Tuesday, 17 December 2019

N.G.Mankiw’s criticisms of Modern Monetary Theory.

Mankiw, who is a Harvard Economist, recently published a work criticising MMT entitled “A Skeptic’s Guide to Modern Monetary Theory”.

His first criticism is that MMT advocates are not too clear on exactly what it is they are trying to say. While I have supported MMT for several years, I think that’s a fair enough criticism. As he says, advocates of a new idea often come in the form of a group of academics, while MMT advocates are a much more diverse lot (of which I am perhaps typical). That diversity almost inevitably leads to a less clear message than where just one or two academics advocate an idea. Mankiw is generous enough to say that that diversity is not necessarily a flaw.

Mankiw’s first main error comes in the last para of his second page, where he claims there’s a problem with the MMT claim that governments and central banks can  simply create and spend money (and/or cut taxes) up to the point where inflation becomes excessive. The alleged problem is that that new money ends up as bank reserves and that central banks have to pay interest on money. 

Well the obvious flaw in there is that interest on reserves is not inevitable: in fact it’s a very recent development for central banks. Moreover, many MMTers specifically advocate a permanent zero rate of interest policy. (That’s a permanent, or at least more or less permanent zero rate on government and central bank liabilities, which includes reserves. In contrast, the rate of interest on mortgages, pay day loans etc will of course always be well above zero.)

Mankiw’s second criticism.

His second criticism (top of his p.3) is that the latter increase in reserves will increase bank lending, which in turn will further exacerbate inflation.

Well Mankiw apparently hasn’t noticed that quantitative easing resulted in an astronomic and unprecedented increase in reserves, but the effect on bank lending was decidedly muted. And that is not entirely surprising: as J.K.Galbraith famously put it, “Firms invest when they can make money, not when interest rates are low.” I.e. it’s customers coming thru the door that induces firms to borrow and invest.

Of course QE is not exactly the same as cutting interest rates, but it’s near enough the same. Central banks cut interest rates by creating money and buying up government debt. QE is simply a continuation of that “buy up” process when interest rates are near zero and the “buy up” may not actually influence interest rates. 

And another flaw in Mankiw’s above second criticism is that if there is indeed a feed-back mechanism of the type he proposes (i.e. more reserves means more lending, which raises demand), then the solution is simply to go for less of a “reserve increase” (i.e. a smaller deficit) than would otherwise be the case!

Feed-back mechanisms are all over the place in our daily lives. E.g. getting drunk may cause you to behave in an even more irresponsible way and drink even more. Solution: don’t drink so much that the latter feed-back mechanism kicks in!! 

The third criticism.

Mankiw’s third criticism (also at the top of his p.3) is: “Third, the increase in inflation reduces the real quantity of money demanded. This fall in real money balances, in turn, reduces the real resources that the government can claim via money creation.”

Well the simple answer to that is that if there is excess inflation, there is no need for government to “claim more resources via money creation” (i.e. raise public spending)! Indeed there is no need for it to “claim more resources” in any other way!


I don’t think MMTers need to seriously re-consider their ideas in the light of Mankiw’s criticisms.

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