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Friday, April 14, 2023

Comments On The Omran/Zelmer MMT Critique

This article is a grab bag of comments on the paper: “Deficits Do Matter: A Review of Modern Monetary Theory” by Farah Omran and Mark Zelmer. I have mentioned this article before, for the good reason that Mark Zelmer will be on the other side of a panel on Modern Monetary Theory (MMT) that I will be on in late May.

The most interesting parts of the article would refer to the “fiscal crisis” that allegedly happened some time in 1994 or 1995 in Canada. I am pushing that topic to one or two other articles. This is probably the most interesting part for readers, as Omran & Zelmer’s view represents the Establishment stance in Canada — which is not really picked up in other countries. Although there is a lot of discussion of MMT and the external constraint, I do not see anyone outside Canada pointing to the 1994-5 episode.

The initial part of the article gives a summary of MMT. I obviously prefer my summary. To the credit of Omran & Zelmer, they warn against at the terrible conventional “critiques” that say that “MMT is just money printing!” Although the article is billed as a “review of MMT,” their summary is deliberately narrow — which is entirely reasonable. I do not see much value in getting excited by non-MMTers summaries of MMT, so I do not have any comments on that. The rest of this article is covering what I see as substantive points that are not directly related to the Canadian historical experience, as I want to cover the currency and bond market aspects in later articles. I will provide quotes from the article, and then respond.

Real Bond Yields and Currency Valuation

Setting aside any inflation concerns, investors, be they domestic or foreign, care about the link between government debt yields and the expected path of the exchange rate when considering whether to invest in Canadian government debt obligations or other investments, such as debt issued by other governments abroad.[Footnote on home bias] Unless investors believe the additional debt is likely to be used in a way that generates future income to service it, they might begin to worry that some of their returns from investing in Canadian government debt instruments could be offset by a depreciation of the Canadian dollar in real terms relative to other currencies.

There are few responses to this point.

  1. The only major bond investors that move their portfolios around based on currency outlooks are foreign central banks/sovereign wealth funds, Japanese households, and some rich people. Most institutional investors own bonds solely for liability-matching purposes, and they need domestic currency bonds1 to match those liabilities. Conversely, pretty much everybody owns internationally diversified risk assets on an unhedged basis — mainly equities, real estate. Risk asset flows are the main drivers of exchange rates. For example, the Canadian dollar lives and dies based on energy prices. Although there are real energy trade flows, the main driver is the relative attractiveness of the energy assets. As such, I have serious doubts about this part of the author’s arguments.

  2. Purchasing power parity (PPP) analysis assumes that relative inflation matters for currency valuations in the long run. The problem is that the long run can take a long time to arrive — currencies have strong deviations from PPP-predicted “fair values.”

  3. The currency weakening because of inflation is the international side effect of high inflation. This is not a surprise. Weakening the domestic value of the currency is going to be linked to a weaker value on foreign exchange (sooner or later).

  4. The whole point of a floating currency is that the value of the currency in fact floats. Policy makers are not supposed to assume that there is a “correct” value for the currency and panic if it drops below that value. (Doing so is a specialty of the British economic chattering classes.) Currency markets are markets, and can do stupid things in the short term.

Bond Purchases

MMT proponents argue that the interest rate on government debt is a policy variable. As such, debt-service costs can be contained by having the central bank acquire the additional debt at low interest rates (Kelton 2020, chap. 3).13 This seems to solve for the need to redirect resources in the future to service that debt, and to protect against rising borrowing costs through higher risk premiums. But the policy itself is not without risk. If investors and the public more generally begin to believe that the central bank is buying government debt to keep borrowing costs artificially low, rather than to support aggregate demand in the economy, as is currently the case, this could undermine public confidence in the Bank of Canada’s control of inflation pressures and be seen as an indication that the government’s fiscal position is no longer sustainable.

The problem with this argument is that it is describing the mainstream policy option: having the central bank to buy government bonds (quantitative easing — “QE”) based on a vague hope that this does something to stimulate the economy. The belief that QE lowers bond yields relies on ignoring the mainstream model of interest rate formation — rate expectations. (Sure, the government can squeeze long maturity bonds, but it is unclear to me what that actually accomplishes — the yields on the tiny fraction left in private hands are lower?) If investors expect to lose money on holding bonds, they will dump them all to the central bank.

If we are going to discuss MMT, we need to look at an actual policy suggestion: lock the policy interest rate at 0%, and stop issuing bonds. (Technically, the Mosler suggestion is to offer unlimited tenders of Treasury bills at the fixed rate of 0.25%. These bills provide risk-free investments to entities that cannot leave assets in banks.) The central bank is not “keeping interest rates artificially low” — the nominal risk-free curve has been obliterated forever. There are no bond investors to worry about the sustainability of the fiscal position!

The authors then raise the question of currency weakness as investors look for “more solvent jurisdictions.” This is an issue for QE, but not the MMT policy — locking rates permanently at 0% (or 0.25%) is going to cashier “solvency” worries.

Non-Federal Borrowers?

Going alone and issuing debt to maintain current living standards, focusing on encouraging present consumption over investment, would be risky even if the economy were operating below potential, unless a clear argument could be made as to how the added debt burden would be sustainable over time. Past experience has shown that the price of doing so could appear in the form of a real exchange-rate depreciation and higher interest rates for non–federal government borrowers.

This continues the previous argument.

The first thing to note is that the authors have the 1990s neoliberal fixation on “investment” versus “[government] consumption.” This was a political strategy to slash spending on education and healthcare (because investing in citizens does not appear to count) and instead shower money on connected private sector entities in things like public-private partnerships (the other PPP). Although this is important for ideological signalling, it does not really matter if the government is analysing spending based on inflationary impacts in the first place.

The exchange rate angle is the repeat of the previous: if government spending is relatively inflationary, one would eventually get an exchange rate depreciation on PPP grounds. But if it’s a floating currency, the government does not care about the currency level. [I will address the “what about the inflationary impact of currency depreciation?” in the following article. Since the assumption here is that policy is inflationary, any exchange-rate “accelerator” effect is already included in the assumption.]

As for non-central government borrowers, the fair value for the “risk premium” is the default risk. If the only prospective alterative for a 5-year Ontario bond is rolling a Government of Canada bill for 5 years at a mandated 0.25% rate, that bond yield is not going anywhere if the Ontario government is not running its finances into the ground.

Note: My treatment here skips over quite a bit of material about how interest rates were allegedly being suppressed by a “safe asset shortage,” and the economic situation at the time of writing.

Burden on Future Generations

We find this prescription for fighting inflation to be at odds with MMT’s claim that government debt does not pose a burden on future generations. There is a natural limit on how much spending and debt can increase the economy’s real capacity before driving nominal aggregate demand above it. This is particularly true when considering Ricardian equivalence – the idea that households take into account government spending decisions when making their own. When the government increases its spending and debt, households will anticipate future tax increases, and will therefore save more and spend (and invest) less. Once inflationary pressures arise, MMT’s prescription to cut spending or raise taxes in effect would place a burden on the generations paying the higher taxes or facing program cuts (Buiter and Mann 2020).

This section seems to be a cut and paste of neoclassical pre-2008 thinking about deficits, which is a subject that has been beaten to death online by heterodox writers since 2010 or so. I just want to point out that tax hikes responding to current inflation at best has a lagged effect of a few years. Unless we are dealing with may flies, these are not “future generations.” Although some people will die in the interval between the introduction of stimulative spending and responding tax hikes, this is not a large enough demographic to build our fiscal policy around. A significant portion of the government’s budgets are spent on things that have multi-year or multi-decade pay-offs.

Central Bank Independence

There is also a long paean to the importance of an independent central bank, with oodles of references to 1990s article. (Not a whole lot of discussion MMT critiques of those arguments.)

I should probably add another article on that topic, but I will give a flippant response to the following (I have added the [1],[2],[3] to the quote line up to my response).

These benefits include [1] low, stable and predictable inflation, [2] improved functioning of markets and allocation of resources and, [3] most important, establishing transparency, credibility and accountability in monetary policy.

  1. I welcome the authors to go grocery shopping with me and we can discuss how “low, stable and predictable” inflation has been in the past few years.

  2. Canada has completely insane housing market valuations, courtesy of BoC rate policy and the CMHC (and an immigration wave that has been met with literally zero thinking on how it is to be absorbed).

  3. There were a lot of central bank actions in 2008 and 2020 that a reasonable person might guess benefited private parties, yet I am unaware of any public discussion in Canada of who benefitted from those policies.

Concluding Remarks

This article responded to the fairly standard neoclassical arguments within the text. The most important part for most of my readers would be the “1994-5 fiscal crisis,” which will be addressed later. I think the “central bank independence” part is important, but that is a horse that has been flogged to death by Bill Mitchell on his blog.


Or currency-hedged bonds, which imply an offsetting hedge flow from a counterparty.

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(c) Brian Romanchuk 2023


  1. Good to see your critique using the phrase "currency valuation", as I think that gets to the heart of the matter. For one thing, finding the relationship between unit currency value and an aggregate value or valuation is particularly difficult, because of the prevalence of credit money.

    Anyway, my biggest issue with Omran and Zelmer commentary, was their heavy reliance on terms like "capital flight", "capital outflow", or "capital inflow", which I believe are misleading if not financially illiterate terms. The issue is the change in valuation of assets, whether that is stocks, bonds, currency, real estate, etc. Many assets cannot "leave" a jurisdiction like bank reserves or real estate. It is an issue of assets trading at depressed prices.

    Yet reduced asset prices also create opportunities for bargain buys. While there is potential for accelerating devaluation, of currency or other assets, it is a matter of finding a defensible support level, before attempting to reverse. If you attempt to stabilize an asset price too high, whether that is a currency, or anything else, it is too costly and eventually fails.

    It is not typical of mainstream recognize inflation as a market driven corrective process.

  2. I commend your restraint at the authors' referrence to "Ricardian equivalence". This has to be one of the most idiotic ideas to emerge from mainstream economics. If it is mentioned when you are on the roundtable in May I hope you'll be able to keep a straight face or prevent your jaw from dropping .

    1. (This is Brian) Yeah, I will have to practice my diplomacy.


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