2019 07 – Modern Monetary Theory

Modern Monetary Theory- Keynesianism for our time?

a talk given by Peter Brooke in Llaneglwys, Wales, June 2019.  Part 1 of 3

THE LOGIC OF ‘AUSTERITY’

I have to begin by saying that I am not an economist. That should be obvious by the fact that you won’t see any charts, graphs, diagrams, algebraic equations or even numbers in the course of this talk. By the same token I’m not an authoritative spokesman for Modern Monetary Theory. There is a very substantial academic literature that has been built up over the past thirty years, at least since the publication of Warren Mosler’s Soft Currency Economics in 1996 and in fact, as I hope to show, there is a much older tradition. My aim is not to give a definitive account but to arouse your interest and encourage you to go further. (1)

The term ‘modern money’ was I think devised by the American economist Randall Wray as a sort of joke since he was arguing that this is a description of what money is and what it has been for the past 4,000 years. Keynes, when pondering the origins of money, went through a period he called his ‘Babylonian madness’, seeking those origins in the state issued money (and this is the crucial definition of money. It is a creation of the state) in ancient Mesopotamia. (2)

In 1924, the German economist Georg Friedrich Knapp published a book translated into English under the title The State Theory of Money. He called his approach ‘chartalism’. (3) The American economist and disciple of J. M. Keynes, Abba Lerner, writing in 1943, used the term ‘functional finance’. (4) Much of the work done in developing MMT has been associated with the Levy Economics Institute of Bard College, established in the United States by the hedge fund manager Leon Levy, where the economist Hyman Minsky was established at the end of his life. Minsky developed a theory of economic crashes which rapidly came into favour after the Great Crash of 2008. Names associated with the Levy Institute are L. Randall Wray, Pavlina Tcherneva and Stephanie Kelton, Chief Economist on the U.S. Senate Budget Committee 2015 minority party staff and an Economic Advisor to Bernie Sanders’ 2016 Presidential campaign. Elsewhere it is perhaps Bill Mitchell, Professor of Economics in the University of Newcastle, Australia, both in his books (recently the large academic textbook Macroeconomics) and on his very impressive online ‘blog’ who has contributed most to popularising and developing MMT ideas. In Britain the best known supporter is probably Richard Murphy, author of The Joy of Tax, with his Tax Research UK website.

My own interest in the question is largely political. I’m one of the many people who joined the Labour Party when Jeremy Corbyn became its leader. My hopes in Corbyn’s leadership were (I suppose I should say ‘are’) twofold: first that Britain would withdraw from its engagement in overseas military adventures; and secondly that a Labour Government would be able to reverse the appalling ‘austerity’ policy that has been imposed on us ever since the Lib Dems enabled the Conservatives to take power in 2010. It is of course primarily the economic question that interests us here. (5)

We all know the argument on which the austerity policy has been based. The Conservatives say that they inherited from Labour a huge deficit, and that this was the major problem that had to be addressed, hence George Osborne’s ambition, supported by the Lib Dems, let us never forget, to achieve a ‘balanced budget’ and hence, of course ‘austerity’ (meaning a reduction in government spending not of course any restraints placed on the conspicuous enjoyments of the very rich). And we should never forget also that in 2010, when Osborne proposed his austerity programme, the temporary leadership of the Labour Party under Harriet Harman was willing to support it. This was seen as the hard-headed realistic option.

We know of course also that the accusation made against the Labour government of profligate spending during the Blair-Brown years was deeply unjust. Leaving aside the absurd expenditure of equipping the army to fight in parts of the world that had nothing to do with national defence, Gordon Brown’s watchword as Chancellor of the Exchequer was ‘prudence’ (‘My first rule – the golden rule – ensures that over the economic cycle the Government will borrow only to invest, and that current spending will be met from taxation.’ (6)). The government did, to its credit, engage in a substantial programme of building schools and hospitals. But ingenious schemes were devised to keep expenditure off the government books, as far as possible getting the private sector to put up the necessary finance, with the predictable result we’re all experiencing now that these schools and hospitals are saddled with long term debts that have to be repaid with interest, as well as commitments to private sector supply of necessary services. Expenses which often have to be assumed not by central government but by local authorities.

Never mind. A great deal was achieved with minimal government expenditure. But then of course along came 2008 and the financial crash. Gordon Brown had to come up with a solution very quickly and the solution he came up with was ‘recapitalisation’ – a massive injection of money from the government into the banking system which completely undid all the budgetary benefits (though I shall soon be arguing that those benefits were imaginary) that had been gained over the years of prudence.

What has been curious has been the weakness of the Labour Party’s response to the charge of profligacy. The financial crash of 2008 was a direct – and I would suggest quite predictable – consequence of the deregulation of the financial services industry by the Conservative government in 1986. (7) The embarrassment for Labour is that it had come to accept this, indeed to accept it as a triumph of government policy. After 1986 things could be done in London that could not be done in more tightly regulated financial centres elsewhere in the world. As a result business flowed into London. Other financial centres had to follow suit, culminating in the repeal of the Glass-Steagall Act (separation of domestic and investment banking) in the US by the Clinton government in 1999.

And it all looked like a great success. Gordon Brown pursued the policy of government withdrawal from the world of finance further with the independence of the Bank of England. he faced very little opposition and when he said in 1999: ‘Under this Government, Britain will not return to the boom and bust of the past’ or in 2007 ‘We will not return to the old boom and bust’ (8) he was only repeating a view that was generally accepted through the economics profession and also expressed by Alan Greenspan and his successor as Chairman of the US Federal Reserve, Ben Bernanke, that the skills had been developed by which, effectively, minor booms and busts could be shifted from one sector of the economy to another in such a way as to prevent a crash of the whole. This was what Bernanke called ‘the great moderation.’

So Labour, having accepted the logic of deregulation of the financial services industry could not blame the Conservative architects of that deregulation for the crash and was unable to formulate a policy for dealing with it other than providing the banks with the means of going back to what they had been doing before it. And it is also difficult to protest against the politics of austerity when you too have accepted the logic that the government deficit is a problem and the ideal (even if it is recognised as an unattainable ideal) is a balanced budget.

(1) A useful starting point is the website of the Gower Institute for Modern Money Studies – https://gimms.org.uk/

(2) L. Randall Wray: How I came to MMT and what I include in MMT – remarks for the 2018 MMT Conference September 28-30, NYC, published online at http://neweconomicperspectives.org/, 1 October 2018.

(3) Georg Friedrich Knapp: The State Theory of Money, London, Macmillan, 1924. See also L. Randall Wray: From the State Theory of Money to Modern Money Theory: An Alternative to Economic Orthodoxy, Levy Economics Institute of Bard College, Working Paper no 792, March 2014.

(4) Abba P. Lerner: ‘Functional Finance and the Federal Debt’, Social Research, Vol. 10, No. 1 (Feb 1943), pp. 38-51. According to Robert Skidelsky (J. M. Keynes: Fighting for Britain, p.276) ‘Keynes was always conscious that new ideas had to be “dressed up” in familiar clothes to make them politically acceptable, especially to the business community. He criticised Abba Lerner’s concept of “functional finance” – a starkly logical application of the General Theory concepts of aggregate supply and demand to financial policy, shorn of any embellishment, on exactly this ground …’

(5) My views on Labour’s current ‘defence’ policy (such as it is) can be seen on this website at http://www.labour-values.com/defence/

(6) Gordon Brown’s first budget speech, Hansard, 2nd July 1997, col 304. Readers will probably recognise Labour’s current (June 2019) ‘fiscal credibility rule’.

(7) I discuss this in my articles on ‘Christianity and the Financial Crisis’ on the ‘British Values’ site – See http://www.british-values.com/index-to-articles/griffiths-2/

(8) Pre-Budget Report, 9th November 1999 and 11th Budget speech, Hansard, 21 Mar 2007, Col.815.

MODERN MONETARY THEORY – A MAGIC MONEY TREE?

It is this logic that is challenged by Modern Monetary Theory. MMT indeed contests the very notion of a ‘deficit’. The government spends so much money and it receives so much in taxes. Someone adds up what is spent and someone else adds up how much is received and the difference between them is recorded (as it would be if this was an ordinary household budget) either as a deficit or a surplus. If it is deficit, so the argument goes, the difference must be made up by issuing government bonds (otherwise known as ‘borrowing’) on which interest is payable. We might remember that in the wake of the 2008 crash it was on the rates chargeable on their bond issues that the economic performance of different members of the Eurozone was judged.

The MMT argument is that, in the case of a government, these two sums – what is spent and what is received – are essentially unrelated. It may be an unfortunate coincidence that the initials MMT for Modern Monetary Theory could also stand for ‘Magic Money Tree’ but there is a sense in which government IS a magic money tree. Unlike an ordinary household, government spending is not constrained by what it receives in income.

This is not a policy prescription. It is a simple statement of fact. Governments may choose for one reason or another to impose on themselves constraints. The gold standard was a constraint. The ‘balanced budget’ is a constraint. I will be talking shortly about the constraints the main spokespersons for MMT believe need to be accepted. But these are a matter of choice, of consciously determined policy. When governments say there isn’t the money to do such and such a desirable thing, it isn’t true. If the government has full control of its own currency, then it can never lack money.

Of course the moment one says this people immediately have visions of overworked printing presses resulting in hyperinflation. Zimbabwe! Weimar Germany! Venezuela! But hyperinflation isn’t the result of overworked printing presses. It would be more accurate to say that overworked printing presses are a result of hyperinflation. The hyperinflation is caused by shortages in the real economy, shortages of available goods and services, often exacerbated by foreign exchange problems. In Zimbabwe the collapse of agriculture owing to a poorly conceived agrarian reform led to massive shortages of food and an inability to pay for imports, not helped of course by international sanctions. In Germany the means of the economy were being sucked away in the post-war reparations and through the occupation of the Ruhr.

In Venezuela  – let me pause for a moment. The BBC continually marvels that a country so rich in oil should be reduced to such a dreadful economic plight. But Venezuelan oil is very heavy and has to be refined. Successive governments – not just the Chavez government – have failed to invest in refineries so the oil is refined in the US. It is an expensive process so the profit margin on Venezuelan oil is very narrow. Chavez had the perhaps illusory good fortune that the international price of oil during his period in office was very high. Perhaps he should have used the windfall to invest in refineries and to wean Venezuela away from its dependence on imports paid for with oil. He instead made a priority of immediate relief for the terrible conditions of poverty so many people were living in. Subsequently the international price of oil crashed resulting in an inability to pay for imports hence a very high level of inflation. But this has been swollen into hyperinflation by the effect of US sanctions (amounting to a grand theft of Venezuelan assets). To quote the recent (April 2019) report Economic Sanctions as collective punishment: The case of Venezuela by Mark Weisbrot and Jeffrey Sachs: ‘The loss of so many billions of dollars of foreign exchange and government revenues was very likely the main shock that pushed the economy from its high inflation when the August 2017 sanctions were implemented into the hyperinflation that followed.’ (9)

The main spokespersons for Modern Monetary Theory are not advocating that government simply throw money at the economy after the manner of the ‘helicopter money’ once proposed by Milton Friedman. Their suggestion is that the money should be spent – the constraint is that there should be things to spend it on. The constraint does not consist in any arbitrary definition of a permissible ‘deficit’ but in the capacities of the real economy – the ability to produce goods and services.

Perhaps a short digression might be in order at this point on the Great Depression of the 1930s, especially as it effected the US. Here we have the deeply amazing spectacle of an economy that was fabulously rich in resources grinding to a halt because of a collapse in the supply of money. Money was supplied through investment. Investment required a profit. Suddenly the financial markets lost confidence in the ability to generate profit. The prices and profit generating possibilities of shares crumbled. Great fortunes were wiped out. And the physical and human machinery that was more than capable of providing the whole population with a comfortable and pleasant life ground to a halt. With the ‘New Deal’ as an indication of what could be done – but could only be done – by an interventionist state.

The problem is – then as now – marrying the two worlds of the real resources of the country, including the labour force, with the means by which production, whether of goods or of services, can be financed. The socially useful function of the financial services industry is to facilitate this process. What we want is for the financial means to be directed to the most socially useful product. The expertise of the financial services industry however is to direct it to the most profitable product, which may be, and often is, a purely financial product, in which case the financial services tend to spin off into a world of their own. Maybe we can’t complain about this. If you or I or the Church of England or a pension fund want to invest our money it is in hopes of securing a return. But the notion that this process by itself will guarantee efficiency in the market – that the criterion of profit will correspond to the criterion of human need – is absurd, even if it is the basic assumption of classical economics.

(9) Published by the Centre for Economic and Policy research, Washington. For a useful account of Venezuela’s problems see also Nafeez Ahmed: ‘Venezuela’s Collapse Is A Window Into How The Oil Age Will Unravel’, Oriental Review, 6th Feb 2019.

Part 2 of Peter Brooke’s talk will appear in the September issue of Labour Affairs.