A Cause for Celebration:
A Paradigm Shift in Macroeconomics is Underway
This once-in-a-century pandemic hasn't given us much to celebrate in 2020. One cause for optimism, perhaps, is that we might finally jettison the mainstream economics fictions about government deficits and debt, which have hampered prosperity over several decades.
Max Planck's observation is often shortened to “Science progresses one funeral at a time”. For macroeconomics, we might think of progress as occurring one crisis at a time, because it is the sequence of crises – 1991 recession, the Global Financial Crisis (GFC) and, now the COVID-19 pandemic – that has generated an accumulated awareness of the failure of mainstream macroeconomics. This has progressively opened the door for Modern Monetary Theory (MMT), the emerging rival paradigm.
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it … German physicist Max Planck, Scientific Autobiography and other Papers, 1950, p. 33-34.
The conjecture here is that, while some want to hang on to the debt and deficit scaremongering that has cruelled policy choices and left a trail of human damage over the last four decades, it is increasingly obvious to people that there is little substance in those narratives.
To find a road to recovery that addresses the health challenges, the socio-economic consequences, and the still-looming climate crisis, will require an almost orthogonal shift in policy thinking, driven by a paradigm shift in economic theory.
From full employment to neoliberal stagnation
The lesson from the Great Depression was that without government intervention, capitalism is inherently unstable and prone to delivering lengthy periods of unemployment. The spending and wage cuts in the early 1930s deepened the crisis – only the military spending and fiscal deficits of the late 1930s, ended the Depression and brought full employment. The challenge was to maintain that in peacetime.
The Australian government's 1945 White Paper on Full Employment articulated those lessons with its nationbuilding plan. Everyone understood that fiscal deficits, which supplemented private spending, could produce sufficient jobs for those who desired them.
It was also understood that public infrastructure (transport, energy, etc), health and education, would underpin strong private investment, strong productivity and real wages growth, and declining inequality.
Full employment became a collective responsibility of society. The low unemployment that followed was not solely due to strong private employment growth and a career public service. During this period, a buffer of public sector jobs was also available for the least-skilled workers who could not find work elsewhere.
This consensus faltered in the late 1960s, as corporate lobbies decided that social democratic gains for workers were impinging on their desired profits. The resulting global resistance by capital holders, exploited the dislocation that followed the OPEC oil price hikes to advance a new economic paradigm – Monetarism.
If this sounds conspiratorial, then readers are referred to the 1971 Powell Manifesto, which articulated a strategic campaign to restore the ‘power' of American capital vis-à-vis labour. This strategy became global.
This new economic ideology advanced its political agenda by creating a ‘fictional' economic world, that was then imprinted on the public psyche through skilful framing and language. A series of interlinked myths about debt, deficits, and inflation,
Some want to hang on to the debt and deficit scaremongering that has cruelled policy choices and left a trail of human damage over the last four decades.
appealed to our intuition as managers of household finances.
This ideology, now loosely termed neo-liberalism, claimed that the nation state was powerless in the face of the globalisation of capital. Accordingly, government policy should aim to appease the interests of capital, lest it create economic crises. The victims of the spending cuts – the unemployed – were demonised as ‘bludgers'.
The view was swallowed, ‘hookline-and-sinker' by social democratic forces who began to articulate a macroeconomic narrative that was indistinguishable from the conservatives. They sought to differentiate themselves on identity issues, but the contest over macroeconomic policy virtually disappeared.
The paradigm shift was framed as a transition from a powerless state to an efficient market. The idea of national sovereignty was derided as a relic of the past. But closer scrutiny reveals that the state was never overpowered by the market. Neoliberalism has not entailed a retreat of the state but rather a reconfiguration of the state, aimed at placing the commanding heights of economic policy under the control of finance capital.
1
It is self-evident, that the neoliberal agenda would not have been possible if governments – and in particular social democratic governments – had not resorted to a wide array of tools to promote it: the liberalisation of goods and capital markets; the privatisation of resources and social services; the deregulation of business, and financial markets; the reduction of workers' rights (first and foremost, the right to collective bargaining) and more generally, the repression of labour activism; the lowering of taxes on wealth and capital, at the expense of the middle and working classes; the slashing of social programs, and so on.
To insulate macroeconomic policies from popular contestation, a process of de-politicisation was pursued, which
...the privatisation of resources and social services; the deregulation of business, and financial markets; the reduction of workers' rights; the repression of labour activism; the lowering of taxes on wealth and capital; the slashing of social programs...
led to policies that have constrained existing national sovereignty and curtailed popular-democratic mechanisms.
Neoliberal policies were systemically pursued throughout the West (and imposed on developing countries) with unprecedented determination, and with the support of all the major international institutions and political parties. The public justifications were all about creating more jobs and reducing poverty, but the reality was different. (see Table 1).
When currencies were backed by gold
Most people are unaware that at the time the forces of neoliberalism were mounting their assault on the Keynesian consensus, a major event occurred that changed the way monetary systems worked and undermined the veracity of all the key neoliberal propositions about debt and deficits.
In an effort to achieve currency stability at the end of World War 2, the fixed exchange rate system (Bretton Woods) was introduced in 1946. All participating currencies were valued against the US dollar, which was then convertible at a fixed value into gold, which was the system's price anchor.
The relevance here is that because currencies had an intrinsic value (convertible rate to gold) central banks had to carefully manage the amount of their currencies in the system to ensure they maintained the agreed parities with other currencies. An excess supply of say, Australian dollars in foreign exchange markets required the Reserve Bank of Australia (RBA) to purchase dollars with foreign currency reserves and increase domestic interest rates to attract foreign investment (and demand for dollars).
But contracting the money supply and increasing interest rates pushed unemployment up. If, in response, expansionary fiscal policy was used too aggressively to reduce unemployment – by putting currency back into the system – it would compromise the RBA'S efforts to maintain currency stability.
As a consequence, if a government wanted to spend more without increasing its gold reserves, then increased government expenditure (injecting currency) had to be matched (‘financed') by taxation. If they wanted to spend more than their tax revenue, they had to borrow and issue debt (draining currency).
The Bretton Woods system collapsed in August 1971 when President Nixon abandoned US dollar-gold convertibility, removing the price anchor in favour of fully floating exchange rates between currencies. This collapse dramatically altered the opportunities available to currency-issuing governments.
In August 1971, President Nixon abandoned US dollargold convertibility, removing the price anchor in favour of fully floating exchange rates between currencies
First, under a fiat monetary system, ‘state money' no longer had any intrinsic value (no longer convertible into gold). For an otherwise ‘worthless' currency to be acceptable in exchange (buying and selling things) some motivation was required. That motivation emerges because the sovereign government requires its use for citizens to pay their taxes.
Second, sovereign governments like Australia are the sole issuer of their fiat currency. Without the Bretton Woods restrictions to offset spending with taxation and/or borrowing, a countries' central bank no longer has to defend the floating currency. There is no financial constraint on government spending.
This is important: the government can buy any goods and services that are available for sale in its currency, including all idle labour. The only meaningful constraint is the ‘inflationary ceiling' that is reached when all productive resources are full employed.
This dramatic change means that the Australian government cannot ‘run out of money' and all notions of not having enough
‘ammunition in the locker' – because the government has been running deficits (spending in excess of tax revenue) – are inapplicable.
The result is that the focus shifts from concerns about financial constraints and negative narratives about the need to ‘fund' spending, to a focus on real resource constraints
– what are the best deployments of the goods, resources and services available. Another dramatic shift in thinking.
Third, logically, the government no longer needs to issue debt. As the government is the issuer of its own currency, it does not need to ‘get' it from the non-government sector through debt issuance in order to spend it.
Crucially, politics is freed from the perennial question of ‘How are we going to pay for it?' Instead the discussion can focus on the functional outcomes we desire from public spending and available real resources.
These insights about the modern fiat monetary systems run counter to the core claims about debt and deficits that are wheeled out on a daily basis by mainstream economists and government ministers. So, what is going on?
The paradigm shift in economics
These post-1971 insights form the core propositions of Modern Monetary Theory (MMT). Successive crises have brought MMT to the centre of the debate as it becomes clear that mainstream economics cannot offer solutions to our problems.
Yet there remains visceral resistance from the mainstream macroeconomists
THE GOVERNMENT NO LONGER NEEDS TO ISSUE DEBT
The Yellow Vests, Trump, Brexit, and the decline of traditional social democratic parties…the Left gave voice to the angst of workers in the C19th, the Right is now articulating these concerns.
across the globe because MMT challenges their dominant belief system.
The resistance to change is not surprising. Social psychologists have long identified patterned behaviour called Groupthink that attempts to maintain the status quo even when it no longer adequately explains the facts.
We are at that point in macroeconomics now.
The dissonance between the statements and predictions of mainstream economists and our lived reality is widening, which is why there is increasing focus on MMT, given its congruence with the economic facts.
Various forces are pushing the paradigm shift. First, an anti-establishment revolt is underway as citizens have realised that neoliberalism has failed to deliver prosperity. The Yellow Vests, Trump, Brexit, and the decline of traditional social democratic parties are manifestations. While the Left gave voice to the angst of workers in the C19th, the Right is now articulating these concerns.
Second, the mainstream insistence that monetary policy dominate policy (‘inflation first' strategies) – with discretionary fiscal policy biased towards running surpluses – has seen central bankers break ranks in recent years and demand that governments use fiscal policy more actively.
They realise that with interest rates around zero or negative, there is no further ‘room' to stimulate spending. Further, the large-scale bond-buying exercises (quantitative easing), which were intended to push inflation higher, have also failed.
Third, the financial sector has realised that the mainstream predictions have not materialised, and profits have been sacrificed as a result.
The fiscal austerity bias, coupled with relatively ineffective monetary policy, has created stagnation, elevated levels of labour under-utilisation and subdued inflation rates. Wage growth is flat, and households have accumulated record levels of debt, making financial stability more precarious. Stifled public infrastructure development has restricted low-risk investment opportunities that have historically formed the 'bread-and-butter' sources of profit for large investment funds.
Central bankers have responded by progressively cutting interest rates, to the point where negative rates are not uncommon. In turn, we are now seeing negative yields on long-term bonds in many jurisdictions.
Take pension funds, which are now facing increasing maturity mismatch as returns on assets have become compromised by these developments. As a consequence, fund managers are taking riskier investment positions to increase earnings given their contractual liabilities. This is an unsustainable situation and insolvency risk is heightened.
They rehearse false moral arguments about today’s government spending burdening our grandchildren. None of their predictions ever materialise for they were lies to begin with.
capacity to sustain full employment.
They manufacture fear about public debt and deficits, predict government insolvency, use the words – Weimar or Zimbabwe – to invoke fears of hyperinflation. They rehearse false moral arguments about today's government spending burdening our grandchildren. None of their predictions ever materialise for they were lies to begin with. Meanwhile adherence to their dogma keeps our economy in a downward spiral.
In contrast, MMT has an impeccable record of prediction and offers answers that the economic orthodoxy fails to provide. An MMT understanding demonstrates that reliance on monetary policy at the expense of discretionary fiscal policy is an ineffective counter-stabilisation approach and undermines private investment opportunities.
A new era of fiscal dominance is the only viable way ahead, as Capitalism labours under state life support. The ‘market', the centre of the neoliberal ideology, has failed and will provide no cure.
Just like in the Depression, citizens will have to get used to the fact that the only thing between total catastrophe and a long drawn out recovery is the fiscal support offered by their governments. The age of worrying about fiscal deficits and public debt ratios will have to give way to a new era of large, continuous deficits supported by the monetary capacity of the other arm of government – the central bank.
Only MMT economists have provided a body of work that is consistent with this ‘new normal'.
MMT is about the world we live in
MMT is not some sort of regime or a set of policies. A government does not suddenly ‘apply', ‘switch to' or ‘introduce' MMT.
Rather, MMT is a lens which provides a better understanding of the fiat monetary system and the capacity of the currency-issuer. By linking institutional reality with behavioural theories, it provides a more coherent framework for assessing the consequences of government policy choices.
MMT allows us to appreciate that most choices that are couched in terms of ‘budgets' and ‘financial constraints' are, in fact, just political choices.
Given there are no intrinsic financial constraints on a currency-issuing government, we understand that mass unemployment is a political decision. Imagine if citizens understood that.
The government's predilection for comparing income-constrained household budgets with that of a currency-issuing government is an ideological fallacy at best, and intentionally disingenuous at worst. It's the very definition of comparing apples and oranges.
Households always have to finance their spending choices, either through earned income, savings, asset sales or through borrowing. If a household tries to create their own currency they're locked up for forgery.
A currency-issuing government creates money constantly and it spends it by instructing its central bank to type numbers electronically into relevant bank accounts.
All the elaborate accounting structures and institutional processes that are put in place to make it look as though tax revenue and/or debt sales fund this spending are voluntary smokescreens, which serve the purpose of imposing political discipline on government spending.
Insiders know this, but actively decline to share that knowledge with the public.
Renowned British journalist Martin Wolf, commenting on MMT, recently wrote: “In my view, it is right and wrong. It is right, because there is no simple budget constraint. It is wrong, because it will prove impossible to manage an economy sensibly once politicians believe there is no budget constraint.”
2 Famous US economist Paul Samuelson said something similar during an interview (Blaug, 1988):
TWO PEOPLE FROM THE EXTREMES OF THE IDEOLOGICAL. SPECTRUM CAN SHARE AN MMT UNDERSTANDING BUT. ARTICULATE RADICALLY DIFFERENT POLICY MIXES..
I think there is an element of truth in … the superstition that the budget must be balanced at all times … Once it is debunked, [it] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have … anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that long-run civilised life requires.
These are profound statements of how a ‘fictional' world is promoted by mainstream economists to serve as a brake on political volition.
An MMT understanding must be combined with a set of values to define a set of policies. Two people from the extremes of the ideological spectrum can share an MMT understanding but articulate radically different policy mixes.
Thus, it makes no sense to talk about a suite of MMT policies.
MMT exposes the fictional world of mainstream economics
The definitive MMT textbook Macroeconomics3 clearly shows how MMT differs from the mainstream.
Mainstream economists claim that governments, like households, have to live within their means. They say fiscal deficits have to be repaid, requiring onerous future tax burdens on our children. They claim government borrowing (to “fund” deficits) competes with the private sector for scarce available funds, driving up interest rates and ‘crowding out' (reducing) private investment. They conclude that public use of scarce resources is wasteful because governments are not subject to market discipline. Finally, they assert that if government ‘print money' then inflation accelerates. Taken together, the mainstream litany supports a bias towards fiscal austerity.
These claims are ingrained in public debate by decades of miseducation and daily onslaughts from the conservative media. Anyone who dares advocate larger deficits is vilified as being incompetent and/or a dangerous socialist. MMT rejects all these entreaties. First, while the household analogy resonates strongly with voters because it attempts to relate the more amorphous finances of a government with our daily household finances, it is wrong at the most elemental level.
We intuitively understand that we cannot indefinitely live beyond our means and neoliberals promote the analogy because they know we will judge government deficits as reckless. But the Australian government is not a
big household. It can consistently spend more than its revenue because it creates the currency.
Second, all government and nongovernment spending carries an inflation risk. If nominal spending growth outstrips the productive capacity of the economy, then inflationary pressures will emerge. Consider two scenarios:
First, all available productive resources are currently fully employed – these resources could be people (employment) or good and services. While government spending is not financially constrained, if it competes for productive resources with the non-government sector, then there will be inflationary pressures – supply and demand.
To increase its use of productive resources, but avoid inflationary pressures, the government has to deprive the existing users and ‘free up' resources from the private sector to make them available to the public sector. Deprivation can be achieved in a number of ways, but taxes are an important tool.
Taxes reduce non-government purchasing power but do not provide any extra financial capacity to government. They just create real resource space which the government can spend into without creating inflation.
In the second scenario, idle productive resources such as unemployed workers, can be brought back into productive use with, say, higher deficits. These resources have zero bid in the market and therefore deploying them introduces no inflationary pressures. The responsibility of government in this case is to spend up to full employment.
The point is clear: if nominal spending growth outstrips the capacity of firms to respond by producing goods and services for sale then there will be inflationary pressures.
Won't continuous deficits be inflationary? The basic rule of macroeconomics is that spending equals income equals output. If the non-government sector desires to save overall (that is, not spend all its income) then output will fall unless that desire is funded by government deficits. As long as government deficits are scaled to fill the non-government spending gap then they are both desirable and sustainable.
Sacrificed on the altar of the Market
In our current system, one of the key mechanisms to manage inflation is to maintain a given level of unemployment. The belief is that unemployment creates competition for limited jobs, keeping wages and inflation low – yet it is a cruel way to manage an economy.
So it is critical to understand that current government policies are deliberately structured to ensure that a percentage of the productive workforce is without a job – irrespective of all the attendant personal and social issues that come with unemployment. All the while they demonising the unemployed as ‘bludgers'.
What MMT enables governments to
Current government policies are deliberately structured to ensure that a percentage of the productive workforce is without a job... All the while they demonising the unemployed as ‘bludgers’.