Review: The Deficit Myth

Review: The Deficit Myth

The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy by Stephanie Kelton

My rating: 3 of 5 stars

Deficits can be used for good or evil.

Robert Skidelsky, in his enormous biography of Keynes, remarks that economics today occupies the same situation as theology did in the Middle Ages—as a complex a priori logic that can be used to reach any number of contradictory conclusions. The more I read in the subject, the more I agree with him. To be taken seriously in politics means being able to use this logic. And yet, despite the seemingly scientific nature of this language, we seem hardly better able to pinpoint the nature of economic reality than the scholastics were able to count the angels.

I am exaggerating, of course. But I am a little distressed to find that, according to Stephanie Kelton, most economists and politicians—who already disagree with one another—are still fundamentally wrong about money, taxes, fiscal policy, and government debt. Here is another perspective to add to the mix: Modern Monetary Theory, or MMT.

Kelton begins the book by taking a page right out of David Graeber’s history of debt. Money was not invented, as so often supposed, to solve the problems of a barter economy. Instead, money and taxes go hand in hand. The argument goes like this: If you introduce a currency into a fully functioning credit economy (where people just keep track of what is owed to one another), then there is little reason why people would adopt it. But if you institute a tax payable only in this currency, and threaten punishment for non-payment, then suddenly everyone must find a way to acquire the new currency, and this means doing some work for the state.

In other words, governments introduced taxes, not to collect money (which it was producing anyway) but to compel work. And Kelton argues that this is still true today: that governments do not depend on taxes. She uses the example of a scorekeeper in a board game. The scorekeeper adds and subtracts points for other players, but they are never in need of points for themselves. Points are simply willed into existence whenever needed. Kelton argues that the US government (and other governments with what she calls “monetary sovereignty”) is in essentially the same position with regard to the US dollar. Since we use a fiat currency, any number of dollars can be willed into existence. Thus, the government does not depend on tax revenue, any more than a scorekeeper must subtract points from other players in order to stay afloat. In short, we do not have to worry about the deficit, since government debt is nothing like the debt you or I may have.

Does that mean that the government can just spend infinite money? No, Kelton says: though the deficit is not a problem, inflation may be. Too much government spending may lead to too many dollars chasing too few resources, which can cause prices to rise. Does that mean that taxes are unnecessary? Also no, according to Kelton, since, apart from compelling work, taxes perform at least two important functions. First, they remove money from circulating, thus decreasing inflationary pressure; and second, they reduce inequality, which leads to a healthier society. Yet if the government cannot spend infinitely, and if we still do need to tax, then what are we doing wrong?

To answer that, Kelton next turns her attention to unemployment. Kelton notes that unemployment is built into our economy, largely via the policies of the Federal Reserve. The Fed aims for an arbitrary level of unemployment (say, 3%) which it considers the “natural” rate. Going below this natural rate would, it is feared, cause inflation to kick in, since demand would outpace supply. But this “natural” rate is little more than a guess, Kelton argues. Even when unemployment has been very low in recent years, inflation has remained low. Indeed, in this argument Kelton seems to have been prescient, since just in August the Fed decided to change its policy of lifting interest rates once employment hits a certain level, thus paving the way for more sustained employment growth.

But Kelton has a fairly dim view of the prospects of using monetary policy to govern the economy. Instead, she thinks that unemployment should be directly eliminated using a Federal Jobs Guarantee. This is the main policy proposal of the book, and Kelton spends a good deal of time selling it. The advantages are compelling. Most obviously, unemployment is bad for people and communities, so it would be highly desirable to get rid of it. And a jobs guarantee would give workers more bargaining power, since the wage floor would rise (the jobs would pay a living wage) and the threat of losing work and health insurance would be eliminated.

Still, I admit that I was not convinced. For one, even according to MMT’s own premises, the huge increase in aggregate demand—caused by increased federal spending, eliminating unemployment, and increasing wages across the board—could cause inflation. Kelton does not really address this potential pitfall.

On a more practical level, I also have trouble imagining the logistics. Kelton describes a program that can employ anyone, anywhere, in socially meaningful jobs. But there is not necessarily the right amount of meaningful work in any given location, nor do the unemployed necessarily have the skills necessary to do this work (and re-training has its limits). I think that a substantial amount of make-work is inevitable in such a scheme. Furthermore, I can hardly contemplate the enormous bureaucracy that would be needed to administer such a program. It seems there would be just as many people making jobs as people needing jobs made for them.

The job guarantee’s major policy rival, universal basic income (UBI), has none of these practical challenges (though of course it could cause inflation, too), since it is merely paid via the IRS. Admittedly, jobs do provide social and psychological benefits that an income does not. But Kelton does not discuss UBI at all, which I thought disappointing.

At this point, the reader may be forgiven for wondering what is so new about MMT. After all, Paul Krugman—an orthodox Keynesian economist critical of MMT—has been writing for years about the mistake of thinking of the federal budget like a household budget, and the desirability of federal deficits in times of recession. The difference, so far as I understand it, brings us into dangerously wonky territory. Krugman avers that when we near full employment, a large deficit may require higher interest rates in order to avoid inflation. Kelton counters that our assumptions that low interest rates boost spending, and higher interest rates constrict spending, are actually incorrect. In other words, Krugman thinks that monetary policy can partly compensate for fiscal policy, while Kelton thinks that monetary policy is not particularly useful.

I have little to add to this, other than to remark that I can never understand why these disputes—like theology—always take the form of high theoretical debates from first principles. It strikes me that the impact of monetary policy is an empirical question that could be answered with a careful look at the historical record. But what do I know?

Well, I have done my best to elucidate this sacred mystery, but I ought to evaluate the book. Like many readers, I found the writing in this book extremely grating. The tone was somewhere between a salesperson and a televangelist—promising instant enlightenment and easy solutions—which immediately put me on edge. In fairness, when Kelton is not selling MMT but explaining it, the book can be quite fascinating. But Kelton’s insistence on treating MMT as blindingly true, and its enemies as either blinkered traditionalists or deceptive politicians, was not charming or effective. And the amount of repetition could even be condescending. By the time I reached the end, I really could not stand to hear another iteration of the central tenets of MMT. I got it the first couple times.

Whatever the flaws of the book, and whether or not MMT is an accurate picture of how the economy works, it at least makes you think about how the deficit is treated in public discourse. Anyone who reads the news cannot help but notice that the swelling deficit is only invoked when we have to pay for, say, healthcare or infrastructure; but, somehow, when tax cuts to the wealthy or defense spending are on the table, nobody seems to worry. Even if the deficit presents more of a problem than Kelton believes, it is obvious that, if anything is worth going into debt for, it is programs that benefit the public, rather than bombs or yachts. I hope that followers of Keynes, MMT, Thomas Aquinas, and William of Ockham can at least agree with that.

View all my reviews

Quotes & Commentary #69: Keynes

Quotes & Commentary #69: Keynes

It is astonishing what foolish things one can temporarily believe if one thinks too long alone, particularly in economics (along with the other moral sciences), where it is often impossible to bring one’s ideas to a conclusive test either formal or experimental.

—John Maynard Keynes

I have been thinking a lot about Keynes lately, and not only because I am reading a massive biography of his life. Keynes is one of those perennial thinkers whom we can never seem to escape. He exerted enormous influence during his lifetime and dominated economic thought and policy for thirty years after his death. Then, as inevitably happened, the Keynesian orthodoxy became too successful for its own good. His ideas came to be taken for granted, and his innovations became the conventional wisdom that the cleverest economists of the next generation came to reject. This ushered in the age of Neoliberalism—with Margeret Thatcher, Ronald Reagen, and Milton Friedman as the great standard-bearers—and the decline in Keynesian thought.

And yet, whenever there is a serious problem with the economy, everyone instinctively returns to Keynes. It was he who most convincingly analyzed the sources of economic recession and depression, and then plotted a way out of it. He was writing, after all, in the wake of the Great Depression.

To oversimplify the basic idea of Keynes’s analysis, it is this: High unemployment leads to a lack of demand, and a lack of demand can push financial systems beyond the breaking point. Put another way, the economy can be envisioned as an enormously complex machine that is composed of millions of cogs. Some cogs are small, some are large, and all are connected—either proximally or distantly. If one small cog stops working, then it may cause some local disturbances, but the whole machine can continue to chug along. But if too many cogs fail at the same time, the machine can come to a grinding halt.

As the coronavirus shuts down huge sections of the economy, this is exactly the scenario we are facing. Waiters, bartenders, actors, musicians, taxi drivers, factory workers—so many people face lay-offs and unemployment as businesses prepare to shut down. Besides this, if we are locked into our homes, then there are now far fewer places where people can spend their money, even if they have money to spend. It is inevitable that some people will not be able to afford rent, that some businesses will go under, and that much of the money that is available to circulate will remain unused in bank accounts. People are not going to be buying houses, or cars, or dogs, or much of anything in the coming weeks (besides toilet paper, of course).

Now, in a capitalist economy, anyone’s problem is also my problem, since buying and spending are so intimately related. The money you spend eventually becomes the money I receive, and vice versa. Thus, if there is a increase in unemployment (limiting the money you receive), an increase in bankruptcies (limiting the money the banks receive), and a decrease in spending (limiting the money I receive), then we have a recipe for serious economic contraction. A wave of bankruptcies inevitably puts pressure on banks; and if banks begin to collapse, then we are in grave trouble. Whether or not we like to admit it, banks provide an essential service in the economy, one which we all rely on. To return to my crude cog analogy, the banks are some of the biggest cogs of all; and if they stop turning, nothing else can move.

Keynes’s solution to this dilemma was essentially to use the government’s almost limitless ability to borrow money, and inject as much cash into the economy as possible. In other words, the idea is to stimulate demand, so that people can continue to spend money. It is an idea that has been criticized by so-called ‘responsible’ people for generations. Can the government really afford to go into so much debt during a recession? Can such artificial measures actually prop up an ailing economy? Can we tolerate such a huge degree of government involvement in a liberal society?

Republicans—and to a lesser extent, even Democrats—have been sharply critical of Keynesian economics over the years. When Obama wanted a stimulus package for the 2008 financial crisis, he faced endless opposition and criticism from the Republican party. And now that we are facing an economic crisis on a comparable scale, the Republicans are turning without hesitation to Keynes: hundreds of billions in stimulus, and even resorting to mailing checks to every American. One could hardly imagine a more straightforwardly Keynesian solution than this. Keynes had this to say about how the government could deal with a recession:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

This is the closest that Keynes got to the notion of simply giving people money. Paying people for absolutely useless work is better than nothing, since at least then people are being paid; and if they are being paid, they can spend their money; and if they spend their money, I can get paid; and so on. If this were a different kind of crisis—a kind where we did not have to practice social distancing—then perhaps we could imagine large-scale infrastructure projects as a way of combating recession. But now, we must resort to the even more radical idea of paying Americans to do nothing. Maybe Andrew Yang’s notion of a universal basic income is not so far after all?

Well, here is where I must warn my readers (all three of you) that I am really quite clueless when it comes to economics, so everything written here must be read in that spirit of ignorance. However, I think that Keynes’s quote is also quite relevant for non-economic reasons. As so often true in economics, we are facing an entirely novel situation. This is a crisis without precedent, and that means that all of our ideas of how to cope with the crisis are untested. The closest historical precedent to the coronavirus is the 1918 flu pandemic; and yet there are important differences between both the disease and the historical situation. We are thus operating without ‘conclusive tests,’ in Keynes’s words, of our ideas. It remains to be seen which country’s approach will be the wisest.

In the meantime, Keynes is an example for us to follow: an intellectual who responded to a historical crisis with both ingenuity and rigor. Let us hope there are many more like him.