MMT Blog

Modern Monetary Theory is a term that one encounters with increasing frequency. It is often applied to a specific policy, such as advocacy of expansionary fiscal policy. But that’s not a very useful definition. Lots of economists now advocate expansionary fiscal policy in the current environment of very low interest rates and high unemployment.

MMT is more than fiscal stimulus; it is a model of the macroeconomy. In order to better understand the MMT model I’ve been reading “Macroeconomics”, an undergraduate textbook written by William Mitchell, Randall Wray and Martin Watts. While MMT is not my cup of tea, I don’t want to be unfair in my appraisal. Thus I’ll discuss one potential problem here , and try to elicit feedback from MMTers—what am I getting wrong? Am I being unfair? If so, what’s the intuition that I’m missing?

On page 342 they make an assertion that caught my attention:

Monetarists are hostile to the creation of base money to finance deficits because they claim it is inflationary due to the Quantity Theory of Money (QTM). MMT advocates would first highlight institutional practice, namely that net treasury spending initially causes an equal increase in base money.

Second, they would challenge the theory of inflation based on QTM, and argue that if a fiscal deficit gives rise to demand pull inflation, then the ex post composition of  ΔB +  ΔMb in Equation (21.1) is irrelevant. Overall spending in the economy is the driver of the inflation process, and not the ex post distribution of net financial assets created between bonds and base money.

A few initial observations:

1. The first paragraph seems misleading, as it may give students the false impression that the Fed does not determine the stock of base money. But I’d like to focus on the second paragraph.

2. The second paragraph seems to apply to all open market purchases, not just those that occur when market interest rates equal the interest rate on excess reserves (IOER). That’s clear from the rest of the book, which focuses heavily on historical examples from the 1960s, 1970s and 1980s. So for the rest of the post I’ll consider OMOs that occur in a world where nominal interest rates are positive and there is no IOER, i.e. the pre-2008 world. To be sure, I don’t think their claim is even true in a world with IOER, but it’s at least more defensible in today’s world.

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