Saturday, May 22, 2010

Argument Against Modern Monetary Theory and the New Keynesians

Can the FED can print all the money it wants to? Not without bad consequences, the ultimate being a Zimbabwe-like collapse of the monetary system.

What is missing from the discussion that of confidence. For the dollar to be an unit of account and store of value, society needs to have confidence that the numbers aren't being fudged, that whatever savings I've built up, my delayed consumption, isn't being manipulated.

Proponents of MMT and New Keynesian economics have pointed out that the government doesn't even need to issue bonds, it could just give itself dollars and spend up to the point where it can purchase 100% of the goods and services offered in the economy. Actually it can't, the monetary system would collapse well before the 100% and people would stop accepting dollars as money because they would have lost confidence in it as a fair and accurate unit of measurement. If even a dictatorship like Zimbabwe isn't able to compel its citizens to accept and use their worthless unit of account, I doubt the US Govt. would be able to.

The reason the government issues bonds at all (that is borrow) is to provide an open and transparent account and to assure the public that the dollar remains a good and fair measurement of the future consumption that they have saved. People want to know that, if they have saved $5 and that can purchase a sandwich at a fast food chain, they will wake up tomorrow and still have a sandwich "due to them" whenever they want it in the future. If they wake up and the $5 in their bank account can't buy them a sandwich anymore, then they know they've been had. Add expected inflation into the mix if you want a more accurate explanation.

When the government borrows money, the public knows that either future government spending will have to decrease, allowing the public to consume more (purchasing bonds is a way to delay consumption to the future), or the public will give up that future consumption in the form of higher taxes. Taxes are very visible and politicians are reluctant to raise taxes without implied consent from the public.

The FED printing money on the other hand, is a stealth tax that is not transparent and is not accounted for. At least with open market operations we can see how much the FED has printed, but as an independent agency that is not directly elected, the people have limited means to control the actions of the FED. No taxation without representation! That's a notion fundamental to our ethos. There are many reasons why FED printing of money and uncontrolled government money creation should be avoided.

Only under a communist dictatorship with an iron grip over society tighter than even Stalin was able to achieve, could government create money like the MMT/New Keynesians advocate. If I have $30000 in my bank account and the government all of a sudden types in $1,000,000,000,000 and posts it to their own account, I know all I've worked for my entire life amounts to nothing. Perhaps this gives a clue as to why people are so pissed off right now and are electing "extremists" like Rand Paul, who seem to understand better than the MMT folks.


Anonymous said...

New Keynesian theorists say the store of value in the currency is backed by the ability to tax - thus offering incentive to increase demand for the currency in question. Also they claim that the government bond auctions are correlated to keeping the federal funds rate at the target set. Which would mean that the treasury and the federal reserve are working hand in hand as opposed to the commonly perceived 'independence' that the fed has. Not to mention they also commonly point out that private net savings is exactly equal to public net deficit or vice versa. In either case both are theories with their own merits. The truth lies somewhere between the two.

WillORNG said...

Hyperinflation is a supply collapse phenomenon rather than a monetary one.

Musgrave said...

Greetings to Chinese-American capitalist pig – honk, honk.

There are possible circumstances where your argument would hold water: in particular where a sizeable portion of the population thought that inflation was determined primarily by the size of the monetary aggregates and actually kept a close eye on those aggregates. But that is just no a realistic description of the real world.

For example there has been an astronomic and unprecedented increase in the US monetary base in the last two years. Some people predicted inflation. Along with others, I predicted no effect. The former were wrong. The latter were right.

Second, many countries tried to control inflation by controlling the monetary aggregates up to about ten years ago. It didn’t work. And it didn’t work because as numerous studies have shown, there is little relationship between the aggregates and inflation (except in the case of lunatic money supply increases, a la Mugabwe).

The reason for this feeble relationship is that the money supply – inflation relationship is swamped by other factors: oil price changes, changes in consumer confidence, etc.

Third, I suggest the main “money supply increase causes inflation” transmission mechanism is via demand. That is,1, give households money, 2, they spend some it, 3, if they spend the right amount, then full employment is obtained without inflation. Problem solved. Or 4, they may spend too much, in which case we get inflation.

Getting the ideal money supply increase (3) would be difficult in an MMT regime, but then governments are not exactly brilliant at organising a nice stable and near full employment scenario using other tools, e.g. interest rate changes.

Also, MMT does not rely just on money supply increases for its effect. If government prints money and uses the money to employ public sector workers, there is an immediate employment effect long before any significant money supply increase. Second, if government uses the money to fund a tax reduction, that will immediately increase workers’ pay packets, a portion of which will be spent immediately, and long before any significant money supply increase.