I am interested in how Modern Monetary Theory (MMT) relates to other macroeconomic approaches. There are strong connections to chartalism and credit theories of money (Knapp and Mitchell-Innes); Keynes and the principle of effective demand; Lerner’s functional finance; Minsky’s analysis of financial instability; circuitist and horizontalist Post Keynesian theories of endogenous money; and Wynne Godley’s stock-flow consistent sectoral balances framework. Individual Modern Monetary Theorists also cite other influences. Bill Mitchell, for instance, emphasizes the importance of Marx and Kalecki.
I have been reading (or re-reading) some of Michal Kalecki’s work lately. Certain aspects are particularly relevant to the current economic and intellectual climate as well as being interesting from the perspective of MMT. I have only covered volume I of Collected Works of Michal Kalecki at this stage. His key theoretical works on the capitalist economy are contained in the first two volumes.
In opening the covers of volume I, it does not take long to realize that the various essays resonate strongly with current circumstances. The opening passage of the essay, “The World Financial Crisis”, is very topical:
The period which preceded the present economic crisis abounded in capitalist utopias. American economists in particular excelled in forecasting an everlasting era of prosperity and – what is most astonishing – themselves believed in these horoscopes.
Kalecki had not, of course, anticipated the current global financial crisis and Great Recession three-quarters of a century ahead of time, or guessed that some economists of the 1990s would proclaim the Great Moderation and an end to the business cycle. He was writing in 1931 and, needless to say, had an earlier crisis in mind:
The crash on the New York stock exchange at the end of 1929 dealt a fatal blow to these “theories”, which vegetated for a short time (nourished by Hoover’s optimism) until they passed into oblivion in 1930.
So the theories of Great Moderation passed into oblivion eighty years ago only to re-emerge decades later.
In the opening paragraph of his famous 1943 essay, “Political Aspects of Full Employment”, Kalecki writes:
A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a government spending programme, provided there is in existence adequate plan to employ all existing labour power, and provided adequate supplies of necessary foreign raw-materials may be obtained in exchange for exports.
Kalecki, as is well known, takes issue with this position. However, the reasons for his disagreement are based on political rather than economic factors, as he points out in a later essay (“Full Employment by Stimulating Private Investment?”, p.386). On the economics, he is in agreement with the “solid majority” of his day:
If the government undertakes public investment (e.g. builds schools, hospitals, and highways) or subsidizes mass consumption (by family allowances, reduction of indirect taxation, or subsidies to keep down the prices of necessities), and if, moreover, this expenditure is financed by borrowing and not by taxation (which could affect adversely private investment and consumption), the effective demand for goods and services may be increased up to a point where full employment is achieved.
Kalecki’s analysis of public debt differs somewhat from MMT, reflecting the different monetary system of the period. Yet, as will become apparent, his conclusions concerning the impact of fiscal deficits on interest rates, inflation and private investment closely resemble those of MMT. These points are dealt with mainly in part 6 on “Full Employment”, especially in two essays, the aforementioned “Political Aspects of Full Employment” and a 1944 essay, “Three Ways to Full Employment”. Since I will refer to these essays repeatedly, I will just call them “Political Aspects” and “Three Ways” for short.
Kalecki’s reference, in the above passage, to taxation adversely affecting private investment and consumption is, on one level, similar to Keynes’ analysis. That is, taxes subtract from aggregate demand. But for Kalecki there is another aspect. Capitalist expenditures (private investment and capitalist consumption), along with the fiscal deficit and net exports, determine aggregate profits in the current period. (I have discussed this previously, for example, here.) At the same time, private investment in the next period depends on expected profitability, which will be influenced by current profitability. Since taxation reduces the size of the fiscal deficit, it impacts negatively on aggregate profit, expected profitability, and therefore private investment in the next period.
Despite a “solid majority” of economists agreeing on the technical capacity of governments to use fiscal policy to deliver full employment, in further shades of today, Kalecki also identified a significant opposition:
Among the opposers of this doctrine there were (and still are) prominent so-called ‘economic experts’ closely connected with banking and industry. This suggests that there is a political background in the opposition to the full employment doctrine, even though the arguments advanced are economic. That is not to say that people who advance them do not believe in their economics, poor though this is. But obstinate ignorance is usually a manifestation of underlying political motives. (“Political Aspects”, p.349)
It is easy enough to identify examples of “obstinate ignorance” in the public policy debate of today. Cries of “the country can’t afford it!”, “crowding out!”, “inflation!”, and “crippling debt burden on our children!” have been common. A perusal of Kalecki’s essay, “Three Ways”, reveals that much the same examples applied then as now. The subheadings of section I of that essay are, in order, “Where does the money come from?”, “The rate of interest”, “The danger of inflation”, and “The burden of the debt”.
Kalecki’s answers to these questions are highly consistent with MMT. There are only minor differences attributable to institutional features of the monetary system that prevailed at the time.
In response to the question of where the money comes from when the government net spends, Kalecki argues:
In reality, the government pays for the services, not in securities, but in cash, but it simultaneously issues securities and so drains the cash off … (“Political Aspects”, p.348)
This is reminiscent of the MMT observation that, in effect, government bonds are purchased with the reserves created by the net spending.
Kalecki anticipates the next question:
Is it not wrong, however, to assume that private investment will remain unimpaired when the budget deficit increases? Will not the rise in the budget deficit force up the rate of interest so much that investment will be reduced by just as much as the budget deficit is increased, thus offsetting the stimulating effect of government expenditure on employment? (“Three Ways”, p.360)
This is the familiar claim that fiscal deficits will simply crowd out private investment. From Kalecki’s perspective, there are numerous flaws in this claim. For one thing, private investment for him is a function of profitability, not the rate of interest per se. If profitability is rising, a higher rate of interest will not necessarily impede private investment. (Kalecki discusses this aspect in his work on business cycles, for example “Essay on the Business Cycle Theory” in part 3 of volume I of his collected works, and “Essays in the Theory of Economic Fluctuations” in part 5.)
Kalecki also rejects the loanable funds doctrine, arguing that:
… the budget deficit always finances itself – that is to say, its rise always causes such an increase in incomes and changes in their distribution that there accrue just enough savings to finance it …
The reasoning is along virtually identical lines to Keynes. An exogenous increase in any injection – whether government expenditure, private investment, or exports – generates an increase in income that, irrespective of saving ratios, tax rates and import propensities, always results in leakages that match the increase in autonomous expenditure:
In other words, net savings are always equal to budget deficit plus net investment: whatever the general economic situation, whatever the level of prices, wages, or the rate of interest, any level of private investment and budget deficit will always produce an equal amount of saving to finance these two items.
This passage refers to a closed economy in which the government’s deficit equals net private saving. Causation, as in Keynes (and MMT) is regarded by Kalecki to run from the autonomous expenditures to saving and tax revenue. The self-financing nature of government expenditure and private investment demonstrates the inapplicability of the loanable funds doctrine, largely dispelling the crowding out argument.
But the similarities with MMT on the question of crowding out do not end there. In response to claims that fiscal deficits cause higher interest rates, Kalecki writes:
… the rate of interest may be maintained at a stable level however large the budget deficit, given a proper banking policy. (“Three Ways”, p.360)
… the rate of interest depends on banking policy, in particular on that of the central bank. If this policy aims at maintaining the rate of interest at a certain level, that may be easily achieved, however large the amount of government borrowing. Such was and is the position in the present war. In spite of astronomical budget deficits, the rate of interest has shown no rise since the beginning of 1940. (“Political Aspects”, p. 348)
As in MMT, the rate of interest is therefore considered to be a policy variable. There is no such thing as a ‘natural’ rate. Interest is a share out of profit – a distributive variable – and can be set as a matter of policy at whatever level the central bank wishes it to be set.
Nor is this regarded by Kalecki as a special case:
The same method of keeping interest rates constant can be followed in peacetime. There is nothing peculiar in the wartime situation which makes this method easier than where a budget deficit is used for financing public investment or subsidizing mass consumption. We may thus conclude that, provided the central bank expands the cash base of the private banks according to the demand for bank deposits, and provided the government issues long- and medium-term bonds on tap, both the short-term and the long-term rate of interest may be stabilized whatever the rate of the budget deficit. (“Three Ways”, p.361)
I am glossing over some institutional features of the monetary system and details of Kalecki’s analysis that differ from the MMT understanding to highlight the more fundamental similarity in their treatment of interest as a politically determined policy variable under the exogenous control of the central bank.
Regarding the potential for inflation, Kalecki’s analysis once again closely resembles the arguments of Modern Monetary Theorists:
It may be objected that government expenditure financed by borrowing will cause inflation. To this it may be replied that the effective demand created by the government acts like any other increase in demand. If labour, plants, and foreign raw materials are in ample supply, the increase in demand is met by an increase in production. But if the point of full employment of resources is reached and effective demand continues to increase, prices will rise … It follows that if the government intervention aims at achieving full employment but stops short of increasing effective demand over the full employment mark, there is no need to be afraid of inflation. (“Political Aspects”, p.348)
Kalecki, like MMT (and also Post Keynesians), rejects the arbitrary assumption of diminishing marginal returns and increasing marginal costs in most sectors and at the aggregate level. Much more typical, in his view, at the firm level, is a situation of constant variable costs over a wide range of capacity utilization, with sharp cost increases only emerging close to full capacity.
Turning to the question of whether public debt can be a burden, Kalecki observes:
In the first place, interest on an increasing national debt (as indeed on all the debt) cannot be a burden to society as a whole because in essence it constitutes an internal transfer. Secondly, in an expanding economy this transfer need not necessarily rise out of proportion with the tax revenue at the existing rate of taxes. The standard rate of income tax necessary to finance the increasing amount of interest on the national debt need not rise if the rate of expansion of the national income is sufficiently high … (“Three Ways”, p.363)
He then goes on to discuss various methods of taxation that could be used to service public debt without impeding output and employment in the event that his second condition was not met. Of course, this is somewhat different to the circumstance of a sovereign currency issuer facing no revenue constraint, but a similar consideration arises in sovereign currency systems in terms of the potential inflationary effects of paying interest on the debt.
In a footnote, Kalecki reiterates that since the government controls interest rates, “nothing prevents the government from reducing the rate of interest” it sets on its debt. The same reasoning applies if the policy rate of interest is simply paid on reserves. The government ultimately controls how much interest it pays through the central bank’s interest-rate policy. Under most scenarios, provided the nominal rate of growth exceeds the nominal rate of interest, inflationary pressures will remain under control.
There are other important components of Kalecki’s work, relating equally to MMT and Post Keynesianism, that I could have covered, but the aspects discussed above seem to be the most obvious in their relationship to MMT. There is his profit equation – with its close connection to the sectoral financial balances identity as well as to the insight shared by Modern Monetary Theorists and Post Keynesians that realized profit is a function of aggregate demand – and his theory of distribution, in which nominal output is a mark-up over aggregate wages and indicates how incompatible nominal wage and profit claims are resolved through inflation.
There are also differences between Kalecki and MMT that could have been discussed in greater depth. Most notable, in this respect, is that Kalecki would undoubtedly take issue with the MMT view over the viability of a job guarantee. Even so, as noted in the discussion, the reason for the disagreement on this issue relates to differing assessments of the political obstacles rather than technical considerations. Since MMT acknowledges the existence of political constraints and provides room for disagreement on these matters, the agreement over the economic analysis of full employment seems more reflective of the broad analytical compatibility between the approaches of Kalecki and MMT than do the differences in political analysis.