Scott Fullwiler: Paul Krugman—The Conscience of a Neo-Liberal?

By Scott Fullwiler, Associate Professor of Economics at Wartburg College

The old saying that bad press is better than no press is definitely true in this case. Without the advent of the blogosphere, our work would likely never even be noticed by the likes of Paul Krugman, so the fact that he’s writing about us (here and here) this weekend at least means we’re doing better than that, even if his assessment of us is far less than glowing. At the same time, and particularly given that Krugman is so widely read, it’s imperative to at the very least set the record straight on where MMT and Krugman differ. I should note before I start that others have done very good critiques already that overlap mine in several places (see here, here, here, and here).

Krugman makes three incorrect assumptions about what MMT policy proposals actually are while also demonstrating a lack of understanding of our modern monetary system (as is generally verified by volumes of empirical research on the monetary system by both MMT’ers and non-MMTer’s). These are the following:

Assumption A: The size of the monetary base directly (or indirectly, for that matter) affects inflation if we’re not in a “liquidity trap”

Assumption B: MMT’s preferred fiscal policy approach or strategy—Abba Lerner’s functional finance—is Non-Ricardian

Assumption C: Bond markets alone set interest rates on the national debt of a sovereign currency issuer operating under flexible exchange rates

Assumptions A and C are central to the Neo-Liberal macroeconomic model. Assumption B is a common misconception about MMT and a common perception of Neo-Liberals about the nature and macroeconomic effects of fiscal policy (i.e., Neo-Liberals often believe that activist fiscal policy is Non-Ricardian).

While MMT’ers argue that all three assumptions are false, one does not need to necessarily agree. The point is that to critique MMT on the basis of assumptions that are inconsistent with MMT is to actually not critique MMT at all. It is a straw man.

I explain these assumptions and how they relate to Krugman’s two posts as I go through the text of both. Krugman begins:

Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.

Of course, Krugman grants in his follow-up (below) that MMT’ers don’t say this at all, perhaps due to the many responses to this post pointing out his error, as this is simply a straw man that makes Assumption B—more on this below.

I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right.

Again, MMT’ers don’t say it is, either.

The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.

Krugman here is using the basic Economics 101 view of a liquidity trap, where interest rates and spending are unresponsive to continued increases in the monetary base. Paul Davidson has explained numerous times that this mainstream conception of a liquidity trap is not at all what Keynes was after, though I won’t go into that specifically here.

The MMT point here, instead, is that changes in the monetary base NEVER matter per se, at least not in terms of causing anything. Recall what the monetary base is—the outstanding quantity of currency (physical “money” held by the households and businesses, or in bank vaults) and reserve balances held by banks in reserve accounts at the Fed.

Increases in currency are portfolio shifts, generally out of deposits or savings accounts. These are not controlled by the Fed—the Fed enables banks to trade reserve balances for currency as banks anticipate their customers’ withdrawals. There is no such thing in the real world as the Fed dropping currency from a helicopter—that would be an increase in private sector income, not a shift in their wealth from savings accounts to physical currency (see here for more on this point). At any rate, the key point is that an increase in currency is a trade made by banks of currency for reserve balances. This occurs in response to the private sector’s desired currency holdings out of existing wealth and relative to existing income, and to the extent they are related to an increased desire to spend, the latter is certainly not caused by the fact that the Fed accommodates the desired portfolio shift.

Regarding reserve balances, the Economics 101 story is that banks use excess reserve balances to create loans. The reality is that a loan is created when a credit worthy borrower desires a loan at a bank’s stated interest rate (that is set consistent with the bank’s anticipated costs of liabilities and the anticipated credit risk of the borrower), and this loan creates a deposit for the borrower. No prior reserve balances necessary. If the bank is short its required reserves after creating the loan/deposit, it will borrow reserve balances in the wholesale markets; in the aggregate, the Fed will ensure sufficient reserve balances to meet requirements are available at its target rate, since that’s what it means to set a target rate. Should the borrower withdraw the deposit (as when a household takes out a mortgage and immediately uses the proceeds from the loan to buy a house), if the bank is short reserve balances to settle this payment it will automatically receive an overdraft to its reserve account and that it will clear by the end of business; again, the Fed ensures that sufficient aggregate balances are circulating that the target rate is achieved. For any individual bank, what matters is the cost of the liabilities the bank anticipates it will ultimately be left with as an offset to the newly created loan along with the capital charge associated with the loan. For this, it is the Fed’s target rate that can matter, but never the aggregate quantity of reserve balances circulating.

As an aside, it should be obvious that this all works exactly the same if a bank purchases, say, a bond from the private sector. The bank simply acquires the asset and credits the seller’s account with deposits. If this raises reserve requirements, then the bank acquires them in wholesale markets if necessary. If the seller banks at a different bank, then the bank may need to borrow in wholesale markets to cover an overdraft as it settles the bond purchase with the seller’s bank.

As with currency, an increase in reserve balances will occur in response to economic activity as reserve requirements increase after a loan has created a deposit (assuming the deposit ultimately remains a deposit and isn’t converted into a money market account or time deposit). More reserve balances don’t help banks make more loans; in the aggregate this will only reduce the overnight rate below the Fed’s target unless the Fed pays interest on reserve balances at its target rate as it has since late 2008.

This has been understood for decades by many heterodox economists operating under various titles such as MMT, neo-Chartalist, endogenous money, horizontalists, and Circuitistes. Particularly since 2008, an increasing number of mainstream monetary economists have started to figure this out, though it has yet to make its way to any of the undergraduate or graduate textbooks.

Returning to the main issue, Krugman here has invoked Assumption A—that the monetary base would matter if the economy wasn’t in a liquidity trap. The MMT response, as I’ve explained here, is that the size of the monetary base never matters per se. The currency component of the monetary base is entirely set in response to economic conditions, whereas reserve balances do not help banks “do” anything they couldn’t otherwise. Indeed, banks in Canada “do” exactly what banks in the US “do” even though the banking system in Canada has operated with 0 reserve balances for many years already.

So suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are once again imperfect substitutes;

Again, Krugman’s Assumption A is false.

Further, his assertion that the monetary base and T-bills eventually will be “imperfect substitutes” demonstrates his lack of understanding of monetary operations. The reason why reserve balances and T-bills are substitutes right now is because they both earn the same return—reserve balances earn the target rate, that is. (Note that the currency components of the monetary base earns nothing, and thus is not now and will not be in the case of any positive rate on T-bills a substitute for the latter.) If the Fed someday in the future does raise its target rate, the question is whether or not it will continue to pay interest on reserve balances at its target rate. If so, then reserve balances and Tbills will be substitutes, at least for banks (since non-banks don’t have reserve accounts and thus can’t hold reserve balances). If not, then the Fed will be forced to drain all the excess reserve balances not consistent with achieving its target rate by selling its own assets, reverse repos, or issuing its own time deposits.

True, reserve balances and T-Bills will no longer be substitutes, but “why” this is so and “how” the Fed will respond to this are far more important than asserting that this will occur. That is, whether or not reserve balances and T-bills are substitutes is entirely dependent on how the Fed chooses to achieve its target rate. Note further that if the Fed chooses to simply pay interest on the excess reserve balances at its target rate, leaving this part of the monetary base at its current size even when the economy leaves the so-called liquidity trap, this will not matter since banks can’t do anything with reserve balances besides settle payments and meet reserve requirements, and the Fed always supplies enough reserve balances in the aggregate to do these things anyway.

also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation.

Remember this point, since it’s key to Krugman’s Assumption B below.

The last time we were in that situation, the monetary base was around $800 billion.

As above, Krugman’s Assumption A is wrong and demonstrates a lack of understanding of monetary operations. Whether the monetary base is $800 billion and the national debt held by private investors is $9 trillion, or the two are reversed such that it is the monetary base that is $9 trilllion, is of no consequence. It’s merely a choice of monetary policymakers about how to achieve the target rate. In the former case, the Fed has set the target rate above the rate it pays on reserve balances and has drained all excess reserve balances not consistent with its positive interest rate target; in the latter case, the Fed has kept the target rate and the rate paid on reserve balances equal such that T-bills and reserve balances are “perfect substitutes” still for banks.

Suppose, now, that we were to find ourselves back in that situation with the government still running deficits of more than $1 trillion a year, say around $100 billion a month.

Here we see, for the first time, Krugman’s Assumption B: Functional Finance is Non-Ricardian. To define terms, “functional finance” refers to a fiscal policy strategy that uses deficits to manage the macroeconomy (for purposes here, the precise mechanisms by which this is done are not important; there’s a lot of MMT research on that point for those that are interested). The core point is that it is not the size of the deficit that matters, but rather the effects of the deficit. As such, MMT’ers only support large deficits to the extent that they do not push the economy beyond full capacity utilization and thereby create demand-pull inflation. Consequently, Krugman’s assumption here that the government is running $100 billion deficits/month must also assume that this deficit is consistent with full capacity utilization, and no more utilization than that, otherwise it is a larger deficit than any MMT’er would ever support. More on Assumption B below.

Ricardian fiscal policy is a Neo-Liberal economics term that refers to a policy strategy that brings the path of the government’s primary budget balance (the total deficit less interest on the national debt) in line with the government’s so-called intertemporal budget constraint. Where this is not the case, the path of the government’s primary budget balance ultimately brings rising inflation—even hyperinflation—or default to avoid this outcome due to exponential increases in debt service. This is referred to as Non-Ricardian fiscal policy. All sorts of fiscal policy strategies can be Non-Ricardian—running large, fixed deficits regardless of the state of the economy; maintaining a primary deficit at its current size even as debt service rises exponentially; and so forth.

MMT’ers generally don’t have much use for the intertemporal budget constraint (as I explain here—largely because it requires Assumption C to be true; MMT’ers reject Assumption C for a sovereign currency issuer under flexible exchange rates, as I also explain below). Nonetheless, and interestingly, Wynne Godley and Marc Lavoie demonstrate that a functional finance-consistent fiscal policy strategy is in fact Ricardian. This is true regardless how large the interest rate on the national debt becomes relative to the growth rate of the national debt since an increase in debt service that pushes the economy beyond full capacity utilization and thereby raises inflation is necessarily—in order to remain consistent with the functional finance strategy—offset by a decline in the primary deficit (see pages 12-23).

It’s important to clarify that while functional finance is Ricardian, it is not so “on purpose”; that is, the policy strategy is to sustain full capacity utilization—no more and no less stimulus than necessary to reach this point (again, MMT’ers have little use for the intertemporal budget constraint given the latter’s reliance on Assumption C). That the functional finance strategy is in fact Ricardian is a side effect—and, again, a very interesting one at that—not something that is pursued directly.

And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates.

This is Assumption C: Interest rates on the national debt are set by “market forces.” Krugman tries to push this heroic assumption without anyone noticing by inserting “for whatever reason” into the sentence, as if somehow he can just wave his hands and make it so. Indeed, “whatever reason” is the crux of the matter, and in this two word phrase he has assumed MMT’s vast literature on the monetary system away in order to make his argument against MMT. It’s like proving theory X is wrong by simply assuming all of the supporting evidence for theory X—for “whatever reason”—is wrong.

There is probably nothing more central to MMT than the idea that the government does not need its own money, since a currency-issuing government is by definition the source of its own money. Taxes, in the MMT framework, have the effect of giving the government’s money value, and also serve the purpose of managing aggregate demand. But since it does not need its own money, it also does not need the bond holders, wherever and whoever they are (and the last time I checked, China’s government created yuan, not US dollars).

Of course, governments—particularly when they are operating on an outdated understanding of the monetary system—can and do impose constraints upon themselves. In the US case, laws previously written by Congress forbid the Fed from providing direct overdrafts to the Treasury. As such, if the Treasury wants to spend and its balances are dwindling, it must either tax or issue bonds to do so. Unfortunately, this self-imposed political constraint is the starting and ending point for Krugman and most others, even as it has little to no economic significance according to MMT.

MMT’s approach to this self-imposed political constraint is more general. A currency issuer under flexible exchange rates that allows itself to receive overdrafts in its central bank account will see the interest rate on its debt equal to the central bank’s target rate at the very lowest. This is because the central bank cannot achieve its target rat in this case unless it pays interest on the reserve balances created by the government’s spending net of balances drained by taxes, and these central bank outlays will reduce the profits it turns over to the treasury (a de facto interest payment by the treasury). This is what I like to refer to as the strong form of MMT regarding interest on the national debt. If the treasury instead decides to issue short-term bills, or is required to by self-imposed constraints, these will arbitrage against the central bank’s target rate; if it issues longer-term bonds, these will mostly arbitrage against the current and expected Fed targets. I call this the semi-strong form, and explained it in more detail here and here. Randy Wray does, too, here. Losing access in the semi-strong form is a non-starter—the arbitrage opportunity grows stronger as the non-govt sector can borrow at a lower rate, and there are primary dealers and thousands of hedge funds that would love to take advantage of that trade.
In neither of these cases should interest rates on the national debt be considered to be set by “market forces” (aside from what Warren Mosler likes to call “technicals”). Further, the self-imposed political constraint is not a constraint of any economic significance—if one is given the choice between an overdraft at the central bank’s target and issuing debt at roughly the central bank’s target, does it really matter if the overdraft option is then withdrawn? MMT’ers say “no.”

Failing the strong and semi-strong forms of interest on the national debt—which I would argue would be exceedingly rare, though the probability is probably not 0—a final option would be for the central bank to purchase the government’s debt in order to keep interest rates on the debt from rising. I call this the weak from of MMT regarding interest rates on the national debt. Marshall Auerback and Rob Parenteau explained this option in more detail here. Here again, access to the bond markets isn’t the issue.

The overall point here is that the interest rate on the national debt for a currency issuing government under flexible exchange rates always is, or at the very worst always can be, a monetary policy variable. Concerns about “bond market vigilantes” are misplaced, as they could apply only to non-currency issuers (e.g., Greece, California) or fixed exchange rate regimes. Assumption C is false.

Finally, note that Krugman’s Assumption C here is related to his Assumption B, since, as explained above, neo-liberal economics holds that a government running a Non-Ricardian fiscal policy strategy can lose access to the bond markets (explained in more detail here). But, again, functional finance is Ricardian, so even if Assumption C were correct, the fact that that Assumption B is wrong makes it unlikely that Assumption C would be relevant at any rate.

So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations;

This is Assumption C again, though this time with the Fed’s intervention to keep rates from rising, as in the weak form described above.

either way, the government would in effect be financing itself through creation of base money.

Before Krugman again invokes Assumption A below, note that the Fed actually cannot do this and achieve a positive interest rate target unless it pays interest on the large quantity of excess reserve balances left circulating (Krugman’s “base money,” since as above these Fed operations aren’t about currency). In other words, an understanding of monetary operations reveals that the only way this can happen is if the Fed makes reserve balances and T-bills perfect substitutes, which was the scenario under which Krugman argued above that the size of the monetary base doesn’t matter.

So? Well, the first month’s financing would increase the monetary base by around 12 percent. And in my hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s not crucial) roughly in proportion to the increase in monetary base. And rising prices would, to a first approximation, raise the deficit in proportion.

This is Assumption A, as the rising monetary base is believed to increase the price level directly.

Recall, though, that the monetary base (actually, reserve balances, since that’s what’s increasing here) in this case is a perfect substitute for T-bills since the Fed cannot engage in these operations to purchase the government’s debt without paying interest on the reserve balances at its target rate. The alternative would be for the Fed to be unable to achieve a positive target rate. Again, Krugman’s own view is that the size of the monetary base doesn’t matter when it and T-bills are perfect substitute—his mistake was that his lack of understanding of monetary operations led him to believe this would only happen when the economy was in a so-called liquidity trap.

More importantly is the fact that a deficit that results in the non-government sector holding government securities is not less stimulative than where the non-government sector does not hold securities. To some degree at least, this should be obvious given that the latter operationally requires that T-bills and reserve balances be perfect substitutes. Note that any government spending results in recipients having more income and increased deposits in their bank accounts, while their banks have greater reserve balances. Taxation does the opposite, reducing income and reducing deposits.

A bond sale does neither of these. It is simply a drain of reserve balances (in the case of a bank purchasing the security) or deposits (in the case of a sale to a non-bank such as a primary dealer) and reserve balances (of the dealer’s bank) in exchange for the security. And the new owners of the security, or security holders in the aggregate, don’t suddenly have less spending power. Treasuries are the most liquid of financial assets and can be sold at any moment should the holders for whatever reason prefer deposits, and dealers that would purchase these from current holders generally finance their purchases by borrowing in repurchase agreement markets—that is, this process can result in the creation of additional deposits. Indeed, unlike deposits created by government spending, Treasuries can and do enable additional credit creation via repurchase agreements, often several times the market value of the security itself.

Similarly, if banks are holding Treasuries instead of reserve balances, as explained above, they don’t somehow have less ability to create additional loans/deposits. And given that the Fed would have to pay interest at the target rate on reserve balances in order to purchase government securities, the banking system would be indifferent between holding T-bills and interest earning reserve balances.

The issue is not whether a given deficit is offset by interest earning reserve balance or securities, since this choice does not create more or less inflation (aside from potential interest rate differentials if longer-term bonds are issued—and in that case the bonds can in fact be more inflationary than not issuing securities), but rather whether the deficit itself—which is raising nominal incomes—and the accompanying debt service—given the Fed’s interest rate target—is pushing the economy beyond full capacity utilization and thus potentially resulting in demand-pull inflation. If this occurs in a functional finance policy world, the appropriate response according to MMT is to reduce the primary deficit. Assumption B is wrong.

So we’re talking about a monetary base that rises 12 percent a month, or about 400 percent a year. Does this mean 400 percent inflation? No, it means more —.

All three assumptions are required to get this result:

The monetary base will only grow as fast as Krugman is implying if the Fed has set interest rates that high; the Fed could slow the growth by simply reducing its interest rate target. Assumption C is wrong.

It doesn’t matter how fast the monetary base grows, per se; what matters is the deficit itself relative to full capacity utilization. Assumption A is wrong.

MMT would argue that the primary deficit should be reduced if the combination of the existing primary deficit and the interest rate on the debt is creating demand-pull inflation. Assumption B is wrong.

because people would find ways to avoid holding green pieces of paper, raising prices still further

Apparently Krugman believes that Fed security purchases raise the quantity of “green pieces of paper.” They don’t. They increase the quantity of reserve balances while reducing the outstanding quantity of Treasuries. And we’ve already established that the Fed can’t do this unless T-bills and reserve balances are substitutes, while it is the interest paid on reserve balances that ensures banks will hold the reserve balances at the Fed’s target rate. Assumption A is wrong.
I could go on, but you get the point: once we’re no longer in a liquidity trap,
Assumption A is wrong.

running large deficits without access to bond markets

Assumptions B and C are wrong.

is a recipe for very high inflation, perhaps even hyperinflation.

Assumptions A and B are wrong.

And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base.

Assumption A is wrong. Yet again, what has to happen when the Fed buys Treasuries is that in order to achieve a positive interest rate target reserve balances must earn the target rate. This is sufficient to ensure someone will “hold the additional base.”

Whether this scenario is inflationary is based on (1) the primary deficit, (2) the interest payments on the national debt set by the Fed, and (3) the size of these two combined relative to the non-government sector’s net savings desired at full employment real GDP. If so, then one or both of these can be reduced.

At this point I have to say that I DON’T EXPECT THIS TO HAPPEN — America is a very long way from losing access to bond markets,

Assumption C is wrong.

and in any case we’re still in liquidity trap territory and likely to stay there for a while.

Assumption A is wrong. Krugman’s own straw-man scenario unwittingly makes T-bills and reserve balances substitutes.

But the idea that deficits can never matter,

Deficits can matter for MMT because Assumption B is wrong.

that our possession of an independent national currency makes the whole issue go away,

It makes the issue of “involuntary default” go away, while the interest on the national debt is or at least can be a monetary policy variable. Assumption C is wrong. The resulting size of the monetary base doesn’t matter either, since Assumption A is wrong.

is something I just don’t understand.

Clearly it is difficult for a Neo-Liberal to understand MMT.

Krugman’s follow up 24 hours later continued with:

I think one way to clarify my difference with, say, Jamie Galbraith is this: imagine that at some future date, say in 2017, we’re more or less at full employment and have a federal deficit equal to 6 percent of GDP.

Just to be clear, the assumption here must be that the six percent deficit is consistent with being at or near full capacity utilization and no additional demand-pull inflation. If not, then Krugman is making Assumption B, which is wrong.

Does it matter whether the United States can still sell bonds on international markets?

Why would it need to? And if it wanted to, why wouldn’t it be able to at roughly the Fed’s target rate? This is Assumption C again, and it is wrong.

As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary.


The perceived future solvency of the government is not an issue.

I don’t really know what “perceived future solvency” means. There are a lot of people, like, say, Bill Gross of PIMCO, who currently perceive that there are problems with the government’s future solvency. Has that mattered in any economically significant way for the prevailing interest rate on the national debt? No. And even if it did, there’s still the weak form of interest on the national debt available as a policy option.

What MMT’ers say is this: How could a government that issues its own currency face involuntary default? This is obviously not to suggest that deficits can’t be inflationary—though this would be imposing Assumption B, which for purposes here is obviouslyly wrong—or that governments cannot impose default on themselves (see here and here).

I disagree. A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary.

If it’s overly expansionary, then MMT would be against it and would argue in favor of a smaller primary deficit. Assumption B is wrong. Using tighter monetary policy instead will only “work” if the higher overnight rate reduces credit creation more than it raises government debt service; consequently, this could potentially require a larger reduction in the primary deficit than not altering monetary policy at all.

But if the U.S. government has lost access to the bond market

“Losing access” to the bond market for a sovereign currency issuer is a non-starter. The closest approximation would be for the central bank to set the interest rate too high or, in the weak form scenario, is purchasing the government’s bonds at too high a rate, such that interest on the national debt is rising so fast that inflation is rising. Assumption C is wrong.

But if this happens, then a primary surplus will be necessary to avoid inflation according to functional finance approach. Assumption B is wrong.

the Fed can’t pursue a tight-money policy —

The Fed can raise the rate it pays on reserve balances—recall that for Krugman’s scenario to work the Fed must pay interest at its target rate. True, this may not actually “tighten,” since it will raise interest on the national debt that much faster, and thus raise aggregate demand absent a reduction in the primary deficit. But interest rates certainly are still under the Fed’s control even if the transmission mechanism is not as the textbooks suggest.

In any event, fiscal policymakers can reduce the primary deficit if a reduction in aggregate demand is desired. Assumption B is wrong.

on the contrary, it has to increase the monetary base fast enough to finance the revenue hole.

Assumption C is wrong—debt service will only grow that fast if the Fed sets an interest rate target that high.

Assumption B is wrong—the primary deficit can be (and under a functional finance strategy, should be) reduced if it is large enough that demand-pull inflation is occurring.

And so a deficit that would be manageable with capital-market access becomes disastrous without.

Assumptions A, B, and C are wrong.


It has nothing to do with our situation now or in the future, or the situation of any other currency issuer now or in the future, as I’ve explained. It can only ever be otherwise if all three of Krugman’s assumption are true. But they are all false.

the rapid growth in monetary base since 2007 has taken place because the Fed is trying to rescue the economy, not because it’s trying to finance the government —

True. Not that it matters, though, since, yet again, Assumption A is wrong.

and that base growth can and will be reversed as soon as the economy gets anywhere close to full employment. (Actually, the big danger is that it will be reversed too soon.)

One last push for Assumption A, this time in reverse. That’s wrong, too. If a larger monetary base doesn’t matter, then it doesn’t need to be wound down, either.

So at the moment this is just an intellectual exercise. Still, it’s a point that needed making.

If only to demonstrate, for anyone who still remains unconvinced, that Krugman doesn’t understand MMT and, perhaps even more, doesn’t understand the basics of how the monetary system actually works.

To conclude by way of reiterating the main point here, one need not agree with MMT that the three assumptions Krugman makes are incorrect. The overarching problem is that Krugman has simply assumed the Neo-Liberal macroeconomic model is correct and the MMT view is incorrect. This is far different from actually demonstrating that MMT is incorrect, which Krugman has yet to even attempt.

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  1. a

    I think Krugman’s right on this one.

    And, while I think Krugman is more a neo-liberal than not, I don’t think Assumption A is particular neo-liberal. A neo-liberal is someone who is free-trade, pro-growth, pro-free markets (perhaps with some regulation), and generally pro-business.

    1. Benedict@Large

      There is nothing in MMT that is anti-free trade, anti-growth, anti-free markets, or anti-business. Yet MMT is quite distinctly not neoliberal. So we have a definitional problem here. My assessment is that neoliberals in general wish to compromise the fiat nature of the currency by superimposing upon it a Tax Standard, and it is in this manner that neoliberalism and MMT differ.

  2. kevin de bruxelles

    While everything in this post may well be true; the problem of international trade seems to be ignored by both Krugman and MMT.

    My theory would be that the current economic problems in the US are not caused by a lack of demand. Instead I would say that due to capitalism’s insistent search for lower wages, the nation-state of the US is acting like a leaky sieve and is unable to turn the robust domestic demand that it already has in abundance into well paying jobs that can support a middle class society. The demand that does exists either leaks over to low-wage countries like China through the process of globalization or, in the case of jobs that cannot move, the low-wage workers are imported into the US through the process of mass third world immigration. By ignoring these facts, both Krugman and MMT arrive at the wrong solution: more stimulus. The reason the US economy is running below capacity is because whatever demand it contains leaks away towards low-wage situations. While it would never be sealed totally shut, until the leaky sieve that is the US economy is adjusted to drain away less demand then increasing stimulus will just leak into China or draw even more low wage workers into the US. Once these leaks are slowed down then we could see if stimulus is really required.

    One constraint that needs to be emphasized on the US dollar also involves international trade. Right now the US relies on Islamo-fascist dictatorships in the Gulf region to impose on their populations the acceptance of US dollars in return for oil wealth. The same process occurs in China where a nominal Marxist-Leninist dictatorship imposes on its proletariat the production of consumer goods in exchange for US dollars. As long as these dictatorships stay in power the US has little to worry about. But if the day ever came where there were to be an Arab Spring (d’oh it’s already started!) or a Jasmine spring in China and these dictatorships were replaced by democracies, we could begin the see that these countries would begin to examine very closely US economic policies before accepting boatloads loads of US Dollars in exchange for boatloads of goods or oil.

    1. Anonymous Jones

      I had similar thoughts reading this post (which I still found to be relatively worthwhile).

      I generally see the merit in many of the MMT posts here. At the same time, very rarely do these posts discuss the type of allocative effects I think most important.

      It would be interesting if the MMT crowd would more clearly describe, for instance, what they think the effects of financing the deficit without issuing bonds would do to trading with countries like China that prefer to run trade surpluses (in effect, deferring consumption of US goods that could have been received in return for Chinese goods sold here). Would the Chinese be as eager to hold other assets or currency? What would this do to our cost structure if they were not? Also, as I have said before, taxes, especially because they fall in complex and obviously disproportionate ways, have severe allocative effects among the citizens, regardless of the extent of their macro effect on inflation, etc., and this fact seems to be ignored time and again when taxes are discussed with respect to MMT.

      Allocation of consumption among the population and across different time periods seems to me to the main issue at hand. Everything should be brought back around to that.

      1. Benedict@Large

        You are missing the point. MMT does not suggest that the deficit be financed without issuing bonds. MMT says that the deficit is NOT financed by bond issuing bonds (in fact, it is not “financed” at all), in spite of the fact that conventional wisdom says it is. Convetional wisdom, in this case, is incorrect.

        It is important to understand that this is not theoretical. When the lifecycle of a fiat currency (with floating exchange) is laid out via a double-entry bookkeeping model, this is simply what is observed.

        1. Jason X. Ray

          I don’t think Anonymous Jones is missing the point. I think he/she is taking MMT to its logical conclusion: the real world. MMTers (and I’m one of them although I try not to do this) seem to fall back to the Abstract the second someone suggests actual implications. One can’t keep claiming it’s just a process that MMT describes because it’s part of the real world.

          MMT needs to describe the implications of running a large deficit that has been deferred. It does in a way, but only in a perfect world where all assets are up for grab to the highest bidder, and where an economy has the capability to meet suddenly increased demand.

          Also, I think that it is this type of mindset that can arise in the MMT community that led to the large balance of payments deficit. It was Nixon’s people who were warned of the implications of continuing massive spending, much of it which went overseas, after ‘going off’ the gold standard. They understood the mechanisms, but not the implications.

          1. Nathanael

            Like most macroeconomists, MMTers don’t seem to spend that much time thinking about the details of how the economy can absorb increased demand.

            The logical way to do it, if there’s some question as to how to do it sustainably, is through targeted industrial policy: pick sectors which we want to grow (clean renewable energy, for example) and steer the money towards creating sustainable businesses in those sectors (training workers, financing businesses, financing people’s purchases of their product, penalizing purchases of alternative products like dirty energy, etc.).

          2. stf


            That comments suggests you haven’t read much MMT. The core MMT proposal, the job guarantee, is all about considering “how the economy can absorb demand.” There’s about 20 years of published literature on this topic, both theoretical and applied. Bill Mitchell finished a 300 page report on this for his region of Australia a few years ago, for instance.

    2. Philip Pilkington

      A few random thoughts on this…

      “Instead I would say that due to capitalism’s insistent search for lower wages…”

      Certainly, this is a true description. But it is important not to abstract the term ‘capitalism’ and turn it into a sort of deus ex machina (that is, after all, a neo-liberal position). There is no ‘inherent’ tendency in capitalism as such. Capitalism is what we choose to make it – the State overrules capitalism, after all (see: China, Scandinavia, pre-Reagan US etc.).

      Investors will go to China if economic policy isn’t run properly in the US – simple as. MMTers seek to put policies in place that will prevent this from occurring.

      “The demand that does exists either leaks over to low-wage countries like China through the process of globalization…”

      Once again, you’re lending an abstraction – in this case ‘globalization’ – an agency it doesn’t possess. (The Marxists used to call this ‘reification’). ‘Globalization’ is not – despite what Tom Friedman says – an autonomous force. It is what we make of it through economic policy.

      “…increasing stimulus will just leak into China or draw even more low wage workers into the US. Once these leaks are slowed down then we could see if stimulus is really required.”


      “…both Krugman and MMT arrive at the wrong solution: more stimulus.”

      This is all just wrong-headed. You’re assuming that stimulus only works on demand. Obviously it doesn’t – it also has effects on supply. Stimulus gives rise to more production as well as more consumption. So, you can’t say definitely that stimulus will ‘leak’ to China. Some Chinese goods will be bought, but production in the US should also increase. This isn’t a zero-sum game…

      Also, MMTers seek to use stimulus (in the very specific sense of a jobs guarantee program) to reassert the trade balance between the US and other countries. Its my understanding that were MMT policies pursued the dollar would devalue vis-a-vis the yuan. This would lead the trade balance to tip back in the favour of the US. In fairness this is probably true of Krugman too.

      “The same process occurs in China where a nominal Marxist-Leninist dictatorship imposes on its proletariat the production of consumer goods in exchange for US dollars.”

      Sorry, that is completely crazy – almost conspiratorial. The CCP don’t ‘force’ their citizens to export to the US. This is a symbiotic relationship. The goods produced in China have nowhere to go except to the US – certainly the Chinese can’t have them until they have sufficient domestic demand.

      If the Chinese stopped accepting US dollars their production base would collapse due to insufficient aggregate demand. Why would any Chinese person want that to happen?

      “But if the day ever came where there were to be an Arab Spring (d’oh it’s already started!) or a Jasmine spring in China and these dictatorships were replaced by democracies, we could begin the see that these countries would begin to examine very closely US economic policies before accepting boatloads loads of US Dollars in exchange for boatloads of goods or oil.”

      Interesting to see that you don’t go into specifics there… So, what would these new democracies do? Collapse their aggregate demand by refusing to accept US dollars? Yeah, that would be a great idea…

      1. kevin de bruxelles

        I agree with your comments on capitalism and globalization but it should be obvious that since I am calling for changes (stop the leaking sieve) that I so not see the current forms we find of these two processes as determined or inherent.

        Where I think you start veering off the tracks though is on focusing on the wrong kind of stimulus. The US has pumped up its deficit from 400 billion to more than 1.3 trillion dollars a year of stimulus and unemployment has barely budged and production is still fleeing the US. Sure we could try pumping it up to say 2 trillion a year but I got to believe most of that money will just be flooding into that vault where the Chinese hold all their treasury bills. Pumping increasing amounts of top-down stimulus into a leaking sieve is hopeless. I prefer two alternative forms of stimulus. One is to turn Chinese factory worker’s one dollar an hour jobs into $40,000 a year jobs for Americans. The other is to turn those $7 an hour illegal immigrant’s under the table construction job into a $20 an hour job for a union carpenter. If you repeat these two small little moves enough time you will indeed see a serious shift in both the unemployment figures and in government tax receipts. In this way instead of the government paying these guys to work or welfare, these guys are paying the government taxes to help rebuild the crumbling infrastructure, etc.

        And I agree it is not zero sum, through these simple moves if America’s economy gets booming again then there will be ample opportunity to help China and Latin America blossom as well.

        The points on Saudi and China were just to show the system was not endogenous but outside factors have to be taken into account. Generally the Saudis have kept oil prices artificially low over the years and combined with a rapidly rising population have meant per capita oil benefits are dropping. A Saudi democracy might not look kindly upon 3 trillion a year deficits and might even allow the price of oil to climb if this were to happen.

        In China the communist party strongly dampens demand from its proletariat. The Chinese people work and work in order to trade finished products for baskets of green money that end up sitting in a vault somewhere as currency reserves. It’s a little like slavery; the Chinese people are fed and given a subsistence standard of living while the work these people do is worth much more than that. A democratic China might very well decide that holding down domestic consumption is not in the people’s interest especially if they see the US running ever larger deficits. This is probably going to have to happen anyway but it would be better for the US to start repatriating those jobs as soon as possible to dampen the inflationary effects of having your workforce paid in a foreign currently when the Chinese do stop pegging to the dollar and the Yuan skyrockets in value.

        1. Nathanael

          I think it is crucial, indeed, to analyze where the stimulus went. Unfortunately, well over half of it went to tax cuts for the well-to-do. All respectable forms of economics will tell you that this doesn’t actually increase demand, *or* supply. It just shuffles accounting around, crediting the rich with more money and the government with less.

          Stimulus spending which went to actual construction within the US, or even for the importation of goods which will generate future value (such as manufacturing tools, trains, etc.), clearly benefited the country. The key question is not about the movement of money but about the movement of resources.

          I could perhaps point out that “jobs” are not a goal in themselves; the utopian situation would allow people to live comfortable lives without “jobs” and to indulge their avocations for the betterment of humanity.

          It is simply the failure of the economy to improve the life of the average American (for over 20 years now) which is the problem. From this point of view, the problem is not so much that the “jobs” are going to China, but that the wealth which the US receives in exchange for this is being concentrated in the hands of a small superrich club, rather than being distributed among average Americans.

    3. DownSouth

      kevin de bruxelles said:

      One constraint that needs to be emphasized on the US dollar also involves international trade. Right now the US relies on Islamo-fascist dictatorships in the Gulf region to impose on their populations the acceptance of US dollars in return for oil wealth. The same process occurs in China where a nominal Marxist-Leninist dictatorship imposes on its proletariat the production of consumer goods in exchange for US dollars.

      This has resonances with what Carroll Quigley calls the second age of conflict in Western Civilization, the time from 1650 to 1730 (the end date was much later in France) in which commercial capitalism had degenerated into state mercantilism.

      Here’s Quigley:

      [The stage] can be seen in legislation, which devoted itself, after about 1650, to the defense of the status quo or to the effort, by political action, to obtain a larger share for oneself of what was regarded as a static and unexpandable body of the world’s wealth… In France these efforts culminated in the crafts codes of Jean-Baptiste Colbert. Issued in seven volumes of 2,200 pages over the period 1666-1730, these sought to prescribe every detail of the established craft techniques and to proscribe innovations in these. Economic aims and economic values were distorted and frequently reversed so that consumption was condemned as an evil, abundance abhorred, work praised as an end in itself, exporting courage, and property regarded as a good because it was the only way to keep people working. The esteemed Sir William Petty (1662) believed that a country could get richer and richer by exporting more and more and that it would be a good thing “if the products of the labor of a thousand men could be burned” since these men could then keep their skills by having to make the goods over again. Charles Davenant in 1698 wrote, “By what is consumed at home one loseth only what another gets and the nation in general is not all the richer, but all foreign consumption is a clear and certain profit.” More briefly in 1673 Becker wrote, “All selling is good, all buying is bad,” while in 1677 John Houghton drew a logical conclusion from these ideas by suggesting that England could get richer by inviting foreigners to come in to “consume our corn, cattle, cloths, coals, and other things.” It was suggested that an enemy in wartime could be greatly weakened if he could be flooded with goods and, as late as 1810, that last great mercantilist, Napoleon, issued licenses to smugglers to carry goods into England secretly. De Mandeville praised vice because it was unproductive, while Defoe praised a law forbidding a more efficient cnalboat able to do the same work with fewer men.

      It can hardly be expected that ideas and statements such as these could be fitted together to provide any self-consistent and convincing economic theory, but even as they stand they reveal a determination to defend isolated vested interests such as prevail in a period of institutionalized organizations.

      As might be expected in such a period, the century 1650-1750 was one of imperialist wars, of class conflicts…and of irrational confusion.

      1. Nathanael

        Nice quote from Quigley. Our modern version, however, is different and more pernicious.

        Work is considered valuable in itself (people call for “jobs”, not leisure, and the Puritan work ethic is in full flower, and the unemployed are attacked). Yet policies are pursued which will reduce the number of people working, automating everything and firing people. The common thread? These seemingly contradictory policies allow the plutocrats to convince people that they should work for free under slave conditions, which benefits the plutocrats.

        Vested interests, indeed, are fighting for themselves even at the expense of everyone including them. Zero-sum thinking must be at the base of it.

  3. Brick

    Despite the fact that there is a lot to agree with in this post there are some nuances which suggest to me that both view points are slightly wrong. Firstly I would agree that it does not matter how fast the monetary base grows exactly, you do need to take into account liquidity conditions. Liquidity trap might be the wrong way exactly to describe it, although that partly covers it, perhaps it’s a combination of liquidity trap, capital destruction and velocity of money deceleration, due to a combination of reasons.

    Next we come to the arguments about deficit and the bond markets. It is clear to me that the US could continue with a complete US bond market shutdown, but the consequences are such that this might not be a rational thing to do. It is not just about the size of the deficit, but the size relative to GDP compared to other nations. Bond, currency and trade markets are interwoven such that currency and trade alter if authorities do step into the bond markets. Possibly one of the mistakes the FED is making is that it is assuming that the bond market has not really changed during QE2.

    Deficits matter because you do not want volatility in your currency exchange rates. Questions then rise about how much the price of fuel can change without a detrimental affect to the taxation base, how price sensitive are US goods and are there world alternatives. I also get a little worried that foreign holdings of US treasuries don’t figure that strongly in arguments. These may not have a direct impact on the US economy, but you cannot assume that trading partners will not put up trading barriers or effect consequences which would affect the economy.

    For me there are flows and feedbacks which mean the theoretical does not quite work due to unintended consequences. Its top down modeling and I would rather see bottom up. Start with modeling your average worker, your investor, your business, your banker, your foreign counterpart decision makings. The US deficits may not matter currently, but I would contend that they will if deficits elsewhere begin to stabilize. It is not just the interest on debt you need to worry about ,but perceptions about trade and currency as well.

  4. JKH

    Well done, Scott.

    The error that was most glaring to me was his complete misunderstanding of monetary base causality and dynamics, which sets him up for a range of knock on errors. Of course, he has a lot of company there. But that’s the operational North Star for all the other issues, in my view.

    As usual, you have demonstrated your extraordinary expertise in monetary operations. Your comment about the education of mainstream since 2008 is interesting and hopeful in that regard. I hope someday you will be given the credit you will be warranted for doing the hard ground work in moving the rest of your profession to get up to speed on this critical stuff.

      1. vimothy

        Hi Scott,

        Agree that this is a great piece–the best, most clearly thought out response I’ve seen so far.

        I think you’re both missing a trick on IOR here though. If you pay the T-bill rate on reserves, so that the private sector is indifferent between base and T-bills, then logically the govt should be indifferent between financing with base or financing with reserves, and it’s not clear to me what this buys you.

        I.e., Krugman is saying what if hypothetically govt doesn’t finance its deficit by borrowing, and you seem to be saying that he’s at fault because he doesn’t take into account the fact that govt can finance its deficit by borrowing (T-bills/IOR).

        1. vimothy

          Should read,

          “the govt should be indifferent between financing with base or financing with T-bills”

        2. stf

          What Krugman misses is you can’t finance with base money without IOR. He doesn’t realize that financing with base money and bill are the same.

          So, I agree that govt should be indifferent b/n that and bills. That’s something I’ve often argued myself. The point is, though, that the govt doesn’t have that choice if the Fed can’t give overdrafts. Not that it matters, in my view.

          1. stf

            What bill financing = base financing “buys” you is the understanding that interest rate on the debt isn’t set by “markets,” since bills arbitrage with the target rate.

  5. jake chase

    Any economic actor anywhere will raise his price whenever he can. If we have low inflation at any point in time, the simple cause is a lack of pricing power caused by competition. Most of the competition now exists in the labor market, although a good deal also now exists in tradeable goods such as autos.

    Debates on monetary policy are smokescreens to cover issues of power. Money created by banks enabled by the Fed is no less inflationary than money created by governments. It does end up in different pockets, which is what all the fuss is about.

    1. Cynthia

      Because Krugman is a longtime member of the debt-is-money club, he is clearly of the opinion that we can spend our way back into prosperity. But because he is more of a fiscal dove than a monetary dove, he’d rather see us return to prosperity by using our fiscal might than by using our monetary might.

      Which makes me wonder why he is holding back on being critical of Ben Bernanke, a loyal heir to the Greenspan throne, for being overly dovish in terms of monetary policy. It doesn’t take someone with a Nobel prize in economics to see that firing up the printing press to warp speed, cranking out billions in free money to the big banks, is not only causing oil and other commodity prices to rocket to the moon, but it’s also causing the stock market to break loose from all things that are real and growth producing about our economy, where it’s now living in its own little bubble world, just one needle prick away from going pop!

      Ground Control to Major Tom
      Your circuit’s dead, there’s something wrong
      Can you hear me, Major Tom?
      Can you hear me, Major Tom?
      Can you hear me, Major Tom?
      Can you….

      1. Nathanael

        Actually, there are unfortunately better analyses of the economic problems you describe.

        * Food commodity prices are up because of major worldwide crop failures. This should be a much bigger story than it actually is. The crop failures are due to global warming, of course. Speculators, knowing about global warming, are simply piling on in expectations of future crop failures.

        * Oil prices are going up due to peak oil (more accurately “peak cheap-to-extract oil”). Same analysis applies, except that there aren’t really any speculators at the moment, or oil prices would be going up faster.

        * Note that OTHER commodity prices are largely flat or down, not counting gold and silver (which rise due to distrust of governments). Check out base metals, aggregates, etc. — all DOWN in price.

        * The stock market rise is the most interesting. This is best explained by an analysis I read a while back: when there is massive additional money going to the *poor*, you get inflation in ordinary goods and services. But when there is massive money going to the *superrich*, they all want to “invest” it, and most want to invest it “safely”. So you get massive inflation in *asset prices*, particularly in perceived “safe” assets. This caused the housing bubble. This caused the generation of phony AAA “securities”. This caused most of the financial engineering which we saw leading up to 2008. Now that money is fleeing the exotic things, it has to go somewhere, and the stock market is still perceived as “safe enough”. When the next major round of corporate frauds come out, the money will probably go into government bonds (a lot of it already has) or into purchases of land outright (also already happening, and could lead to a neo-feudal economy).

        * In other words, the stock market bubble, like the housing bubble, is caused by *inequality* — by allowing the superrich to get too large a percentage of the money.

        1. Nathanael

          I will point out that my analyses are substantially more frightening than yours! Essentially, what the Fed does is just fiddling while Rome burns, in my analysis.

  6. Timothy Gawne

    Let’s cut through the Gordian knot of complexity here.

    “Neo-Liberal” economic models have zero predictive power when applied to real-world situations. Therefore “Neo-Liberal” economic models have no validity. End of story.

    “Neo-Liberal” economists display zero concern when their models have no predictive power in real-world situations. Therefore “Neo-Liberal” economics is not a science, but a refined form of propaganda, and “Neo-Liberal” economists are

    A. Useful idiots
    B. Corporate shills
    C. All of the above.

  7. gf

    C. All of the above.

    I would also add that if bond markets have as much control over government decision making as they appear to have in Europe, then those governments are no longer functioning democracies at all. Bond markets are just another way to usurp government power and effectively redistribute money up the ever narrowing wealth pyramid.

  8. Max424

    Billy Mitchell calmly weighs in from Down Under.

    Giggle. It’s more like bilbo erupted out his corner throwing lethal combinations, looking to knock PK right out of the ring and in to the economic dustbin.

    Paul better wake up and take these guys seriously. MMT lads and lasses are not fraternal Friedman-Chicago School neo-liberals — with whom you can spend a professional lifetime engaged in amiable quibbling; nor are they Austrian lunatics, that can be deservedly scorned outright. No, leading MMT advocates believe their theory is sound (are convinced it is sound), they have done their homework (massive amounts of homework), and they’re looking to engage.

    I for one have been waiting for this for three years, felt it had to come, and felt it was inevitable the Professor was going to be the portal. Perhaps PK is aware of this, understands his role, and has made a decision (finally!) to do his professional duty and provide the theory a public forum (as senexx postulates in the comments section); or, maybe not.

    Either way, the cat is out of the bag. The Professor now has two choices, he can take MMT on in a fair and open exchange, or he can get right with history (liberal history), and join the MMT camp ( I hope so). But the one thing he cannot do, he cannot brush the theory aside with nonsensical babble, and still call himself a professional economist.

    Note: The Conscience of a Liberal. No sir! You cannot be both a liberal and a neo-liberal — the two are diametric opposites

  9. z. todorova

    I am a bit surprised that none of the comments above (one exception is the one by JKH) show any remote understanding or appreciation of the magnitude of Scott’s extraordinary response to Krugman’s straw man. Rather, they go onto tangential directions missing the main point.

  10. Hugh

    “Conscience of a neoliberal” is just brilliant. Conceptually, I don’t think that Krugman ever left the gold standard. My concern is that I don’t see how MMT fits into our present situation of kleptocracy, wealth inequality, and class warfare. For MMT to work for the good of the many, there must be some minimal level of good intentions by those who run the financial system. A fact not in evidence. In this regard, Krugman’s neoliberalism is much more comprehensible since its purpose is to direct attention away from the underlying looting of his class and so keep it going as long as possible.

    1. stf

      Thanks, Hugh! Regarding your concerns, have you seen the research by Bill Black and Jamie Galbraith (separately, of course) on at least some of these issues? They’re both in the MMT “camp.”

  11. softinthehead

    I am a bit surprised that none of the comments above (one exception is the one by JKH) show any remote understanding or appreciation of the magnitude of Scott’s extraordinary response to Krugman’s straw man. Rather, they go onto tangential directions missing the main point.

    I for one understand very little of Scott’s explanation. I’m going to read it some more because he seems to think he’s got some important points to relate, but he’s not relating them very clearly at all. honestly, I don’t even know what his main point is other than “Krugman sucks !”.

  12. Rodger Malcolm Mitchell

    The fact that Mr. Krugman won a respected prize, while people like Scott, Bill Mitchell and Randy Wray did not, tells me the prize itself has no significance in science. Mr. Krugman’s operative statement was, “As I understand the MMT position . . .” Clearly he does not, and seemingly has made no effort in that direction.

    The repeated concerns about T-securities, when these securities became obsolete as money-raising devices in 1971, tells me Mr. Krugman has pursued fame more arduously than knowledge. Fundamentally, Mr. Krugman does not understand the implications of Monetary Sovereignty (nor does the EU, but that is another story).

    From the standpoint of federal spending, our Monetarily Sovereign nation neither needs to tax nor to borrow, nor to use any other device to acquire the dollars it already can create in unlimited quantities. I suspect Mr. Krugman, being an intelligent man, already senses this, but his personal intuition screams at him, “This can’t be right; it simply can’t.”

    So he twists and turns in fits of illogic, searching for some way to merge his intuitive beliefs with reality. Winning the prize was the worst thing that could have happened to him, intellectually. How could he possibly have an open mind, carrying that investment burden?

    Rodger Malcolm Mitchell

    1. Peter D

      Rodger, how do you square your position with other MMTers regarding monetary tools for controlling inflation? Because Scott et al would do away with govt debt altogether, paying maybe a very small % in IOR. I’d like to see you debate it with them, because it seems like a big gap.

  13. bks

    A few questions to Scott: what is the _observable_ evidence that MMT is more correct than Dr. Krugman’s neo-Keynesian theory? (I really don’t care about which theory is intellectually cleaner, and I like the symmetry of MMT’s thought process: but what really matters is predictive power.)

    Why was Milton Friedman’s empirical observation of an apparently causal link between monetary base and inflation wrong? (Or is it only wrong _now_? If so, why?)

    While a sovereign currency issuer may be able to set the interest rate on its own debt, what effects would doing so have on the ability of its citizens to finance _private_ debts? Would those effects not constitute a de facto constraint on how much a sovereign can usefully manipulate the interest rate on its own debts?

    1. Nathanael

      Regarding the empirical observations of Milton Friedman, see my brilliant comment below. :-) I believe it has to do with the correct *measurement* of monetary base. In our new world order with massive financialization, the traditional measures of monetary base fail. Thus, when using those measures of monetary base, MMT is correct.

      On the other hand, there is a measure of “money flowing around in the real economy” which *does* relate to inflation. This *used* to be measured by monetary base, but due to financialization and the recycling of money through dozens of banks and financial institutions with no substantive addition to the amount available to real people and real businesses, we no longer have a good measurement of it. If you somehow redefine monetary base to correctly measure this amount, then Krugman is correct — except that Krugman still thinks the government can control this number directly, which it can’t.

      Next question? I really do think this is all there is to the discussion, and I hope the MMT people agree….

  14. Cedric Regula

    Yes, yes. MMT has been tried before in numerous single planet space alien regimes. In fact, I remember Emperor Zorg doing it on the planet Zorg. He became infatuated with the concept of fiat science when an advisor suggested he make Pi equal to 3. They were delighted to find out this lead Zorg scientists to discover the warp drive. Knowing that economics is a science too, they decided to develop fiat economics to it’s fullest potential.

    The idea that Emperor Zorg could have his spending of the planet’s currency, The Zorg bill, was nonsensical to Zorg. “Why should I have to borrow my own money, and have to pay more than the zero maturity rate of interest…like I’m paying for long term credit or something?”, he exclaimed. His advisers cowered in the corner a moment, but then quickly proposed the “Flat Yield Curve” as a solution. “Is this possible?” the Emperor queried. “Quite so.”, say the advisers. “We will have the Treasury work together with Zen at the Emperor’s Reserve and make it so! We will have the Emperor’s Reserve pay everyone’s taxes to the Treasury too, so the Zorg bill will have value, which we deem to be important in a currency!”

    “So Be It!”, exclaims the Emperor.

    And so it came to pass that Zorg historians chronicled the following events.

    1) Zorg and his brother Zim had a falling out over whether banks loaned money first, or got their hands on the money first. Zim thought they should run the free toaster ad to attract savers, but Zorg insisted interbank repos and a discount window at the Emperor’s Reserve should suffice. Zim went into self exile on Earth to try it his way.

    2) After the Emperor declared that Zorg did not need bond holders, The Intergalactic Federation of Space Aliens (IFSA) put Zorg on the quarantine list.

    3)The 25% of Zorgians whom were domestic bondholders opted for early euthanasia, which is the retirement safety net on planet Zorg.

    4) The Zorg economy was booming building warp drives, but having no domestic dilithium sources, and the Zorg bill having been declared toxic waste by the IFSA, the warp drives were useless for transportation and instead displayed in parks and street corners as decoration.

    5) The remaining private sector of Zorg began rioting, shouting, “We are no longer debt slaves. We are money slaves! What the frack is the difference???”, and decided to let the Treasury and Emperor’s Reserve play with money, credit, and interest rates without the public’s involvement, and went on the barter system.

    6) Economists on Zorg are still arguing about whether this transition was inflationary or deflationary.

    7) In a momentary lapse of security, Emperor Zorg was beheaded, but is listed in stable condition while his new head is growing back.

    1. MyLessThanPrimeBeef

      I think when you put the word ‘modern’ in front of something, you instantly give that something a lot of desirability.

      But the same theory, if you call it ‘not-so-odern monetary theory,’ it is bound to lose a few not-so-ardent followers.

      1. Cedric Regula

        Yes, sooner or later someone always rolls out Irwin Fisher’s 1900 vintage equation MV=PQ. M is base money (quantity), V is velocity of transactions, P is price level, and Q is real output or GDP. This is fundamentally accepted by any flavor of economics, and I seriously doubt Krugman forgot about it. But it is easy to make a slip of the tongue and refer to money supply when you really mean mean money quantity times it’s velocity of transactions. You will then be chastised endlessly for adhering to the quantity of money theory, even when using words like liquidity trap which implies the problem is with very slow velocity. Or you can have a later 90s period when velocity went quite high creating a stock bubble and collapse. Greenspan scoffed at the notion of using interest rates to slow the bubble growth, because the price of money at say single digit values won’t deter mania which is borrowing it with the expectation of 50% annual returns. This situation and the opposite, liquidity trap, shows where monetary authorities have little control over velocity of money. But oddly we find they want to make up for their lack of control over V, by overcompensating with quantity of money, even tho it doesn’t seem to have any immediate useful effect on the real economy. Then later on during the depression, Fisher developed the credit bubble-bust-debt deflation explanation for GD1.

        But anyway, back on Zorg, the Emperor’s economic advisers are in fear for their lives once the Emperor’s head grows back. They are working on a fix for MMT. Zorg fashion designers are working on orange jumpsuits and Zorg scientists have developed a Cat ‘o Nine Tails which the advisers believe can be used to properly regulate the velocity of transactions and insure a rate of output growth that will please the Emperor.

      2. Hannu

        John Law was a fan of fiat money and central banks. He died 1729, so I suppose he could be said to be a modern man.

      3. Nathanael

        I suspect it’s “modern” monetary theory because a bunch of its conclusions depend on particular regulatory (etc.) features of the *modern* world.

        It’s not a monetary theory which applies to every historical regime. For instance, in an economy with no central bank, or with little in the way of government-issued currency, the analysis must be very different. Astoundingly from a historical perspective, the 19th century US after Andrew Jackson *was* such a country, with each bank a separate currency issuer, exchange fees charged to change New York banknotes for Omaha banknotes, and the government issuing mostly gold and silver coins (with gold and silver coins from other countries accepted at their metal value, even).

        I’m sure that MMT’ers *have* an analysis for such economies, but it’s not going to be the same one, and it’s not going to be “modern”.

  15. flow5

    WARREN MOSLER: “operationally, there is no such thing as the US government running out of dollars, being dependent on foreign borrowing, or potentially facing a solvency crisis like Greece”

    Exactly what Krugman was talking about. MMT’ers have developed a reputation.

    FULLWILER: the operational put & take is b.s. Treasury-Federal Reserve collaboration exists in its present state, because whenever in the past the FED’s responsibilities were subordinate to the Treasury’s, this country experienced intolerable rates of inflation.

    The FED already had authority for direct purchases from the Treasury, and it would be instructive to explain why the $5b “overdraft privilege” in Sec. 14 (b) of the Federal Reserve Act was allowed to elapse?

  16. darms

    This may be a good post but I don’t know, while being a fast reader w/good comprehension frankly your verbiage lost me about halfway through. Would it be possible for you to summarize or condense your post of 5575 words into a few hundred for us non-economists?

    1. JTFaraday

      I’ll give it to you in seven:

      “Dick Cheney was right: deficits don’t matter.”

      (I can’t imagine why that makes so many people nervous).

    2. stf

      I understand your point, but Krugman made some very big assumptions that needed to be carefully drawn out. There’s not really any other way to do it. I did link in the beginning to other posts that do overlap. Bill Mitchell and Marshall Auerback also posted critiques today that would be more accessible.

      And “Dick Cheney was right” is NOT what I’m saying at all.

      1. JTFaraday

        Well, but ultimately you are because his side of the ledger has a way of making the cards turn up all spades.

        Just look at what happened to Jacob Hacker.

      2. darms

        I understand that complex points require a number of words to explain, it’s just that my eyes glazed over for some reason reading this one. And I’ve read a number of long posts today, here & elsewhere, too. I’ll try again tomorrow w/some fresh eyes as I’m a long-time reader of Mr. Krugman and do appreciate when he’s made an error. Not that I revel in his errors, it’s more that I want to ‘keep him honest’…

        1. stf

          No worries at all. As I said above you might try the critiques written by the others if you prefer. Pavlina Tcherneva has a very good one today on the KC Blog, too.

  17. Conor

    Advertisments for Ron Paul on this blog?

    Golly, Ms. Smith, we all have to make livings, but you’ve sadly larded up your content with so much advertising which neither reflects nor is consistent with the content on this blog. Naked Capitalism, indeed.

    1. Yves Smith Post author

      I don’t control the advertising, my ad service does.

      And I think you have it backwards. I’m delighted and amused when people I think are morons waste their ad dollars on a site ideologically opposed to what they stand for. Wouldn’t you rather have Rand Paul throw his money away than spend it productively?

      1. Cullen Roche

        Quietly lurking here Yves, but I had to say that this is one of the greatest comments I have ever read on the internet….

        Thanks for all your work btw….big fan.

      2. psychohistorian

        I vote for an ongoing list of people Yves thinks are morons.

        Here Here!!!! We need more humor as the world’s ships of state sink hopelessly.

  18. Max424

    Sorry, I don’t mean to overload the thread, but since we have Fullwiler, Mitchell, and Wray represented, I thought it would be appropriate to slip a link in for Mosler as well.

    Plus, this is one of the great factual takedowns of all-time.

    And the facts are: N. Gregory Mankiw, world renowned professor of economics at Harvard, could not possibly pass an Econ 101 quiz.

    (Mankiw passing a 101 multiple choice test, at this stage of his development? Out of the question).

  19. vimothy


    As I said upthread, great article. There’s a lot to think about here, but I have I have a couple of initial comments related to assumption A and I’d be interested in your response.

    “The MMT point here, instead, is that changes in the monetary base NEVER matter per se, at least not in terms of causing anything.”

    I think this is wrong. Let’s say that the private sector holds a given quantity of govt debt (determined by govt’s fiscal arm to an extent and ultimately by the time path of previous deficits), which is then divided between base money and debt (the mix determined by the govt’s monetary arm, subject to its CB reaction function), and then the stock of base money is divided between currency and reserves (the mix being determined by the private sector in toto). Let’s further hold nominal aggregate income constant. And finally, let’s leave the issue of interest on excess reserves to one side as a fundamentally different regime to the classic case I want to consider here.

    I think you’re saying that if the CB increases the stock of base money held by the private sector, this will not “cause anything” in terms of producing inflation. But what this suggests in terms of the private sectors’ base money demand function doesn’t make sense to me. It suggests that the quantity of base demanded is not a function of its price. Interest on reserves is still significant here, because it implies that for the private sector to hold the excess base, yields on other assets must fall. Thinking of the dynamic response of the private sector, a fall in interest rates affects the individual at the micro level in terms of his/her intertemporal consumption-saving decision. If you raise the opportunity cost of consuming in the future vs consuming in the present at the margin, then consuming in the future (saving) should fall, and consuming in the present should rise. Saving is increasing in the interest rate.

    Warren Mosler likes to say the govt as currency monopolist can set the price it wants. In the long run, it can, but only by supplying the quantity demanded by the private sector at that price. If you change the quantity, for a given demand function, you change the price. And the relative price of money is its real value in exchange for other goods and services, If you increase the supply of money, cet par, you will reduce its relative price, which is inflation.

    1. stf

      If you are assuming interest on reserves is lower than the Fed’s target rate, then I completely agree, and that’s pretty central to MMT. We’ve always argued that.

      But that’s a price effect, not a quantity effect–as we always say, it’s about price, not quantity. The additional reserve balances can reduce the overnight rate if it’s more than banks want to hold at the target, but beyond that banks can’t “do” anything with them that they couldn’t have done without them.

      Krugman’s suggesting that the additional quantity of MB is what is adding “fuel,” not the interest rate, since he’s assuming the Fed achieves its interest rate target that is set at the Fed’s desired rate. That’s not right. First, there’s no quantity effect in his model since the additional MB doesn’t “do” anything for anyone. Second, there’s no price effect in his model since he’s also assuming a positive interest rate target, and the only way to keep that target and incrase the monetary base is to pay interest on reserves at the target rate. Third, that makes reserves and t-bills essentially perfect substitutes, so even in his own framework, additional MB shouldn’t matter.

  20. Nathanael

    This is an excellent analysis, and it is of course correct.

    What *both* you and Krugman have missed, however, is the deeper question of what causes people to trust the currency. If trust in the currency is lost, all of this goes out the window, and I believe at some fundamental level that is the missing factor not being discussed by either of you, which is causing you to get caught up in technical discussion.

    Demand-pull hyperinflation *could* be a source of loss of trust in the currency, I suppose, but I don’t think it’s the primary one, as the demand-pull effect would most likely create trust in the currency.

    I believe that the sources of trust in the currency, in the deposits in the banking system, and in Treasury bonds, are fundamentally not necessarily “economic” in nature, but are related to other markers of trustworthy behavior.

    A bank which has a habit of inventing new fees to nickel-and-dime its customers with, or of cheating its customers generally, will lose *trust* in the status of its deposits; it will find that it has to get all its deposits from the Fed, or pay higher interest rates, and will eventually be liquidated in favor of its competitors.

    In a similar way, dishonest behavior by the government will remove *trust* in the currency and in T-Bills. The lies told to justify the criminal war in Iraq destabilized the currency more than anything purely “economic” prior to that point. The way the government is letting big banks get away with massive frauds is potentially the cause of a great loss of trust in the currency, and is definitely causing a great loss of trust in bank deposits.

    Now, on the “monetary base” issue. I would describe the analysis you have given a little differently from some of the other people here. You have a demand-side analysis of banking, where the primary driver of the banking sector is people choosing whether to take loans at the rates offered by banks; with the level of deposits being driven primarily by that. This seems correct. You further note that the Federal Reserve will make up for any deposits which are not deposited by the private sector. This is clearly correct, with one quibble below. You also note that loans do not directly translate into a change in deposits, and that only the actual spending of the loaned money reduces overall deposits. This is obviously correct.

    This means that the value of loans is in the transference of money from persons unwilling to spend it to persons willing to spend it. This is of course the entire value of loans to the economy, and obviously correct. However, this means that an increased demand for loans results directly in a replacement of private deposits with Fed loans in banks. This leads to my quibble: if this happens generally, all the banks will simultaneously appear overstretched and untrusted-by-average-people, being backed solely by the Fed, and will be shut down by the banking regulator. However, assume this doesn’t happen, as the banking regulator is not on the case, or because the Fed/government simply doesn’t care whether the banks are backed by anyone but the Fed, and the analysis can continue.

    You end up basically showing that the monetary base does not matter because it is not actually measuring money in the hands of those with a propensity to spend. You are saying that money in the hands of banks is essentially interchangeable with money in the hands of the Fed or in the hands of the government, and you appear to be right.

    However, consider what happens if the monetary base is measured differently: if it is measured by the access to money, for use in paying workers, buying materials, etc., in the hands of people *with* a propensity to spend. Specifically, consider only T-bills, currency, and deposits held by individuals or actively operated industrial and commercial businesses, excluding all “investment” operations and other financial activity; then further exclude money held in the accounts of the rich and the very rich corporations who have no additional propensity to spend on labor or materials.

    I suspect that MMT would proceed to the conclusion that this form of “monetary base” — not the conventional definition — has the behavior which Krugman described, to wit, that its expansion leads to inflation.

    The key insight here is that money put into financial instruments has no meaningful effect on the real economy. To have a measure of what will cause inflation, one must look at the interface between the financial world and the real economy, and work out whether more money or less money is flowing *through the interface*. However, this is *not* the normal measure of “monetary base”. This also explains why the Federal Reserve operations have been largely worthless; they have mostly shuffled money around between financial actors. The only injection of money into the real economy from these operations has been the extraction of money by bank executives, and we might expect an increase in the private-jet and caviar sector of the economy.

    Is there anything wrong with my analysis here? I suspect that MMT is not actually very unconventional at all, but has simply spotted the fact that most financial movements of money do not represent real movements and have no effect on the real economy whatsoever.

    Given this, surely it would be simpler if the Federal Government simply loaned money directly to people as it desired, rather than laundering it through the central bank and commercial banks, with the result that intended policy can be compromised by any number of intermediaries.

  21. Jim

    The MMT Framework as a Normative Argument

    By what independent historical criteria did MMT construct its framework?

    Is there some stable external conceptual fulcrum that can make sense of the “facts” or the events that are integral to the MMT historical account?

    Does the MMT theorist not face severed and unmoored events so that the MMT creators must weave patterns of interrelationships between the events, which may never be able to receive conclusive confirmation or corroboration?

    What if it is the case that the materials out of which coherence is generated acquire their character as relevant material from the antecedent judgments of pre-MMT historians and are in no way independently, transpersonally confirmed?

    What if it is the case that the MMT framework does not lie, already identified, somwhere in the past, waiting to be picked up–(i.e. that it does not exist until it is assembled by an MMT creator?

    If such a process is involved in the creation of the MMT framework than the normative dimension must be looked at more closely and their argument that their framwork is purely descriptive is misleading.

    And yes, all of these arguments would apply to my own framework for understanding the operatons of our monetary and political system,as well.

    1. Yves Smith Post author

      Read Randall Wray’s Understanding Modern Money. He discussed at some length how the origin of money (as in evidence from archaeologists) does not at all support economists’ fables about how money started but is instead consistent with the MMT view.

      They do have the goods, You are incorrectly suggesting they don’t.

    2. reslez

      > What *both* you and Krugman have missed, however, is the deeper question of what causes people to trust the currency.

      This has been discussed extensively by MMTers. The government has the coercive power to tax. As long as this holds the currency will have value. When April 15 rolls around you must have currency in your bank account. As for what would cause a crisis of confidence in a government, see Cullen Roche’s recent article explaining hyperinflation:

      1. Nathanael

        Thanks for the link, but what supports the power to tax? It’s most certainly not fundamental; it’s essentially about two things: general public respect for the governmental system, and the amount of force the government can deploy, with the first being more important than the second.

        I think it’s quite evident that the government has already lost the power to tax income from the barter economy — if it ever had it — and likewise has the power to collect sales tax from the barter economy. The power to collect taxes on transactions in foreign currency is shaky, and the power to collect tax on transactions by the rich and powerful appears to be pretty damned shaky too.

        The power to collect property tax seems to be solid.

          1. Nathanael

            Here’s a subtle and important future problem which will be faced by MMT people:

            They’re analyzing a system with a trustworthy government and central bank.

            After the government collapses and the currency is rejected, if we end up back on a non-government-backed currency with no “lender of last resort”, then banks which are not trusted enough *will be reserves-constrained and deposits-constrained* and the entire analysis, though correct, will not be relevant for generations. (Banks which are trusted enough will issue their own currency, obviously, and will therefore not be reserves-constrained.)

            MMT people had better make it absolutely clear that their analysis that banks are not reserves-limited is driven by the *current* legal/monetary regime, and that there are others throughout history which require a different analysis. I suppose there are probably some functional finance people who analyze *historical* economic systems who have already done this.

            However, this is precisely the point which is not being made clearly by MMTers: that the introduction of trusted central banks *changed the nature of banking* and requires a *different* analysis from the days of private currency creation, backing by metals, etc.

  22. Schofield

    Kevin Bruxelles rightly argues two of the principal poles of Neo-Liberal capitalism are Price Point and Labor (Wage) Arbitrage producing zero-sum games when what is really required are genuine partnering solutions between capital and labor.

  23. rogue

    Crucial to understanding where Krugman is in error is knowing why he thinks the US will loss access to bond markets? Under what circumstance can it lose it, and why losing access is the logical outcome in that scenario.

    Countries that lose access are usually those losing productive capacity, filled with dying industries, its people out of work. Hence, foreigners fear that it will soon lose tax revenues it can use to pay back the bond, or it will simply monetize the debt, inflating away the real value of the bond. Also, its locals do not have the income to take the place of the disappearing foreign bond investor.

    If the US ever really gets to a full employment scenario, its locals will have productive income. Some of them will begin to think of the future, and save some of that income. The logical choice would be in the currency that they plan to use in the future. US bonds is the logical choice.

    If there is full employment, we can deduce that the economy is growing, hence there is less risk of the bond payment being monetized and inflated away, or of deflationary measure eroding the productive capacity of the country, and its ability to pay. Hence, foreigners will even more likely see it as a safe haven.

    So how can we see a scenario in 2017 where the US has full employment, and the government still has to incur a deficit, and at the same time has lost access to the bond market?

  24. Bruce S

    It would be nice if this discussion started out with some definition of “MMT” and ensuing terms – do you not want people outside the priesthood to even try to understand you? If not, what’s the point?

      1. Bruce S

        Thanks! I know this is part of an ongoing discussion, but I think it’s always useful to at least unpack acronyms in one’s first paragraph, unless you’re truly intent on shooing away the general, but interested, reader.

        Just saying.

  25. Ancaeus

    You haven’t answered Prof. Krugman’s main argument, in spite of a boatload of impenetrable verbiage.

    Krugman argues that once we are out of the liquidity trap, then deficits will matter. He gives reasons for why he thinks that this is so.

    If you disagree with him on this point, then please say so, and then tell us why, in short simple sentences without jargon. Give us a convincing argument.

    N.B., an explanation of why you are misunderstood by Prof. Krugman is NOT a convincing argument that you are right. That is a fallacy.

    1. stf

      Apparently you didn’t see the first, oh, 2000 words of my post, where I explained why Krugman’s ASSUMPTION (for the record, he assumed deficits matter when we are out of a liquidity trap–he in fact DID NOT actually explain HOW the end of a liquidity trap changes anything) that the end of a so-called liquidity trap changes anything.

      I’m sorry I used so many big sentences that you couldn’t understand. But Krugman made some very big assumptions–and virtually nothing else besides following the logic of those assumptions–that needed to be unwound. Just because something isn’t simple enough for you to understand doesn’t mean it’s wrong–how are you with astrophysics? Is that wrong, too?

  26. Cullen Roche's Censorship Friend

    Cullen Roche likes to censor people that give dissenting comments on his website.

    From Dr. Malveaux to some afrifan economists, it was pointed out to him that as our youth lost the competitive edge because they were not educated as well as in other nations, people would not want to invest with them. I don’t want to buy bonds in nations with lots of drugged up people with no skills or knowledge.with them.

  27. circuit

    Scott, this reads like a checkmate to me. Thanks very much for your efforts in responding to Prof. Krugman’s comments in such a timely and comprehensive fashion. Brilliant analysis.

  28. ChrisPacific

    As others have pointed out, Krugman has the wrong end of the stick. MMT doesn’t claim deficits never matter, just that they don’t matter in the situation in which we find ourselves right now. In the alternative situation he describes, MMT (if I understand it correctly) would actually recommend running a surplus. That could easily be achieved via tax policy. Trying to do it using monetary policy in the situation he describes would be stupid, as he demonstrates – not that I think anyone other than him really needed convincing.

    I am willing to cut Krugman a little slack on this as I had difficulty grasping the concept myself when I first heard it, and I appreciate that he’s willing to listen to and consider new ideas, sadly a rare quality in economics these days (even though it should be a prerequisite for anyone in the sciences). Some of the material out there on it can be on the impenetrable side. However, I don’t think he gets it just yet.

  29. Peter

    Fantastic article!


    what I always face when touting MMT is “where is the evidence?”.

    You write that MMT literature on the monetary system is “vast”. Where is it? Please give links. And I don’t mean theoretical proofs that will never move stubborn minds. I want econometric analysis on data that shows that the behavior of the monetary system is consistent with MMT and not with neoclassical’s view.

    Let’s drive the stake thru the hydra’s heart.

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