The Deficit Myth: a review

One common objection to neoclassical economics is that it underweights the importance of history and class. It is therefore paradoxical that Stephanie Kelton's The Deficit Myth, which claims to challenge orthodox economics, should be guilty of just these vices.

Let's start by saying that I wholly agree with the main claims she makes - that a government which enjoys monetary sovereignty can always finance its borrowing. Asking how we will pay for public spending is therefore daft. Instead, the question, as Dr Kelton says, is: can the extra spending be resourced? The constraint on raising health spending for example - if there is one - is a lack of doctors and nurses, not a lack of finance. Where there are resources lying idle, governments should raise spending to employ them. Dr Kelton explain these ideas wonderfully clearly, so I recommend this book to all non-economists interested in government finances.

For this economist, though, it poses a problem. I remember writing a research note for Nomura back in the early 90s arguing that increased government borrowing would not increase gilt yields because the same increased private saving that was the counterpart of government borrowing would easily finance that borrowing. Nominal gilt yields, I said, were determined much more by inflation than by government borrowing. But nobody accused me of originality. And rightly so. I was simply channelling Kalecki, Beveridge, Lerner and Keynes, who famously said back in 1933:

Look after the unemployment, and the Budget will look after itself.

For me, Kelton is - albeit very lucidly - reinventing the wheel. Reading her, I felt like Mr Jourdain in Moliere's The Bourgeois Gentleman, who was surprised to discover that he had been speaking prose all his life.

Here, Dr Kelton is more ambiguous than I would like. At one stage she claims that MMT "didn't exist" before the late 90s. But whilst the phrase did not exist, the ideas certainly did. Randall Wray is right to say (pdf) that "the main principles of functional finance were relatively widely held in the immediate postwar period."

And indeed Kelton does occasionally see this. There is passing reference to Lerner and to Keynes' How to Pay for the War, though not to Kalecki. And she cites JFK agreeing with James Tobin saying that "the only limit [on government borrowing] really is inflation."

Which is why I say she underplays history. I agree with Gavin Jackson that MMT is not new, and with Hans Despain that she neglects the ontology of MMT. We must ask, as she doesn't: why did these old truths get forgotten*?

I'm not sure about Wray's explanation, that it was because of the inflation of the 1970s. In principle, we might have interpreted that as consistent with functional finance, except that the inflation constraint on borrowing had tightened since the 50s.

Instead, I suspect the answer lies in Kalecki's great paper (pdf), "Political Aspects of Full Employment", written in 1942. He starts by saying "we are all 'MMTers' now":

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 plant to employ all existing labour power, and provided adequate supplies of necessary foreign raw materials may be obtained in exchange for exports.

What's not to like, he asks? His answer lay in something else Kelton neglects: class.

Capitalists, he wrote, disliked what we now call MMT because it weakened their power. If governments can use fiscal policy to maintain full employment, they don't need to maintain business confidence and so "this powerful controlling device loses its effectiveness":

The social function of the doctrine of "sound finance" is to make the level of employment dependent on the "state of confidence...[Capitalists'] class instinct tells them that lasting full employment is unsound from their point of view and that unemployment is an integral part of the " normal " capitalist system.

It is surely no accident that the backlash against functional finance came at a time when capitalists re-asserted their power over governments. Nor is it an accident that it's happened when capitalism has shifted away from mass-market Fordism to extractive finance capital: the former requires full employment and a mass market, the latter requires cheap money instead.

The analogy between government and household finances is of course a fiction - as we've known for almost a century - but it is a useful fiction for maintaining capitalists power.

Which is a big gap in Kelton's analysis. In treating public finances as merely a technocratic matter, she is ignoring the fact that capitalist power sometimes precludes good policy. She is making the error Kalecki warned us against:

The assumption that a government will maintain full employment in a capitalist economy if it only knows how to do it is fallacious.

Kelton is right. To implement her ideas (and those of Kalecki, Keynes, Lerner, Beveridge and Minskly!) however requires more than an intellectual (counter-)revolution. It requires a dismantling of capitalist power. And that's a tougher job.

* She neglects another historical question: if monetary sovereignty is as good as she claims, why were European nations (with the support of both public and economists) so keen to abandon it in the 1990s? One answer, I suspect, is that countries lacking the US's "exorbitant privilege" had less effective sovereignty. Whereas demand for Treasuries and dollars is so great as to give the US room to borrow, demand for drachmas, escudos and lira was not so great - and the dumping of such currencies meant their governments faced a tighter inflation constraint than the US.

Comments

[Danny Axford]

This book is certainly not aimed at (heterodox) academics, they're going to find it a little frustrating and unsatisfactory. This is a (very good) political pamphlet for the USA for the here and now.

[TickyW]

The issues I have with MMT are

1. MMT defines bonds as money. Keynes quite clearly illustrates that bonds are not money when he explains the speculative demand for money, eg, wealth holders have a choice between holding money and bonds. High interest rates encourage bond holding, low rates encourage money holding.

2. MMT fail to see that deficits are always funded either by debt or by selling real assets. To this extent, irony or irony, MMT ignores the principle of double entry booking. Money can not be created as a single entry in a central bank's books of accounts - there must always be an equal and opposite entry in the books.

Boring I know, but nevertheless inescapable.

All this is not in disagreement with the need for deficits - they are needed in times of war, pestilence, and famine (there are only 3 independent horsemen).

So really, I suspect Dr Kelton's book boils down to standard Keynesian economics.

Good points about class, Chris.

[Pete B]

"Keynes famously said in 1993..."
1933?

[phoenix_rising]

TickyW,

Government deficits are the norm, not the exception. This is because the non-government sector typically desires to net save, i.e., save in excess of investment.

Absent deficit spending, and because saving must always equal investment, the attempt to net save means that a portion of the non-government sector's saving will be unplanned inventory investment. That leads to recession and unemployment rises. Government tax revenues fall and welfare payments rise, and the deficit rises that way.

As such, the government's fiscal balance is non-discretionary. The only choice the government has is in what type of deficit the government wants to run, i.e., the good kind with full employment, or the bad kind with unemployment. The latter type of deficit will always be higher, and will be accompanied by more social ills, like higher crime rates, divorce rates, etc.

[Paddy Carter]

Does the book discuss the risk that a government following through on mmt policy advice might underestimate the difficulties, cock it up and end up with a stagflation problem that could be painful to sort out? E.g. the sort of risk the MMT sceptic worried about?

[chris]

@ Paddy - no. For me, one of the weakspots was her claim that a job guarantee would help reduce inflation by making otherwise unemployed people more employable, without addressing the opposite possibility - that a JG would raise wages.
For me, the fact that inflation is the only constraint on govt borrowing doesn't help us know the point at which inflation will emerge. In fairness to MMT, though, maybe is a purely conjunctural issue which should be addressed by the standard if unglamorous analysis if day-to-day data.

[Kevin Carson]

The #MMT focus on fully employing resources is unfortunate. It's every bit as Hamiltonian, in its way, as the TARP plan. The focus should be on level of output needed for a decent quality of life, not on keeping the inputs employed.

[Kallan Greybe]

I don't know if it's fair to say MMT ignores class. Bill Mitchell is quick to say he'd love to tax rich people out of existence for pretty explicitly class based reasons.

Surely it's right to fight one ideological battle at a time?

I mean, if it were down to me, tackling people's assumption that the state has purely monetary constraints seems like a pretty solid start.

[Ralph Musgrave]

I find Chris's idea that business confidence falls if full employment is maintained via MMT wholly unrealistic. Is Chris seriously claiming that the average business owner would rather have sales of £0.9X (combined with excess unemployment) rather than sales of £X?

[Peter K.]

Great review.

[Ralph Musgrave]

I forgot to mention that I've supported MMT for about ten years. Anyone can find hundreds of comments of mine on the blogs of the two co-founders of MMT, Warren Mosler and Bill Mitchell going back that far. So I'm thoroughly pleased at having helped bring about a major change in economics.

I do have other equally original ideas, but I'm far too worldly wise to think that more than a minute proportion of the population is interested in original ideas till they're almost part of the conventional wisdom and have at least a million followers.

[Paulc156]

@Ralph Musgrave
There's plenty of literature on what is referred to as 'capital strike'. Investment withheld for ideological reason or fear of government treading on business shoes.
And surely it's not such a stretch to accept the notion that big business would sacrifice what it saw as temporary profits to be bargained away in tight labour markets in favour of leverage and control over the workforce?

[Robert Mitchell]

"Nominal gilt yields, I said, were determined much more by inflation than by government borrowing."

How do Treasury Inflation Protected Securities change this analysis? If you are worried about inflation, you buy TIPS and inflation swaps.

Unlimited currency swaps at away-from-market rates solve small country inflation constraints ...

[Egmont Kakarot-Handtke]

MMT – a Wall Street myth
Comment on Chris Dillow on ‘The Deficit Myth: A Review’

Chris Dillow’s main point of critique is “For me, Kelton is – albeit very lucidly – reinventing the wheel.”

This is, in fact, a compliment because MMT is proto-scientific garbage and Kelton is an academic fraud.#1

MMT’s macroeconomics is provably false since Keynes, Kalecki, Lerner etc. So, MMT policy guidance has no sound scientific foundations.

The macroeconomic profit Law implies Public Deficit = Private Profit. This means that the greater part of profit in the United States is actually produced by the state. The US economy hangs for a long time already on the state ventilator for its survival.

Among all that the academic crap, MMT has the right message for Wall Street. Who is MMT’s first apostle? Right, Warren Mossler, ex-Wall Street. But Stephanie Kelton is, without doubt, the more attractive sales-person. Economics has become part of the entertainment industry long ago and the casting is done in Hollywood where they know best what sells.

The rest is marketing/PR routine. Interviews, book, media hype, No 1 on the best-seller list, and then, of course, trolling in the social media. This is where Chris Dillow comes in “Dr Kelton explain these ideas wonderfully clearly, so I recommend this book to all non-economists interested in government finances.”

MMT is itself a myth. MMT policy is NOT for the benefit of WeThePeople. MMT is the issuance of counterfeit currency in the form of deficit spending/money creation for the benefit of the one-percenters. Because PublicDeficit = PrivateProfit, MMT is the biggest redistribution program ever. MMT is a political fraud.

“Chris Dillow is a Marxian economist,” says Tom Hickey at Mike Norman Economics. There are historians who claim that already Marx was on the payroll of the financial Oligarchy.

Egmont Kakarot-Handtke

#1 More details
https://axecorg.blogspot.com/2017/07/mmt-cross-references.html

[Danny Axford]

It looks like someone should send David Gauke a copy of Kelton's book, I think there is undeniably still need for well presented explainers like the Deficit Myth.

[Ralph Musgrave]

Paulc156, Why would the extra profits that businesses earn when demand rises and unemployment falls to its lowest feasible level be "temporary"? Because workers are able to demand better pay when business is booming? But when business is booming, employers are ALSO able to award themselves pay increases by increasing their prices, strikes me.

[Blissex]

«Where there are resources lying idle, governments should raise spending to employ them.»

This is a typically narrow point of view that in essence negates the very valid behind "supply side" economics: just as there can be gluts of human resources, there can be gluts of material resources, and shortages of material resources too.

But also most people continue to confuse a "general glut" with a "particular glut". For example if the *only* resource partly idle is workers then government spending to employ idle workers is just going to create inflation, unless it is 100% redistributive, because production cannot increase in proportion.

Because only if *all* resources are partly idle ("general glut") production can rise if the idle parts are put in operation.

«provided adequate supplies of necessary foreign raw materials may be obtained in exchange for exports.»

As a rule that's the critical constraint. Especially as to imports of oil, as modern industrial systems depend far more more on oil than on capital or human resources for productivity.

«why were European nations (with the support of both public and economists) so keen to abandon it in the 1990s? One answer, I suspect, is that countries lacking the US's "exorbitant privilege" had less effective sovereignty.»

And that is because exporters, in particular of oil, demand to be paid in "strong currency", and freshly printer "drachmas, escudos and lira" are not going to make them part with their oil.

[George Carty]

Blissex,

You often bring up how Western (and particularly English-speaking) societies have been warped by greed for residential land speculation profits. Isn't the West's addiction to foreign oil yet another negative consequence of this greed, as working people are priced out of urban cores and thus move to low-density suburbia where they are dependent on cars to get to work, shops and other amenities?

I think there's a lot going for the Ecomodernist policy of dense cities powered by nuclear energy: the density fights dependence on oil, while the nuclear power fights dependence on the other fossil fuels. (Due to their inherently fickle weather-dependent nature, wind and solar are in practice mere supplements for natural gas rather than independent power sources.)

[aragon]

Look at the vast discrepancy in the distribution of resources. Economics has failed society!

And what resource is in such short supply that we need a glut of human resource in the UK of approximately Three

Million? (plus bullshit and gig economy jobs?) Enquiring minds want to know?

It's not oil looking at the oil price! It's not 1973, and economies are decarbonising due to climate change.

Is it land? most (50+%) owned by richest 1%, wealth in stocks and bonds, the richest 0.01%?

Why were European nations so keen to abandon it in the 1990's.

Not because of the public but because it suited the rich with globalisation (creating a glut of human labour) and maxamising shareholder value in the short term! Only the elite matter. Every unit of currency gets a vote in economics, resulting in efficiency of the transfer of wealth to the top 0.01%.

What is currently, the most valuable resource? Intellectual Property, is it in short supply?

We the raw material - people are not - and it is infinitely reproducible at zero cost and distributable over the

internet. The economic solution, artificial scarcity enforced by international law.

Another source of wealth, inheritance, not collectively as a society, but individually with an grossly unfair initial allocation.

We can spare resources for the yachts of the super rich, but not the population as a whole, in fact the super rich can stockpile currency and resources offshore.

“In its majestic equality, the law forbids rich and poor alike to sleep under bridges, beg in the streets and steal loaves of bread.”

― Anatole France

ditto Economics.

[Egmont Kakarothandtke]

aragon

You say “Every unit of currency gets a vote in economics, resulting in efficiency of the transfer of wealth to the top 0.01%.”

And how does this happen practically? This is due to the macroeconomic Profit Law which implies Public Deficit = Private Profit.#1 As a logical consequence, the public debt of WeThePeople is roughly equal to the financial assets of the one-percenters.

You are an economist, and this happens right before your eyes! And you don't see that the MMT policy of deficit spending/money creation is the biggest financial hoax of all times ($3.7 trillion)? And you do not wonder that the “Marxian economist” Chris Dillow applauds the Wall Street agenda pusher Stephanie Kelton? And all you can think of is this Anatole France kitsch?

Egmont Kakarot-Handtke

#1 Profit
https://axecorg.blogspot.com/2020/06/profit-axiomatic-economics.html

[aragon]

Egmont,

If you must issue bonds (double entry book keeping?), why not tax the rich at a (much) higher rate than the bonds return on unearned income?

Start with a Land Value Tax - LVT and inheritance tax (not a squeek from the dead), Capital Gains Tax in line with earnings is likely to be gamed.

What about taxes on debt and rent? A transaction tax on shares? Abolish compound interest - simple only.

https://www.theguardian.com/money/2020/jul/14/rishi-sunaks-capital-gains-tax-review-may-usher-in-higher-taxes-on-wealthy

"The chancellor said: “This review should identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behavior or do not meet their policy intent.”"

Or is the policy intent for the taxes to be avoidable? As that appears to be the outcome for the wealthy!

p.s

aragon is not chris, and I stand by the Antole French quote. Life is not fair.

[aragon]

Masters of the Universe (tm) upto thier old tricks?

From the Telegraph.
https://www.telegraph.co.uk/business/2020/07/14/have-care-global-stimulus-running-pandemic-has-defeated/

"Nobel economist Myron Scholes"
...
"His view is that the pandemic shock has broken large parts of the American economic system and accelerated the “death of Thatcherism” as dirigiste ideologies come back into favour. It will be a very long time before the process of creative destruction unleashes fresh growth."

To the Atlantic [link in the Telegraph article]

http://t.email3.telegraph.co.uk/r/?id=h4d33ee8a,38c38a46,36b15186

"And then, sometime in the next year, we will all stare into the financial abyss. At that point, we will be well beyond the scope of the previous recession, and we will have either exhausted the remedies that spared the system last time or found that they won’t work this time around. What then?"

Enjoy the read!

[Robert Mitchell]

"freshly printer "drachmas, escudos and lira" are not going to make them part with their oil."

Hence currency swaps: print lira, swap into dollars, buy oil, print more lira, swap into dollars, pay off first loan, rinse, repeat.

You can hedge by shorting lira at the same time, leading to a stream of dollars no matter what.

[Egmont Kakarot-Handtke]

aragon

You quote approvingly “It will be a very long time before the process of creative destruction unleashes fresh growth.”

It is pretty obvious that you have NO idea of how the monetary economy works.

The underlying problem is that the monetary economy (capitalism or communism does not matter) is NOT a self-optimizing equilibrium system but will eventually break down.#1

The Profit Law#3 Qm≡I−Sm tells one that macroeconomic profit is positive in a growing economy as long as the business sector’s investment is greater than the household sector’s saving. If this fails, macroeconomic profit turns into loss and the economy breaks down. This must eventually happen, what is unknown is the exact date.#2

However, there is a way to postpone the breakdown. The Profit Law including the state sector reads Qm≡(I−Sm)+(G−T), that is, the second component of macroeconomic profit is the state sector’s deficit. It holds Public Deficit = Private Profit.

This tells one that the greater part of profit in the United States is actually produced by the state. The US economy hangs for a long time already on the state ventilator for its survival.

The MMT policy of deficit spending/money creation is ultimately a means of postponing the breakdown of the US economy. From a political standpoint, the COVID pandemic provides a good rationale to mute the budget-balancers and to blow the deficit up to hitherto unknown proportions.

The volume of the deficit and the popularity of MMT#4 is a good metric for the acceleration of the breakdown.#5 This breakdown has nothing at all to do with creative destruction, it is destructive destruction. And it is very improbable that it “unleashes fresh growth” somewhere in the future.

If you intend to learn economics I recommend the new textbook Sovereign Economics.#6

Egmont Kakarot-Handtke

#1 Major Defects of the Market Economy
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2624350

#2 Mathematical Proof of the Breakdown of Capitalism
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2375578

#3 Wikimedia
https://commons.wikimedia.org/wiki/File:AXEC143d.png

#4 Keynes, Lerner, MMT, Trump and exploding profit
https://axecorg.blogspot.com/2017/12/keynes-lerner-mmt-trump-and-exploding.html

#5 Criminals and the monetary order
https://axecorg.blogspot.com/2019/10/criminals-and-monetary-order.html

#6 Amazon or BoD
https://www.bod.de/buchshop/sovereign-economics-egmont-kakarot-handtke-9783751946490