MMT fails and increases interest rates – advocates assume raising taxes is easy

The difficulty of confronting MMT about those failings is compounded by its practice of walking back its positions and adopting those of its critics without acknowledgment. Examples include replacing the full employment threshold model of inflation (Wray, 1998) with the Keynesian Phillips curve model, and also recognizing that capital controls may be needed to contain international economic forces that can potentially disrupt fiscal policy. Recently, Kelton (2019) has slipped in another long-standing Keynesian argument that stability of the debt-GDP ratio requires that the nominal interest rate be less than the nominal rate of growth (i < g). In doing so, she tacitly admits another financial constraint on government and continues the walking back process. On one hand, the walking back process is reasonable: on the other hand, it undermines MMT’s claims regarding government being financially unconstrained. The second column in Figure 2 concerns the political economy failings of MMT. These political economy failings fundamentally challenge the viability of Lerner’s (1947, 1951) functional finance approach and suggest an MMT policy regime could even create economic instability. As noted above, money financed budget deficits drive the economy to full employment by increasing wealth and AD. That makes it critical there be institutional arrangements for closing the deficit once full employment is reached to avoid inflationary excess. However, MMT relies on a highly simplified and implausible political economy in its attempt to address that problem. Thus, it assumes taxes can be abruptly and precisely raised at full employment to contain excess demand, when the reality is taxes are politically contested and difficult to raise. Long ago, Friedman (1961) argued that fiscal policy was impractical for “fine-tuning” stabilization policy owing to inside (decision) and outside (implementation) lags. Those lags mean policy implementation is likely to be poorly timed, so much so that it could amplify the business cycle rather than dampen it. The Friedman critique of fiscal policy concerns “timing” of policy actions. It can be augmented to include a “public choice” critique based on politicians aversion to raising taxes and cutting spending. 10 That aversion stands to reinforce the problem of fiscal policy timing. Additionally, it stands to impart an inflationary bias and gradually ratchet up government spending as a share of GDP. That is relevant because MMT recommends increased spending to stimulate the economy below full employment, and higher taxes once full employment is reached. Over successive cycles MMT’s policy frame is likely to be destabilizing.11 Absent budget discipline, spending and deficits would tend to ratchet upward owing to the political attraction of money financed deficit spending and the political aversion to higher taxes. Yet, MMT reduces budget discipline by arguing the central bank should be under the direct control of the fiscal authority which is encouraged to use money financed deficits.12 Another political economy critique (Lavoie, 2014) is that central banks and fiscal authorities are institutionally separated in most economies, but MMT ignores this and treats them as a unified decision maker. The separation is usually justified on public choice grounds that politicians have an inclination to inflationary monetary populism, and separation of fiscal and monetary powers helps prevent that. MMT ignores the separation, invoking an “as if” argument. Two implications follow. First, as Lavoie (2014) notes, the current system does not support MMT’s policy claims as the system is not structured as needed. Second, if the system were changed and structured as required by MMT, financial markets would likely shift to expecting an increased likelihood of inflationary monetary populism owing to MMT’s policy frame. That would cause asset prices to fall and interest rates to rise. The latter critique links to MMT’s comprehensive failure to take account of the impact of expectations of policy on economic behaviors and financial markets (about which more below). Expectations about the future impact current private sector decision making, which implies the inflationary bias in MMT’s fiscal policy assignment will impact present conditions long before inflation accelerates or full employment is reached. Given that, it is easy to envisage how an MMT regime could even generate economic instability. An untimely money financed fiscal stimulus could raise concerns about financial instability or inflation expectations, thereby raising current market interest rates and prompting need for further fiscal stimulus. That we do not see such patterns today may be because policy is not constructed according to MMT’s institutional and policy recommendations.13