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Tuesday, April 10, 2018

MMT Versus "Structural Keynesianism"?

Professor Thomas Palley has once again launched a critique of Modern Monetary Theory (MMT) in "Modern Money Theory (MMT) vs. Structural Keynesianism." One could argue that there are some useful nuggets in his argument, but they are arguably behind the times. His critique is of how he perceives MMT -- which has only a limited relationship to MMT as it exists now.

I probably should have ignored his article, but too many people have discussed it, and so I do not want to leave the impression that his arguments actually represent weak points of MMT.

Old School Academic Issues

On the pure academic side, he summarises his views as:
I like to say that MMT is a mix of “old” and “new” ideas. The old ideas are well known among Keynesian economists and are correct, but the new ideas are either misleading or wrong.
I will put aside the "correctness" issue, and focus instead on the originality. If you are an academic that is discussing the history of economic thought, or worrying about the proper citation chain for ideas, originality is a big deal. Back when I was an academic, I treated the importance of originality seriously; I was pretty much the equivalent of a grumpy old man screaming at punks to get off the lawn. I do not have access to an economics research library, and so I am not the person to make judgements on originality in economics research.

That said, I have read the MMT scholarly papers, and I saw no particularly reason to be concerned about the originality of the ideas. The papers made the lineage of MMT abundantly clear. The figure below is my informal summary of the origins of MMT.

I have negligible interest in the history of economic thought, so I am not particularly concerned about any details in the above that might horrify pedants. The point is that it is clear that MMT is at the end of long line of development. If a non-economist can put together this family tree from reading the MMT literature, there is no excuse for an academic to cast aspersions about the originality of MMT.

In any event, this is moot. Modern Monetary Theory is no longer just the writings of a handful of academics, it now comprises a very large research programme. For example, I gave a presentation at the first MMT conference at Kansas City last year, and so that work is arguably part of the wider MMT research programme. His textual analysis of a few decades-old papers is no longer an adequate read of this wider body of theory.

Government Finance -- Not Just Polemics

Palley asserts:
The size of government deficits and how they are financed matters. Deficits involve issuing financial liabilities, and different financing policies involve issuing different mixes of liabilities. The extent and mix of liability issue can have consequences.
These are content-free statements that have no empirical support whatsoever.

He then adds:
They have the ability to borrow from future generations; they can issue money; and they can create a demand for their money by imposing taxes. But that does not mean they are free from market constraints and market competition, and they also confront difficult political constraints. That limits what governments can do.
What are these constraints? Given the huge variety of political forms seen over the centuries, in what sense are "political constraints" binding on economic policy?

Palley's major point about fiscal policy is this:
MMT is best understood as political polemic, aimed at beating back the budget deficit hawks. It does not add to economic theory, so talking of policy being made according to MMT does not make sense.
No, it's not just polemic. Thinking clearly about what the true constraints on fiscal policy -- real resource limitations, and inflation -- eliminates writing content free slogans about fiscal policy. Such as invoking mysterious "constraints" on fiscal policy that cannot be quantified, nor offer any guidance as to what happens when the alleged constraint is violated. One can debate the MMT language, but the complete inability of conventional economists to quantify the consequences of fiscal constraints is obvious when one presses the matter.

Misunderstanding of the Job Guarantee

Palley asserts:
Fourth, MMT says government can spend its way to full employment by printing money and, when the economy hits full employment, government can just raise taxes and drain the money back out. That is a naïve view. First, the economy is made up of lots and lots of sub-economies so that some reach full employment long before others. That is why inflation starts to appear before full employment.
Palley is thinking like an Old Keynesian, and completely ignores the structure of the Job Guarantee. Non-targeted fiscal stimulus -- infrastructure and military Keynesianism -- does exactly what Palley describes. A Job Guarantee is going to create jobs only where there is already unemployment, and so all sub-economies would hit "full employment" at exactly the same time.

One can debate the effects of the Job Guarantee. But any analysis has to start off with the obvious point that is not structured like Old Keynesian policies.

Interest Rate Policy

Palley gives the conventional line on interest rate policy.
Second, MMT economists tend to say the central bank should park the interest rate at zero and forget about it. I think that is crazy. It is throwing away an important economic policy tool, and it would likely promote dangerous asset price inflation and financial instability which would come back to haunt us.
Sure, interest rates would be lost as a policy tool. But is it really important? Palley just assumes that it is, with providing any good evidence for that claim.

If we look at the post-1990 period, one can have a field day ridiculing consensus forecasts of "hockey stick" recoveries that have never materialised. Conventional economists of all stripes have been horribly and repeatedly wrong about growth.

One may note that the defining characteristic of the consensus is that they all agreed that interest rates for almost entire post-1990 period were "unsustainably low." This presumably led to their repeated wrong forecasts.

There is not a whole lot of empirical evidence to suggest that anyone understands the effect of interest rate policy, which then leads to the obvious question: why is it an "important" policy tool?

Emerging Market Canard

As is typical, he pretends that MMT economists have not discussed emerging markets.
Third, MMT economists say all a country needs is a floating exchange rate, and then it can use money financed budget deficits that push the economy to full employment. I think that is nonsense. Just ask an economist from Mexico or Brazil. Exchange rates matter a lot for economies, and the effects of exchange rates and exchange rate volatility ramify widely, often with very disruptive consequences.
The failure of MMT to provide good guidance for countries like Mexico is important. Economics should provide theory that holds up widely. MMT does not, which is a warning sign something is wrong.
I write about developed country bond market economics, so I am not the person to ask about emerging markets. However, there is a MMT literature on emerging markets.

Sure, everyone wants to pretend that all countries are equal. However, no serious commentator believes that Mexico has the same policy space as Canada. Mexican policy makers need to worry about corn prices on household welfare; Canadian policymakers have not had to worry about the effect of food prices on the household sector for an extremely long time.

The developed countries have largely ignored their currencies for decades; working from memory, the last coordinated forex intervention was when the euro was being trashed after its inception. Otherwise, Japan is the only country that kept the tradition of unilateral forex intervention alive. The argument that "exchange rates matter" in the context of the developed country has not been paying attention to the past few decades (modulo the euro peg system).

(Note: As some might guess, this section got some pushback from certain quarters. To be clear, I am just stating that the MMT research on emerging markets exists. Whether that research could be improved is a question that is outside my area of interest. If there are room for improvements, well that just leaves openings for research at upcoming MMT conferences.) 

Quantitative Regulation?

Palley inadvertently provides an example of the advantages of the MMT focus on operations. He cited his paper on "quantitative regulation." He argues that all financial intermediaries should be forced to hold reserves against assets. To describe it as sketchy is an understatement.
  • I have a self-directed Registered Retirement Savings Plan (RRSP) which holds financial assets. Legally, it is a stand-alone trust, and it is unclear what separates it from any other financial entity organised as a trust (and that is a lot of them). If we took his suggestion literally, every single retirement account would have to be given direct access to the payments system so that they can post reserves at the central bank. Furthermore, central bank personnel will have to monitor every single retirement account to determine the reserve requirements, which are to be set dynamically based on the asset classification. We then need to multiply this for every single firm that holds financial assets -- which is most of them.
  • If we accept that going that far would be categorically insane, we realise that we need a specific legal criterion to differentiate "financial firms" subject to reserve requirements, and those that are not. Needless to say, his proposal completely misses that discussion (rendering the paper effectively useless as a policy piece). Then we need to explain why firms will not use the principles of English Common Law to have practically every financial intermediary fall under the list of exceptions. Starting in the 1950s, Hyman Minsky was documenting how that process worked.
  • Citing banks and insurance firms does not help his case. They voluntarily submit to regulation to enter lines of business from which they would otherwise be barred. Otherwise, all firms more sophisticated than a lemonade stand have financial subsidiaries, and would end up ensnared in Palley's regulatory net.
  • Even if the regulations stick, they would be largely pointless in regulating activity. Let's say the government forces you to stick 10% of your equity portfolio in non-interest bearing "reserves." What would equity investors do? Borrow 10% against their equities to restore their desired risk exposure. A reform that pushes investors to leverage their portfolios is not going to help financial stability.
  • The proposal seems to somewhat unaware of the existence of financial derivatives -- which typically have a book value of zero, and can be netted out to a zero market value with variation margin. Canada used to have "Canadian content" rules on pension funds (including RRSP's); they were made a mockery of by total return swaps.
  • For all his alleged concern about the foreign sector, he ignores that this proposal would be equivalent to telling everyone in the country to pack up their financial activity and domicile it offshore. All the risky assets would be held externally (beyond reserve requirements), and people will get the risk exposure with (near $0 market value) total return swaps. No country would want to shut down its non-bank financial sector, leaving the financial intermediation to be handled at the behest of foreigners.
  • Since there is no way that every financial entity can bank with the central bank, they will be forced to work with banks as intermediaries. That service will come at a price. Furthermore, extremely few financial firms operate in the repo market or interbank market, nor do they have discount window access -- which means there is no direct way for central bank operations to provide "reserves" for these non-bank firms. You have imposed reserve requirements on firms without having a mechanism to provide those firms with reserves.
The MMT research community is in touch with legal scholars, as well as financial market practitioners. A proposal this far from operational reality would not get very far without being heavily corrected.

(c) Brian Romanchuk 2018


  1. "But any analysis has to start off with the obvious point that is not structured like Old Keynesian policies."

    I can never understand why both PKs and NKs can't see that the Job Guarantee is a powerful spend side auto-stabiliser. It is just a very clever way of beefing those up so they have real power - both in deployment and withdrawal.

    AFAIK there has never been any serious doubt about the power of auto-stabilisers. So why would you object to a stronger and more immediate one that clearly deals with the 'debating delay' that Wren-Lewis and the like pray in aid of monetary policy.

    A spend-side auto-stabiliser works far faster than movements in interest rates - even when you dampen the delay harmonics by playing the expectations card.

    1. On the NK side, there is no way to take into account an auto stabiliser into their cripppled little models. Plus it destroys the narrative of central banks as “benevolent central planners” (snort).

      On the PK side, I am detecting a lot of tribalism behind the icy reception. In Palley’s case, he pretty much sounds like we can replicate the 1950s somehow, with good old fashioned hydraulic Keynesianism.

  2. Brian, you make a lot of good points, but ... it seems more honest to me to call functional finance "functional finance." Abba Lerner was not the first person to come up with what we now call FF, but Lerner seems to have been the first Western academic to publish it as a neatly packaged concept and I tend to begrudge him credit for that. First-to-publish counts for something.
    I'm good with Godley's sectoral balances, but as with FF it makes more sense to me to call sectoral balances "sectoral balances," not "MMT."
    I see only thing two things that are unique to MMT 1) Minsky's highly flawed ELR proposal -- itself a non-original bastardization of the 1963 Freedom Budget's job proposal (which in turn was a riff on Henry Wallace's 1946 Full Employment proposal, which in turn was preceded by the 1894 job proposal of Coxey's Army, and so forth). 2) the naive belief that all government serves the "public purpose," whatever that is. Aside from the JG and the childlike belief in government serving "public purpose," MMT has no "claim to fame," as Ramanan put it.
    One can endorse FF and SB, yet have serious doubts about the JG and about capitalist governments serving "public purpose."

    1. I’m not the person to discuss the history of economic thought with. If we are discussing economies qualitatively, you can argue that any prolific author will have prefigured practically any economic theory. I am not that much of a bug on mathematical economics, but it does provide one way to judge originality. (And based on my experiences, there’s even a lot of judgement calls in applied mathematics on that front.)

      I don’t see any value in trying to define what is “unique” to MMT. It is explicitly an attempt to hack an internally coherent narrative out of the broad tent post-Keynesian traditions. Post-Keynesian economists resist against this, and want to minimise MMT as being solely the writings of an explicit list of “MMT authors.” Well, tough luck. The English language is defined by usage, and MMTers define MMT as being that broad tradition, even including authors who were explicitly not MMT (e.g., the SFC model work of Wynn Godley). If you want to say that “MMT is just post-Keynesianism”, feel free, but then you are stuck with trying to define post-Keynesianism. Marc Lavoie did a good job to try to build an overall view of PK economics, but it is clear that it consists of squabbling camps. That ugly reality explains why MMT was created in the way that it was.

      As for public purpose, I’m from the Canadian Prairie Populist environment. The populists had no choice but to be political realists. I don’t see any issues with the “public purpose” characterisation; you periodically need to drag the politicians in the right direction to achieve some semblance of the public purpose. It’s a very different world view than I have seen other countries (very limited sample).

    2. Coercion under law is usually justified with reference to some claim of Authority or with reference to authority in the service of Public Purpose (six page pdf):

      The History of the Public/Private Distinction

      Government finance, financial regulation, and bankruptcy law are redistribution schemes that can be captured by private groups or can serve another public purpose. If finance markets cannot be inherently stable, and if stable prices and full employment are in the nature of public goods, then government should be used to stabilize prices, regulate finance, and promote full employment as a valid public purpose in modern financial nations.

  3. I agree Palley's article is poor quality stuff. I'll do a criticism of it on my own blog in a day or two.

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  8. So I've been reading some of palley's critiques, I think he may have a different definition of "full employment", something about an increase in aggregate demand pushing up the price level. I couldn't find it when I went back through the paper.

    Anyway, these guys just don't get it. Palley says of zirp:

    "That implies steady nominal appreciation of the dollar to compensate for lack of interest income on short-term dollar holdings"

    I have no idea what "nominal appreciation" is supposed to mean.

    And then he went off about "consolidated budget restraint"

    Oh well.

    There is no model for stupidity.

    It's funny when neoclassicals point to Palley's critiques.

    Here's a model: "The price level is a function of prices pays by government when it spends or collateral demanded when it lends."

    Okay to simplify assume overt monetary financing, so no bond issuance, etc.

    Then there is a money stock M.

    M = S - T.

    The money stock is total spending minus total taxes.

    Next prices are an input output relationship. Assume consumption level has no effect on price. So the price of bread is a function of wheat price, which is a function of land rents etc. So this is going to be an input/output model of prices, not a S&D model.

    Assume one commodity, bread. Government spending generates useable land(by providing infrastructure like roads), using labor.

    So there is no currency, only bread coupons. The government produce no bread itself, it only taxes bread, so the coupon or bread can be tax payment.

    Then we can figure out constants for generating land from labor, and how much bread gets produced from land, and we can model this. I'll be working on this, I think it's better than the firefighting model.


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