Ron Berger —
One of the influential books I read while studying sociology in graduate school was Thomas Kuhn’s The Structure of Scientific Revolutions (1962). Kuhn revised the conventional view that scientific progress evolves through the accumulation of accepted facts and theories. This he referred to as “normal science.” But Kuhn also thought that the discovery of puzzling anomalies that could not be explained by existing paradigms periodically led to qualitative breaks from normal science and the emergence of new paradigms that changed conventional knowledge and mapped new directions for research and application. This Kuhn called “revolutionary science,” and a classic example is the Copernican Revolution of the 16th century, which supplanted Ptolemaic astronomy and posited that the Sun, not the Earth, was at the center of our solar system.
Kuhn came to mind as I a read Stephanie Kelton’s The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy (2020), where she introduces readers to Modern Monetary Theory (MMT), which purports to be a new paradigm of economic science. In doing so, Kelton challenges some basic tenets of the economic orthodoxy that imbues our political and civic discourse and has failed to anticipate and address the most pressing economic problems of our time.
Kelton has served as Chief Economist for the Democratic Minority Staff of the US Senate Budget Committee and as an advisor to the Bernie Sanders presidential campaign in 2016. She is currently a professor of economics and public policy at Stony Brook University and a senior fellow at the Schwartz Center for Economic Policy Analysis at the New School for Social Research. The Deficit Myth focuses on the ideological myths about the federal budget deficit that constrain our ability to meet the needs of our people. Kelton does not argue that deficits don’t matter; indeed they do matter, but for reasons other than balancing the budget. She offers a fresh perspective on our monetary system that can help us differentiate between legitimate constraints and artificial barriers.
The Myth of the Household Budget Analogy
The first myth that Kelton aims to dismantle is the idea that the federal budget should be managed like a household, and that the federal “household” budget is broke. Hence the inevitable question in policy debates about healthcare, infrastructure, education, climate change, and so forth is inevitably: “How are you going to pay for it?” But what if, Kelton asks, “the federal budget is fundamentally different than your household budget?” How would this alternative perspective change things?
A central tenet of MMT entails the difference between a household budget and the federal budget, a distinction between currency users and currency issuers. Unlike households, which are currency users, the US federal government is a currency issuer. People in households cannot create their own currency, but the federal government can, as an exclusive right granted by the US Constitution. It does this by minting coins, printing bills, and “creating digital dollars known as reserves that exist only as electronic entries on bank balance sheets.”
When reading this part of Kelton’s book, I was reminded of Yuval Noah Harari’s discussion of money in Sapiens: A Brief History of Humankind (2014). Harari notes that money evolved historically from commodities like barley, which had intrinsic value, to metals such as silver and gold, whose value is in large part symbolic and cultural, to money as electronic data—90 percent of all the money in the world—that exists only on computer servers, “created exclusively,” writes Kelton, “via keystrokes on a computer controlled by the government’s fiscal agent, the Federal Reserve.” In some ways the whole system, like the belief in God, is based on trust in a shared myth—enforced by the power of the state—that something intangible is real.
A key caveat of this argument is that a nation must maintain “monetary sovereignty” by not incurring debt in a currency other than its own. Currently the United States, United Kingdom, Canada, Japan, and Australia are among the countries that for the most part maintain monetary sovereignty. Conversely, nations that belong to the European Union and peg their money to the euro, which can only be issued by the European Central Bank, have relinquished their monetary sovereignty. This has turned even advanced economies like France, Spain, and Italy from currency issuers into currency users. It also explains the debt crisis experienced by countries like Greece, which borrows and hence owes money to the EU. The United States is in an especially advantageous position in that the dollar is the dominant currency in the world and most foreign reserves, including China’s, are held in US dollars.
An important part of MMT’s relevance to the United States of today is our nation’s abandonment of the gold standard in the early 1970s, which relieved the federal government of the obligation to convert its dollars into gold if holders of dollars chose to claim them. Economists call this nonconvertible or fiat currency, which essentially means that the government “can issue more dollars without worrying that it could run out of the gold that once backed” it. (In Latin, fiat means “let it be done.”) With fiat currency, the government cannot run out of money; it cannot go bankrupt because it can always create more money. This does not mean that there are no adverse consequences of creating more money. The primary adverse consequence is that more money injected into the private sector can potentially increase inflation, which lowers the exchange value of the money in circulation. But according to MMT, it is inflation, not balancing the budget, that is the primary reason for budgetary restraint; and inflation also has other causes and can be managed by other means.
Kelton views financing in monetarily-sovereign federal governments like the bank in the game of Monopoly.
The game can’t begin until someone is put in control of the currency. The players don’t pony up the money to get the game underway. They can’t because they don’t have it yet. The currency has to be issued before anyone can get it….Because the players are merely users of the currency, they can and do go broke. The issuer, however, can never run out of money. In fact the official rules of the game literally read: The Bank “never ‘goes broke.’ If the Bank runs out of money, the Banker may issue as much more money as may be needed by writing on any ordinary paper.”
A telling exchange at a hearing of the US House Committee on the Budget in 2005 between then-US Rep. Paul Ryan and then-US Federal Reserve chairman Alan Greenspan illustrates Kelton’s point. Ryan, the quintessential “budget hawk” who believes that cuts in “entitlements” like Social Security and Medicare are necessary to reduce the deficit, asked Greenspan whether he agreed with that assessment. Greenspan, who is no liberal, replied, “there is nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.” Similarly, Greenspan’s successor, Ben Bernanke, responded to a question on CBS’s “60 Minutes” about whether the $1 trillion bailout of the banking system in 2009 was paid for by taxpayers. Bernanke said, “It’s not taxpayer money….We simply use the computer to mark up the size of the account….It’s much more akin to printing money than it is to borrowing.”
Indeed, I’m sure everyone has asked themselves, why does there always seems to be enough money to pay for Wall Street bailouts or military spending or tax cuts for the wealthy? Why are questions about how to “pay for it” only asked when it comes to healthcare, education, and the like? MMT helps explain this. According to the US Constitution, it is the US Congress that has the power of the purse. “If it really wants to accomplish something,” Kelton argues, “the money can always be made available….Spending or not spending is a political decision.” As US Rep. Alexandria Ocasio-Cortez said, “We write unlimited blank checks for war. We just wrote a $2 trillion check for…the GOP tax cut, and nobody asked those folks, ‘How are they going pay for it?’” In light of this, she thinks that MMT should at least be “a larger part of the conversation” about how we are running our economy.
MMT on Taxation
According to conventional economic thinking, the government relies on two sources of funding: taxes and borrowing. Let’s begin with taxes. According to MMT, the primary reason for taxation is not that the US government needs our money to pay for its operations, but that the government taxes to create a demand for its currency by compelling us to find paid work in order to pay our tax liability. In other words, it is taxation that forces people to use the currency of the government under which they live. In the United States, because Americans are required to pay taxes in dollars, they have reason to earn, spend, and otherwise use dollars as opposed to euros, bitcoins, or some other currency.
Another way to look at it is like a “chicken or the egg” question regarding taxation and government spending. According to conventional thinking, taxation precedes spending. As British Prime Minister Margaret Thatcher famously said in a speech she gave in 1983, “the state has no source of money, other than the money people earn themselves.” According to MMT, however, it is the other way around: It is the government’s issuance of currency—“spending”—that puts the money into circulation that allows people (via paid employment) to pay taxes. According to Kelton, “Obviously no one can pay the tax until the government first supplies its tokens….Taxpayers [aren’t] funding the government; the government [is] funding the taxpayers.”
This reversal of common wisdom derives from a body of historical scholarship known as chartalism, which finds that money as a medium of exchange was not “just a convenient device that sprang up organically as a way to make trade more efficient.” Rather, “taxes were the vehicle that allowed ancient rulers and early nation-states to introduce their own currencies, which only later circulated as a medium of exchange among private individuals.” Nowadays, clear examples are the billions of dollars that the US government spends on defense and on research and development that leads to technological innovations that fuel the private sector (for example, computers and the internet).
According to MMT, taxes are also what make money in a particular currency valuable. The government’s role is to manage the level of taxation to preserve that value by minimizing inflation. If the government merely spends money, it will need to withdraw money through taxation to avoid inflation. According to Kelton, “More than any other economic school of thought, MMT emphasizes the importance of deciding when tax increases should accompany new spending and which taxes will be more effective at restraining inflationary pressures.” It is not just a matter of more or less taxes, but of how money is invested, for what purposes, and of who benefits and who pays.
In addition, taxes are an important tool for altering the distribution of wealth and income. Taxes can be structured to widen or lessen the gap between the rich, middle, and poor. In the last few decades, the US tax system has been structured in a way that maximizes economic inequality. Currently there is more income and wealth inequality than at almost any time in US history. According to Kelton, “About half of all new income goes to the top 1 percent, and just three families own more wealth than the bottom half of America. Such extreme concentrations of wealth and income create both social and economic problems.” For one, it is hard to have a strong economy when most of the income goes to a thin slice of wealthy people who don’t need more disposable income. Under these circumstances, businesses don’t have enough customers who can afford to purchase their goods and services, and enough customers don’t have sufficiently remunerated employment to pay for these goods and services. Additionally, extreme concentrations of wealth have a corrosive effect on our political system; we live more in an oligarchy, where wealth buys political power, than a democracy that reflects the will of the people. In contrast, MMT argues that we have the constitutional power to use taxation to achieve a fairer and more sustainable economy.
MMT on Borrowing
In addition to taxes, according to the conventional view, government spending is dependent on borrowing. One of the ways the US government “borrows” money is by allowing people to buy interest-bearing US Treasury bonds. Conventional economics views the interest obligation as debt. But according to Kelton, “paying interest on government bonds is no more difficult than processing any other payment….The Federal Reserve simply credits the appropriate bank account.” The main concern, as with taxes, is inflation. If interest payments become too large, too much additional money in circulation can spur inflation. Likewise, bond sales are not important because they are needed to finance the government, but because they allow the government to drain off excess private sector reserves. They are also a way for the government to regulate interest rates, which is an important tool of monetary policy.
Kelton thinks it is misleading to characterize the sale of US Treasuries as “borrowing” and the government’s obligation to pay interest as “debt.” Take the case of the country’s alleged indebtedness to China. MMT takes a step back and asks how China manages to hold US dollars in the first place. In 2018, for example, China carried a $420 billion trade surplus with the United States, that is, the dollars they received from US consumers exceeded the value of Chinese imports into the United States. (In turn, the United States carried a $420 billion trade deficit with China.) Like any other holder of US dollars, China has the option to sit on those dollars, which are held in China’s bank account at the Federal Reserve, or use them to buy something else, like US Treasury bonds. According to Kelton, “‘Borrowing from China’ involves nothing more than an accounting adjustment,” whereby the Federal Reserve transfers dollars from one China account to another; and paying them back “simply reverses the accounting entries….It’s all accomplished using nothing more than a keyboard at the New York Federal Reserve Bank.” What the conventional views misses is that “the dollars don’t originate from China. They’re coming from the United States. We’re not really borrowing from China so much as we’re supplying China with dollars and then allowing those dollars to be transformed into a US Treasury security….There is no real debt obligation.”
Theoretically, China could decide to stop buying US Treasuries and sell off its US holdings, causing disruptions in foreign exchange and bond markets. However, China is unlikely to do this because it needs to hold on to dollars if it wants to maintain the trade surplus with the United States that is important to its economic growth.
MMT on Trade and Jobs
Donald Trump made the US trade deficit a major issue and instituted tariffs on foreign imports, which are essentially a tax on US consumers. The purported goal is to make foreign imports more expensive and thus impel consumers to spend more money on domestically produced goods. But according to MMT, the real problem is not trade deficits per se but the exporting of US jobs by US corporations, which reduces domestic manufacturing and employment and erodes the fabric of life in communities across the nation. It also leads to the squandering of our collective potential, “the difference between what the economy is capable of producing and what it actually produces at any point in time.” Tariffs will not solve the problem. Neither will blaming immigrants, foreign currency manipulators, or some other culprit.
MMT’s solution to the problem of involuntary unemployment (and underemployment) is the introduction of a federal job guarantee, with appropriate training and skill development, which would establish “a legal right to a good job at good wages with good benefits.” It essentially amounts to a public option in the labor market that puts people to work building infrastructure and performing other public service functions in what MMT economists call a “care economy.” The idea, of course, goes back to Franklin Roosevelt’s notion of an “economic bill of rights.” According to Kelton:
It may be hard to imagine an economy that doesn’t allow millions to fall by the wayside. But that’s because America has…not achieved anything like true full employment…outside of wartime….With a job guarantee, free trade is no longer a threat to employment, and trade wars are no longer necessary to prevent unemployment….Trade negotiations can then focus on labor standards and environmental sustainability, with the US using its market power to promote acceptable working conditions and environmental standards worldwide….Especially in an era of global climate crisis, we should not be suckered by the simplistic rhetoric of “winning” and “losing” at trade. The quality of trade is at least as important as the quantity of trade. What ends and whose interests are our trade relationships serving?
Conventional economics asserts that there is an inherent tradeoff between unemployment and inflation—that too much employment creates too much spending which causes inflation. In this view, federal monetary policy becomes a matter of trying to decide how much unemployment is necessary as a hedge against inflation. Maximum employment is defined as the level of unemployment that the Federal Reserve deems necessary to hit its inflation target. MMT takes an alternative view and points to evidence that lower unemployment has not come at the cost of inflation (which has other causes, like monopolization, besides employment).
It is important to note that the Federal Reserve does not alter the tax structure or inject money directly into the economy. “The best they can do to promote employment is to try to establish financial conditions that will give rise to more borrowing and spending.” It may lower or raise interest rates that flow through the banking system, but it “cannot force anyone to take out a loan” and consequently incur debt. “Households and businesses are currency users, not currency issuers, so they do need to worry about how they’re going to make their payments.”
Whereas the monetary policy of the Federal Reserve involves the setting of interest rates it believes is optimal for the economy, fiscal policy involves decisions about taxation and spending, which can be understood as “investments.” MMT argues for less reliance on the former and more reliance on the latter. “We must end the cruel and inefficient practice of relying on democratically unaccountable central bankers to target the ‘right’ mix of inflation and unemployment.” Building an economy for the people should be the responsibility of our elected representatives. “Congress, with its great power over the federal budget, must play an active and permanent role in stabilizing output and employment through time.”
Kelton writes, “Transformational moments in human history have come about when someone or some group of people were able to imagine a world that the rest of us couldn’t.” Sometimes just a simple change of perspective—such as the realization that the Sun, not the Earth, was at the center of our solar system—can lead to new discoveries and knowledge advancements.
MMT is in one sense a very simple way of seeing the big picture of modern economies from a different perspective, but we should not underestimate the profound change a simple shift in perspective can have. We have been too restrictive in public policy out of unwarranted fears about numbers recorded in government agency spreadsheets. We have held back in science, fought unnecessary wars, kept living standards too low, and lived with less beauty than we could have enjoyed….MMT is about identifying the untapped potential in our economy, what we call our fiscal space. If there are millions of people looking for paid work and our economy has the capacity to produce more goods and services without raising prices, then we have the fiscal space to bring those resources into productive employment. How we choose to utilize that fiscal space is a political matter.
To be sure, the range of issues addressed by MMT are more complex than what I have chosen to highlight in this review of Kelton’s book, and you would be right to be skeptical and think that the “devil is in the details.” For non-economists like myself, some of the technical issues are difficult to absorb. In the acknowledgements to her book, Kelton thanks her editor for steering her away from esoteric economic debates and encouraging her to write for a lay educated audience. She does as good a job as possible doing this, but the details and technical arguments need to be studied and cannot be assimilated in one reading.
Of course, professional critics of MMT abound, and they include both conservative and liberal economists. Some of the criticisms and technical arguments are addressed in Kelton’s book, and there is growing commentary among journalists and economists on both sides of the political spectrum. I would expect conservative economists to dismiss it and indeed some have accused MMT of “magical thinking.” But as a progressive, I take notice that Paul Krugman is not a fan, and J.W. Mason writes in The American Prospect that MMT is not “a Copernican revolution that is going to refound economic thought” but part of “an older Keynesian tradition of economics…in which government deficits are seen not as a problem to be solved but as a useful tool” for stimulating demand in the economy (Marc Lavoie considers it part of the post-Keynesianism tradition). Mason also chides Kelton for failing to address the role of private banks, which may not be issuers of currency but are distributors of money. Nonetheless, he agrees that “a large, active public sector is more needed today than ever, and unfounded fears of public debt are a big reason we haven’t gotten it. Which means [Kelton’s] eloquent, accessible book is performing an important public service.”
Beyond the criticisms, however, I also notice the glowing endorsements from progressive economists like David Cay Johnston and James Galbraith. Johnston writes that “The Deficit Myth is simply the most important book I’ve ever read,” and Galbraith writes, “Clear! Compelling! Eye-opening and persuasive!” In a review in the London School of Economics Review of Books, Hans Despain writes:
Kelton’s book achieves a revolution in political economy. Kelton’s first great achievement leaves the conventional hawk/dove concept of deficits shattered. She decisively shows there is no budgetary constraint on government spending; instead the only real constraints…are the limits of real resources and the threat of inflation. Kelton’s second great achievement is to shift the normative grounds of government spending from the false and unproductive idea that federal deficits are evil, and to the productive political activity of deciding which spending programmes should be prioritized. Her Copernican achievements furthermore make esoteric debates on money accessible to a wide audience and wonky “pie-in-the sky” policy debates both comprehensible and realistic. The context of the current economic shutdown will place modern monetary theory and The Deficit Myth centre stage. Stephanie Kelton is the economist to carry this debate forward.
I think it is best to view MMT as an evolving paradigm, rather than a stationary canon, and it should not be viewed as a prescription for a free lunch. This is a canard that is sometimes levied against it. It is not a blank check that gives us carte blanche to fund new programs. MMT is first and foremost, Kelton writes, “a description of how a modern fiat currency works,” and with this improved understanding “comes the ability to distinguish artificial barriers from legitimate constraints.” At the very least, Kelton has brought many non-economists into the conversation about economics in a way that few of her contemporaries have done.
Kelton believes that our current way of thinking involves a collective failure of imagination, a failure of imagination that leads economists and political officials to embrace “austerity” as the remedy for fiscal deficits: We can’t have what we need and will have to learn to live with less—because we can’t afford it. But Kelton thinks that the most important “deficits” in our society are not on the budgetary balance sheet but the deficit in the utilization of our productive resources, the deficit in our quality of life and environment, the deficit in our infrastructure, healthcare and education systems—the deficit in our democracy.
Nobel-winning economist James Tobin, who served on President John Kennedy’s Council of Economic Advisors, recalls Kennedy asking, “Is there any limit to the deficit? I know of course about political limits….But is there any economic limit?” Tobin admitted that “the only limit is inflation,” to which Kennedy replied, “That’s right isn’t it? The deficit can be any size, the debt can be any size, provided they don’t cause inflation. Everything else is just talk.”
On May 25, 1961, Kennedy delivered his famous “moon-shot” speech before both Houses of Congress that launched the US space program that put a man on the moon: “I believe we possess all the resources and talents necessary. But the facts of the matter are that we have never made the national decisions or marshaled the national resources required for such leadership. We have never specified long-range goals on an urgent time schedule, or managed our resources and our time so as to insure their fulfillment.” Kennedy made no reference to taxes in his speech. He knew that Congress had the power to provide the funds, investments that not only landed a man on the moon but led to the development of much of the computer and smart phone technology we take for granted today. Kennedy knew what Dorothy and her friends only learned at the end of their journey in The Wizard of Oz: We’ve had the power all along. It’s up to us to decide what we want to do about it.
John C. Cochrane. 2020. “‘The Deficit Myth’ Review: Years of Magical Thinking.” Wall Street Journal, May 5.
Hans G. Despain. 2020. “Book Review: ‘The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.’” London School of Economics Review of Books, June 22.
Jim Edwards and Theron Mohamed. 2020. “Here’s a plain English guide to ‘Modern Monetary Theory’ and why it’s interesting.” Business Insider, March 2.
Milton Ezrati. 2019. “What Is Modern Monetary Theory?” Forbes, May 28.
Stephanie Kelton. 2019. “Paul Krugman Asked Me About Modern Monetary Theory: Here Are 4 Answers.” Bloomberg, March 1.
Stephanie Kelton. 2019. “The Clock Runs Down on Mainstream Keynesianism.” Bloomberg, March 4.
Marc Lavoie. 2019. “Modern Monetary Theory and Post-Keynesian Economics.” Real-World Economics Review, No. 89.
J.W. Mason. 2020. “Can We Create All the Money We Need?” The American Prospect, July 14.
Dylan Matthews. 2019. “Modern Monetary Theory, explained.” Vox, April 16.