- Principles of Modern Monetary Theory have come in handy as governments attempt to spend their way out of Covid-19
- Economists with new ways of thinking haven’t yet found a clear solution to the inflation problem
Stephanie Kelton doesn’t seem to think that her readers will believe that governments which issue their own currency have limitless spending power. She spends the first 40 pages of The Deficit Myth convincing us that economists and politicians have had it wrong for decades and that countries - unlike households - don’t need to come up with money before they can spend it and - unlike businesses - can’t go bust. When the book was published in early 2020 perhaps that argument was a hard sell. In the wake of President Joe Biden’s $1.9 trillion (£1.37 trillion) stimulus package it’s far easier to believe.
Those shuddering at the amount central banks including the Federal Reserve, Bank of England and European Central Bank are being asked to cough up to foot the Covid-19 bill might find comfort in the first few chapters of Kelton’s book. Her explanation of Modern Monetary Theory (MMT) does indeed make the reader question why there is ever any limit on government spending or why politicians put the public under pressure to ‘plug the deficit’ with excess taxation.
If the Bank of England can simply press a button to make more digital pounds appear in the public purse, why did firefighters, teachers and police officers suffer years of pay freezes under Tory austerity measures? And if issuing sterling-denominated bonds doesn’t undermine the UK’s financial independence, why now is the £200m cost of a 2 per cent increase in nurses salary even being questioned?
Kelton - an academic at Stony Brook University who also served as the chief economist for the Democrats in the 2015 Senate Budget Committee - asks similar questions of the US. Was Barack Obama right in 2010 when he suggested that because families across America were tightening their belts, the federal government should do the same? And is the PayGo system - which puts borrowing to finance new expenditure technically off limits - introduced by speaker Nancy Pelosi in 2018 good economics? Although this book steers clear of overt criticism of the Democratic Party, you get the sense that Kelton’s answers to both these questions is no.
But, perhaps unwittingly, the book also provides ammunition for conservative economists who are currently worrying that unrestricted spending might lead to a spike in inflation. “Demand-pull inflation occurs when businesses raise prices due to changes in buying habits,” she says and this often happens when “people are spending faster than the economy can churn out new goods and services.” Kelton points to the fact that exorbitant spending in the wake of the 2008/09 financial crisis didn’t cause inflation because the recession had resulted in a prolonged period of unemployment where people, factories, machines and raw materials sat idle. Increased spending allowed the economy to get moving again, resulting in more jobs and better productivity - the rise in demand was satisfied by an increase in production meaning prices stayed stable.
In 2021 unemployment is not especially low, particularly in the UK where the furlough system has protected jobs. There is the feeling that the economy is currently sitting on ice, waiting for its reopening. And if that reopening causes a surge in demand above pre-pandemic levels, supply might not be able to keep up, leading to a spike in prices and a fall in the standard of living. In the US, where unemployment is still below the 7 per cent mark defined by conservative economist Martin Goodfriend in 2014 as the level that would spark inflation, there are concerns that the country won’t be able to increase supply to satisfy the demands of the millions of Americans who will soon receive a $1,400 government bonus. Spending to spark growth is a good thing, but only if that growth is kept in check.
MMT’s solution to limiting inflation lies in small fiscal adjustments which work together to balance the entire economy. Kelton explains that operating a fiscal deficit does not necessarily mean a country is overspending and a deficit will only prove problematic if it does spark inflation. But the theory fails to offer a solution to the problem that economists have grappled with for years: what level of overspending will spark inflation and how do we control it if not with taxes? MMT may call for the use of taxation to ‘balance the economy’ rather than ‘balance the books’ but the effect is the same: politicians must ask citizens for more money and that is not something that will help them get re-elected.
Amid the melting pot of economic ideas bubbling away in the wake of Covid-19, the Deficit Myth doesn’t completely dispel the concerns of conservative economists. The book in fact highlights that before the coronavirus pandemic even some of the strongest proponents of MMT had not previously considered the levels of spending currently in play or the knock-on impact this might have in complex and finely tuned economic systems. But for those seeking an explanation for the challenges currently facing Rishi Sunak, this book is a must read. And - on the off chance that you find yourself deep in a discussion of economic policy when the pubs reopen next month - the sooner the better.