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Two Cheers for Modern Monetary Theory

Macroeconomics is both a study in exploration and of action of the economy as a whole. It is exploratory, insofar as different explanations are provided for macroeconomic effects, such as economic growth, unemployment, inflation, money supply, changes in investment and consumption, and the economic behaviour between different economies. With this information, macroeconomists can make recommendations to government concerning how to best use the economic tools to utilise to ensure growth with stability, and issue predictions on what effects alternative policies will generate. Whilst the following provides a critical summary of mainstream macroeconomic thought, it is also motivated towards those policies which promote sustainable growth, provide full employment, and control inflation. In doing so it reviews short and long-run macroeconomics, especially accounting for technology, the effects of an open economy, investment and consumption, and the use of monetary and fiscal policies.

Modern Monetary Theory (MMT) is an unorthodox macroeconomic theory. The fact that it is a macroeconomic theory at all is beneficial, as there is still far too much attention paid to treating an economy as a large-scale version of microeconomic endeavours. Of course, there is an intuition in thinking of economics this way because it individual perception operates at this scale. It is, however, quite incorrect. Even taking mainstream macroeconomic theory into consideration, however, MMT raises a couple of interesting challenges.

Firstly, it rejects the conventional doctrine of a "natural rate" of unemployment. The natural rate of unemployment is the rate of unemployment arising from all sources except cyclical fluctuations in aggregate demand, such as structural unemployment (mismatch between skills, technological redundancies) and frictional unemployment (between jobs). Attempts to boost aggregate demand in a situation to reduce the natural rate of unemployment has been reached will lead to wage and inflation increases far in excess of any employment gains. The natural rate of unemployment is equally complemented by the rate of full employment. To MMT advocates, however, the only time that this inflationary pressure will occur is when the economy is operating below capacity. Thus MMT advocates also encourage socially-useful job guarantee projects, such as Bernie Sanders' "Green New Deal"; it is notable that one of Sanders' advisors was Stephanie Kelton, an economist who advocates MMT.

Secondly, MMT advocates have a very different view about budget deficits and money supply. Part of what they is in absolute agreement with conventional macroeconomics; when public expenditure can be a social investment that produces greater returns as welfare. The idea that public expenditure should be used to enhance positive externalities (e.g., positive health, education, infrastructure) and mitigate against negative externalities (e.g., pollution, natural disasters, genuine defense) is obvious enough. Where MMT really departs from mainstream economics is the claim that instead of public budgets needing to raise money through taxation or the sale of bonds etc to fund public works, it's the other way around. Produced by fiat but as a legal tender currency-issuing nationals government (not regional or local), have to spend money before it can draw taxation. Public spending (good, bad, indifferent, whether by reserve banks or fiscal policy) actually precedes taxation. Government taxes are instead used to keep inflation under control, and as a premium cost for goods with negative externalities (Pigouvian taxes). A proposed implication of this is that governments can issue their own fiat currency to whatever level and can never go bankrupt. Alan Greenspan, then chair of the US Federal Reserve, main the following observation at the Catholic University of Leuven, Belgium, in 1997:

Let me begin with the fundamental observation, that a nation's sovereign credit rating lies at the base of its current fiscal, monetary, and, indirectly, regulatory policy. When there is confidence in the integrity of government, monetary authorities--the central bank and the finance ministry--can issue unlimited claims denominated in their own currencies and can guarantee or stand ready to guarantee the obligations of private issuers as they see fit. This power has profound implications for both good and ill for our economies.

Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit. They can discount loans and other assets of banks or other private depository institutions, thereby converting potentially illiquid private assets into riskless claims on the government in the form of deposits at the central bank.

That all of these claims on government are readily accepted reflects the fact that a government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit.

Quite clearly this is at odds with a whole school of monetarist and mainstream neoclassical thinking on the nature of budget deficits or increasing the money supply, even if Greenspan himself certainly fell into the category of conventional thinking in the most part. Certainly, there is a long-run association between inflation and money supply. Equally, because money is representative capital whose value must equate to the value real capital (i.e., physical goods), some inflation is absolutely necessary as real goods depreciate. Without inflation, representative capital becomes more valuable than real capital, converting the acquisition of money as the ultimate economic activity, rather than the production of goods. Whether or not this is a contemporary problem is an exercise for the reader's observations. However, the mere printing of money, clearing-effects withstanding, does not improve productivity. A government could pay everyone a million dollars, making everyone millionaires, but very soon afterwards prices would match.

It is at this point that MMT sails into some troubling waters, however. There are obvious challenges to an expenditure-based fiscal policy to ensure an allocation of resources into socially-useful activities, and likewise through a job guarantee. These are matters of public economics and unfortunately, that is often determined by the vagaries of political power, rather than an optimal-rational approach. Of course, the market often determines according to economic power as well, so really one has to draw upon institutional economics to determine the deviation from reason by power at this point. From the perspective of public economics would elected governments, under public pressure, pull back expenditure (or use taxation) when the economy is operating close to full capacity to avoid excess inflation? Financial markets, especially international financial markets, would certainly react to an implementation of MMT as well; the demand for a national currency will certainly suffer if the government that backs it shows reduced concern for budget deficits and a willingness to increase the money supply.

Thus, at this stage of its theoretical development, one can only offer "two cheers" for MMT, and one set of reservations. Insofar they have put investment-orientated macroeconomic policy and the objective of full employment back into public consideration, the advocates of MMT certainly deserve accolades. Likewise, their interpretation that legal-tender money is a public good that can be expanded and contracted as required is certainly a realistic appraisal of fiat-currency a matter, as the advocates observe, is not fully understood by orthodox economics. Nevertheless, a real challenge is faced with the association of currency value with real value, the ability to allocate resources in an optimal manner, and the reaction of financial markets to such a policy. These are of course a challenge to any macroeconomic policy. But they become increasingly difficult with MMT because it represents such a change from mainstream macroeconomics. Whilst the mainstream does have many (and sometimes quite similar) flaws as MMT, bold conjectures require strong evidence. At this point in time, MMT provides most of the evidence required for some advocacy, but not total advocacy. Nevertheless, watch this space. If it succeeds, it will a major revolution in the science of macroeconomics.

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