Special thanks to Patricia Pino and Christian Reilly
On March 31st, 2021, Pete Davis and Sparky Abraham invited journalist Doug Henwood on Episode 9 of the “Is MMT Real?” series of the Current Affairs Podcast. This is my attempt at responding to his criticisms of MMT and answering questions he and readers might have, beginning with the fundamental premise of MMT and what this means for ZIRP, MMT’s positions on material resources and redistribution next, continuing with inflation, and ending with a discussion of The Footnote.
What MMT is
Henwood starts the interview by stating that despite reading MMT literature and listening to talks, he still doesn’t know what MMT is. He is correct. As Bill Mitchell has stated, the “fundamental principle” of MMT is that “a government can always use its currency-issuing capacity to ensure that all available productive resources that are for sale in that currency, including all idle labour, can be productively engaged.” This means that no purely financial ratio or expression, be it debt-to-GDP or deficit-to-GDP or interest-to-GDP, has any bearing on a country’s fiscal space if that country maintains a floating exchange rate and a permanent zero-interest policy and does not borrow in foreign-denominated debt. Henwood explained that he believes there is a purely financial limit to deficit spending, although he failed to specify what it is.
I agree that obsessing over the deficit is ridiculous. I would not agree that the US Government can go on deficit spending on this kind of scale forever. We don’t know exactly how it’s gonna break, but something will break if we keep running deficits of 10% of GDP forever. (41:30)
The MMT position is that this number, 10% of GDP, is completely irrelevant. Henwood appears to believe that creating a budget requires balancing both the financial resources and the real resources. The MMT position is that only the real resources need to be considered. Henwood correctly points out that figuring out how to pay for the Green New Deal or Medicare for All would require creating input-output tables to determine what the strain on resources would be and where productive capacity would need to be increased. The MMT contribution is that those input-output tables are the only thing the government would need to refer to – there is no need to refer to or even draft projections about the future of the government debt. The debt is just a promise to pay dollars; the government, through its central bank, can issue as many dollars as it wants to whomever it wants whenever it wants.
Henwood thinks that in “normal times,” the government should reduce its deficit. He claims that MMT is “unclear” about what should happen in normal times. Henwood already knows the answer to this, which is that the MMT position is the same as Abba Lerner’s Functional Finance (as Henwood wrote in his Jacobin article), meaning that deficit spending may be appropriate even when the economy is doing well. What matters is whether demand is outstripping the country’s productive capacity. A country whose private sector runs a large external surplus, like Norway, may need to run a government surplus to avoid too much spending power accumulating in the economy. For a country running an external deficit, like the United States, there may not be a need to ever run a surplus, even when the economy is doing well.
The question which follows – that Henwood implicitly asks – is “How is MMT different than Functional Finance?” The answer is very simple and is stated explicitly in most of the MMT literature, including in Mosler’s 7DIF book. MMT recommends the interest rates on Treasuries and the Fed Funds Rate be set at zero, permanently (ZIRP, or zero interest rate policy). Henwood disagrees with this policy, and his remarks on interest rates are reproduced below.
Interest rates are not going to stay low forever.” (48:16) “We’re spending several percentage points of GDP on interest. First of all, that’s an upward redistribution of income because rich people own treasury bonds.” (48:25) “Also, the United States never has had any problems selling its bonds to foreign investors. That may change, you know? Who knows?” (48:58) “I don’t see how we can keep the interest rates at zero forever. Nobody would buy your bonds, so you’d have to print the money to pay them off, and that would be massively inflationary…insanely inflationary…The financial markets would riot and everything would fall to pieces.” (49:45) “If you set the treasury bond rate to zero, Investors will say ‘where else can I make more money?’ And then they’ll get involved in all this speculative nonsense and finance all kinds of bubbles” (50:55) “I’m not sure that [setting the interest rate to zero] could even be technically possible unless the fed bought up all the debt, in which case you would really get to a seriously inflationary situation. (51:18)
Henwood correctly points out that interest payments on bonds are a source of income inequality. MMTers want to eliminate this income stream. We have said this in the past, but Henwood apparently doesn’t think we were being serious, since he wonders if such a thing could “even be technically possible” despite describing how it could happen in the same breath. The MMT position is that the government should keep interest rates at zero, either through ceasing the issuance of new bonds, having the central bank commit to buy bonds from the private sector or buying them directly from the Treasury, which he believes would be “insanely inflationary.” However, there is simply no evidence that low interest rates are inflationary. The experience of the United States in the last decade and the experience of Japan over the last several decades have taught us this. Jeff Faux wrote in 1995 that there was no “empirical evidence to support [the Federal Reserve’s] series of preemptive strikes against phantom inflation.” Twenty-six years later, there are three empirical studies on interest rates inflation, which were performed not only in the US and Europe, but also in Malaysia in forty developing countries in the Islamic world. All four studies fail to find that low interest rates cause inflation, and three find that high interest rates cause inflation. There are studies which purport to demonstrate how high interest rates can reduce inflation, but virtually all are fundamentally flawed because they do not control for the government’s fiscal position.
Henwood’s other argument regarding interest rates is that keeping interest rates low would cause asset price inflation. The claim is that if we paid at least enough interest on Treasuries to cover inflation, then investors would be satisfied, and they wouldn’t speculate. I find this unconvincing for four reasons. First (and most obviously), the lack of central bank bond-purchases before the Great Recession did not prevent speculation on dangerous assets.
Second, if investors could be satisfied with safe assets, they would simply buy safe assets that already exist. For example, they could buy municipal bonds, which have an average yield of about 3% (which is higher than average CPI inflation over the last several decades) and sometimes even 5%. These bonds are virtually risk-free; fewer than 1% ever default, and the default rate is 0% for AAA rated bonds. Investors already have access to the ultra-safe assets they claim to want from the Treasury, and they still speculate.
Third, the actors and the relationships between them is improperly framed by Henwood’s argument. Instead of “investors who are starved for profits have no choice but to make investments they know are risky,” the correct framing is “financial advisors who are shielded from financial loss have an incentive to mislead their clients about the risks of investments.” The employees of investment banks made huge money in commissions and sales of risky assets leading up to the 2008 recession. Their companies were bailed out by the government, and none of them went to jail for fraud. They are the ones guiding the decision-making, and there is no risk to them, other than the risk that they might be scolded in a Congressional hearing. Also, we need to consider the rates of return that speculative investors are actually hoping to get. According to American Banker's Asset Securitization Report, the average rate of return on investment-grade (safe, allegedly) CDOs in 2001 was 16.5%, ranging from 14.1% to 18.6%. So, from the perspective of the investment bankers, they had a zero-risk investment that paid up to 18.6%, so they invested with wild abandon. So, from the perspective of the investment bankers, they had a zero-risk invested that pays 20%, so they invested with wild abandon. The existence of a 10% or even 15% Treasury wouldn’t deter this behavior.
Fourth, you might then ask, “What if Treasuries had paid more than the CDOs? What if they had paid 25%? Would that deter speculation?” Maybe, but this would mean deterring profit-seeking behavior by offering them an even more profitable deal. Henwood seems to imply that this would be his preferred approach, but it is bizarre for a self-proclaimed socialist to insist on giving free money to the rich. More importantly, a 25% yield on Treasuries would result in commercial interest rates that would be incredibly harmful, either by causing inequality and inflation through the interest income channel or by causing unemployment and recession through the substitution channel, possibly both at once. Furthermore, investment bankers would still have an incentive to lie in that scenario. If Treasuries pay 25%, there would be no need for investment advice because the only guidance would be “buy Treasuries because they are the best asset, with zero risk and high yield.” No one would pay for that recommendation. That means that the only way investment bankers would make money off commissions and advisory fees would be if they promised returns that were even higher than 25%. They would invent a new financial asset with a potential 30% yield and lie to their clients about how safe it is, and the same speculative behavior would happen. This is why MMT’s solution to asset bubbles is not to raise interest rates but to use regulations to make certain types of speculative behavior illegal. Unfortunately, such so speculation continues today because Congress failed to take the necessary steps to effectively prevent speculation after the Financial Crisis, not because of ZIRP.
The impact of being able to maintain ZIRP without runaway inflation needs emphasizing. Critics of MMT constantly try to minimize the differences between MMT and mainstream economics. In Henwood’s words, “Are they saying we can deficit spend? Who doesn’t think we can deficit spend?”. The difference is that MMTers actually believe that the government can deficit spend as long as it has the real resources. Mainstream (and even other Post-Keynesian) economists only pretend to believe this. What they actually believe is that the government can deficit spend as long as private investors are satisfied with the yield on treasury bonds. MMTers believe that if private investors do not want to buy treasury bonds, the central bank should buy as many of them as the treasury needs to fulfill its objectives, a policy called Overt Monetary Financing or OMF.
Henwood thinks OMF would be inflationary. He doesn’t state why, but the typical reasons given are (1) Milton Friedman’s argument inflation is always a monetary phenomenon and (2) that it would place downward pressure on the exchange rate. This is more fearmongering. Friedman’s monetarist theory of inflation relies on a number of unrealistic assumptions, and the exchange rate theory of inflation has been proven to have minimal explanatory power. In 1989, the Federal Reserve of St. Louis’s research officer, R. W. Hafer, performed a thorough review of the literature and concluded that the view “that a falling foreign exchange value of the dollar means higher U.S. inflation” was “off the mark.” Most of the studies he reviewed found that a 10% dollar depreciation only led to around a 1% increase in inflation, but the studies he reviewed that attempted to separate dollar depreciation from oil price shocks found that a 10% dollar depreciation led to an increase in inflation of 0.02% or had “no appreciable effect.” The reason pass-through inflation is so weak is because importers have to compete on prices with domestic producers and other importers for market share. Because the US market is so large and robust, importers cannot freely raise prices to match exchange rate fluctuations.
The Material Economy and Redistribution
In another section of the podcast, Henwood claims that MMT has nothing to say about the material economy.
There’s nothing about production, about wages, about incomes, about consumption, investment, all the standard things of macroeconomics. They have almost nothing to say about that; it’s all the government spending into the economy. (16:10)
This simply not true. MMTers like Fadhel Kaboub have written extensively on the need for a country to develop the productive capacity to produce food, energy, and high-value-added manufactured goods in its own borders. If it cannot produce these in its own borders, then the country will rely on imports, which increases the need for spending in currencies other than the national currency. MMT does not pretend that this is easy for developing nations, but we do believe it is absolutely necessary and more important than balancing the budget to develop fiscal capacity. By contrast, consider the IMF’s official policy on building fiscal capacity. It is entirely dedicated to financial sustainability. The word “food” does not appear. The word “energy” appears only in a section recommending reducing subsidies. The word “manufacturing” appears only in a section describing a tax on manufacturing. Readers should examine these two articles and determine for themselves which school of thought is more concerned with the material economy.
Henwood believes that MMT undermines the efforts of socialists to redistribute resources from the rich to the public. In his own words,
I’m a socialist. I want to expropriate the private control of investment. I want to expropriate the owing class, the ruling class. I want to democratize things in some serious sense. I think that MMT, or as people say, the ‘Magic Money Tree’ is – at best – a diversion from that and – at worst – actively harmful. It’s discouraging people from thinking about the actual political conflict that’s going to come around distributional issues…We can’t even approach a kind of welfare state like the Nordic model without facing down those distributional issues. (55:30)
He believes that increasing taxation on the rich is the most important thing we need to do to be able to achieve a Green New Deal. MMTers fully support taxing the rich, but there is no need to delay pursuing the Green New Deal until we pass tax increases on them. From a perspective of fiscal space, their spending and consumption matters more than their income and wealth. An MMT critic once said that every mansion the rich don’t build represents materials for ten regular houses. Let’s assume that’s true. There are 660 billionaires in the United States, with a net worth of $4.1 trillion. Let’s say we take every last dollar and they each have ten houses (like Mark Zuckerberg) which they demolish and sell. We just raised $4.1 trillion in revenue and freed up enough raw materials for 66,000 houses. We destroyed the billionaire class, but we only got enough material resources to build a small town. Rather than diverting from the political conflict, MMT focuses the conflict on the issues that matter. Henwood’s view, which makes taxing the rich a prerequisite to investing for the non-rich, gives the rich more power, not less, because it insists that we must rely on rich people’s money.
This is why MMT focuses on real resources. As Scott Fullwiler, Rohan Grey, and Nathan Tankus wrote in their article “An MMT Response on what Causes Inflation” “excess demand is rarely the cause of inflation” and “not all inflation that does result from excessive demand can and should be addressed by higher taxes.” The best way to reduce inflation might be changing business or financial regulations or spending more to increase productive capacity. The MMT position is that each incident of inflation needs to be treated by addressing its specific needs. For example, if inflation is occurring due to a shortage of electricity, the treatment is to build a power plant, not to increase taxes and hope that consumers will decide not to use as much power. More importantly, we do not need to delay addressing inflation until after it has arisen. The inflation prevention tools should be enacted at the same time in the same bill as the spending. Every bill should evoke the question “What inflation-prevention measures have you built into it?” instead of “How are you going to pay for it?” If Congress drafts a bill to enact a program which will increase the demand for electricity, it needs to include funding to build a new power plant before the bill even leaves committee.
The final comment about inflation that I will respond to is that MMTers are “really not clear about how much inflation is too much?” (25:56) This seems like a good question, but it itself needs clarification. What does Henwood mean by “too much?” Is he asking how high can inflation be while still having optimal growth? Is he asking what amount of inflation guarantees a spiral into hyperinflation? Is he asking what is the maximum amount of inflation that can be addressed by nonfiscal pay-fors? Is he asking how much inflation can occur before the dollar loses its reserve currency status? It probably doesn’t matter what answer we give to any of these questions. Henwood’s response will either be “that’s no different from mainstream” or “that’s too high,” both of which he will use as grounds to dismiss MMT. The question should not be answered until Henwood can define his terms in a good faith conversation.
At long last, we turn to the issue of The Footnote. For readers whose time is too valuable to spend following Twitter debates, I’ll explain the issue. MMTers have written extensively about endogenous money, including Randy Wray’s 1990 book Money and Credit in Capitalist Economies: The Endogenous Money Approach. The issue that J.W. Mason and Doug Henwood have is that Stephanie Kelton’s book, The Deficit Myth, only mentions the distinction between currency and bank-created credit money in a footnote (The Footnote). Host Pete Davis asked “Why is that such a high stakes question. Why does it matter?” (18:40). Here is the most relevant part of Henwood’s response:
Well, currency is just one form of money, and a very small portion of it…Most of the action in money happens through bank accounts, so the banking system is really at the core of money. I don’t get what the point of it is beyond that – the different types of money, and they have very little to say about the banking system because it’s largely out of the purview of their government model, where the government is the driver of everything. (21:46) (emphasis added)
First, we should all acknowledge that Henwood didn’t really answer the question. He wasn’t being evasive, but I don’t think he understood what Davis wanted to know, which was “What predictions will MMT get wrong specifically because they don’t place bank-created credit money at the core of their theory?” This is why it would matter, but this is not the question Henwood answered. The question Henwood answered was “What is another perspective on endogenous money that you find compelling, of which people interested in gaining a more academic, well-rounded understanding of economics should be aware?”
The reason MMTers put government currency at the center of the money story is because currency, not bank money, is a net financial asset of the private sector, and because bank money is merely a claim with respect to currency. That being said, to properly analyze this passage, we need to go over some accounting and define what we mean by “money” and “currency”. According to the definitions used by the Bank of England, money is a widely trusted IOU, but currency is specifically an IOU of the government. Governments satisfy these liabilities by forgiving tax debts and providing certain goods and services at prices set by statute or regulation. When MMTers refer to currency, we are talking about all money created by the government, which includes central bank notes, coins, and reserve balances (together, the Bank of England calls these three “base money”).
Bank deposits are simply IOUs that represent a claim on the use of the bank’s base money. If you have $10 in the bank, it means that you have the right to ask the bank for $10 in physical cash or the right to request the bank to make a payment to another bank or to the government using its reserves. Because commercial banks have access to so much liquidity and have institutional advantages such as FDIC insurance and the ability to borrow from the central bank, commercial banks are usually able to satisfy these obligations. Because banks usually satisfy these obligations, bank deposits circulate in the economy as substitutes for currency. For most purposes, a bank statement that says you have a $10 deposit is just as good as a $10 bill because you can use the bank deposit to make payments just as easily as with the $10 bill.
When we say that banks can create as much money as they want, we mean that they can issue as many claims on the use of their base money as they want. Because people only spend or withdraw a fraction of their bank accounts daily, banks can issue more claims on their base money than the bank has at any given time while still being able to satisfy their obligations to their customers. When a bank wants to pay someone, they can just increase the number in that person’s deposit account. Because banks don’t need to match the value of their customers’ deposits with the value of the bank’s reserves and because people will accept deposits as compensation, the private sector is not constrained by the total amount of base money with respect to transactions that only involve private sector actors.
However, the private sector is base-money constrained with respect to transactions with the government. When a person in the United States makes a payment to any government agency, the individual’s bank transfers reserves into the Treasury General Account or some other account in the Federal Reserve System. Government agencies do not accept bank deposits as final compensation; the Post Office does not have a checking account at Wells Fargo. The Treasury does have Tax and Loan accounts which it uses to aggregate tax payments before transferring them into the Treasury General Account, but this does not change the fact that the private sector is reserve constrained with respect to transactions with the government because almost all of the money in these accounts is quickly and frequently transferred to the Treasury General Account in the form of reserve balances. Unlike checking accounts held by individuals, which only transfer a small portion of their value in any given month, 80% of the money in Tax and Loan accounts is transferred to the Treasury within two days of it being deposited, and the rest is transferred in periodic calls. Equally importantly, commercial banks are required to post collateral equal to the value of their Tax and Loan accounts, so commercial banks are not free to simply mark up their Tax and Loan accounts with whatever number they wish. Actors in the economy need base money to satisfy their liabilities to the government.
To further illustrate, imagine what would happen if the government decided that you owed it one quadrillion dollars in tax. If base money created by the government was truly immaterial, then your bank could simply issue a deposit to the Treasury with a nominal value of one quadrillion dollars and hope that the Treasury never tried to pay anyone with the money in its deposit account at your bank. In the real world, your bank would never do this. Within two days, the Treasury would attempt to transfer one quadrillion dollars in reserves into the Treasury General Account. Either the transfer would simply fail, or your bank would have an overdraft at the Federal Reserve which it would never be able to clear. In either case, your bank would be insolvent and would be shut down by regulators.
Returning to Henwood’s words, he calls currency “just” one type of money, and he doesn’t “get what the point” of distinguishing between “the different types of money.” The point of distinguishing between different types of money is that bank money is just a derivative of currency. It plays an important role in the economy, but banks are financially and legally reliant on the government to operate. One of the main claims made by MMT is that the government is the sole issuer of the things that it requires in exchange for tax relief and provision of certain services. The government only accepts base money, not bank money, and only the government can create base money. The fact that commercial banks can issue claims on the use of base money does nothing to change this. That is why Kelton’s book, which was aimed at a non-academic audience, didn’t call special attention to this point and placed it in The Footnote.
Hopefully, this discussion has shed some light on what MMT is and is not and how it compares to mainstream economics. Throughout this response, I tried to reference, cite, or link to as many freely available texts as I could find which helped explain and justify the MMT position. I encourage you to read them all, but I also encourage you to do your own research.