Dan Kervick, New Economic Perspectives
A common criticism of Modern Monetary Theory is that it is a naïve doctrine of free lunches. The critics grant that a country like the United States, which issues its own freely floating fiat currency, can always make the policy choice to issue whatever quantity of that currency it deems appropriate. The US government can spend as many dollars into the private sector economy as it chooses, without obtaining those dollars from some other source first, and it can always pay any debts that have been incurred by borrowing dollars. But the critics will go on to charge that MMT mistakenly concludes from these few institutional and operational facts that there are no economic limits to the wealth-generating capacities of the government. They caricature MMT as a doctrine of manna from heaven, in which the power of issuing a generally accepted medium of exchange confers the power of conjuring real wealth into existence by prestidigitation. In short, they see MMT as a disordered syndrome characterizing people who are experiencing massive money illusion.
But this criticism misses the mark. MMT does focus a good deal of attention on the monetary system and the banking system, and on the operational mechanisms of public and private finance. But the whole point of analyzing and clarifying the monetary system is to help people see through the glare of the economy’s glittering monetary surface to the social and economic fundamentals that operate below that surface. The point is certainly not to deny real limits on our capacity for economic development and progress, but to correctly identify where those limits lie – and where they don’t. MMT’s criticism of some standard economic and public policy approaches is that the standard discourses sometimes incorrectly locate those limits, and as a result manufacture artificial barriers to progress where none exist.
Our real opportunities for economic progress are grounded in our ability to apply work, cooperative activity and creative ingenuity to the real resources we already possess. By the enterprising application of our industry and intelligence, we transform the things we have into different and better things, and exchange our work and the products of our work among ourselves to make our lives better. Our real limits, then, are the constraints imposed by our inherently finite nature: we only have so many resources; we can only work so hard; our cognitive capacities are only so great; we only live so long, etc.
But what we must try to avoid is the imposition of artificial barriers to progress that are only the psychological fallout of confusion about the complex social institutions we ourselves have constructed. When we possess resources that are not used to improve our lives in the ways they could be used, when there are unemployed people in our societies who are both able and willing to do the work needed to improve those resources and realize their potential to yield value, and when people are suffering needlessly or living under deprived conditions as a result of the underemployment of resources and people, then we are somehow failing as a society to seize our real opportunities, and have succumbed to artificially imposed limits.
The monetary system is best seen as a public utility that is employed by its users to finance the production and exchange of goods and services. It is a system of institutions created by human beings to help realize opportunity, and match opportunities for the creation and transfer of goods with the potential producers and recipients of these goods. It’s our monetary system, and we can do whatever we want with it to achieve our society’s full potential. We can create, destroy, transfer or manipulate the monetary medium of exchange as we see fit to advance the good of society and improve the condition of our people. Thus there can be no such thing as an economic limit due solely to our society as a whole being “out of money”. That’s like saying we can’t organize better schools, or write more and better books because we have run out of words.
Many of the key ideas of Modern Monetary Theory go back to the years during and immediately following the Great Depression and the Second World War, when great thinkers and public servants applied bold, creative thinking and practical problem solving to the daunting economic and organizational challenges of their times, and helped their societies overcome systemic failure, triumph over threats and adversity, and achieve renewed optimism and growing prosperity. One of those thinkers was Abba Lerner, who developed the concept of functional finance, which he described this way in his paper “Functional Finance and the Federal Debt”:
The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and withdrawal of money, shall be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine what is sound and what is unsound.
Lerner then articulated two “laws of functional finance”, which I think still very well capture the spirit of the MMT approach to economic policy. The two laws are given as follows:
♦ The first financial responsibility of the government (since nobody else can undertake that responsibility) is to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce.
♦ The second law of functional finance is that the government should borrow money only if it is desirable that the public should have less money and more government bonds, for these are the effects of government borrowing.
These two simple rules of action yield immediate logical results that people still find surprising or counter intuitive, and sometimes even find impossible. Recall that taxation generally reduces the total rate of spending and government spending generally increases total spending. Thus, a combination of tax changes and government spending changes will tend to increase government spending if it increases the government deficit, and will tend to reduce total spending if it reduces the government deficit. So, suppose the country is running a deficit, but suppose the total rate of spending in the country on goods and services is less than that rate which at the current prices would buy all the goods that it is possible to produce. Then the first law says the government should increase its deficit. But suppose it is not desirable that the public should have less money and more government bonds. Then according to the second law, the government should not issue more bonds. It should not finance the increased deficit with more borrowing.
But how is this possible? If a government wishes to increase its deficit, doesn’t it necessarily have to borrow to cover the larger gap between revenues and spending? No, it does not. A government that is the issuer of its own currency has the option of increasing its deficit without increasing bond sales. It can issue new money in the very act of spending it. And that is what the two laws of functional finance recommend in the hypothesized circumstances.
Unfortunately we have not made full use of this inherent governmental option, and have not implemented the laws of functional finance. Congress has legislatively implemented a system in which deficit spending automatically triggers bond sales, without regard to any calculations as to whether it is in fact desirable that the public have more government bonds and fewer dollars. And we have divided up the two important functions of issuing money and issuing government bonds between two different operational branches of the government – the Treasury and the Fed. Happily, there is some degree of a workaround available for those who might want to apply functional finance within our current legislatively determined framework, so long as these two branches of the government are able to work cooperatively. The Treasury can issue bonds and sell them for dollars, while the Fed is at the same issuing dollars and using them to purchase government bonds. But the system is probably not as efficient as it should be, and its functioning can be hampered by institutional jealousy over policy turf, and by the neoliberal preoccupation with central bank independence that characterizes the thinking of the most powerful members of the global financial class, a preoccupation which imposes a pressure for the Fed not to be seen as not cooperating too closely with the Treasury. So to fully implement functional finance, we might want to think about changing the current system.
Now note what the first law of functional finance says about a situation in which the total rate of spending in the country on goods and services is likely to be greater than that rate which at the current prices would buy all the goods that it is possible for the economy to produce. The result is that prices would then rise until spending and production at the new price level are in balance, and Lerner’s first law thus entails that the government’s responsibility in such a situation is to decrease spending to so as to prevent or curtail such price increases. So here is where functional finance takes account of the real limits of our economy, the ones built into our limited resources and limited capacity to produce.
Now, to be frank, Lerner’s first law of functional finance is perhaps overly austere. It views the economy as analogous to a factory or business enterprise, and views the government as a sort of demanding manager whose chief job responsibility is to assure production up to the level of full capacity. But our economy is not a wartime factory; it is a democratic society. And whether or not we produce everything that it falls within our capacity to produce should be a matter of public choice, not iron policy law. We might choose a somewhat more leisured and relaxing life than the one we would have if we were producing up to our full capacity.
But I believe the spirit of Lerner’s recommendations is still valid. If we are faced with a society in which there are many people who want to be working and contributing and producing, and earning incomes as a result, but who are not provided with the opportunity to do that work; and if we are presented with a society in which there is a general sense of stagnation and a general dissatisfaction with the levels of output, innovation and improvement, then surely it is our responsibility to act through our government to boost employment and the pace of economic development.
We owe all of our fellow citizens an opportunity to participate fully in the common work of building a prosperous life for ourselves, and we also owe them a fair share of the economic goods that that all of that work produces. And when we finally do right by them, perhaps they will at least be able to buy a well-earned lunch.