Democrats Will Test The Limits On Spending

Modern Monetary Theory (MMT) is taking hold. Relying on the insight that a government can never go bankrupt in its own currency, it posits that deficits don’t matter until they cause inflation (see our review of The Deficit Myth by Stephanie Kelton).

On a week that incoming President Biden unveiled a $1.9TN package to fight COVID and the economic downturn, ten year treasury yields fell. This was helped by Fed Chair Powell, who said, “When the time comes to raise interest rates, we’ll certainly do that, and that time, by the way, is no time soon,”

Meanwhile, JPMorgan (JPM), Citi (C) and Wells Fargo (WFC) released $5BN from their loan loss reserves because of the improving economic outlook.

Empirically, deficits don’t seem to matter. The Congressional Budget Office (CBO) projects that Federal Debt:GDP will reach 107% in two years, eclipsing the past high that followed World War II. After a brief pause, it is projected to move stratospherically towards 200% and beyond. This projection was made last September, so omitted the $1.9TN that Biden proposes to add.

Meanwhile, thirty year bonds, which encompass the period during which Debt:GDP will soar, yield under 2%.

MMT remains a fringe theory among mainstream economists. Paul Krugman, liberal credentials burnished by his regular NYTimes op-ed slot, is a critic. Far across the political divide, Larry Summers describes it as a “recipe for disaster.” It’s not political orthodoxy for either party, although progressive Democrats see in it a way to finance their liberal agenda. But you could also envisage Republicans relying on MMT to justify tax cuts.

While economists like Paul Krugman and Larry Summers are debating the merits of MMT, practically speaking the debate is over. In Kelton’s book, she doesn’t argue that deficits never matter – if government spending exceeds the economy’s non-inflationary productive capacity, inflation will rise. That’s how you find out where the limit is.

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