That Doesn't Mean What You Think It Means

5. Investment is not very responsive to interest rates.

It is true that a decline in interest rates does not usually do much to boost investment, and vice versa.

From this valid claim, MMTers wrongly conclude that a decline in interest rates induced by an expansionary monetary policy does little to boost investment. I.e. they conclude that monetary policy has little impact on aggregate demand.

This is reasoning from a price change. Most declines in interest rates are due to the income and/or Fisher effects, not easy money. Those sorts of declines are not expansionary. A fall in output or inflation reduces the natural rate of interest, in which case the central bank must cut the target interest rate even faster to stimulate investment. Because MMTers mostly ignore the income and Fisher effects and view the natural interest rate as being zero, they miss the fact that most changes in interest rates do not reflect shifts in monetary policy.

6. In a closed economy, net saving equals the budget deficit.

The MMTers define private net saving as the budget deficit plus the current account surplus. Thus it’s true (by definition) that net saving equals the budget deficit in a closed economy.

From this valid claim, MMTers wrong conclude that if the public wishes to engage in more net saving, the government needs to run a larger budget deficit.

Actually, the central bank should respond to this scenario with a more expansionary monetary policy, which will push the public’s desire to net save back into equilibrium with the budget deficit at full employment. Conversely, when there is an exogenous change in the budget deficit, the Fed needs to adjust policy so that net savings moves appropriately, without impacting the Fed’s targets. The Fed did this fairly well in response to the sharp reduction in the budget deficit during 2013, and again in response to the sharp increase in the deficit during 2016-18.

These MMT errors are all interrelated. Because MMTers misinterpret the supposed “endogeneity” of money and the supposed “exogeniety” of interest rates, they get monetary policy wrong, greatly underestimating its potency (at least when interest rates are positive). This leads them to miss the importance of monetary offset, and that leads them to greatly overrate the importance of fiscal policy.

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