Seeking “some education” Jared Bernstein recently asked some questions about MMT (Modern Money Theory).This series is my effort at some answers. Part I is about deficit spending.

Possible Overheating

Jared says that to dial back fiscal stimulus MMT writers “argue for tax increases.“

He continues:

That’s fine in theory, but how does that work in the real political economy? The president goes to Congress and proposes a tax increase to bring us back down to potential, and Congress says, “sure, boss. We’re on it!”? Presidents and Congresses don’t like tax increases, and they don’t happen quickly (yes, the last tax plan came together pretty quickly—because it was a cut!), they have distributional implications, and there’s a huge industry to fight you tooth and nail.

That’s why we have a Federal Reserve that can quickly and without political interference decide to take money out of the economy (to be clear, monetary policy also has distributional implications). That seems like an immeasurably more reliable way to handle the overheating problem, but I don’t think the MMT crowd agrees, or at least I don’t understand where the Fed and interest rates exist in their cosmology.

MMT writers do say that tax increases will drain demand, and sometimes advocate higher taxes to control inflation, but the scenario provided by Jared just above doesn’t describe a method most of us would use to prevent or treat inflation if it occurs. Instead there are other methods we would rely on that are effective and less intermittent.

They are: 1) not using fiscal stimulus, and instead using continuous deficit spending in full employment fiscal policy to compensate for demand leakages, 2) using an employment buffer, rather than an unemployment buffer to anchor the price of labor against inflationary shocks, 3) hedging against inflation by strengthening the automatic stabilizers in fiscal policy, including legislating programs providing for automatic tax rate adjustments and tax increases triggered by unexpected inflationary episodes, 4) bringing new sources of supply to bear, and 5) wage and price controls, supplemented by large-scale bond  sales to consumers, if necessary.

Looking at the first of these, it seems to be part of Jared’s paradigm to think about using fiscal stimulus and deficit spending to moderate or end recessions, and after that is done to wait for the economy to fully recover, rely on the Fed for economic adjustments, and then just wait for the next episode of recession to rinse and repeat.

But in the MMT paradigm, we think about fiscal policy in the context of foreign sector surpluses, private sector deficits and the need for the government to compensate for anticipated demand leakages with continuous and precisely targeted and calibrated deficit spending, while strengthened automatic stabilizers moderate the effects of inflationary impacts. That is, we think about and would recommend enacting, continuous fiscal policy spending supplemented by new and existing automatic stabilizers for maintaining full employment with price stability.

Next, the MMT-based policy of a federally-funded Job Guarantee (JG) at a living wage with a full package of fringe benefits is a powerful hedge against demand-pull inflation, and would introduce a new automatic stabilizer into the economy. One of the things that has been most important in killing inflation since the 1980s has been the policy used by governments and central banks in developed economies to slow or stop rising real wages by maintaining high levels of unemployed labor.

Central banks contribute heavily to this by looking at increases in wages as an indicator of inflation that ought to be met with an increase in interest rates resulting in a business slowdown and higher levels of unemployment. Policies like this along with policies of slowing minimum wage increases until they fall far behind the pace of productivity increases have served to maintain an unemployed buffer of workers helping to depress wages for decades.

MMT prescribes instead, creating an employed buffer of workers through the JG. The JG would ensure that everyone who wants a job can have one at a true living wage. Since the living wage would be very much higher than today’s minimum wage, passing a JG would have an initial stimulative effect on the economy.

But, in the medium and long run using an employed buffer both ensures full employment and prevents inflation because during inflationary episodes the JG program would not raise the living wage and so would not provide a higher living wage alternative to workers bargaining with their employers for higher wages. So, generally speaking, the JG provides both true full employment and also a price anchor on labor, dampening the inflationary impact of rising wage costs in a bubble economy.

The third plank, in MMT’s anti-inflation program is strengthening the automatic stabilizers in the economy. During economic cycles the size of the JG program changes with cycle dynamics. Participation in the JG is at its highest point when private sector employment is at the low point of an economic cycle, and is at its lowest point, when it is at the high point of a cycle. Unemployment insurance payments, which would continue even with a JG work the same way. Other safety net programs either supply a floor for the economy, or work the same way as the JG and unemployment providing stabilization for the economy at all points within the economic cycle.

Taxes are important automatic stabilizers as well. Income taxes, sales taxes, business taxes of various kinds, all destroy more net financial assets in the private sector as the economy expands and destroy less net financial as it contracts. MMT-based polices would strengthen the network of automatic stabilizers, both by expanding benefits paid by existing safety net programs and also by adding such programs.

In addition, MMT policies would add taxes on business and consumers where the rates of taxation would vary counter-cyclically with changes in the business cycle. So Jared’s scenario of Congress being asked to pass a tax increase would occur only very rarely in the case of an extreme inflationary episode, since the automatic taxing stabilizers would moderate inflationary tendencies without Congress having to intervene explicitly.

The last two methods in an MMT-based framework for achieving price stability would occur only infrequently and most often in cases where cost-push inflation created by supply shortages, rather than demand-pull inflation created by government deficit spending or private sector credit bubbles were at issue. To prevent supply shortages of resources critical for producing a wide variety of products in the economy, MMT-based policies would establish continuing government programs to anticipate shortages of critical resources and bring new sources of supply online long before shortages happen.

Buffer stocks of critical resources would also be established to stabilize supply cycles that may also lead to cost-push inflation. In case of failure to anticipate shortages policies would also be put in place to respond to supply emergencies along with rapid development programs to establish new sources of supply.

Finally, but given the historical record, most probably only very rarely, wage and price controls would be used as a last resort along with bond sales to prevent inflation. We know this will work based on our World War II experience, but also based on our experience during the Nixon and Carter Administrations, we also know that half measures with respect to wage and price controls won’t work.

We have to go to a full bore program like the one we had in World War II to achieve success. Fortunately we will probably have to do something like this only once in a generation and perhaps never,

So, to summarize, there is no sudden stimulus; just spending precisely targeted at full employment and calibrated for price stability, as well as a variety of other public purpose goals. There is also continuous monitoring to see if things are going off-track. If they are, then we’d have early warning and be in a strong position to create new supply initiatives, while using wage and price controls and large-scale bond sales and marketing programs as last resorts to head off inflation until the new sources of supply were available.

No economic approach can guarantee that inflation will not occur, but MMT-based fiscal policy is based on deep consideration of the sources of inflation in modern economies, and a deep desire to have both full employment and very stable prices. The canard that MMT economists don’t care about inflation is just that. See, for example: here, here, here, here, here, and here.

 

End of Part II