By Christian Lundblad, Director of Research at the Kenan Institute, and Professor of Finance at UNC Kenan-Flagler Business School
I must admit that never in my wildest dreams did I expect to see commentary on Modern Monetary Theory (MMT) on the front page of the investment management journal Pensions & Investments.1 In contrast, given where we are politically in the United States, MMT has come up a number of times recently in the popular press – so much that I think a bit of commentary is warranted. This intellectual approach takes an unorthodox view of the nature of government taxation and expenditure, arguing (among other things) that a sovereign nation that can spend, tax and borrow in its own currency faces very different constraints than often modeled in traditional economics textbooks.
Under MMT, such a government essentially prints money when it spends – the only limit being the inflationary pressures this could induce. MMT’s proponents argue that taxation policy can be employed to withdraw the appropriate amount of money from the system to essentially target desired inflation rates (N.B., fiscal policy, rather than monetary policy, would be the primary tool for managing inflationary pressures – a sharp departure from the central role the Federal Reserve plays in the United States today). While this is surely not a traditional view, it has gained some attention for a few interesting reasons. First, this means that governments could carefully spend to address infrastructure investment, environmental and energy concerns, health care provision, and so on – things that some might argue are critical, and perhaps even productivity-enhancing (and hence disinflationary in their own way). With such a possible funding role for the government in critical value-enhancing expenditures, you can see immediately the reason MMT has gathered some attention alongside recent proposals from the emerging left for Manhattan Project-like levels of government action, such as the Green New Deal. Second, as long as inflationary pressures are absent, one need not worry about elevated levels of government indebtedness. While the more serious proponents of MMT are careful to acknowledge inflationary concerns, the idea that deficit and debt levels may not matter (at least as we traditionally understand them) has created some excitement – and derision – toward this intellectual approach, depending upon one’s perspective.
To be clear, I’m quite orthodox on these matters, and I don’t share this intellectual view of government activity at all. Even if I viewed money creation in this way, I would be skeptical along two important age-old dimensions. First, the government is often not best equipped to allocate resources – however generated – to pursue value and productivity enhancement. Second, the real-world political machinery would certainly not permit dynamic taxation policy to address the possible inflationary constraints that serious MMT proponents do acknowledge.
That said, we have learned a few important and unexpected things since the 2008 financial crisis. U.S. government deficits and debt (and even outright Fed Quantitative Easing) have not created the kind of inflationary pressures that many would have expected. Second, while we have witnessed the formal default of several sovereign nations that could not borrow in their own currency, this is a non-issue for the U.S., so scaremongering about impending default as a motivation for immediate and punishing austerity is out of place. In fact, given the still remarkably low Treasury rates despite high debt levels, this may be exactly the time to strategically expand the federal government’s debt load if it could target some high-value infrastructure investments that do generate greater bipartisan support (and are harder for the private sector to pursue, given their scale).
Despite fully acknowledging these interesting observations, I firmly reject the notion that the federal government can operate without constraints. Let me be blunt. Take the least serious version of MMT – a subset of proponents arguing that we can borrow limitlessly because we have the luxury of doing so in our own currency. The unfortunate reality is that this misguided view already passively informs our current fiscal policy in a way that is both unsustainable and irresponsible. This naïve version of MMT is already with us and has been for a long time. Every recent administration and legislature has operated under this fiscal approach, regardless of party or professed philosophy. This decades-long kicking of the can down the road is consistent with the least serious read of MMT. Deficits only seem to matter when the other side is in power. Fiscal piety and “How are you going to pay for it?” only kick in when the other side proposes a new expenditure.
Rather than lament our lack of intellectual honesty in Washington, let’s move beyond the current level of discord. Here is the reality. If you care about national security, remember that there is nothing more central to U.S. security interests than our medium-run fiscal health. If you worry about private sector value creation, productivity enhancement and jobs creation, extend that concern to the health of business resource allocation in an environment increasingly characterized by policy uncertainty and fiscal risk. Alternatively, if you are deeply concerned about environmental policy, displaced workers or the educational needs of our young, keep in mind that fiscal health is the necessary precursor to supporting the government’s critical expenditures. If you want to have a good-faith philosophical argument about the appropriate role of the government in the provision of health care, recognize that we cannot if we doubt the sustainability of the government itself.
Here is the inevitable corollary – over the medium-run, the tax base has to increase and the expenditure budget (across entitlements, defense and other discretionary items) has to decrease. There are, of course, different weights we can put on these levers and there are more or less strategic ways to raise tax revenues that do not necessarily destroy the incentive to produce or cut expenditures in a manner that retains government investments we deem critical. At the end of the day, however, simple arithmetic demands that everything must be affected at some level. Of course, acknowledging this reality makes me unelectable (along with an abundance of other reasons). Nevertheless, it is long past time to level with the American people.
Regardless of our individual political priorities on taxation or expenditure, the reality is that we either get serious about medium-run fiscal sustainability or we will eventually face constraints imposed by our creditors. This is not a purely academic exercise. Roughly 40% of U.S. marketable treasury debt is already held by foreigners, having ballooned from almost zero in the 1980s.2 The nonpartisan Congressional Budget Office forecasts that our expected treasury debt-to-GDP ratio will increase from 80% of GDP in 2019 to 93% of GDP in 2029, with additional sharp upsurges eventually reaching to 150% in 2049.3 As a particularly stunning example, the CBO reckons that paying the simple interest cost on our existing treasury debt in 2029 will significantly surpass the entire U.S. defense budget.
We simply do not get to these elevated debt levels without a heavy reliance on the global credit community. Hence, there is an external governance mechanism that has implications for one of the core assumptions of MMT—the ability to borrow in your own currency. If the rest of the world loses faith in the U.S. dollar as the global medium of exchange and the U.S. Treasury as the risk-free asset of the world, fiscal constraints will significantly tighten. To be clear, this disaster state is not my baseline forecast, but we are definitely playing with fire. As a historical reference point, I would conjecture that few in 1870 envisioned the end of the United Kingdom’s dominant role as the global financial sovereign. Of course, in that case there was a natural replacement – an economic powerhouse emerging at the same time the U.K. was struggling with multiple wars and imperial downsizing. Today, while there is no obvious current replacement to the U.S., I nevertheless caution against the presumption that the dollar’s current role is a permanent state of the world. To the extent that MMT takes this role as a given, the “Who is going to pay for it?” complaint is a reality for the time being, and whatever “it” is, a sizable fraction is and will be financed by foreign investors. Rather than toy with the confidence of the foreign investor, I contend we need to fight like hell for it. Let’s make the hard decisions now, rather than risk a crisis where all the important decisions reside with other outside parties. I remind the entirety of Washington that the luxury of the global currency is not only a privilege, but also a tremendous responsibility.
1Debate rages over practicality of modern monetary theory, Pensions & Investments, April 15, 2019
https://www.pionline.com/article/20190415/PRINT/190419917/debate-rages-over-practicality-of-modern-monetary-theory. [By the way, it should be noted that MMT appears to have originally emanated from the fund world rather than the economics classroom.]
2United States Treasury; https://www.fiscal.treasury.gov/files/reports-statements/treasury-bulletin/b2019_1ofs.doc
3Congressional Budget Office’s Long-term Budget Outlook; https://www.cbo.gov/publication/53919