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Kelton argues that, for a country that issues its own currency, there is never a danger of debt spiraling out of control.
The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy
By Stephanie Kelton
PublicAffairs
Over the past decade, government debt in the U.S. and elsewhere has reached unprecedented heights. Yet the supposed costs of this debt are nowhere to be seen. Excessive debt, we’ve been warned, will lead to mass flight by investors and spiking interest rates, or else spiraling inflation and a collapse in the currency. But in the U.S. and elsewhere, record-high public debt has been accompanied by record-low interest rates and low inflation.
These developments have opened the door for a revival of old-fashioned Keynesian views, in which government deficits are seen not as a problem to be solved but a useful tool of demand management—and today an essential source of economic recovery.
Many mainstream economists have backed away from the view that deficit-financed public spending is necessarily risky or counterproductive. Space has also opened in public debate for non-mainstream thinkers who argue full-throatedly for a bigger, more active public sector, freed from imaginary financial constraints. The most visible of these today is the school called Modern Money Theory or Modern Monetary Theory (both terms are used), or MMT.
Both supporters and opponents tend to present MMT as a monolith, a doctrine that breaks radically with established schools of thought and must be accepted or rejected in its entirety. But in my view it’s better—both more accurate and more productive—to see it as a body of arguments within an older Keynesian tradition of economics. Contrary to the sense you might get from both supporters and detractors, it’s not a crystalline logical structure where, if you remove one piece, the whole thing collapses. Rather, like most emerging bodies of thought, it’s a ramshackle assemblage of parts built at different times for different purposes, tied together with loose solder of association and inference rather than tight bonds of deduction.
Stephanie Kelton is among the most prominent of the dozen or so economists associated with MMT. Her new book The Deficit Myth is intended to bring MMT to a broader audience. In addition to an impassioned call for a bigger, more active public sector, The Deficit Myth contains a number of distinct economic arguments.
The most important of these is that a government with its own currency can spend as much as it needs to without worrying about the bond markets. The constraint on public spending is not debt but real resources. Only when government borrowing leads to more purchases than what the economy can produce is it necessary to cut spending, raise taxes, or otherwise rein in demand. Or as Keynes long ago put it, “anything we can actually do, we can afford.” One can share this conclusion without necessarily accepting all the arguments Kelton uses to reach it.
The book begins with a claim that all money originates with the government. “MMT takes as its starting point a simple and incontrovertible fact: our national currency, the US dollar, comes from the US government, and it can’t come from anywhere else.” Government spending, in this perspective, creates money, while taxes destroy it. Thus the function of the budget isn’t to get the government the money it needs, but “to add or subtract dollars from the rest of us.” And since a deficit for the government must be matched by a surplus for the private sector, an increase in government debt must equal an increase in “net financial wealth” for everyone else.
The next set of arguments concerns government debt specifically. First, the growth of public debt over time depends not only on government spending and taxes, but on growth, inflation, and interest rates. In the decades after World War II, for example, debt-to-GDP ratios fell steeply in the U.S. and most other advanced countries. This was not because they were paying the debt down with surpluses, but because the combination of strong growth, moderate inflation, and low interest rates eroded the burden of debt over time even as governments continued to spend more than they took in in taxes. Second, government debt is not only a liability for the government, but an important asset for the financial system. As Kelton notes, when it seemed like the U.S. might pay off the national debt in the late 1990s, there was considerable worry about how the financial system would function without its safest and most liquid asset—Treasury debt.
On the policy level, the most important claim is that what limits government spending is the productive capacity of the economy, not the state of government finances. Inflation, not rising debt, is the sign that the government is spending too much.
It’s sometimes suggested that MMT’s inflation constraint is just a budget constraint under a different name. (I’ve been guilty of this myself.) But while every dollar of spending adds exactly one dollar to the deficit, the amount of demand it adds depends on what it is spent for. As Kelton notes, buying up carbon-emitting power plants to decommission wouldn’t directly add to the demand for labor or other real resources, so there’s no reason to think it should be offset with higher taxes. Spending on new public services—universal health care or child care, say—does add to demand, so it’s likely that higher taxes would also be needed.
Policy orthodoxy holds that stabilizing inflation is primarily the responsibility of the Federal Reserve. But Kelton is skeptical: Many other factors also influence the borrowing choices of businesses and households. In a depressed economy, it’s unlikely that even very low interest rates will call forth much new spending. (People sometimes describe this as “pushing on a string.”) Public spending, by contrast, creates demand directly. Kelton is, however, also skeptical about conventional fiscal policy, which involves adjusting spending or taxes to keep the economy at potential: “there’s just no way for Congress to react to changing economic conditions … quickly enough.” Instead, she argues for more robust automatic stabilizers, which directly adjust public spending in response to unemployment or other macroeconomic indicators. Her preferred stabilizer is a job guarantee program, which would offer employment to anyone who wants it at a stipulated wage.
The policy conclusions are mostly convincing; the route by which they’re arrived at is less so.
The big weakness is the book’s central theoretical claim that government has a monopoly in money creation, a theory known as “chartalism.” This claim has a serious problem: the existence of banks. It is true that government has a monopoly on currency. But most of the money we use in our daily lives is not coins and bills issued by the government, but ledger entries created by banks. Banks are money issuers every bit as much as the government. Government has tools to influence how much money is created by private banks, but its control isn’t absolute. And when its control is effective, that’s a function of the regulations and institutions of the financial system; it has nothing to do with the government monopoly on currency.
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The book shows little interest in the private financial system, though banks are money issuers every bit as much as the government.
The private financial system is hardly mentioned in this book—in a typical graphic, the economy is divided into the “currency issuing” federal government and “currency using” businesses, households, and state and local governments, with no mention of banks. And there’s good reason for that—bringing banks into the story would make it clear that the fact that currency comes from the government tells us nothing about where money comes from. Kelton, to be clear, never says anything factually untrue, but she gives the strong impression that the government is the only source of money that we use for transactions, which is not true at all. Similarly, while Kelton is right that federal debt is an important asset for the financial system, the stronger claim that government deficits necessarily correspond to increased private wealth is true only if we tautologically define “net financial wealth” as the negative of government deficits. In any economically relevant sense of wealth, it is false—asset values go up and down without any change in the government budget position.
For many MMT critics, the holes in the foundation make the whole structure unsound. I don’t agree. I think there are real insights here, which can stand on their own without the support of the overarching theory of money.
One strength of Kelton and her colleagues is not so much that they start from different assumptions, but their insistence that those assumptions be applied consistently. For example, one puzzle of economic orthodoxy is the coexistence of different concepts of the interest rate. There is an interest rate on loans under the control of the central bank, and a long-term “natural” interest rate determined by the fundamentals of thrift and technology. There is also an interest rate set by financial markets. But if the Fed can always set the short-term interest rate where it wants, it’s not clear how markets can influence the interest rate on public debt, or how the natural rate comes into play. Kelton cuts this Gordian knot by insisting that “the interest rate is a policy variable,” full stop. If spending and taxes are at the right level to match demand with supply (and the central bank cooperates), then the government can pay whatever interest rate it chooses.
Non-economists may be surprised to hear that inflation just depends on whether aggregate demand lines up with aggregate supply, and has nothing to do with money printing. So it’s important to stress that there is nothing radical or distinctively MMT about this position. What’s unusual about Kelton’s version is how stable and predictable the relationship between demand and inflation is supposed to be. At one point, she even suggests that the Congressional Budget Office (CBO) could, rather than calculating the effect of spending bills on the deficit, instead calculate their effect on inflation.
This suggests a more reliable link between spending and inflation than historical experience supports. We can agree in a general way that an economy running at full potential is more likely to experience inflation than one with a great deal of slack. But past efforts to use this relationship to shape macroeconomic policy have shown it to be an unreliable tool in practice. Kelton correctly observes that the Federal Reserve has repeatedly overestimated how close the economy is to potential, and sacrificed full employment for the sake of inflation fears that turned out to be unfounded. It’s not clear why these judgments would be made any better by the CBO.
Here as elsewhere, my concern is that Kelton has taken a reasonable argument and expressed it as if it were an absolute logical relationship and not a historical, contingent one. The variety in macroeconomic dynamics between countries and over time calls for skepticism about how far economic policy can be guided by deductive, syllogistic reasoning, whether it’s the reductive “Econ 101” that dominates so much of our political discourse, or the counter-101 that MMT offers.
There are, of course, benefits to telling a simple, logical story. Kelton and her colleagues have brought a great many non-economists into the economic conversation in a way that no other contemporary branch of heterodox economics has been able to. No, MMT is not a Copernican revolution that is going to refound economic thought. But that’s setting the bar awfully high. We may have to reject Kelton’s broader theoretical arguments, but she’s dead right about a central political fact of our times: A large, active public sector is more needed today than ever, and unfounded fears of public debt are a big reason we haven’t gotten it. Which means her eloquent, accessible book is performing an important public service.
