Modern Monetary Theory: Part IV

In Part III, we examined the role of economic paradigms in the equality/ efficiency cycle. This week, we conclude this four-part series with a discussion on the flaws of Modern Monetary Theory (MMT) and market ramifications.

The Flaws of MMT

All of the major economic paradigms previously discussed lead to eventual problems. Capital-friendly policies, such as Classical or supply-side theories, eventually lead to inequality. Policies less friendly to capital eventually become inflationary. MMT has a few flaws as well. Here are the ones we are most concerned about.

All investment is hard and public investment may be the hardest. There was a good reason why Keynes was so concerned about investment shifts. Investment is a bet on the future and no one can predict the future with certainty.

These charts show the level of inflation-adjusted fixed assets for government (left chart) and the private sector (right chart). Public fixed investment was increasing during the Great Depression, then soared during WWII and the early part of the Cold War. It made a secondary peak in 1970 and has been steadily declining since. Notably, private sector fixed investment also fell below trend after the Great Financial Crisis and remains weak.

These charts would suggest that public investment has been so “starved” that it should be feasible to find good projects to boost economic efficiency. However, public investment doesn’t have a profit test in the way private sector investment does. MMT could open the door to significant public investment and risk a problem like the “bridges to nowhere” program that Japan faced in the 1990s into the turn of the century. Public investment in an emerging economy can easily lift an economy because it starts from such a low base. Conversely, in a developed economy the challenge for making efficiency-boosting public investment is much more difficult. For example, adding additional lanes to major urban highways would be very costly but probably wouldn’t reduce bottlenecks, and there is the risk that high-speed passenger rail networks may lack riders. Getting investment right is really hard in the private sector, which has a profitability test. It’s even harder without such a test.

Taxpayers view taxes and government expenditures differently than MMT postulates. The U.S. has a voluntary self-reporting tax system that generally works well.[1] The most likely reason, beyond the threat of incarceration, is that our taxes are thought to “pay” for something. Paul Samuelson worried that spending could spiral out of control and eventually lead to a serious inflation problem without the belief that fiscal budgets need to be balanced.[2] If taxpayers begin to believe they are being taxed to prevent them from spending instead of paying for government services, the incentive to comply will end up relying solely on the fear of incarceration. In addition, state and local governments do face a real budget constraint; it is unclear if taxpayers will be able to distinguish the difference, or, if they do, they may ask why we have state and local spending at all? If taxes aren’t necessary for spending, then why not have the Federal government supply all services for “free”? Obviously, this argument against MMT is a bit of a “straw man,” in that MMT doesn’t say taxes are unnecessary; but, by saying they aren’t needed to pay for spending, there is the chance that a disconnect will develop for taxpayers and it may be hard to argue for taxing at all.