MMT: when does government deficit spending improve debt-to-GDP ratios?

Modern Monetary Theory (MMT) (previously) is an alternative to neoclassical economics that holds that sovereign states that issue their own currency can't default on debts denominated in that currency (if you are the sole source of Canadian dollars and all your debts are in Canadian dollars, you can always pay those debts), and that deficit spending is normal (every dollar in circulation was "deficit spent," since the money to pay taxes enters the economy when the government spends it into existence), and that inflation isn't a mere function of government spending — but rather, inflation occurs when governments and the private sector are bidding against each other for the same goods and services.

A more nuanced take on MMT spending is that some government spending improves the ratio of debt to GDP — because the spending increases overall economic growth — and some of it worsens that ratio. Governments can also change that ratio through taxation — raising and lowering taxes changes the purchasing power of the private sector (at the top brackets, taxation can reduce the power of the super-rich to buy lobbyists and make campaign contributions that would allow them to distort national policy to serve their narrow interests).

Writing for the Carnegie Endowment for International Peace, Michael Pettis describes the outcome of his informal Peking University debt seminar on MMT, which evaluated the effects of policies that give to the rich, policies that give to the poor, and policies that increase infrastructure investment. Pettis and his students classify the outcomes of different starting conditions as "MMT Hell" (runaway inflation) or "MMT Heaven" ("conditions under which there are no intrinsic constraints on government spending").

Pettis describes giving money to the rich as being largely noninflationary, since the rich already have everything and they tend to squirrel their money away in investments, and these lead to growth that keeps the national debt-to-GDP ratio constant.

But giving money to the rich only works if there are productive investments for the rich to make. In the absence of these, you get asset bubbles, stock speculation, stock buybacks, and a wealth-transfer from poor people to rich people as speculation starts to impact housing, education, health, etc. This also weakens demand, because eventually no one but rich people has any money to buy stuff with (this all sounds eerily familiar, ten years after the bailout and a year after Trump's #taxscam).

Next, Pettis contemplates transfers to poor people. If there's a lot of economic slack — weak demand, unemployment — then giving money to poor people will spur growth and hold the debt/GDP ratio in check. It's MMT heaven.

But if there are systems that prevent the supply side from meeting the demand side — if starting new businesses is too expensive due to monopolies, tight capital controls, regulation, etc — then the new money injected into the economy starts to chase the same goods, driving up prices, creating inflation and sending you straight to MMT hell.

Then there's infrastructure investment. If infrastructure is weak, undermaintained, or missing, then investment in infrastructure will boost the economy, driving growth and holding debt/GDP constant (MMT heaven — this is basically the story of Chinese growth).

But if the infrastructure investment takes the form of expensive boondoggles — bridges to nowhere, empty Chinese cities built to keep property prices from crashing — then the money injected into the economy will be chasing the same goods as the private sector, but there will be no productivity gains by the private sector from the useless infrastructure investment, so you're mired in debt, inflation and MMT Hell.

It is not clear to me that pure money creation under the positive circumstances listed above comes with comparable problems, so perhaps this means that governments should fund wealth-enhancing income transfers or productive investment mainly by creating money, not by borrowing. This suggests that hard-core MMT proponents are right when they say that governments don't borrow or raise taxes to fund spending. Instead, they simply spend. The purpose of borrowing or raising taxes in those circumstances is to counter the impact that MMT can have in some cases, but not in all.

There are, on the other hand, cases in which governments can simply create money or borrow with no ill effects, that is to say, with no inflationary impact and no increase in the debt burden. As always in economics, the outcome depends on the underlying conditions.

So how do these insights apply to the world today? If they so choose, the U.S. and European governments should be able to create money or debt with no ill effects if the proceeds were used to fund needed infrastructure or to reverse income inequality by increasing the incomes of the poor and middle classes. Either way, productive investment would rise faster than debt or the money supply, as would the total value of goods and service produced.

MMT Heaven and MMT Hell for Chinese Investment and U.S. Fiscal Spending [Michael Pettis/Carnegie Endowment for International Peace]

(via Naked Capitalism)

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