The purpose of this article is to entertain ideas and point out bad assumptions, rather than to solve the debate between Modern Monetary Theorists and the Archaic Monetarists. Trying to lay out the issues may be helpful for many. I did get a laugh out of William K. Black's analysis of Monetarists as being "archaic". The very best economists are divided, scholars, and PhDs. This is a civil war. 

MMT says stimulus is needed to maximize productivity.

Clearly, MMT has been practiced by the Republicans more than the Democrats. Seems that the Republicans use it mostly for war, rather than for domestic benefits. After all, it was Richard Cheney in the midst of war in 2002 who said: "Deficits don't matter".

We know both parties have abandoned free trade for tariff socialism. There are multiple forms of good and bad and very bad socialism. Yet even the Chinese are more capitalistic when it comes to trade. Historically, the US as a developing nation had far higher tariffs than does emerging China! 

Both parties are wrong in shedding and shredding free trade. So maybe both parties are also wrong about the virtues of their versions of MMT as well.

Before discussing the Fed, MMT, and helicopter money at the end of this article, we need to look into stimulus and how bonds are behaving.

Stimulus, Austerity, and Bond Reading

It has been said that US government largesse is better than European Austerity. Jim Edwards, editor of Business Insider London said this on Twitter. He liked my reply that supply-side economics is not very effective in times of low productivity and maybe only worked with Reagan because of productivity gains during his tenure as POTUS. But, I guess if you live in Europe, the worst thing is the relentless withering away of economies under the regime of Austerity.

We know that long interest rates are not rising in both prosperous times and in times of QE/QT. I think a big reason for this is because bonds as collateral are being hoarded. It could be that bonds have demand all their own, and are no longer an economic indicator of inflation or deflation or of GDP or whatever they used to portend.

So, the question for me is not whether MMT or the "archaic" guys like Scott Sumner or Rogoff are right, but whether we can really measure anything by how long bonds react and how bonds as collateral impact interest rates. And if bonds are paying out low interest because of a separate demand for bonds that is due to financialization, are we reading bonds wrong? 

MMT says that long bonds prove that we could be running bigger deficits. But what if they don't prove anything of the sort?

It was almost naive that the Fed would try to normalize interest rates recently, and honestly, it was just a show that they were trying to go back to the good old days of normal. But those days are gone. 

The new normal will not let them normalize interest rates. Donald Trump thought it would be easy to kill off the new normal. Now the Democrats want to kill off the new normal with MMT and the Green New Deal. There is an austerity attached to the New Normal that is unpleasant for sure.

If interest rates are based on bond demand for the sake of bonds and not for the sake of reflecting the economic risks, then raising rates to previously normal levels could prove to be a futile endeavor anyway.  As Liberty Street implied, collateral demands take precedence over traditional bond behavior, and we see this as bond tantrums to push up rates fail continually.

The Limits to Stimulus

Bill Dudley adds a practical warning that there are limits to stimulus. On Bloomberg Opinion he said:

Yet Modern Monetary Theory goes one big step further. It suggests that a government like the U.S. needn’t worry about debt at all. As long as it borrows in its own currency, there is no risk of default or bankruptcy. It can spend as much as it wants on any projects, such as education and health care, and just create additional IOUs to cover the cost.
Alas, there is no free lunch. For one, the economy might not have enough resources — in the form of workers and industrial capacity — to meet the combined demand from the government and the private sector. The result would be inflation, as too much money chased too few goods and services.

Capacity utilization sits just below the historic average of 80 percent in the US, and MMT could push it towards a danger zone, although we are not there now. Demand is still fairly weak. Retail is not doing that great. Something will need to be done at some point. Perhaps a modified MMT, recognizing the limitations of industrial production could be reached quickly if caution is not applied.

The point is, MMT, in an effort to maximize production, may actually surpass production capability like gangbusters, leading to inflation. With so many bonds being used as collateral, that could be a disaster.

Fed Lending Vigilantes

Bond vigilantes are made benign by circumstance. But there are still vigilantes who don't like out of control debt. Who are they?

 Scott Sumner, Talkmarkets contributor, quotes George Selgin on MMT, about MMT:

But the MMT people are just wrong in believing that the only question you need to ask about the budget deficit is whether it supplies the right amount of aggregate demand; financeability matters too, even with fiat money.

In other words, MMT must ask whether its ideas will kill lending. I know its answer, that banks lend first and worry about settlement later. 

But the Fed worries about inflation, and risk management, whether banks worry about those things or not. The Fed may not be able to break the new normal but it can raise rates a little and shut off Eurodollars and the world economy if it sees wage inflation. The Fed has a quick trigger when it comes to inflation.

So, then, the debt vigilantes live at the Fed. You can count on it.

Will lenders, who watch the Fed, start to fear at some point? Well, the Fed did act with fierce procyclicality in the Great Recession, allowing the commercial paper market which included subprime to be destroyed. Also banks have been slow to lend to consumers compared to before the Great Recession. Scott Sumner, an "archaic" monetarist ripped into the Fed for paying interest on excess reserves (IOER) because it was the opposite of stimulus:

The decision to adopt IOR helped to prevent the Fed from achieving its policy goals, by making the Great Recession more severe than otherwise.  That’s not just my opinion; unless I am mistaken that’s the implicit message of Bernanke’s memoir, where he indicated that, in retrospect, the Fed did not move quickly enough to cut rates in the fall of 2008.The world would be a better place today if the Fed had never instituted its policy of IOR in 2008.  I really don’t see how anyone can seriously dispute this claim.

The Fed is a fierce liquidator in times of credit crises, and even the "archaic" ones know when more stimulus is needed and when the Fed is hurting the American people!  They are just concerned that misplaced populist stimulus could be too much at the wrong time and that it will bring upon us the wrath of the Fed. We saw that wrath in 2007-2008.

Bill Mitchell, the guru of MMT says that banks will always lend to qualified buyers so don't worry. But he is wrong! Selgin is right. Mitchell said:

Banks will always lend when a credit-worthy customer walks through the door and the terms are to the bank’s favour.

This view could only be right if banks were perfectly countercyclical. But they aren't. When circumstances change that have nothing to do with the creditworthiness of a borrower, banks sometimes pull back lending or have even called in loans! If MMTers cannot see this, you have to wonder. 

The Fed and MMT and Helicopter Money

We know that excess bank reserves were a tightening even though they appeared to be a loosening. But that money never left the banking system.

Therefore, we know that the Fed cannot be a fan of MMT because too much stimulus could make its job harder and it could become even more procyclical in the next downturn. The Fed won't even let Fintechs like Paypal join the banking system. Apparently, some of those don't want to be regulated.

The Fed will always remain vigilant as to inflation, especially wage inflation. Remember, deficits didn't matter to Cheney, and W. Bush never gave much to the people except for easy money lending. Defense contractors and their need for war, and massive TBTF bank fraud and increased financialization were what Bush 2 gave to America.

Not surprisingly, then, the Great Recession started on the Bush/Cheney watch, not on Obama's watch. Then the Fed made it worse. Obama practiced austerity and McConnell made sure he would be a one term president rather than to give an adequate fiscal stimulus to the economy. That just made it harder on the people and Obama won twice anyway.

The flip side is the radical green policy of the newer Democrats, who want to spend on the people, and in a permanent fashion, while taking away airplanes and cars. That may prevent broad demand weakness, leading to recession that they then create, but may also put the Fed on the alert for even more inflation than the Republican version of MMT under Cheney/Bush. 

However, Helicopter Money would be under the total control of the Fed, a one time gift to the people. Whereas, MMT would make the job of a Fed that fears inflation more than it fears its shadow, a reason to blow it all up at the first sign of inflation or of out of control bubbles. MMTers should pay attention and think about what could go wrong and proceed cautiously. Their assumptions are often invalid.