Conventional economic policies are shambolic compared to Modern Monetary Theory.

The recent recession, like most recessions, was sparked off by excessive and irresponsible borrowing. So how have the authorities responded? By cutting interest rates to record lows – with a view to bringing stimulus via . . . . wait for it . . . . more borrowing!

You couldn’t make it up.

The above absurdity is a bit like the emperor with no clothes. The folk looking at the emperor with no clothes got so used to the sight that they ceased seeing anything absurd. Likewise, most of us are so used to mantra about interest rate reductions being a good way of dealing with recessions that we fail to see the absurdity.

Modern Monetary Theory (MMT) doesn’t make the above interest rate mistake because it advocates bringing stimulus via more government net spending (i.e. more public spending and/or less tax). That is, in a recession, the government / central bank machine just creates new money and spends it: neither taxes nor borrowing are raised so as to fund the extra spending. And conversely, when inflation looms, the government / central bank machine does the opposite: that is, it reins in money via extra tax, and “unprints” or extinguishes money.

But the above “more borrowing so as to solve the problems brought by excessive borrowing” is not the only crackpot element to the conventional wisdom. There is another, and possibly even more hilarious bit of nonsense: Keynsian “borrow and spend”.

The idea here is that government borrows and then spends the money borrowed. This allegedly brings stimulus. The big problem here is that taking money away from the private sector (borrowing) and then channelling it back to the private sector in the form of more spending quite possibly has no net effect.

But even if it does have a net effect, there is still a nonsense involved, as follows. The government of a sovereign currency issuing country (e.g. the U.S., Japan, etc) can print any amount of money any time. Now what’s the point of borrowing something (i.e. money), when you can produce it yourself for free? Even worse, what’s the point of borrowing money from OTHER COUNTRIES and paying them interest for the privilege of having something you could have produced yourself for free? Darned if I know.

MMT doesn’t make the latter mistake either.

And the third absurdity is quantitative easing (QE). That involves giving the rich cash in exchange for their securities. Now what’s the reaction of the rich going to be? No prizes for guessing the answer.

What they WON’T do is what we want them to do: raise their weekly spending, which would raise demand and create jobs. The spending habits of the rich are not much influenced by changes in the value of their income or assets.

What they WILL do is purchase other assets with their newly acquired pile of cash. That is, they’ll try to buy other securities – hence the stock market appreciation. Or they’ll seek investment opportunities abroad, which messes up other countries: exactly what has happened.

Apart from dropping nukes on cities so as to provide re-construction work, I can’t think of a more hopeless collection of anti-recessionary policies than the above.

Afterthought - 28th April 2011: Apart from the theoretical flaws mentioned above is using interest rates to control demand, the evidence seems to be that adjusting short term interest rates does not actually have a dramatic effect anyway.

Afterthought (4th May 2011): I said above that the borrowing involved in fiscal policy might negate the stimulatory effect of the relevant spending (commonly called “crowding out”). The conventional view is that the “negation” is less than 100%, i.e. that fiscal policy still has some effect. However, Tim Congdon in the Financial Times argues that the crowding out effect is more than 100%. I.e. that the effect of fiscal policy is the opposite of the intended effect! So the farce is possibly even bigger than I thought.

Afterthought (5th May 2001): The first paragraph above highlighted the self-contradiction involved in encouraging more indebtedness so as to escape a recession sparked off by excessive indebtedness. This contradiction was alluded to very eloquently by Mervyn King, governor of the Bank of England, a couple of days ago, when he said “the sheer volume of debt in the economy, is still very large and this poses massive macro- economic challenges,”


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