Monday, September 28, 2020

The Deficit Myth

As a society, we spend a lot of time worrying about debt. Consumer debt, household debt, municipal debt, state/provincial debt, federal debt etc. But one of these types of debt is not like the other: the federal government creates currency out of thin air, therefore its debts don't matter. So says Stephanie Kelton in her book, The Deficit Myth.

It goes against conventional wisdom, but I think the theory is sound: the federal government cannot go broke as a result of some sort of debt crisis because with a series of key strokes it can wipe out its debt by creating more dollars. Note that this would not apply to countries with debts denominated in foreign currencies (like Eurozone countries). The constraint for a country that recognizes this insight is simply inflation: it has to be responsible enough to avoid making its currency worthless.

To that end I found the book short on framework on how exactly we can shift from the current regime (Fed sets monetary policy, elected government sets fiscal policy) to one that lets the government freely spend its way to inflation. The pressures on elected officials to keep spending even when inflation is high could send us into a spiral. In the last chapter, there is discussion of automatic stabilizers (i.e. most spending could be on autopilot, like employment insurance is today, naturally increasing during a recession when federal spending is advisable and decreasing during boom times when checking inflation is the more important goal), but what if the automatic stabilizers themselves push us into inflation?

Kelton's own suggestions of stabilizers are so heavy on spending (e.g. a federal jobs guarantee at $15/hour) that they increase the chances of such an event. How are elected officials expected to take away a benefit like that, even during times of inflation? Not to mention the incentives of such a program (why even show up to work or do a half-decent job if the job is guaranteed?), the fraud that would result, and the destruction of private sector work that would otherwise benefit both consumers and producers (e.g. how can a grocery store employ baggers for the elderly/disabled when competing with wages like that?).

Which brings me to my second criticism of the book: it's like two books in one. One is about MMT and the other is a left-wing call to action to fund Kelton's pet spending programs (like the jobs guarantee cited above). The new spending available from the MMT insight would just as easily fund lower taxes or more wars or whatever your own favourite pet projects are. How to spend that money to create a better society is a separate question from MMT's main principles.

Clearly, there are some issues with how things are currently done. Keeping interest rates low for a decade has distorted a lot of industries (e.g. real-estate) and has been unable to push up inflation, resulting in an economy with extended periods of slack (as seen by slow employment recoveries alongside benign inflation) despite central banks keeping the pedal to the metal in terms of rates. Recognizing the insights of MMT, but without the boondoggle of more beaurocratic messes like make-work programs, I'm partial to some sort of "individual dividend", where the government hands out cash to the population on an equal basis once interest rates hit a certain floor. Such a direct payment from the government to the people needn't be regressive, as it could be taxable at the individual's marginal rate. You could just keep paying people until inflation hits your target, rather than meddle around with quantitative easing and other mechanisms that don't necessarily see money flow down the income ladder.

While I wouldn't necessarily recommend this book, I think MMT is an important concept to learn, and it's influence and importance may only grow with time, so read it up on it!


k2 said...

Really balanced commentary about an incendiary topic (at least in austrian econ circles). Thanks for that.

Anonymous said...

Barel, I think that it is fair to say that nobody understands how inflationary mechanisms exactly work. Nice summary of the book though.