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Sunday, July 5, 2020

The "Noble Lie" Critique Of MMT

One relatively common complaint that I have seen is that Modern Monetary Theory should be ignored because fiscal policymakers cannot be trusted to control inflation. This might be called the “noble lie” critique: we need to avoid discussing MMT as policymakers might make “undesirable” decisions.

(Note: This is an unedited excerpt from my manuscript MMT primer. This comes from a chapter of MMT critiques.)

This is obviously a political economy concern, related to the perennial “is MMT socialist?” debate (Section 1.2). The other issue with this critique is that this is obviously referring to a narrow definition of MMT (the parts that are related to Functional Finance). Since most online arguments about MMT are about those parts of MMT, this narrow scope matters, but as I argued in Section 1.2, that is missing too much of MMT for anyone interested in economic theory.

I am going to base my remarks here upon the article “Modern Monetary Muddle,” by Michael Edesess. This article was a review of Stephanie Kelton’s book The Deficit Myth. I have often encountered looser versions made by internet commentators. Edesess’ critique could be related to arguments made by neoclassical economists about fiscal policy, which I defer to a technical appendix.

Edesess’ Arguments

Within his review of The Deficit Myth, Edesess argues that the arguments of many prominent MMT critics – Martin Wolf, John H. Cochrane, Larry Summers, and Paul Krugman (a bipartisan group) – come down to similar theme. The theme is that the critics agree with the analytical premises of MMT, but are concerned about its effect on policy. Edesess argues:
But there is an even more basic issue raising those fears. They don’t trust Congress to make the appropriate adjustments. Would Congress, observing that - or being advised that - the economy was overheating therefore raise taxes to mop up the excess dollars, as MMT advocates? Would it restrain itself from spending programs once Congresspersons had to deal with lobbyists for various programs who had learned that MMT tells you that you don’t have to raise taxes to do it?
No, they don’t trust Congress to do that - in fact they don’t trust democracy to do it. And for good reason.
Democracy has a Tragedy of the Commons problem. A Tragedy of the Commons is, for example, a fish pond shared by many anglers, each of which, in their own self-interest, catches as many fish as they can, with the unfortunate collective result that the pond gets fished out.
Any threat to that arrangement is dangerous. To keep the unwashed masses from prevailing upon - or electing - a government that tries to provide all things to all people, as in a populist state, we must perpetuate the fiction that all new expenditures must be immediately paid for by new taxes. And we must delegate the management of the supply of money not to a democratic process, but to a quasi-authoritarian government arm, the Fed.
I do not think that Edesess’ analogy to the “tragedy of the commons” is persuasive (he discusses it further in the article); it sounds like a story out of Economics 101. The neoclassical arguments I allude to in the technical appendix is the more rigorous version of the argument. Instead, the value of the argument is that Edesess explicitly writes out the political economy argument: the “unwashed masses” need to be controlled by the “quasi-authoritarian” central bank.

I would argue that there are two reasons why one would be interested in MMT: from the perspective of economic theory (e.g., a fixed income analyst), or from a policy aspect (e.g., a political activist).I will discuss this critique from these perspectives in turn.

Economic Theory Matters

The argument that policymakers might behave badly is a complete non-issue from the perspective of economic theory. I am not going to believe something that is nonsensical just because someone might misuse the knowledge. From an academic perspective, this seems so obvious that it does not need elaboration.

The only interesting aspect is that I would argue that many people feel that theory ought to be tied to advocacy. The analysis of governmental bond markets and how they relate to fiscal policy is a major topic in financial news (roughly the only reason that government bonds are discussed at all on the media). One is typically treated to bank economists and strategists explicitly tying their market views to their political standpoint. For example, loudmouth free market fundamentalists predicting the demise of either the Japanese or American bond market is a staple attraction.

However, it is not necessary for bond investors to scream their views from the rooftops. For example, when I had any contact with outsiders, I was expected to not offer any useful information about how our fund was positioned. (The easiest way of doing this is professing ignorance of practically everything, and just nod a lot to what other people say.)

For anyone who is not broadcasting their views, what those views are should literally have no effect on what politicians do. As such, this entire line of enquiry is a non-starter.

What About Policy?

If we are interested in policy, we have a plausible reason to be concerned about policy biases. Of course, we must deliberately ignore all the policy implications of almost all of “broad MMT,” including the Job Guarantee. (Even from a conventional economic analysis standpoint, the Job Guarantee has almost no inflation implications in steady state if the wage is held stable.)

The first thing to note is that MMT is very unwelcome from the perspective of free market parties. These parties want to plead that the government cannot afford to offer social programmes, and that political strategy has been effective. So, if one wants to meet the doctrinal purity requirements of free market parties, one probably needs to keep any sympathies for MMT hidden from view.

However, not everyone wants to base their views on what is convenient for pro-market parties. In that case, the objection revolves around the question whether politicians are incapable of controlling inflation. In my view, this question devolves into a question of faith. I will return to this question in the technical appendix.

If we put aside the disputed question of whether only an independent central bank can control inflation, we are stuck with a rather unusual situation (which Edesess acknowledges). The MMT argument is that the only constraint on fiscal policy is inflation – and that fiscal policy frameworks should be based upon that premise. Turning around and complaining that this is somehow inflationary appears to be a non sequitur.

A less risible re-phrasing of this argument is that particular MMT proponents are not analysing inflation risks properly. In my view, this is the only firm ground of debate. Nevertheless, this is a long way from arguing that we need to hide the truth from the unwashed masses. I will return to the question of inflation control in Section 5.5.

Another related issue is that MMT critics seems to assume that MMT requires extremely active changes of tax rates to control inflation. If that were in fact necessary, it would be politically awkward. However, MMTers put much more faith in automatic stabilisers, and there is limited need to change tax rates as often as the policy interest rate. After all, MMTers argue that interest rate changes have little effect on inflation, yet inflation has been stable since the early 1990s in the developed countries in the absence of active fiscal policy movements.

Policy Ambitions

The main academic MMT proponents are arguing in favour of ambitious policies, such Medicare for All, as well the Green New Deal. These plans have a lot of moving parts, and each has its own inflationary and deflationary effects. Even the Job Guarantee will have some effect on the price level in the short run, and its exact effect will depend upon many hard-to-model effects.

Given the complexity of those plans, I cannot argue either way about the inflation analysis. Given that my view is best summarised by “inflation is complicated,” (a phrasing I have taken from Marc Lavoie, but I am sure he was not the first to suggest that), all I can suggest is let the dueling inflation modelling commence. Even if the unwashed masses are not interested in discussions of models, there would certainly be an interest in the real-world policy issues raised. In any event, this debate is entirely on MMT territory; the “inter-temporal government budget constraint” is likely never to come up.

Fiscal Conservatism a Dead Religion?

Finally, I would note that this argument is just a reheating of the neoliberal consensus of the early 1990s. Although there are some remnants of the political dynasties of that era still around, it is unclear how much influence it has.

The reality is that any sentimental attachment to the balanced budget religion disappears as soon as it becomes even slightly inconvenient. Free market parties have been cutting taxes and hiking military spending since the early 1980s. all the while shedding crocodile tears about governmental debt levels. Fiscal interventions in response to the Financial Crisis and the Pandemic of 2020 were robust, although the Obama administration’s response in 2008 was too small because of the mediocrity of the economic team.

The developed countries are filled with university-educated citizens who have access to the internet. I have extreme doubts about the sustainability of an economic theory that says one thing to policy-making elites, and another to the masses.

Technical Appendix: Policy Consistency

One of the big ideas of neoclassical modelling of the 1970s was time consistency of policies. This was part of the ideological attack on Keynesianism, as it was argued that fiscal policy was time inconsistent.

Since I am not writing a primer on neoclassical economics, I will outline the argument very briefly. Imagine that policymakers want to reduce unemployment while keeping inflation stable, and we assume that the framework is Old Keynesian: increase government spending to create jobs (or cut taxes), but the rise in aggregate demand creates inflationary pressures. (Needless to say, this hydraulic Keynesian framework ignores the Job Guarantee, which features full employment with no changes in the policy wage. However, the people who apply time inconsistency arguments against MMT ignore that part.)

The time inconsistency shows up in the following fashion. Assume that unemployment is “too high,” and so policymakers want to launch a fiscal stimulus programme. They argue that future fiscal tightening will offset the future inflation risks, so that the mixed policy objective is met However, in the following year, unemployment is at a more comfortable level, and inflation is higher. When trying to find the optimal policy for the policy mix, the tightening of fiscal policy is less than was forecast in the previous year. As such, even though the policy objective for trading-off inflation versus and unemployment is unchanged, future policy does not match what looks like optimal policy at the beginning: there is a bias towards running higher inflation.

The literature is premised upon using mathematical optimising models. We need step back, and ask: what are these models?
  • You first assume some mathematical relationships in a system of equations (and constraints, etc.).
  • You then apply the rules of mathematical operations to examine the properties of the solution of the set of equations. For example, you can simulate the results on a digital computer.
In this case, neoclassical economists have created a mathematical system that assumes that fiscal policymakers prefer a system that generates inflationary outcomes. The obvious question: why should we assume that the model applies to the real world? Has this particular model been fit to real-world data, and done a good job of explaining outcomes? The answer is: not really, but other neoclassical models have been fit to data. How convincing this defense is ends up being a question of faith. Since this is not a primer on neoclassical economics, I cannot hope to address this aspect of the critique. All that can be said is that post-Keynesian economists reject pretty much all the underlying assumptions used in the models.

References and Further Readings

(c) Brian Romanchuk 2020


  1. Brian,

    Thank you for taking the time to write about MMT. I disagree with your labelling of this critique of MMT as the "noble lie" critique. Branding it as such suggests that MMT's critics accept its premises and conclusions, but fear that the subtleties of the theory will not be understood sufficiently well to be implemented in an effective manner by, for example, US congress.

    From what I can tell, the above-described view does not accurately characterize that of MMT's most cogent critics (see, eg, Cullen Roche). Rather, critics take issue with both premises of MMT (eg, not making a distinction between the Federal Reserve and the Treasury) as well as arguments that are made (eg, that the cause of unemployment is necessarily a shortage of money, forcing one to conclude that the sole supplier of money --the government-- should step in to employ all of those who fall victim to this shortage of money).

    This is all to say that when people contend that congress should not be charged with managing inflation, they are not conceding that MMT is correct, consistent, or worthy of consideration, but merely too complicated of an idea for our politicians. They are pointing out that in the toy-model universe discussed in MMT, congress is in charge of managing inflation. They then point out that our "real world" congress manages inflation through the Federal Reserve-- not taxes. I think it is more accurate to characterize this critique as a critique of one of the premises of MMT (that is, lumping the Fed and the Treasury into one thing).

    You are absolutely right that economic theory matters, and that MMTers are more than justified in exploring their ideas in an academic setting with simplified and idealized conceptions of a sovereign currency issuing government. However, when examining policies advocated by MMTers, it is reasonable to scrutinize these simplifications, and criticise them if they differ from reality in important ways.

    To conclude, I disagree that these critics are uttering a "noble lie" when they point out that congress has no track record of managing inflation in the short or long term, that it is not designed to do so, and that it has in fact mandated that a separate government entity be responsible for doing it for exactly these reasons. I think that they are making an accurate appraisal of how our government is currently designed to work, as well as how it might reasonably be able to evolve to function.

    1. I am writing a chapter on MMT critiques. This article represents one section, and one critique. The people making the argument are not disagreeing with the premises per se, rather they argue that we need to lie to politicians and voters. The quoted text refers to the "unwashed masses."

      Cullen Roche makes up random stuff about MMT. I don't view anything he writes as being a good faith critique.

      As for Congress managing inflation, you can't point to past history and conclude much. In previous decades, you had Old Keynesians, and currently you have New Keynesians. Heterodox authors argued that both the Old and New Keynesians were out to lunch. The premise that the central banks are micro-managing inflation is rejected by MMT; at best, they can induce a financial crisis with sky-high interest rates. But since the early 1990s, there's not a whole lot of convincing evidence that monetary policy has accomplished much. Fiscal policy should be analysed properly, and that is not happening now.

    2. Noted that this article represents one critique of many. I think that the critique you are examining-- that US congress lacks the ability to actively manage inflation-- is indeed a common critique. I am trying to suggest that you brand it something other than a "noble lie."

      A noble lie would be for me to say "taxation has no effect on inflation" when in reality I am just afraid that charging congress with managing inflation through taxation would be ineffective. This is not what is happening-- people are not disguising their concern for the incompetence of congress with some other lie. They are just pointing out their concern regarding the design of congress. For this reason, I think your book might be better served to brand this critique something like the "incompetence of congress" critique.

      As for Congress managing inflation, I would argue that you can conclude that Congress has decided to delegate this task to the Federal Reserve. In other words, you can conclude that managing inflation is not something it does directly in its current form, and at least concede that doing so in the future would represent a substantial change in the way our monetary system operates.

      Regarding your last paragraph, I am not an economist/economics person, so I am not very good at debates in the abstract over New/Old Keynsians/Heterodox. With that said, I agree broadly that monetary policy is more effective at fighting inflation than it is at spurring it, and that encouraging a better understanding of how a sovereign currency issuer pays for things on the part of both our elected officials as well as the general public is a worthy pursuit. Best of luck with the book.

    3. The “noble lie” is lying to the people about the reality of fiscal policy; e.g, all spending has to be immediately matched by taxes. I suggest you re-read the final paragraph I quoted, It explains it quite well. You may find that a stupid critique, but that doesn’t stop people from making it. I expect to rename the section, but there was nothing obvious.

      You are discussing an issue that will be discussed in another section.

  2. The inflation problem is easily addressed: The Job Gty/Green New Deal law should include automatic across-the-board tax increases that kick in when certain monthly wage inflation target are hit-say for 6 months in a row. These can include:
    a) Income Taxes,
    b) Sales/VAT Taxes
    c) Asset Value (or Wealth) Taxes
    That'll cool things off pronto.

    1. The Job Guarantee itself is not an inflationary concern - once the phase-in happens. The gov’t is buying something at a fixed price. It’s hard to spin any story how that can keep driving up prices.

      The Green New Deal is a big programme, designed to change the structure of the economy. It would obviously require fine-tuning. Automatic tax triggers is an option.


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