Mike Sax — Sumner on the Achilles Heel of MMT

What Scott Sumner doesn't seem to want to understand is that MMT favors fiscal policy based on functional finance over monetary policy involving interest rate setting. His scenario depends on interest rates only and doesn't take into account what MMT actually is about, namely, the replacement of monetary policy run by the central bank ("monetarism") with fiscal policy under the direction of the political authority ("fiscalism"). Instead, Sumner only argues within his own paradigm, the assumptions of which MMT rejects.

In the US, fiscal policy is the constitutional responsibility of Congress, with appropriations originating in the House, subject to the veto power of the president. The president gets to submit a budget, which Congress is under no obligation to accept.

There are political reasons for preferring a fiscal approach to a monetary approach as being more in consonance with democratic governance. Moreover, interest rate setting by the central bank at the apex of financial system smacks of a command economy.

Warren Mosler recommends setting the interest rate at zero and issuing Treasury securities of no longer than 3 mo duration. This obviously means that MMT is unconcerned by the size of the monetary base.

Why? Because the amount of reserve don't affect bank lending, which is influenced by demand from creditworthy borrowers. Banks will charge a competitive risk-weighted rate.

If the cb sets the interest rate at zero, then banks will have a lower cost of lending and can lend less expensively, which they will tend to do in a competitive market. This will favor investment, e.g., permanently low long term rates for residential RE.

MMT regards monetary policy as ineffective in controlling inflation, which result either from supply shortages, e.g., the Arab oil embargo, or demand outstripping the capacity of an economy to meet it. If the government deficit spends to the degree this creates or contributes to excess demand at full employment, then inflation will result. The obvious answer is to cut spending and increase taxes to reduce demand.

MMT is fiscalist, holding that demand is the key fundamental and the chief objectives are full employment along with optimal output and relative price stability.

MMT is anti-monetarist, holding that the size of the monetary base is essentially irrelevant, as QE has shown, the quantity theory has been discredited and interest rates are at best a shotgun, whereas fiscal policy can be tightly targeted. In addition, interest rate setting involves picking winners and losers.

Rather than using interest rates to conduct policy, MMT would use fiscal policy in accordance with the sectoral balance approach and functional finance, along with the MMT JG as a price anchor.

It is important to note that the fiscal balance is different from the budget balance due to variability of tax receipts and automatic stabilization across the cycle. Thus the fiscal balance is set endogenously. Therefore, automatic stabilization and tax rates become the focus in allowing relatively automatic adjustment of the fiscal balance across the cycle.

Diary of a Republican Hater
Sumner on the Achilles Heel of MMT
evilsax

Maybe the Modern Money Network could arrange a debate between Scott Sumner and Warren Mosler or one of the MMT economists.