Home > Uncategorized > Modern Money Theory (MMT) vs. Structural Keynesianism

Modern Money Theory (MMT) vs. Structural Keynesianism

from Thomas Palley

A journalist sent me some questions about MMT. My answers are below.

1. What are the major flaws you see within Modern Monetary Theory?

(A) I like to say that MMT is a mix of “old” and “new” ideas. The old ideas are well known among Keynesian economists and are correct, but the new ideas are either misleading or wrong.

The essential old idea, which everybody knows, is government has the power to issue money. We used to talk of “printing” money. In today’s electronic world we talk about “keystroke” money created by electronic credit entries.

Everyone knows that because government has the capacity to create money, it can always pay its bills and debts by printing money. But having the capacity is not the same thing as saying it should, which is the beginning of where MMT goes astray.

In economic debate and economic journalism there is a “demand for difference”. On one side you have extreme budget hawks who see every deficit as a dire existential threat. MMT is the counterpart to the hawks. And here’s the rub. MMT is needed as an anti-dote to austerity hawks, but neither make for good economic theory.

That creates a dilemma for progressive economists. On one hand, there is need for a powerful progressive polemic to counter neoliberal austerity polemic. The basic MMT message that government has a lot more fiscal space than mainstream economists say, is correct. On the other hand, MMT’s theoretical arguments are not novel, and are sometimes incorrect. 

My past criticism has focused on MMT as economic theory. [READ HERE] and [HERE].

(B) I have found it is difficult arguing with MMT economists because they tend to change their positions. But here are some objections I have made in the past.

First, MMT economists used to say it is easy to have full employment without inflation. I don’t think that is true. As you edge toward full employment, inflation will increase.

Second, MMT economists tend to say the central bank should park the interest rate at zero and forget about it. I think that is crazy. It is throwing away an important economic policy tool, and it would likely promote dangerous asset price inflation and financial instability which would come back to haunt us.

Third, MMT economists say all a country needs is a floating exchange rate, and then it can use money financed budget deficits that push the economy to full employment. I think that is nonsense. Just ask an economist from Mexico or Brazil. Exchange rates matter a lot for economies, and the effects of exchange rates and exchange rate volatility ramify widely, often with very disruptive consequences.

The failure of MMT to provide good guidance for countries like Mexico is important. Economics should provide theory that holds up widely. MMT does not, which is a warning sign something is wrong.

The size of government deficits and how they are financed matters. Deficits involve issuing financial liabilities, and different financing policies involve issuing different mixes of liabilities. The extent and mix of liability issue can have consequences.

Fourth, MMT says government can spend its way to full employment by printing money and, when the economy hits full employment, government can just raise taxes and drain the money back out. That is a naïve view. First, the economy is made up of lots and lots of sub-economies so that some reach full employment long before others. That is why inflation starts to appear before full employment. Second, government does not just push a button so that taxes go up or spending goes down. There are vested interests working to stop their taxes being raised and stop favored spending programs being cut. MMT takes no account of these political complications, which adds a further dimension of critique.

Once MMT starts addressing these critiques, it collapses into fairly standard Keynesian economics. But MMT does not want to acknowledge that because it undercuts its policy polemic and claim to fame.

2. Could MMT ever provide an effective method for making policy decisions in the U.S.?

(A) MMT is best understood as political polemic, aimed at beating back the budget deficit hawks. It does not add to economic theory, so talking of policy being made according to MMT does not make sense.

As a political polemic, it has done a lot of good by riposting the budget hawks and by persuading people that government has much more financial space than the hawks say. Keynesians have also said that for a long time, arguing we can use budget deficits to fight recessions, finance infrastructure, and pay for part of on-going spending.

During the last recession, we did finance the budget deficit by “printing” money, but we did it in a two stage transaction called QE (Quantitative Easing). The government sold bonds, and the Federal Reserve then bought those bonds with “printed” money. That was standard Keynesian economics, which shows MMT adds nothing new to public finance theory.

However, owing to political and intellectual failure, budget deficits were not large enough in the early stages of the recession and recovery. And nor did we use the money in the best possible ways.

(B) The challenge is twofold.

First, we need to get Keynesians who had lost heart in fiscal policy to get back on board, and we need to beat back the budget hawks who say deficits are the end of the world. Unfortunately, much of the economics profession is made up of budget hawks owing to the triumph of neoliberalism and Milton Friedman’s Chicago School of economics.

Second, we need to persuade the general public about the role of government. Persuade people we need government to stabilize the economy. Persuade them that government should provide things (like health insurance & education) because the market is riddled with market failure & provides these vital things expensively, incompletely, and at a low level of quality. And persuade them that government has a lot of space to finance the programs we want.

But from an academic standpoint, there is a danger of over-stating how easy it is to finance these things. Yes, governments are different from households. They have the ability to borrow from future generations; they can issue money; and they can create a demand for their money by imposing taxes. But that does not mean they are free from market constraints and market competition, and they also confront difficult political constraints. That limits what governments can do.

MMT tends to oversimplify and understate these restraints. That is part of its political polemic which helps sell it. That makes for good politics but not good economic theory.

3. What economic theories do you believe are better suited for informing decisions on government spending?

I have long advocated a theory which I call “structural Keynesianism”.

The starting point is the Keynesian idea that a large number of problems in capitalist economies are related to aggregate demand, and especially aggregate demand shortage.

Economic policy needs to ensure that the process of demand generation is robust and sustainable so that it supports full employment.

That means paying attention to income distribution, because income distribution affects aggregate demand.

It also means having the right institutions and regulations that help ensure a robust income distribution, help prevent monopoly, and help prevent financial instability.

Government is a critical part of the structure. To set and enforce the rules of the game; to stabilize the economy in booms and busts; and to provide important things we need.

Doing that needs financing, which is why we must understand government finances. Budget hawks draw an analogy between households and government. That is an incorrect bad analogy. Governments have much more financial space than households, but that does not mean they are as financially unconstrained as MMT seems to suggest.

Lastly, the extent to which government is financially constrained depends on policy. That is why I have long advocated quantitative regulation, to strengthen monetary policy and increase government’s financial space.

  1. April 10, 2018 at 12:59 am

    Many thanks for this – it has crystallized my own big questions about MMT.

  2. April 10, 2018 at 2:19 am

    Interesting and illuminating intervention! I learned much from the Modern Money Theory (MMT), but I felt it necessary to make this kind of discussions on theoretical basis of the MMT and heterodox economic theories in general. Thomas Palley’s answer taught (or reminded) me three points:

    (1) All theory debates are involved in politics.

    (2) We should not judge theories by their policy implications.

    (3) Social theories including economic theories progresses through debates between pros and cons.

    Let me add a short comment on each point.

    (1) Theories are not free from politics, but …
    This is true but we should also keep in mind that theory (at least a good theory) has its own power that can change the political debate. Remind the last paragraph of Keynes’s General Theory:

    {A}part from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. (Chap. 24)

    (2) Policy implications
    There are so many anti-mainstream economics people who want to judge an economic theory only by its policy implications. We have to be cautious to the idea that a theory has its policy implications. Policies depends on the actual situation that the economy of a country is overthrown. Generally speaking, a theory which implies a unique policy is a bad theory. Either they are too narrow as a theory, or either they are too far from reality.

    (3) Deeper explanations than predictions
    I recalled Stanislav Andreski’s book Social Sciences as Sorcery. Many heterodox economists are against Friedman’s instrumentalism. Even though, they are prone to think in a prediction game language. Predictive power of an economic theory is not great, because economy is a complex system and does not permit simple prediction. Research strategy should be changed fundamentally.

    • Ralph Musgrave
      April 10, 2018 at 8:53 am

      Re whether economics can be kept separate from politics, I’d say the two basically CAN BE kept separate, though about 75% of so called “professional” economists are COMPLETELY HOPELESS at doing so.

    • April 11, 2018 at 3:56 am

      Very difficult question. It may not be a simple question of the capability of an individual economist.

      A theory framework is often biased for a specific direction. For example, the general equilibrium theory (à la Arrow and Debreu) excludes involuntary unemployment by its assumption (All resources are efficiently used). The same thing happens in international trade theory. Normal formulation excludes unemployment by assumption and economists argue that unemployment is not a serious question of trade conflicts.

      When we talk about policy implications of a theory, we should distinguish those that come from the framework itself, those that depend on particular assumptions on the state of the economy, and those that comes from political and ideological orientations .

  3. April 10, 2018 at 3:05 am

    As an amateur student of MMT, let me make these comments:

    1. “..we did finance the budget deficit by “printing” money, but we did it in a two stage transaction called QE (Quantitative Easing). The government sold bonds, and the Federal Reserve then bought those bonds with “printed” money. That was standard Keynesian economics, which shows MMT adds nothing new to public finance theory.”

    No MMT proponent that I am aware of has ever advocated QE. So why is Palley implying the opposite in struggling to prove his point?

    2. “MMT economists used to say it is easy to have full employment without inflation. I don’t think that is true. As you edge toward full employment, inflation will increase.”

    MMT proponents advocate a Job Guarantee which is a targeted program that aims to employ those whom the private sector does not need so that the inflationary impact is small. In the extract above, Palley ignores this proposal. But his criticism certainly applies to his own position, a general reliance on increasing “aggregate demand”.

    3. “MMT tends to oversimplify and understate these (difficult political) restraints.” As if political restraints don’t apply to all economic proposals, including the aggregate demand, income distribution, monopoly prevention, institutional and regulatory reform proposals of Thomas Palley!

    • April 10, 2018 at 5:45 am

      Indeed. Palley criticizes MMT as a bad sort of Keynesian economics, with various sorts on “nonsense” added (low or zero interest, unemployment eradication is easy, floating rates).

      But the history is that the “additions” went the other way. MMT is much closer to the economics of Keynes, FDR & Lerner. Apostles of low interest, targeted unemployment eradication and floating rates or national self-sufficiency. MMTers do not claim much originality in the basics. So MMT is mostly 1945 Keynesian + institutional, New Deal economics, simplified and modernized. IMHO this makes for a theory that is the clearest, most coherent, logically consistent, best fit to the real world available, with the most practical and imperative proposals.

      Postwar Keynesianism started out OK, but it kept on “adding” so much (wrong, illogical) stuff, stuff that Keynes himself had fought against, that it became closer to what Keynes criticized than to Keynes. And it became far less genuinely mathematical, with far less coherent logic than Keynes or Lerner or MMT.

  4. Craig
    April 10, 2018 at 7:18 am

    MMT, as Steve Keen correctly states, talks about government debt which is a smallish percentage of private corporate and personal debt. The paradigm of Debt Only of course is about all debt and its inevitable negative effects (the continual build up of debt costs and so prices to the point of deflationary collapse) as is its replacement Monetary Gifting which resolves that problem with a new economic philosophy, the comprehension of insightful stable datums within the chaos-complexity of modern economies that virtually all current economists are missing for a variety of reasons and enables the crafting of new policies whose temporal universe effects are the inversion and beneficial transformation of the problematic ratio of the greater flow of total debt costs/prices to rate of flow of total individual incomes simultaneously created.

    MMT has the mechanics of money creation correct, but it is mostly just an ideology looking for justification….the same as Keynesianism was and its various derivatives still are.

    It’s about the paradigm-pattern…not the details fallacious or true.

  5. David Harold Chester
    April 10, 2018 at 8:54 am

    There is much confusion in macroeconomics and the MMT does not help. It seems to be, as pointed out above, to be a combination of many past ideas, some of which are likely and some of which have political natures or are according to an agenda of making a change in our thinking processes in macroeconomics.

    1) As i see it, the nature of money existed even before actual money (currency) was used, because it was possible to extend credit (in its most general meaning) and that means that people began to trust one-another. Later the credit was redistributed and shared instead of being returned and this led to the creditor wanting some guarantee on the investment which took the form of interest on the sum involved. Governments (treasuries) were empowered to produce a kind of credit that had no return date and this was how money became separate from credit.

    2) The loss of the gold-standard in money had the effect of making it easier to create nationally provided credit, but it did not change the fact that it was there already. Recently economists have begun to accept that a government has the alternatives of paying for its expenses by raising more taxation or by issuing more money (often as “keystroke” form). The former moves the kind of employment from free-market kinds to national kinds, without reducing it. The latter seems to provide more employment but as the prices of goods rise due to the resulting inflation of “more money chasing the same goods” so that the effect of the issue is lost. Inflation is bad for savers and good for those in debt. But it is dishonest and should not be encouraged.

    3) The control of national progress by adjusting the bank-rate of interest has limitations. This is because if there is a big difference between this rate and the average rate at which shares in public companies behave, then there will be dangerous changes introduced to investment performances and instability is likely. So most governments find this to be only a long-term device with small changes only to be made.

    MMT does little more than explain these effects in more elaborate language but is not really new.

  6. rjw
    April 10, 2018 at 2:22 pm

    Thanks, useful post. I share a lot of these views. MMT has been useful in putting a strong emphasis on the institutional mechanics of money creation, and highlighting the importance of understanding this to get your macroeconomics right. But there is nothing in it that is fundamentally new. The problem is that MMT in itself does not generate a clear policy agenda, and some MMT hardliners push the policy envelope a long way without a sufficiently convincing view on how to handle the political economy aspects.

  7. April 10, 2018 at 4:20 pm

    “They (governments) have the ability to borrow from future generations.” Present day politicians love to say that deficits created today take money from the children of the future. How, pray tell, does that happen? It seems to me that every government (whatever its timeframe) spends into its own economy the amount needed to run public affairs.

    • David Harold Chester
      April 11, 2018 at 12:53 pm

      JJEHR–what it doesn’t add is by implication that when those future generations come along they too are expected to borrow into their future generations too. When we include the effect of interest, the debt steadily grows. Thus the continuous inflation of the national debt can be used to keep us all in the money supply chain. This Ponsi kind of activity, like the gambler who on loosing, doubles his next bet in the sure belief that eventually he will win and more than cover his previous losses, is unique to governments and is not advisable for us mere micro-economic entities!,

  8. Craig
    April 10, 2018 at 5:29 pm

    A few R. Buckminster Fuller quotes:

    “We are powerfully imprisoned by the terms in which we have been conducted to think.”

    “If I ran a school, I’d give the average grade to the ones who gave me all the right answers, for being good parrots. I’d give the top grades to those who made a lot of mistakes and told me about them, and then told me what they learned from them.”

    “You never change things by fighting the existing reality.
    To change something, build a new model that makes the existing model obsolete.”

    “If I ran a school, I’d give the average grade to the ones who gave me all the right answers, for being good parrots. I’d give the top grades to those who made a lot of mistakes and told me about them, and then told me what they learned from them.”

    • Craig
      April 10, 2018 at 5:32 pm

      That last quote was a mistake, but upon reflection I decided to leave it in….because typed and hopefully understood in a new unit of time/the present moment…it was new.

  9. April 10, 2018 at 7:22 pm

    Palley via link to “quantitative regulation” :

    “Financial markets in industrialized countries provide the resources that fuel the global system”. Not true. Nature, fuelled by the sun, provides such resources as we have.

    “Instability in these enormous markets poses the greatest potential threat to systemic soundness”. True. Not surprisingly, given that what are being bought and sold are bets on businesses acquiring more credit than they are worth by talking up prices. Second hand shares (like money is ultimately, made from thin air) are both a negative resource and a risk as far as real economic activity is concerned.

    I like JJEHR’s comment. The age we live to now, it is not our children who will need to reproduce in the next production cycle what we consume in the present use cycle; it is us.

  10. Craig
    April 10, 2018 at 8:18 pm

    The moment to moment macroeconomic reality of profit making systems is that the flow of total costs and so total prices exceeds the the flow of total individual incomes actually available to liquidate those costs/prices. Combine that with the monopoly on the form of money creation and distribution, i.e. Debt Only, which even at 0% interest incurs an additional cost….and one cognites on the fact that a new form of money distribution is required to resolve the problem, namely Monetary Gifting directly to the individual and reciprocally to the individual and then back to the merchant at the ending point of the entire legitimate economic process known as retail sale.

    Those that have eyes to see and ears to hear, let them see and hear.

  11. michael
    April 10, 2018 at 10:12 pm

    Is the Fed “government”? You can pretend. It is not federal although the name is
    Federal Reserve.

  12. December 10, 2018 at 7:43 am

    What this article fails to understand about the MMT claim is that this is not something people want to implement, it is how it already works. According to MMT this is why there is always money for war but not social programs.

  13. February 19, 2019 at 10:37 am

    As always, Palley makes sense. “Structural Keynesianism” taken as support of aggregate demand does not seem to be so far from MMT’s job guarantee and use of fiscal policy. The contradictions he points out are … let’s just say, both would inform a working economics and the contradictions are not so large. A system where banks create the money leads to what we have now. Government creating at least some of it is long overdue.

  14. ghholtham
    May 4, 2020 at 12:11 am

    D H Chester, You cannot borrow from future generations unless you have a time machine. You can only borrow from people existing now who will lend to you. They may pass their assets on to their offspring who will want repayment from other people living at that time. You have shifted income from tax-payers to bondholders at some point in the future; that is not “borrowing from the future”. It is an inter-personal not an inter-generational transfer. The way we influence the future is by the real investments we make or don’t make now. Physical and social Infrastructure we build now benefits future generations and they are disadvantaged if we don’t build it. We are glad to have the roads and schools and hospitals previous generations built. We don’t care who holds the bonds – they are probably in our pension funds anyway.

    • Meta Capitalism
      May 4, 2020 at 4:10 am

      Well said Gerald. Thank you. It is a keeper.

    • May 4, 2020 at 12:20 pm

      It was JJDHR who wrote (without attribution) about borrowing from future generations. D H Chester merely added the implication that our future generations will borrow from theirs, given the way the system is. Gerald, the implication of your comment seems to be that you don’t believe in “cause and effect”. Of course I agree with you on the way we influence the future, but “real investments” can be and are sabotaged by vested interests and mistaken ideas in government. Only partly joking, what I would like to see is government automated in a way which eliminates the one of hese, and avoids the other. Constitutional law requiring us to generate and account for trade finance with free personal credit cards could have that effect. Arguably, it would provide us with the information necessary for us to govern our own lives.

  15. ghholtham
    May 4, 2020 at 1:27 pm

    Dave. I am not questioning cause and effect. On the contrary, causal ordering implies I cannot take resources from the future and use them now. I can use only resources that exist at the present time. My effect on the future comes if I create additional resources for them to use or if I deplete or destroy resources that would otherwise be available to them. Borrowing does not necessarily do either of those things. It is the use of resources that affects the future not the way spending is financed. That just affects inter-personal income distribution.

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