest rates implicitly lets finance call the tune. In financial booms fiscal policy must turn contractionary, and the reverse holds in busts. This interest rate policy passivity is tantamount to believing that financial markets are stable and set interest rates and asset prices appropriately. The same belief is reflected in MMT’s confidence about freely floating exchange rates. This view is inconsistent with the assessments of both Keynes’ (1936) and Minsky’s (1992, [1993]) regarding financial markets, although MMT claims to represent a Keynes-Minsky perspective. (Palley 2013, 29)

Rather MMT argues that to promote financial stability via interest-rate manipulations is of limited effectiveness and can actually be destabilizing. Instead, government has a role to play through the promotion of safe underwriting (to promote what Minsky called hedge financing), the establishment of a banking structure that promotes long-term recurring relationships, and the regulation of financial innovations toward safe financial products. Loans made by private banks should be limited to creditworthy[3] borrowers who are scarce (but banks should be encouraged to look for them wherever they are and to avoid redlining).

We do, however, believe that direct credit controls can be useful to control lending for speculative behaviors, or to more generally fight inflation pressures. This is far more effective than trying to use rate hikes to reduce lending to speculators.

In terms of development policy, the Treasury and the central bank of a country should avoid issuing financial claims that promise the delivery of a foreign currency. That would include prohibition of “bailing-out” domestic financial institutions that have issued liabilities in foreign currency. Let private sector firms go through the bankruptcy process if needed. Governments have the means to use their financial power for internal development and to promote activities that employ local resources. As stated in the previous section, the limited availability of physical resources may limit what can be done by government policies.

Fiebiger and Lavoie are worried that using MMT leads to ill-suited policy advice given that the use of the consolidation hypothesis does not fit current institutional framework.

It must be accepted that most federal spending is financed by taking money from people within society (non-voluntarily for taxes) creating winners and losers. That is not an “illusion” and to insist otherwise is counterproductive. (Fiebiger 2013, 77)

If sales of Treasury securities do not “finance” spending but are issued “voluntarily” after spending to “stabilise interest rates”, then, the “fiscal cliff” should be a non-issue as according to MMT the Treasury deficit-spends first and then “voluntarily” issues bonds later as a part of monetary policy (to set the overnight federal funds rate target). (Fiebiger 2013, 71)

The counterpoint to this new MMT position is that one cannot start from the general case, based on consolidation, because it is antinomic to the real world and to existing institutions, and it would lead to mistaken advice and confusion […] For instance, as recalled by Fiebiger (2012A, 6), based on the consolidation assumption, one could argue that public-debt limits pose no threat to economic stability. (Lavoie 2013, 23)

We would argue instead that MMT reframes the nature of important economic debates. For example, most of the debates surrounding Social Security and Medicare are framed in terms of insolvency. Once one accepts that solvency is not an economic issue—government can always pay—one can reframe the debate in another way (Eisner 1998; Wray 2006).

There is a potential problem with Social Security but it is a demographic problem not a financial problem. Payments can be made at the time they are due just by crediting bank accounts, but the needed goods and services may not be available. The financial side and real side of the Social-Security problem are solved very differently, and putting funds in a locked box or a trust fund is not necessary, confuses the issue, and actually can make the real production problem worse.

As long as Congress upholds that social security payments are an obligation of the United States government, it will budget the necessary funds for Social Security and it will find the means to obtain the funds. One can then advocate for more profound reform of the system that would abolish the trust fund, remove the payroll tax, promote immigration of young workers, and policies that increase the productivity of workers.

Taxes may be advocated but not with a view of funding Social Security, but rather with a view of reducing purchasing power of those of working age in order to leave enough for retirees to consume. As Fiebiger noted, taxes are part of fiscal activism and create winner and losers. But discussing taxes in terms of means to pay for something confuses the economic role of taxes and leaves one open to conservative critiques that taxes are a burden instead of a means to fight inflation.

The language and logic used is important to frame debates and possibilities surrounding government programs.

Another example is the debt ceiling debate. It is not that it is a non-issue, as it can lead to instability in the current institutional framework. But the point is that it is not an economic problem, it is a political problem. The mechanics of the monetary system have been subverted by self-imposed constraints on government; presumably on the fear that monetary financing is inflationary because taxes are unnecessary once monetary financing occurs.

With the MMT framework one can reframe the debate away from the need to reduce our national debt, toward the need to abolish the debt ceiling because it is a relic of the gold-standard that contradicts other budgetary procedures of Congress.

MMT explains why one should not be afraid of removing the debt ceiling nor afraid of allowing the central bank to directly fund the Treasury; this would not directly promote price and financial instability and such changes do not necessarily promote careless spending. Taxes and bond offerings are still needed and budgetary procedures and political accountability are still necessary to make sure that government is involved in the economy according to the wish of its people and in a non-fraudulent and economical way.

More broadly, one can understand that budgetary procedures are of a political nature, and the point is to promote procedures that make the political process run well by promoting accountability and transparency, while eliminating procedures that are put in place on the basis of fear of unaffordability and bankruptcy.

The fact that government can spend an unlimited amount of money does not mean it should, and ultimately the choice of how much a government should spend is a political question. MMT aims at bringing that forward and at promoting political processes that allow the will of the people to be expressed as well as possible, free of unnecessary financial constraints.

Similarly, it does not make sense to argue that a government program cannot be implemented because the government ran out of money.

A sovereign government can always afford to buy anything for sale denominated in its currency so discussing the pros and cons of a government program should not be framed around financial constraints. Instead the focus should be considerations of equity, full employment, financial stability, and price stability.