Modern Monetary Theory, or perhaps we had better call it old Abba Lernerian fiscal theory, holds that the government’s fiscal-balance condition is not independent of the economy’s macroeconomic price-stability condition. Anything that pushes the government out of fiscal balance and requires raising taxes to avoid default will also produce higher inflation and so require macroeconomic austerity. And part of such austerity is, yes, raising taxes.
Why? Suppose people start to fear that the government will not raise enough in taxes to pay off its debts. They will then try to dump government liabilities for real goods and services. That will, the MMTers say, push aggregate demand about potential output and generate inflation.
I was saying to Noah that this seemed to me to rely very heavily on the efficient market hypothesis
What if investors mistakenly thought that the debt was sustainable? Then there would be no dumping of bonds and no inflation. And suppose that one day, suddenly, expectations shifted discontinuously, so that the government was required to pay much higher interest payments in order to rollover the debt? And what if amortizing those high interest payments required raising taxes too far, and pushed the economy over onto the unsustainable part of the Laffer curve?
It thus seemed to me, I said, that MMT required the EMH. Deviations from the EMH, I said, allowed the possibility of a government debt-crisis baking itself into the cake without any advance warning via inflation.
Whaaaaat?
WCEG — The Equitablog
Bond Bubbles and Modern Monetary Theory: Extra Monday DeLong Smackdown by Noah Smith
Brad DeLong | Professor of Economics, UCAL Berkeley
crossposted at Grasping Reality
crossposted at Grasping Reality
I don't recall Abba Lerner saying any such thing ???
ReplyDeleteModern Monetary Theory, or perhaps we had better call it old Abba Lernerian fiscal theory, holds that the government’s fiscal-balance condition is not independent of the economy’s macroeconomic price-stability condition.
ReplyDeleteIf brad means that fiscal policy faces an inflation constraint, even for a currency sovereign, he is correct.
But the rest of it assumes that Lerner and MMT believe in the bond vigilantes (bogeymen), who can force the government into default. Not only does MMT deny that, even Alan Greenspan knows better and has testified to the House that the US government, having its own central bank that issues the USD, cannot become insolvent or be forced into default.
Bonkers.
BTW, we went through the supposed insolvency constraint with Paul Krugman some time ago and he conceded that point.
ReplyDeleteThe aftermath of the GFC in the US bond market should put to bed the myth of the bond vigilantes. Chief bond vigilante Bill Gross got his ass handed to him, for example, and he never recovered from it.
Jure makes some very interesting points in a comment over there.... rsp
ReplyDeleteAs Frank Newman articulately and persuasively wrote to Professor Kelton, U.S. Treasuries are preferable to time deposits at commercial banks.
ReplyDeleteEven if Uncle Sam were subject to the discipline of the market (which he is not) the bond vigilante hypothesis has it backwards. The rational holder of dollars in time deposits would prefer to hold treasuries.