Here’s a NY Times piece calling for a MMT “victory lap”, with an asterisk. It’s an interesting article, but the asterisk seems to be doing an awful lot of heavy lifting here. The basic gist of the article is that the government spent a lot of money and the government didn’t go broke. And sure, on the one hand, the economy is robust. On the other hand, inflation is worrisomely high. Depending on how you pick your narrative you can frame this as either very good or very bad. But does MMT deserve a “victory lap” or is the current economic experience a worrisome sign of how they’d handle a truly scary inflation? My view is the latter. I’ll explain why.
First of all, there’s a lot to be proud about in the COVID policy response. Yes, inflation is high, but the alternative scenario would have been truly awful. In my opinion some high-ish inflation was the worthwhile cost of fighting off a once in a lifetime crisis. It was worth the cost, especially when we look back at March of 2020 when it looked like we might actually be on the verge of Spanish Flu 2.0. But you also need to know when enough is enough and that’s where MMT appears to fail in a rather worrisome manner.
The basic gist of MMT is that a very wealthy country doesn’t have a solvency constraint and instead has an inflation constraint. So they claim that the government can afford to run perpetually large deficits so long as inflation isn’t out of control. This is true. I’ve written about this a billion times here. But my major worry about MMT has always been that their flawed theory of inflation would fail in predicting the causal factors of inflation and that when that high inflation actually arrived they wouldn’t have the political will to respond the way they need to. The COVID MMT experience with inflation is worrisome at best and frighteningly wrong at worst.
To be clear, MMT’s theory of inflation claims that the government need only worry about “real resource” constraints since they can print money to cover any solvency problem. This is obvious in one sense (the government has a printing press) and also vague to the point of being useless (since “real resource constraint” isn’t a measurable concept).¹ In any case they claim that we should implement policy that would pre-emptively account for high inflation. The problem with this claim is: NONE OF THE MMT ADVOCATES PREDICTED THE CURRENT HIGH INFLATION. So, right off the bat they’re claiming they can build a proactive inflation fighting model even though their existing models clearly didn’t predict the current inflation. Strike One.
But let’s cut them some slack. Predicting inflation is hard. I say that all the time. So, maybe when the government spends too much you just wait until it’s a problem and then you try to get in front of it. Given that, we would expect MMT advocates to be out in force calling for tax hikes and smaller deficits, right? Except no. THEY’VE ACTUALLY BEEN CALLING FOR MORE GOVERNMENT SPENDING IN THE LAST YEAR. Strike Two.
Okay, but maybe that’s not what they really meant. Maybe they want to spend more in certain areas, but also increase taxes and run countercyclical policies that would counteract inflation. Except no. In Turkey, for instance, MMT’s founder actually said that the government should cut rates, but when the Turkish Central Bank cut rates the Lira collapsed 50%. So, countercyclical monetary policy isn’t an option there. We’ll call this ball one because I am being generous even though this is a called strike three right down the pipe.
What about fiscal policy? Surely MMT advocates are calling for broadly higher taxes despite calling for targeted spending increases. But no. Stephanie Kelton says higher taxes are not part of MMT’s inflation fighting policies. Except Kelton’s book explicitly says that taxes are an inflation fighting tool:
“We agree that we should rely on adjustments in taxes and spending (fiscal policy) rather than interest rates (monetary policy) to balance our economy. We also agree that fiscal deficits, in and of themselves, are neither good nor bad. What matters is not whether the government’s budget is in surplus or deficit but whether the government is using its budget to achieve good outcomes for the rest of the economy. We agree that taxes are an important way to reduce spending power and that taxes should never be increased simply to appear fiscally responsible.”
In fact, the NY Times article citing the “victory lap” says the same thing:
“In an M.M.T. world, the Congressional Budget Office would have carefully analyzed possible inflation ahead of time, and lawmakers would have tried to offset any strain on available workers and widgets with stabilizing measures and tax increases.”
But as soon as there was a voracious backlash to this article calling out this contradiction Kelton went to Twitter to declare:
“MMT has obviously proven correct….MMTers never said to fight inflation with tax hikes.”²
Her own book explicitly said taxes are an inflation fighting tool. But now that high inflation is here they’re saying we shouldn’t rely on tax increases and government cutbacks to fight inflation because this is mostly a supply chain issue.³ This is all very confusing to be honest. And I hate to say it, but this is strike 3, 4, 5, 6, 7, 8 and 9. The inning is over.
In summary, MMT hasn’t been proven correct by any measure. If anything they’ve handled the current inflation in a worrisome manner. They didn’t predict the current high inflation, consistently said it would be transitory and have had no countercyclical response to combat it now that it’s here (despite claiming tax hikes are the right way to beat down inflation). Which begs the question – what if they’re wrong again? What if inflation lingers longer than they think? I personally think inflation will decline slowly in the coming years, but I also think the Fed and Congress are right to hedge that bet by slowing spending and raising rates. Meanwhile, MMT advocates have no countercyclical response at all. In fact, their response has been more procyclical spending. Not only is it a poor predictive model, but the model appears to contain little to no sensible risk management in case of a worst case scenario. It’s a worrisome response at best and a sign that MMT has failed its first real test with inflation.
¹ – This is the primary reason why, as Larry Summers notes, that MMT isn’t taken seriously in academic circles. Their theory of inflation isn’t something that is quantifiably supported by models or empirical evidence.
² – This is an especially odd comment given that Mosler, Wray and Kelton all emphasize the importance of tax hikes as an inflation fighting tool in their books. Perhaps they’ve changed their minds. And it’s perfectly fine if they have, but this is part of the frustration with MMT – every time they’re wrong about something they change the narrative to make it look like they didn’t really say this or that. Paul Krugman once called MMT a big game of “Calvinball”. He was right.
³ – It’s true. COVID caused many unusual supply chain problems. But we also know that government transfer payments more than offset ALL of the lost income from job losses during COVID. The idea that government spending didn’t contribute to inflation isn’t just unbelievable. It’s preposterous.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.