Saturday, 26 January 2019

Scott Sumner’s flawed criticisms of Modern Monetary Theory.

Scott Sumner is a former economics prof at Bentley University. He penned an article entitled “Tax-and-spend progressives put faith in flawed policy theory” published by The Hill yesterday, which criticises MMT.

His first criticism is this:

“The basic problem is that MMT proponents mix up the roles of fiscal and monetary policy. They argue that monetary policy should play a supporting role, holding down interest rates to reduce the cost of public borrowing.”

Well the first problem there is that several other organisations and economists are also guilty of the latter “mix up”. For example the UK Labour Party’s new fiscal rule basically claims that if interest rates are significantly above zero, then interest rate cuts should be used to provide stimulus, whereas if interest rates are near zero, the fiscal stimulus should kick in. So in that scenario, interest rates will often bump along a small amount above zero. I.e. it’s not just MMT which is guilty of “holding down interest rates”: the Labour Party is guilty as well.

Incidentally the latter Labour Party rule was composed by Simon Wren-Lewis, former Oxford economics prof.

Another economist guilty of “mixing up” was Milton Friedman. In his 1948 American Economic Review paper he advocated a system where government did nothing to artificially raise interest rates (he advocated zero government borrowing). Plus Friedman advocated (much as MMTers do) so called “overt money creation”: i.e. a system where government and central bank simply create base money and spend it into the economy as needed. That system which would mean commercial banks would never particularly short of reserves and thus would not be induced to raise interest rates. Ben Bernanke also gave an approving nod in the direction of the latter “print and spend” policy: see para starting “A possible arrangement…” here.


Only monetary policy influences inflation?

Next, Sumner makes the bizarre claim that a cut in fiscal stimulus will not reduce inflation because it’s only monetary policy which influences inflation. To be exact, he says:

“Unfortunately, there is a long history suggesting that this approach will not work. In 1968, President Johnson raised taxes and balanced the budget, in the hope and expectation that this would hold down inflation. Instead, inflation got even worse, as monetary policy was still highly expansionary. It is monetary policy that determines the price level, not fiscal policy.”

The answer to that point by Sumner is that it is widely accepted by economists that BOTH fiscal and monetary policy can be stimulatory or “anti-stimulatory”. It is also widely accepted that the likelihood of getting cancer is related to age, diet and genetic factors. The fact that there is one instance of someone getting cancer while young, does not disprove the claim that age and cancer are related.

Why, you might ask, is it necessary to give lessons in basic logic to economics professors?

Sumner’s next mistake comes where he says “If MMT proponents are right that fiscal policy determines inflation….”. Well MMTers do not say or imply that fiscal policy alone DOES determine inflation.

As explained above, MMT supports what is sometimes called “overt money creation”: that is, and to repeat, where stimulus is needed, government and central bank simply create new base money and spending it. Since that, pretty obviously, increases the private sector’s stock of base money, there is clearly a monetary effect there.

Monetary policy is “powerful”?

Next, Sumner claims “at the zero bound for interest rates, monetary policy is still more powerful than fiscal policy. A dramatic $500 billion reduction in the budget deficit did not lead to the growth slowdown…”.

Unfortunately Sumner doesn’t say how he is measuring “power”. But if he’s referring to “number of increased jobs created per dollar of monetary or fiscal stimulus”, the fact that there was about $3.5trillion worth of QE between 2008 and 2014 (that’s seven times the above $500 billion) rather casts doubt on his claim that monetary policy is particularly “powerful”.

But in any case, “power” or what is sometimes called “bang per buck” is irrelevant, and for the simple reason that stimulus dollars cost nothing to create. As Milton Friedman put it, "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances." (That’s from Ch3 of Friedman’s book “A Program for Monetary Stability”.

I.e. government is not like a household which quite rightly looks at the benefit per dollar spent on any consumer item.

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