14 July 2020

 Do deficits matter? Kelton says 'No'

A Review of Stephanie Kelton, The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (2020: John Murray Press)

‘How are we going to pay for it?’ That seems to be the concern of swathes of our political class and journalists as on a seemingly weekly basis we get another announcement about coronavirus spending. Theresa May famously told us 'There is no magic money-tree' and James Meadway, former adviser to John McDonnell, would seem to agree, so on at least some parts of both the left and the right the problem of how to pay for coronavirus is indeed a problem.

But is it? For as UK public debt has grown by a staggering £190bn and our debt to GDP ratio is at a 50-year high, Stephanie Kelton, Professor of Economics at Stony Brook University steps into the debate and essentially says, ‘Don’t worry, it will be fine.’ That is perhaps, not entirely accurate. But what she does say is that the deficit is not the thing we should be worried about. That is not our problem; unemployment is.

Kelton is an advocate of what is called Modern Monetary Theory (MMT). A bit like postmodernism, MMT is so different to how we usually think about public finance that it can take a bit of effort to get our head round it and it is also sometimes a bit slippery around the edges. Nevertheless, it has a core idea that turns on its head how we usually think about tax and public spending.

In short, MMT states that we don’t need taxes to pay for things; the government can pretty much pay for what they want. There really is a magic money tree.

As Kelton makes clear, this is not necessarily a socialist idea; the things we pay for could just as well be more military spending as much as unemployment benefits and healthcare. But the primary point is that we don’t need to collect the taxes to pay for what we want. In a reversal of the usual tax then spend dynamic, according to MMT, we first spend and then collect the taxes afterwards.

The key point here is that contra Thatcher, national governments – at least ones which are able to issue their own sovereign currency (USA, UK, Australia, Japan, but not the Eurozone) – are not like households. They don’t have to balance their books; their central banks really can just print money. How is this possible? Because money is not gold. The British pound used to be pegged to a tangible asset, like gold, but the gold standard disappeared in the '70s and since 1992 the pound hasn’t been fixed to anything. The reason our pound has value then is primarily because our government says it has value, and we – and many other countries in the world – continue to have a sufficient level of trust in our government. In particular, we trust the value of the money we hold because the government requires us to pay taxes in that currency. In other words, the very fact that the government asks us to pay taxes in pounds means that we seek to earn pounds in order to pay those taxes. And if we are seeking to earn pounds then such pounds have value. Their value lies not in their gold equivalence, but in the demand that everyone has for them.

But if they are not pegged to any fixed standard, then one implication of this is that the government (via its central bank) can just issue money as it sees fit. It doesn’t need to be backed by anything fixed and tangible. The government can just do it.

But if that’s the case then why do governments collect taxes – why not just print as much money as we want? Because to do so without restraint would cause runaway inflation, and in a situation of runaway inflation the value of our currency obviously does decrease.

So MMT is not a recipe for recklessness, there are limits to the magic money tree, but Kelton’s point is that the limits are set by inflation, not by the size of the deficit – hence the title of her book. Taxes then are one of the ways in which we stop the runaway train of inflation. They take money out of the system so that in essence we don’t have too much to spend. They act as a break on inflation, but critically – according to Kelton – they are not being collected so that we can pay for things.

As she argues, we don’t tax in order to then spend. We spend the money and then tax it partly to ensure there’s not too much of it sloshing around. 'The government doesn’t need our money. We need their money. We’ve got the whole thing backward.' All of which means we needn’t worry about the deficit in the way that most economists and politicians seem to.

Now all of this might sound a bit crazy – it just can’t be true. And that was very much my first reaction, and while MMT is certainly not mainstream economists it does seem as though those who would criticise it don’t quite manage to land their punches.

So, Edward Chancellor, an economic historian has suggested that following an MMT prescription would inevitably lead to inflation because 'The truth is that governments have an inherent bias towards inflation', but we’ve not had an inflationary problem for 30 years and with the current crisis the chances of that are near-zero. More to the point, inflation is precisely the one thing that MMT watches like a hawk – it is not a prescription for reckless spending.

More significantly, Martin Wolf in his analysis of MMT essentially argues that its framework is correct – the value of money is created by governments demanding tax receipts in that currency – but that we need to be careful, not least because governments cannot be trusted to implement it wisely. He has a point, but at the same time the history of neoliberal economics is that even with so-called responsible government behaviour huge boom and busts have occurred. It is not as though, in the absence of an MMT approach, our economic system has been devoid of crises. In other words, the problem he posits is not unique to MMT, it’s a feature of any reckless government.

So overall I’m quite taken with Kelton’s argument but I do have two critiques, not so much of the theory, but of the book. The first of these is simply that it does lack empirical support. There is a smattering of empirical evidence cited throughout but overall it feels somewhat thin. Presumably Kelton would argue that’s because MMT hasn’t been tried sufficiently and of course there may be some truth in this.

More importantly, I don’t think she does enough to directly engage with those economists who do reject MMT. It’s not enough to say they are just stuck in a different economic paradigm. I presume some of them are intelligent enough to be open to new ideas, so why isn’t it more broadly accepted? The book would have been considerably strengthened by dealing directly with such critiques.

Whether or not we need to worry about the current deficit is of major political and economic significance, and therefore for that reason this book is hugely important. MMT has been around for some time and so, in one sense, this is nothing new, but its arguments have to a large extent been ignored and ridiculed. It is time they were taken seriously and properly engaged with, and this book is a great introduction to ensuring that happens. MMT might still be dismissed but it can no longer be ignored and for that we can thank Kelton.

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