The Deficit Myth (Stephanie Kelton)

The Deficit Myth will, I suspect, be a bestseller. 

Stephanie Kelton, former chief economic advisor to Bernie Sander’s 2016 election campaign, is the most prominent proponent of Modern Monetary Theory (MMT), which the book is (mostly) about. MMT is a lens through which to view macro economics in a country that has a monopoly of its own currency; it is often caricatured as the idea that there is no limit to which a government can print money.

The Deficit Myth, a popular economics book framed around parts of the author’s professional autobiography, can be described as containing Good, Bad and Ugly. 

The Ugly is the author’s description of the current U.S. political economic situation. Whilst Kelton openly has an agenda, her critique is largely factual. Whilst unemployment is low, there is severe underemployment in the US jobs market; undeniably healthcare and higher education are structurally flawed (for example, life expectancy is falling, and considerably below countries spending a third of the U.S. per capita on health), and infrastructure underfunded. Kelton briefly critiques the democratic process, as being captured by wealthy individuals and large corporations, and gives a short, inevitable mention of the environment. Whilst I wholeheartedly agree with the author’s assessment of the current state of affairs, such an assessment can be found in numerous sources and is the least original part of the book; this assessment is a bridge between what I would characterise as the good and bad of the book.

The Good. Stephanie Kelton has clearly spent many hours explaining Modern Monetary Theory to professionals and laypeople alike, and does a wonderful job of outlining the theory in a non-technical manner. Often economists explain concepts to non-economists in an insultingly basic way, but Kelton manages to explain serious and complicated topics exceptionally well. 

At its core, MMT is a descriptive model which allows us to better understand economics. So often do politicians discuss the government budget using the household budget as a metaphor, that the idea of ‘going broke’ or 'mortgaging the future’ become genuine worries for the citizenry. But, Kelton explains, a country that borrows in, and has a monopoly in printing, its own currency, simply cannot unintentionally go broke. If the UK or U.S. wished to clear its entire debt tomorrow, either could simply type some commands into a computer, and buy back all bonds it had issued. When one considers that the notes in our wallet have worth because we all believe they have worth, it is easy to see that in a sense, money is an idea or a metaphor - one that is for all intents and purposes ‘owned’ by the sole issuer. Therefore argues Kelton, governments do not need to raise taxes or issue debt in order to spend money or fulfil their obligations; taxes and bonds perform other useful functions in a society (by making people owe taxes in dollars, people demand dollars, by issuing risk-free bonds, people can hold dollar denominated bonds instead of unproductive cash). If there is no limit to nominal government spending, is MMT saying governments should print money forever? No. The limit to government spending is the real limit - that is, the limit of goods and services a country can actually produce. As everyone knows, print more money than you can produce goods, and prices rise - eventually inflation becomes hyperinflation, ruining the economy. If the sign of over stretching resources is inflation argues Kelton, the sign of under utilising a nation’s resources is unemployment. Furthermore, issuing bonds is not ‘putting the nation in debt’, since the bonds ('yellow dollars') and the cash they are exchanged for ('green dollars') are opposite sides of a ledger we collectively hold. Kelton explains this using an analogy of two buckets, and then extends the story to include imports and exports, again demonstrating that a trade deficit is not the disaster some politicians like to paint it as.

So far, MMT is dealing in truisms, albeit useful ones for anyone contemplating government spending. Where this train of thought becomes prescriptive, is in the argument that constraining government spending using tax and borrowing limits leads to under investment, and that any unemployment is under-utilisation of a nation's resources; and so the only restraint on government spending should be inflation. 

There are serious problems with this logic. 

Firstly, government spending plans are large, unwieldy, and long-term, whilst the inflationary outlook can change extremely quickly and by external factors (such as an oil price shock). There would be little flexibility in government budgeting to be able to deal quickly with short term changes in inflationary outlook without unforeseen consequences. Secondly, inflation is a non-linear product of its causes. Because price rises are partially caused by to what degree people expect them to rise, inflation is notoriously difficult to get under control after a certain point. It’s expectation becomes self-fulfilling, as it did in most western economies by the 1970s (leading to stagflation). The fact that it is less than an exact science is precisely why policy makers should err on the side of caution when controlling inflation. Interest rates set by an independent central bank are a better tool than net government spending for controlling inflation for the above reasons. Thirdly, consider the position of elected officials, who already fight a losing battle arguing against spending government money on extremely emotive topics; no politician wishes to argue for fewer hospitals, lower pensions or not fixing the roads. The false-dichotomy of ‘we don’t have the money’ criticised by proponents of MMT is actually an effective tool. By forcing voters to decide whether they would like higher taxes or more hospitals, politicians are able to stay within the productive capacity of the country without being voted out of office. If, however they said ‘we can’t provide school lunches in case it causes inflation’, this would be a deeply unpopular message, and likely voters would choose a little extra inflation. Unless you experienced Weimar Germany, inflation will likely feel like an abstract concept, hardly to be feared. If we agree that inflation is a destructive force, we should be institutionally geared towards combating inflation - and MMT moves us in the opposite direction. Put simply, whilst it is technically true that nations with a monopoly over their currency printing presses do not need to budget like a household, ultimately they need to restrain spending against inflation, and perhaps the metaphor employed by politicians is the most effective way of doing that. After all, the movement towards independent central banks with a mandate to control inflation came into popularity precisely to alleviate the political pressure to overheat economies for political purposes. 

Beyond the alluring logic of MMT, it must surely be the case that it’s current popularity is linked to the fact that inflation hasn’t been a problem in western economies for decades. Kelton is likely correct that the stimulus bill passed by Obama in 2008 was too insubstantial, and a reason for the slow recovery; the lack of inflation and near-zero interest rates for a decade certainly suggest as much. The fact that the US government is presently considering another trillion-dollar stimulus to combat the economic effects of Covid shows that when it comes to crunch time, policy makers realise their ability to spend government money is virtually limitless. Ironically, the latest stimulus is mooted to involve large scale construction projects; a combination of the Covid crisis and a November election may make Donald Trump the first MMT president. 

The Bad. The Deficit Myth will likely be many people’s only exposure to Modern Monetary Theory, and in a way it is a shame that Kelton combines her fine explanation of the concept with her highly partisan policy solutions. MMT as a theory isn’t a particularly left or right wing concept, but most will come away from that book thinking it is solely left-wing, and those of a different political persuasion will oppose the ideas. That said, the author is free to write the book she wishes to write, and is more than qualified to do so. 

Where the policy solutions are ‘bad’ in my opinion, is in their outright emphasis on the demand side, and on the implicit assumption that jobs are the solution to so many of society's ills. 

The centrepiece of the author’s policy solution is a fully-funded job guarantee scheme, with meaningful jobs (caregiving, environmental clean up etc), the specifics of which would be decided by local institutions - available to all, paid at $15 per hour plus benefits. There are good arguments for this scheme; spending money on jobs both gives money to those who need it whilst creating a productive member of society. Long-term unemployment becomes static - companies tend not to hire people who have been longer than 6 months unemployed, and people often stop looking altogether. The job guarantee will create a tight labour market, and force companies to pay higher wages whilst automating demeaning, minimum wage jobs (this is the sole way in which productivity may be improved by this scheme). 

The strongest argument for a job guarantee is the automatic mechanism it creates to alleviate economic shocks. To Kelton’s credit, she addresses the problem of governmental fiscal discipline, by discerning between ‘discretionary’ and ‘automatic’ government spending (a distinction that formally exists in the US system). As she states, when there’s an economic shock and unemployment increases, governmental spending automatically increases, helping to mitigate the fall in demand - this happens as unemployment payments explode. But she argues, this is not nearly enough. A serious job guarantee would provide the same mechanism but far more rapidly and effectively

If an economy is depressed and seriously under utilising its resources, the job guarantee could create demand enough to stimulate a recovery. Real growth however, stems from ideas, innovation, new technologies and inventions. The job guarantee will not generate innovation, nor efficiency-driving competition. If the idea of this mechanism is to allow it to rapidly expand and contract as needed, how can the jobs be worthwhile? If unemployment goes from 300,000 to 5 million in a couple of weeks, how could the (inevitably) enormous bureaucracy possibly invent millions of jobs that needed to be filled? If the idea is that when the economy expands people leave their jobs to work in the more productive private sector, what is the motivation for them to leave? How can a quantity of caregivers or construction workers fluctuate by orders of magnitude without massive disruption? 

In the 1960s, Milton Friendman visited a worksite in China where a new canal was being built. He was shocked to see that, instead of modern tractors and earth movers, the workers had shovels. He asked why there were so few machines. The government bureaucrat explained: “You don’t understand. This is a jobs program.” To which Milton replied: “Oh, I thought you were trying to build a canal. If it’s jobs you want, then you should give these workers spoons, not shovels.” This story is often told to illustrate the point that jobs exist to produce things, not to give people work - and this applies to the policy recommendation made in The Deficit Myth. More important though, is the reason Kelton wants to create jobs in the first place. 

If we wish to print government money to alleviate poverty and inequality, why make people work for it? It is, in my view, a pessimistic and patronising way to run an economy, giving people relatively pointless jobs (and as above, they will by necessity be such). If you want them to avoid hunger or struggle to pay rent, simply give them money. This will save having to build a huge new bureaucracy which will likely be corrupt, and definitely be inefficient. If you want people to create new businesses, to innovate, to invent - give them time. How do we give them time? Simply give them money!

Whilst I have been critical of The Deficit Myth’s prescriptions, it is an indispensable book for those interested in macroeconomics. Thought provoking, lucid, and enjoyable, this book will spark much-needed policy debate, and hopefully provoke a new honesty in both the conduct, and reporting of these debates.