Monetary Policy Flapping in the Wind


The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy
By Stephanie Kelton
New York, 2020
325 pages

Stephanie Kelton’s new book has attracted much attention, and Bob Murphy and Jeff Deist have already reviewed it, with devastating results. Why another review? The policies proposed in the book are so pernicious that further exposure of what she has in store for us is needed, and I have some new points to offer for your consideration. Besides, there are few things I enjoy more than writing a critical review.

Kelton, who teaches economics at Stony Brook University, writes clearly, though I wish she would not so frequently repeat in her endnotes passages from the text. The essence of the book is straightforward: it’s impossible for the United States, and other monetary sovereigns, to run out of money. “Today, we have a purely fiat currency. That means the government no longer promises to convert dollars into gold, which means it can issue more dollars without worrying that it could run out of gold which once backed up the dollar. With a fiat currency, it’s impossible for Uncle Sam to run out of money.”

A monetary sovereign doesn’t have to worry about how to get money to pay for the goods it wants produced. Government spending does not need to be backed by anything. There is always new money available. “Think about where the points come from when you play a card game or go to a basketball game. They don’t come from anywhere! They’re just conjured into existence by the person doing the record keeping….Uncle Sam doesn’t lose any dollars when he spends, and he doesn’t get any dollars when he taxes” (emphasis in original). When Congress votes money for a program, either new money is printed or the Fed increases credit balances. Borrowing does not change this: selling T-bills just involves more typewriter strokes.

Kelton hastens to assure us that she opposes unlimited government spending. She knows the dangers of inflation. “No one wants to live in a country where inflation gets out of hand. Inflation means a continuous rise in the price level…if prices start rising faster than most people’s incomes, it means a widespread loss of purchasing power. Left unchecked, this would mean a decline in society’s real standard of living. In extreme cases, prices can even spiral out of control, gripping a country in hyperinflation.”

She isn’t much worried by this possibility. Our problem today is not too much inflation, but too little, and if inflation ever did start to get out of hand, the government could increase taxes to end the danger. “If the government wants to boost spending on health care and education, it may need to remove some spending power from the rest of us to prevent its own more generous outlays from pushing up prices. One way to do this is by coordinating higher government spending with higher taxes so that the rest of us are forced to cut back a little to create room for additional government spending” (emphasis in original).

Here I would venture my first critical point against Kelton. Even if you accept all that she has said about modern monetary theory (MMT) and its manifold blessings—and of course you should not—why should we think that increased taxes would suffice to halt an inflation that has once begun? Taxes take time to come into effect, and what happens if inflation reaches unmanageable heights before this happens? What next—confiscation of people’s bank accounts in a perhaps futile effort to restore stability?

Kelton underestimates how rapidly inflation can get out of hand. As Mises with characteristic force remarks in Human Action, “This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

“But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crackup boom appears. Everybody is anxious to swap his money against ‘real’ goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”

“It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.”

Kelton, in the grip of her theory, is willing to risk the collapse of the monetary system on the chance that the government will be able to curb inflationary pressure. If the US government did lose control, the result would be much worse than the examples of hyperinflation Mises mentions. The American dollar stands at the center of the world’s financial system, and its collapse could bring the entire world to ruin.

Why is Kelton willing to risk so much? The answer is clear. She thinks there is a great deal of “slack” in the economy and in this circumstance we need not worry about the pressure of spending on prices. I do not propose to challenge her Keynesian framework here. Rather, I wish to concentrate on a mistake she makes that leads her radically to overestimate the amount of slack.

She supports a federal jobs guarantee. “The federal government announces a wage (and benefit) package for anyone who is looking for work but unable to find suitable employment in the economy.” In defending this proposal, she makes the mistake I have in mind. She says: “Since the market price of an unemployed worker is zero—that is, no one is currently bidding on them—the government can create a market for these workers by setting the price it is willing to pay to hire them. Once it does, involuntary unemployment disappears.” Kelton has not taken account of the fact that the workers on federal jobs projects would use physical resources that must come from elsewhere in the economy. The cost of employing these workers is by no means negligible, as she wrongly says.

A federal jobs guarantee proposal to cope with unemployment during a recession thus rests on a false assumption. And it carries with it additional bad consequences, as Professor Joseph Salerno has aptly noted. Such programs, he says, “will thus siphon off labor and other resources from productive investment in the structure of production and forcibly increase the consumption/saving ratio and hence overall time preferences, reducing genuine savings and capital accumulation.

“Furthermore, as price inflation begins to rear its head, the increase in taxation aimed at ‘sopping up excess purchasing power’ by the private sector, will further increase the public’s time preferences, reduce voluntary saving and eventually cause capital consumption. Everyone will have jobs and rising money incomes and there will be a boom for government contractors so it will not look like a typical depression, but living standards will progressively decline. Also, the private sector will progressively shrink relative to the State sector because BOTH the fiscal inflation AND the later increase in taxes to offset its inflationary price effects will divert resources to the State sector. And of course the recurring increases in taxes will not arrest the inflation, because the government will continue to run fiscal deficits by financing its ever increasing spending with new money. This would be the worst of both worlds: massive inflation proceeding hand in hand with chronic depression.”

The book also contains some factual inaccuracies. Kelton deplores the fact that government welfare programs are usually not called “earned entitlement programs,” but just “entitlement programs.” Following Hendrik Hertzberg, she in part blames Robert Nozick for this change. “It was a clever move. They [Nozick and Robert Nisbet] dropped the word earned, which sounds like a good thing to most people, and emphasized the word entitlement—which by the 1970s had taken on negative connotations, as when we say that a spoiled or privileged person acts entitled” (emphasis in original). Had Kelton read Anarchy, State, and Utopia, she would not have said this. For Nozick, entitlements are good, not bad. He favors the “entitlement theory of justice.” She also wrongly calls the civil rights leader A. Philip Randolph “reverend.” He wasn’t a clergyman.

The problem with the book, though, does not lie here. Rather it is lies with Kelton’s way of looking at the world. She is fond of speaking of the Copernican turn that the MMT revolution makes possible. At any rate, it leaves my head spinning.

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