Congress won’t pass policies -- neither side agrees on MMT provisions to mitigate inflation

If MMT sounds too good to be true, that’s because it is. All progressives want to devote additional funding to a series of sectors, from health care and education, to economic security and the environment, so the theory carries an obvious appeal. But MMT is riddled with pitfalls.

1. It assumes politicians will easily raise taxes and cut spending.

Under an MMT regime, policymakers would need to respond to inflation by doing two of the most unpopular things ever: raising taxes and cutting spending.

With MMT, if inflation starts to get out of control, money needs to be pulled out of the economy either by taxing people more or spending less. Raising taxes is, of course, historically difficult in America. For example, the last time Congress passed a meaningful increase in the payroll tax was in 1993 when the earnings limit was repealed for the Medicare portion of FICA.3 The last Republican president to sign a tax increase into law was President George H.W. Bush in 1991.4 With one party adamantly opposed to increasing taxes, it seems like a fantasy to believe that politicians would approve a tax increase while people’s earning power is being eroded by inflation. On the spending side, do we see Democrats actually cutting spending and taking an ax to things like national parks, food inspection, and health care services? They shouldn’t have to—and they won’t.

Further, the current political system moves painfully slow. People rightfully blame gerrymandering, primary challenges, the filibuster, and a host of other political issues. But the end result is the same: depending on Congress to react as quickly as the Fed currently does takes a lot of faith. We can easily imagine divided government’s paralysis to fight inflation—Republicans refusing to raise taxes and Democrats refusing to cut spending.

2. It ends our central non-political economic manager.

The Federal Reserve provides an important macroeconomic safety net for the country. And it is able to play the role of an independent steward in the economy free, or mostly free, from political intrusion. For example, in the wake of the Great Recession, Congress worked to provide stimulus to bring the economy out of the tank. But it wasn’t enough. Fortunately, the Federal Reserve stepped in to help the economy through the fiscal policy doldrums in 2011 and 2012.

Further, our current economic situation is one of low inflation and low-interest rates. This is because markets trust the Federal Reserve and, as a result, businesses and individuals have well-anchored inflation expectations (i.e. they think inflation is going to be low and stable). Under MMT, however, the Fed’s role would be upended. A shift in strategy and relationship to inflation would have an uncertain effect on individuals’ and businesses’ inflation expectations. And possibly more dangerous during economic downturns, we would move from having both monetary and fiscal policy tools to only having fiscal ones.

Why does MMT require the Fed to get out of the way? Because the Fed currently has a dual mandate of full employment and stable prices. The Fed’s toolbox to help manage the dual mandate is, primarily, changing short-term interest rates and buying and selling publicly traded bonds.

Currently increasing the deficit can raise interest rates in two ways:

The Treasury must auction significantly more bonds, which results in higher demanded interest rates in the marketplace.

Inflationary pressure from larger deficits would, under current practice, provoke monetary tightening (higher interest rates) from the Fed.