In-depth analysis on Credit Writedowns Pro.

Brad DeLong believes deficits matter in Modern Monetary Theory

By L. Randall Wray

Finally, a prominent “mainstreamer” Keynesian gets MMT. Over the past couple of years, Paul Krugman has got close, but he keeps claiming that MMT believes “deficits don’t matter”. He refuses to cite any MMTer who has ever said such a silly thing. One doubts he’s actually read any serious piece by any proponent of MMT. I suspect he is just reacting to comments made on his blog—likely by anonymous supporters of MMT who might not have got it quite right.

In any case, Brad DeLong has written an excellent piece recognizing that MMTers actually are not crazy hyperinflationists (link is at the bottom of this post). Why does he, alone, get it right where everyone else fails? Well, he took the time to actually read some of the MMT literature. This is something none of our critics are willing to do.

Yes, I know, some critics provide a few citations and occasionally a few quotes. But it is obvious they never bothered to read the things they cite, and the quotes are taken out of context and then misinterpreted. I won’t mention names, but you know who they are.

Back to Brad. Here’s the background to his piece.

There’s been a mighty kerfuffle going on between Jeff Sachs and Paul Krugman on budget deficits and debts. For the life of me, I cannot understand why anyone would listen to Sachs on anything having to do with macroeconomics. He has no credibility at all. Along with the rest of the Harvard Boys he gave disastrous economic advice to Russia that led to the deaths of literally tens of thousands of people, and shortened the lifespans of millions more. Ignore him is always the best advice.

He accuses Krugman of “crude Keynesianism”. Years ago I was called a “vulgar Keynesian” by Henry Aaron, who argued way back in 1989 that America would not be able to afford to take care of tomorrow’s seniors. Yes, he was one of the original deficit hysterians. And, like Sachs, he understands no macroeconomics at all. I wore “vulgar Keynesian” as a badge of honor. If “crude” or “vulgar” means that we believe Uncle Sam can afford to take care of our seniors, then I join Krugman in insisting that Sachs is an ignoramus. Krugman’s responses are mostly right-on; Sachs doesn’t understand anything about sovereign deficits and debts—and it shows.

But Krugman just can’t resist the chance to take a sideways slap at MMT whenever he can: MMTers make the crazy claim that deficits don’t matter. Here’s a 2011 Krugman quote from Brad’s article:

“Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency. I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right….”

Brad begs to disagree. MMTers do not make that claim. And he backs up his argument with facts. What a novel approach—to actually look at what MMT says!

Brad actually quoted from a long-forgotten piece I wrote:

“Deficits Do Matter, But Not the Way You Think | Next New Deal: Our claim is that a sovereign government cannot be forced into involuntary default. We have never claimed that sovereign currencies are free from inflation. We have never claimed that currencies on a floating exchange rate regime are free from exchange rate fluctuations. Indeed, we have always said that if government tries to increase its spending beyond full employment, this can be inflationary… we have admitted that currency depreciation is a possible outcome of using government policy to stimulate the economy….”

I mean, crap, all you have to do is to read the damned title of the piece. Deficits Do Matter. How can Krugman claim that MMT says “Deficits Don’t Matter”. Can he read plain English? At least the titles of the MMT literature?

Might be worthwhile to read the rest of my piece. I am tempted to immodestly call it rather good, but I’ll refrain. In the piece, I go on to deal with the other favorite claim made by critics who are too lazy to actually read: MMT ignores inflation. Brad also quotes this bit:

What if the economy runs up against a full employment constraint, but government stubbornly keeps spending more, driving up prices toward hyperinflation?… [W]e never claimed that a sovereign government will necessarily adopt good economic policy. The last time the US approached such a situation was in the over-full employment economy of WWII. Rather than bidding for resources against the private sector, the government adopted price controls, rationing, and patriotic savings. In that way, it kept inflation low, ran the budget deficit up to 25% of GDP, and stuffed banks and households full of safe sovereign debt…. After the war, private spending power was unleashed, GDP grew relatively quickly, and government debt ratios came down (not because the debt was retired but because the denominator — GDP — grew more quickly than the numerator — debt). In other words, [John Kenneth] Galbraith, senior, used rational policy to avoid the Zimbabwean fate. I do not understand why Krugman prefers to believe that our policymakers would choose hyperinflation over more rational policy….

OK, I know it’s bad manners to quote oneself and I’ll stop now. Does MMT address the issue of inflation? Yes, over and over and over.

Indeed, when Warren Mosler founded the Center for Full Employment and Price Stability in the late 1990s (directed by Mat Forstater and begun at the Levy Institute before moving to UMKC) we made inflation one of our two main concerns; sort of like the dual mandate of the Fed: full employment AND price stability. We’ve never wavered from that. And MMT grew out of that effort.

Oh, and here’s another title that might provide a little hint about our attitude toward inflation. The first book-length treatment of MMT was my 1998 book, Understanding Modern Money: The Key to Full Employment and Price Stability. Gee, I wonder if maybe it addresses inflation? Admittedly, you must read all the way through to the subtitle, which I guess some readers find too demanding—a journey too far for the lazy critic to tread.

(To be clear, by price stability we do not mean zero inflation, or, indeed, any particular inflation target as measured by a favorite index. You do not want accelerating inflation. You definitely do not want deflation. You can live with low-to-moderate steady inflation. Exactly what qualifies as acceptable low-to-moderate steady inflation comes down to socio-cultural-political factors. I think inflation is often the scapegoat for poor economic performance and governance. If that boat is riding a rising tide for everyone, inflation will be overlooked. If a lot of people are drowning, inflation will get the blame. In any event, inflation indices are necessarily the product of choices of measurement that require many judgment calls. When inflation is in the lower single digits, those choices make a big difference. Pointing all this out does not mean that MMTers are more cavalier about inflation than are any other knowledgeable economists on these issues. Yes we care about price stability, but we do not define that as zero inflation as measured by a CPI, for example.)

Our argument is that you need to anchor the currency to preserve price stability. Goldbugs want to anchor it to the Cross of Gold. Australia used to anchor its dollar to sheep. Long ago, Bill Mitchell realized that Australia’s bufferstock program for wool price stabilization means that sheep are kept fully employed. How nice for them. Wouldn’t it be better to fully employ humans? Ergo—he came up with the idea of a labor bufferstock program that would stabilize wages, prices, and consumption while ensuring job availability to anyone who wants to work. He called it buffer stock employment—BSE—which was great until cows started dropping like flies from some brain disease also called BSE.

We called it employer of last resort, after Hyman Minsky’s writings from the 1960s. We also experimented with versions of “public service employment” (PSE) and Bill switched to “job guarantee” which is probably best. Warren Mosler is now calling it transitional employment.

Whatever it is called, it is our approach to using full employment to help stabilize prices. Those in the JG/ELR pool are doing their part in keeping the currency strong. They will do a better job than sheep do—since the production of everything requires labor, while sheep can help out in producing only things made from wool or mutton. Unless you’ve got an economy largely based on wool and mutton, you’d better go with a labor bufferstock.

And that is why the goldbugs have got the wrong bufferstock. Gold is not an important input into very many production processes, and its distribution is haphazard. Sort of like adopting a sheep bufferstock in the Amazon or Antarctica—where there are no sheep. Unless you happen to have a gold vein, unemployed labor cannot go pan for gold. The 18th century hope was that the specie-flow mechanism would send gold where it was scarce to put labor to work to produce exports to be traded for gold. That was supposed to stabilize prices, exchange rates, and employment. It didn’t work. It encouraged Mercantilism and wars, while economies boomed and burst with alternating inflations and deflations. In every financial crisis, government abandoned the gold bufferstock in favor of reason. Then took it up again when the crisis was past, in a fit of irrationality—or what Einstein labeled insanity: trying the same thing over and over again while expecting a different result. That ended with the end of Bretton Woods. Goodbye gold. Hello Ron Paul goldbug.

Why not give the labor bufferstock a chance? Full employment with greater wage, price, and output stability than we have now. Will it eliminate all undesired fluctuation? Undoubtedly not. But we would still have the full arsenal of macroeconomic tools at our disposal to fight inflation. Except for one. We’d use an employed reserve army rather than resorting to Marx’s old reserve army of the unemployed and destitute. So it is only the forced idleness and poverty that we’d abandon.

Whether you believe we are right or not, it is just plain dishonest to claim MMT ignores inflation. Or stupid. Probably both.

But the hyperinflationary hyperventilators keep on keeping on. They’ve got their mantra and they are sticking to it: “MMTers would turn the USA into the next Zimbabwe land”.

I’ve always found it extraordinarily funny that they’d use the Zimbabwe example. Yes, President Obama is pumping up those deficits and Uncle Ben Bernanke is flying those money helicopters so the US is certainly on the same path that led to Zimbabwe’s hyperinflation.

You know, whenever I think of a country to which to compare the USA, Zimbabwe always pops into my mind. Huge industrialized country. Democracy. No civil wars for 150 years. Issues a currency in demand all over the globe. Yes, Zimbabwe is the closest comparison I can think of.

How silly.

Why not choose a modern industrialized economy, with a highly educated and skilled workforce. With a nominally democratic government. With a budget under control of elected representatives. With a huge economy that is integrated with the economies of all the major nations in the world. That issues its own, sovereign, floating rate currency.

That adopted ZIRP (zero interest rates) and Quantitative Easing when a major economic and financial crisis hit.

I’m talking about Japan, of course.

What is the more likely scenario:

a) the USA is following Japan’s path; not toward hyperinflation but toward deflation and a prolonged slump.

Versus:

b) the USA will replicate the fate of a smallish agricultural economy that endured a tragic failure of crops and widespread social unrest.

Only a thoroughly confused or deranged mind would find in Zimbabwe a close analog to the USA’s situation.

No, we do not ignore inflation. We just happen to believe that our deficit and hyperinflationary worriers mistake the USA for Zimbabwe.

One final note. In his piece, Brad Delong summarizes the main contentions of MMT, following Warren Mosler’s exposition. Brad concludes—as we do—that a sovereign currency-issuing nation like the USA cannot be forced into involuntary insolvency as it can always pay all debts as they come due by issuing currency.

So far, so good. However he disagrees with Warren’s claim that the US government cannot face a “financial risk” because if inflation occurs, it is paying with cheaper money. Some claim that is a kind of default—as the real value of the promised interest and principal payments are inflated away.

In my view this argument is confused on two levels—terminology and theory.

Look, if I promise to pay you $10 a year hence, and I deliver to you $10 in 365 days, by no stretch of the language can you claim I defaulted on my promise. If instead I promised to deliver to you a sum of money that would allow you to buy some pre-specified box of commodities, that is a different matter entirely. Occasionally such contracts are written. And a government can offer inflation-indexed bonds. If it then refused to increase its payment to account for inflation, one could rightly call that a default. But nominal contracts are nominal and no court of law in this country (or any other) is going to rule that if I promised $10 and paid $10 that I’ve defaulted when inflation occurred meantime.

And here’s the more important point. Why is only government blamed for “default” when inflation occurs? Almost all of us have outstanding debts; and I suspect that very few readers have inflation-indexed their liabilities. So all of you are “defaulting” all the time on your commitments because you are not compensating lenders for inflation. Indeed, outside the rare case of Japan, it’s not a stretch to argue that all debtors default all the time in the sense that inflation exists everywhere.

Yes, I know that the goldbugs claim that inflation is everywhere and always government’s fault—so these “defaults” are due to government’s propensity to run up inflation in an attempt to deflate away its debt.

But that is silly. The two postwar high inflation periods in the USA (1974, 1979) were largely due to OPEC oil price hikes. You can go through a long-winded round-about geopolitical argument to blame that on Uncle Sam, I suppose. But it was oil, not budget deficits or helicopter money drops that caused inflation. In other words, out in the real world, the nongovernment sector plays a vital role in initiating price increases. So we might as well say that OPEC caused the inflation that led to “defaults” by government and nongovernment that repaid debt in cheaper dollars.

And, by the way, if it were so easy for government to create inflation through Obama-style deficits and Bernanke-style helicopters, why they heck can’t the Japanese get inflation going after a whole generation of desperate attempts to do so?

So kudos to Brad for recognizing that MMT does believe deficits matter, and that one of the ways deficits can matter is in sparking inflation. But let’s not confuse inflation with default.

Source: Brad DeLong

Randall Wray

About 

L. Randall Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri–Kansas City. His current research focuses on providing a critique of orthodox monetary policy, and the development of an alternative approach. He also publishes extensively in the areas of full employment policy and the monetary theory of production. Wray received a B.A. from the University of the Pacific and an M.A. and a Ph.D. from Washington University, where he was a student of Hyman Minsky.