Thomas Palley

Led by Randy Wray (see this and this), supporters of so-called Modern Monetary Theory (MMT) are declaring that they were the first to identify the problems of the euro and that MMT has now proved itself to be the correct approach to monetary theory.

As regards these two claims, permit me to quote the following:

“5.3 Will capital still be able to veto policy?
…First, financial capital may still be able to discipline governments through the bond market. Thus, if financial capital dislikes the stance of national fiscal policy, there could be a sell-off of government bonds and a shift into bonds of other countries. This would drive up the cost of government borrowing, thereby putting a break on fiscal policy (Palley, 1997, p.155-156).”

MMT is a mix of old and new. In my view, the old is widely understood by old Keynesians and the new is substantially wrong. The above quote from my 1997 paper shows two things:

(1) MMT’ers were not the first to predict the structural flaw in the euro’s design regarding possibilities for conduct of fiscal policy.

(2) Old Keynesians fully understood that if you remove the national central bank, national government is reduced to the status of a province and may be unable to run deficit based fiscal policy if bond markets refuse to finance it.

With regard to theoretical weaknesses, MMT lacks a convincing theory of interest rates, over-simplifies the economy by assuming an L-shaped supply schedule that ignores the effects of sectoral bottlenecks and imbalances, lacks an adequate theory of inflation, and ignores expectations and exchange rates. These omissions lead it to overstate the powers of monetary and fiscal policy.

In this regard, I offered an early critique of MMT in the context of its twin policy proposal for an employer of last resort (see Palley, 2001). I am not necessarily against an ELR. However, because of their reliance on MMT, supporters of ELR tend to oversell the proposal and ignore problems that may be considerable. This illustrates how the theoretical short-comings of MMT can promote dangerous over-simplifications of important and complex policy issues.

References:

Palley, T.I., “European Monetary Union: An Old Keynesian Guide to the Issues,” Banco Nazionale del Lavoro Quarterly Review, vol. L, no. 201 (June 1997), 147 164.

Palley, T.I., “Government as employer of last resort: Can it work? Industrial Relations Research Association, 53rd Annual Proceedings, 2001, 269 – 274.

by Thomas I. Palley

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