Voodoo Economics or Keynes Redux? How Lawrence Summers and MMT Align
(Bloomberg Opinion) -- It’s an intense period for modern monetary theory. After decades in obscurity it finds itself under the flashlight of public attention. Federal Reserve Chair Jerome Powell and BlackRock CEO Larry Fink have both taken a swing. Economics heavyweight Lawrence Summers compared it to the “voodoo economics” peddled by supply-siders in the late 1970s.
An alternative comparison – one that might come closer to the mark – is to the extended period from World War II to the 1970s, when monetary policy played second fiddle to public spending in keeping growth on track.
That was a golden age of rising incomes, progressive social policy and strong infrastructure investment – all things that are needed today.
Getting a grip on modern monetary theory is tough to do. At its core, though, the idea is rather simple. Governments that issue their own money can’t go bankrupt. The only constraint on increasing spending to support demand or fund social priorities is inflation. In the current environment, with inflation below target, governments should ramp up spending. Central banks can play a supporting role by keeping rates low.
It’s the extreme position of MMT disciples – the devil-may-care attitude to monetization of fiscal deficits – that has earned them the ire of mainstream economists. In its direction of travel, though, the prescriptions of MMT look similar to the modus vivendi between Keynesian demand management and supportive central banking that was the economic orthodoxy from World War II through the 1970s.
During World War II, the necessities of the moment meant the Federal Reserve pegged interest rates at a low level to facilitate the financing of government debt. Even after that peg was removed in 1951, the prevailing view was that the Fed should support the Treasury. The “even keel” approach saw the Fed stabilizing rates before and after Treasury auctions. William McChesney Martin, who was Fed chair from 1951 to 1970, was browbeaten into holding rates low by President Lyndon B. Johnson.
It worked rather well. GDP growth from 1950 to 1970 averaged 4.2 percent, significantly higher than the 2.6 percent gains from 1980 on. In 1956, President Dwight Eisenhower began the construction of the interstate highway system. In 1964, Johnson’s Great Society program created Medicare and Medicaid, financed a Job Corps for the unemployed, and expanded access to college for low-income groups.
Not by coincidence, building infrastructure, providing job guarantees, and expanding health-care coverage and college access are also policies advocated by proponents of MMT.
Of course, it didn’t end well. The 1970s was a period of high unemployment and runaway inflation. Inflation ended only after Fed Chair Paul Volcker jacked interest rates close to 20 percent.
The election of Ronald Reagan in the U.S. and Margaret Thatcher in the U.K. signaled a wholesale shift in economic policy. Keynesian demand management was out; monetarism was in. Government intervention was out. Supply-side economics – with its voodoo promise of lower tax rates but higher tax revenue – was in.
Would a swing back to a world of high deficits and low interest rates risk a return to 70s-style stagflation? Mainstream economists, noting the experience of runaway inflation in countries like Venezuela, say it could. There are also arguments in the other direction:
-- MMT doesn’t advocate deficits without limit; it advocates deficits subject to the constraint that inflation should be under control.
-- Keynesian demand management and an accommodative Fed contributed to the great inflation, but they weren’t the only forces at work. Other contributing factors are no longer in place. Wages are not indexed to prices. The shale revolution has put a cap on oil prices.
-- Other developments are also weighing on inflation. Notably, globalization and advances in technology have reduced workers’ bargaining power, capping wage gains.
-- Since the great financial crisis, the U.S., Japan and the E.U. have had an extended period of low rates and high deficits. There’s little sign of spiraling inflation.
In the end, the extreme view of MMT is unlikely to become the new economic orthodoxy. Hobbled as it is by political economy constraints, fiscal policy is simply not nimble enough to play the lead role in managing the ups and downs of the economic cycle. The gains that independent central banks have brought in controlling inflation expectations will not be easily sacrificed.
In its direction of travel, though, MMT is a reminder that a more ambitious approach to economic management worked in the past and could work again today.
A global economy struggling with low growth, low inflation and rising inequality should not be hostile to new ideas. As Stony Brook University professor and MMT proponent Stephanie Kelton has said, cutting rates in a slump is “weak tea” – ineffective at boosting investment when profit expectations are low. The idea that a low-inflation, low-interest-rate environment creates an opportunity for a more ambitious fiscal policy should not be controversial.
Summers, who recently called on Washington to “put away its debt obsession” and focus on “worthwhile investments in such areas as education, health care and infrastructure,” might well agree.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tom Orlik is the chief economist for Bloomberg Economics. He's the author of "Understanding China's Economic Indicators" - a guide to China's economic data. He is based in Washington DC., following more than a decade in Beijing.
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