Modern monetary theory is all the rage right now and suffice to say not everyone is a fan.
One person who definitely isn’t enamored with MMT is Jeff Gundlach who, on his latest webcast (called “Highway To Hell”), deemed it a “crackpot” idea, akin to an old riddle about an innkeeper with a guilty conscience, a scheming bellhop and three hotel guests.
For anybody who missed Jeff’s March 12 webcast, allow us to present, again, the audio from the MMT discussion, because there’s nothing quite like listening to a self-righteous Gundlach butcher the story of the “missing dollar” in the course of trying to come across as pretentious vis-à-vis MMT. Here it is:
And here’s the chart Jeff refers to there at the outset:
We’ve talked more about MMT in these pages than we would otherwise think is ideal, and not so much because we have an opinion one way or another about it, but rather because the fact that it’s grabbing so many headlines speaks to two key macro undercurrents.
One is the notion that central banks are effectively “out of ammo” (so to speak), which means monetary policymakers will confront the next downturn with limited capacity to cut rates and little in the way of room to expand their balance sheets lest everybody should become Japan. The second is the ascendancy of populism and a concurrent rethink with regard to the desirability and/or relative merits of austerity and fiscal discipline.
MMT has a place in both of those discussions, hence its newfound popularity. I dare say MMT is on the verge of becoming an extremely unlikely pop culture phenomenon.
On Monday, both Goldman’s Jan Hatzius and BofAML’s Ethan Harris weighed in on MMT and their comments are grabbing headlines. To be perfectly honest with you, I read the Goldman note early Monday morning and didn’t even make it to the bullet points about MMT, which comprise points 7 and 8 on an 8-point list. My mistake, I suppose.
In any case, here’s what Hatzius had to say (this is pretty brief, so it’s really not worth the effort to try and paraphrase it):
Without endorsing modern monetary theory (MMT) in its entirety, we think its proponents make a couple of points that are both correct and important. One is that a DM government with its own currency and central bank—like the US or Japan but unlike Greece or Italy—cannot go bankrupt because it can always create fiat money to cover the gap between spending and tax revenue. One might say that this should be obvious, but that did not stop many commentators from expressing fears of government bankruptcy in the aftermath of the crisis. The main constraint on deficits—especially money-financed deficits—is the risk of inflation, but this depends on many factors, not just fiscal and monetary policy. It is typically small or non-existent when governments expand fiscal policy to fight a recession, although it could be a bigger issue in coming years, especially under our forecast of further labor market tightening. Another key point associated with MMT is that private sector deficits are generally more worrisome than public sector deficits. The basic reason is that households and businesses do not have a captive central bank and can very much go bankrupt. In fact, a large private sector deficits—which typically develops on the back of an asset market bubble—has been a great indicator of future financial crises across advanced economies over the past three decades. In the current environment, we are therefore more reassured by the US private sector surplus than we are concerned by the public sector deficit.
So that’s Goldman.
As for BofAML’s Harris, his piece is longer and after rehashing the now-familiar basics and adding a bit of nuance, he notes that the bank’s economics team “has serious reservations about MMT.”
But it’s not all bad news. In fact, he starts with the “good” which, simply put, is that when demand is in the gutter and rates are glued to the lower bound, theory (in this case MMT) can and does work in reality.
“Indeed, this is essentially what the US did in response to the Great Recession, combining large budget deficits with large Quantitative Easing programs”, Harris writes, adding that while “critics argued that this ‘debasing the currency’ could trigger runaway inflation, we strongly disagreed.”
Obviously, the runaway inflation that so many feared Bernanke was sure to trigger did not in fact materialize.
The bad news is that when something sounds too good to be true, it probably is. To wit, from Harris:
Consider the current Fed exit from zero rates and a big balance sheet. As the economy recovers and inflation forces start to build, zero interest rates and an ever expanding balance sheet no longer were appropriate. Had the Fed been under political control and refused tighten monetary policy, today we would be experiencing a massive overheating of the economy. MMTers would argue: “don’t worry politicians will do the dirty work of containing inflation.” Really? If the Fed wants to contain inflation, it must either stop flooding the economy with reserves or pay interest on reserves so that banks will be willing to hold them. One way or another, the government has to pay interest on its debt. In other words, the free lunch thinking on MMT only applies when the economy is deeply depressed.
He also cites misconceptions about “full employment” and casts doubt on the notion that politicians can be trusted to rein in inflation. Even if there’s a “will”, he suggests there might not be a way (i.e., Harris questions whether fiscal authorities even have the “ability” to control inflation).
If all of this is starting to make you think that MMT sounds like something Donald Trump would wholeheartedly support, that’s because it is.
Of course Trump also purports to champion supply-side economics which is amusing because, as BofAML goes on to say, MMT is hardly the only “free lunch” model. We’ll just leave you with two quick additional sentences from Harris’s note and you can extrapolate where the discussion goes next.
Supply-side economics can also be used to justify a lack of policy discipline. As with MMT, it includes some core truths that tend to be exaggerated once it enters the political arena.