I’ve been asked quite a few times about chartalism and its recent rebadging as modern monetary theory (MMT). My answer has been that I really should get around to looking into this. However, the issue came up again at Crooked Timber following my post on hard Keynesianism. Looking around, I drew the conclusion that an attempt to define and assess the various versions of MMT would take more time than I had available. So, instead, I thought I would draw up a set of propositions bearing on the claims I made about hard Keynesianism and invite comment from MMT advocates and others as to whether they disagree. Here they are
1. Except during the period since the GFC, money creation has not been an important source of finance for developed countries
2. Except under extreme conditions like those of the GFC, money creation cannot be used as a significant source of finance for public expenditure without giving rise to inflation and (if persisted with) hyperinflation
3. Government deficits must be financed primarily by the issue of public debt
4. The ratio of public debt to GDP cannot rise indefinitely, since governments will ultimately find it impossible to borrow
5. The larger the deficits governments want to run during deficits, the larger the surpluses they must run in booms
Now some justification for these claims:
On point 1, the US monetary base has expanded from $800 billion to $2400 billion since the beginning of the crisis. Prior to that, growth was roughly in line with nominal GDP, that is, around 5-6 per cent per year or additions of $50-60 billion.
My take on this: Quantitative easing and similar operations since 2008 have created money equal to around 15 per cent of GDP or around 5 per cent per year, without obvious inflationary consequences. We can conclude (assuming the inflation doesn’t materialise) that, in a liquidity trap, there is substantial capacity to use direct money creation as a source of finance.
Pre-GFC, seignorage/base money creation was a minor source of finance for the US government (about 0.5 per cent of GDP, consistent with money base being about 10 per cent of GDP). And, I’m confident the same is true for all developed countries except maybe Japan, which has been in a liquidity trap for a long time.
On point 2, there are plenty of examples of governments trying to finance their operations through the printing press, and the outcome is always the same: inflation at first, then hyperinflation, then the end of the currency. Zimbabwe, which now has no currency of its own, is just the latest example. There are various possible mechanisms by which this outcome occurs, but the central point is that the monetary base is typically around 10 per cent of GDP, which presumably reflects people’s desire to hold money. Any substantial increase in the monetary base can be sustained only if interest rates are pushed down to low levels, ultimately to zero. And, except in crisis conditions like those of the present, zero interest rates will lead fairly rapidly to inflation in asset prices and ultimately in consumer prices.
Point 3 follows from point 2.
Point 4 like point 2 has been verified by sad experience many times.And its obvious that, the higher the debt ratio, the stronger the incentive for the government to default or inflate their way out of trouble, and therefore the higher the interest rates they will face. At some point the capacity to borrow runs out.
Point 5 follows from Point 4.
So, there are my propositions. Feel free to comment.