Yves here. I very rarely put up posts that consist substantially of tweets, but this short exchange helps clarify a misunderstanding about Modern Monetary Theory that I may have been guilty of helping to promote. Now that Modern Monetary Theory has come out of the wilderness, at a time when the US government has broken with its post Volcker-Reagan pattern of being obsessed with balanced budgets and strict inflation containment by throwing boatloads of money at Covid-related stimulus.1
Modern Monetary Theory describes how government spending operates in a fiat currency system. It posits that the constraint on government spending is real resources, as in as long as there is slack in the economy, it can tolerate and in fact needs more net spending (what laypeople would call deficit spending). Modern Monetary Theory scholars contend that taxation in a fiat currency system serves to create incentives and disincentives, redistribute income, and drain demand (as in control inflation).
Many recap this argument as the constraint on Modern Monetary Theory-prescribed spending is inflation, and the government needs to raise taxes when that takes place. Needless to say, there are many ways to skin this cat. One is for government programs to have a large dose of countercyclical spending. That would be consistent with a heavy focus on social safety nets. When times are bad, spending rises automagically. When the economy picks up and more people are working, the expenditures fall. Germany provides generous unemployment support. Germany was accordingly mystified when the US hectored them after the 2098 crisis that they weren’t spending enough. The US was unaware of how much spending would kick in as the economy fell, and accordingly, less discretionary spending was necessary.2
Many orthodox economist are wringing their hands that Biden’s spending plans could produce too much inflation. This concern has gotten so far into the mainstream that my Alabama physical therapist last week expressed his concern that the Biden infrastructure plan was too big and needed to be delayed in light of his Covid stimulus.
Never mind that weak labor bargaining rights create a high bar to generating what is called “cost push” inflation. That was a, arguably the, driver of 1970s stagflation, not just the impact of the oil shock but also the amplification that occurred though formal and informal mechanisms to increase pay in response to price increases.
Rohan Grey points out below that taxation isn’t the only way to constrain excessive demand, which is mechanism that could create inflation with a spending overshoot. Not that the US now would go this route, but in World War II the US had massive deficit spending, low interest rates, and yet did not generate inflation due to rationing and price controls. Some economists contend that the much-ridiculed early 1970s “Whip Inflation Now” program of price controls and wage increase limits were starting to work when the Administration lost its nerve and cancelled the program.
Am I mistaken, or doesn't MMT say that spending *does* have to be "paid for" (in the conventional use of the term) if and only if inflation constraint is binding. Reason we don't have to "pay for" now is because inflation constraint is slack. For now, at least. https://t.co/hzXak2ZKi9
— David Andolfatto (@dandolfa) May 3, 2021
Spending environment, when In reality your spending is limited only by the extent to which you can find appropriate demand offsets.
— Rohan Grey (@rohangrey) May 3, 2021
Not that I want to rain on the Modern Monetary Theory parade, since the level of discouraged and involuntary part time workers say we are likely to be much further away from any risk of inflation than the deficit-scolds would have you believe. However, expecting discretionary “demand offsets” to be implemented on a timely basis is a stretch. It’s going to rain on some parties, and the hosts will push back hard. Modern Monetary Theory advocates need to press not just for programs that are natively countercyclical but also to integrate countercyclical features into ones that aren’t (like inflation-triggered curbs or inflation-triggered regulatory constraints).
1 Reagan-era fiscal orthodoxy was more talked about than practiced.
2 Not that Germany did enough discretionary spending, mind you, but the US was calling for excessive amounts from Germany in light of its automatic stabilizers and the US response.