What follows is a simple parable. The post is long because it illustrates numerous scenarios and their implications, but the parable itself is simple and hopefully very easy to follow. The parable is designed to illustrate as simply as possible the difficulties that arise in a commodity-backed monetary system and the benefits of sovereign currency. It is based on Bill Mitchell’s ‘business-card economy’ teaching model but is adapted for present purposes.
In a recent NYT post, “I Would Do Anything for Stimulus But I Wouldn’t Do That (Wonkish)”, Paul Krugman writes:
Right now, the real policy debate is whether we need fiscal austerity even with the economy deeply depressed. Obviously, I’m very much opposed — my view is that running deficits now is entirely appropriate.
But here’s the thing: there’s a school of thought which says that deficits are never a problem, as long as a country can issue its own currency. The most prominent advocate of this view is probably Jamie Galbraith, but he’s not alone.
In this passage, Krugman mischaracterizes Modern Monetary Theory (MMT) from the outset. MMT does not say “deficits are never a problem”. It is unlikely that any economic theory or economist would say that.
For Marx, the most important tendency of a capitalist economy is the ‘law of the tendential fall in the rate of profit’ (LTFRP). This ‘law’ is often misinterpreted as referring to a permanent fall in the rate of profit, but it actually refers to a tendency that is overcome periodically through crises. Marx argued that during an expansionary phase, there is a tendency for the rate of profit to fall until a crisis point is reached, after which capital values collapse, cheapening prospective investments. This revives profitability and paves the way for a new expansionary phase. Crises, while causing widespread hardship – including bankruptcies, mass unemployment and poverty – play a functional role under capitalism of restoring profitability for those capitalists, now fewer in number, who survive the process.
Modern Monetary Theory (MMT) implies some interesting connections between money, taxes, social cooperation, freedom and different economic systems. In particular, it brings to light some of the social possibilities open to societies with sovereign currencies.
To understand aggregate behavior, it is necessary to start at the aggregate or macro level of analysis rather than the individual or micro level. This is because there are certain relationships that must hold, by definition, at the aggregate level. These relationships are specified in macroeconomic accounting identities.
The abstract to Brian Riedl’s Heritage Foundation paper, ‘Why Government Spending Does Not Stimulate Economic Growth: Answering the Critics‘ reads:
Despite decades of repeated failure, President Obama and Congress continue to promote the myth that government can spend its way out of recession. Heritage Foundation economic policy expert Brian Riedl dispels the stimulus myth, lays out the evidence that government spending does not end recessions–and presents the evidence for what does end recessions. Hint: It’s not another “stimulus package.”
These are strong words. The arguments presented in the paper, in contrast, are not. Picking the arguments apart is an easy task, but may be instructive and also serve a purpose given the influence right-wing think tanks seem to have on the policy debate.
The MMT position on hyperinflation is that it is initiated by a sharp contraction in output and in the supply potential of the economy. Bill Mitchell provides an in-depth explanation in a recent post. Mitchell points out that in Weimar Germany, for instance, the French and Belgian armies retaliated to the German default on reparations payments by taking control of the industrial area of the Ruhr. German workers stopped work in response. This resulted in a massive contraction of supply relative to demand.
A major component of the policy response to the economic crisis in the United States, Japan and Britain has been ‘quantitative easing’. The policy is having very little impact on the real sectors of the economies in question, which should not be surprising given the weakness of the policy’s theoretical underpinnings. But neither is the policy likely to cause excessive inflation, as some of its critics erroneously claim.
The present is a time of deep private indebtedness, especially household indebtedness. A key question for macroeconomic policy is how this debt burden can be alleviated. Until excessive private debt is cleared away, the expenditures of households and firms will be severely constrained, hampering economic recovery. One approach would be to conduct an orderly write down or cancellation of a substantial part of private debt. Another method would involve government making appropriate use of fiscal policy by engaging in substantial and concerted net spending (government spending in excess of tax revenue) to sustain overall demand and income until households and firms can sustainably revive their own levels of spending. A currency-issuing government always has the financial capacity to conduct net spending of this kind. This post focuses on a key positive effect of the second policy approach, but ideally a combination of the two approaches would be employed.
A fiat currency has neither intrinsic value nor convertibility into a valuable commodity. This raises interesting questions about the nature of a currency, the role of taxation and public debt in relation to government spending, and the democratic potential of modern societies.