More about money supply (theoreticals)

Still going on about money supply...

Few worries about debt 

 Newly elected left-winger Alexandria Ocasio-Cortez is proposing a new 70% tax rate on income above $10m to help pay for a so-called Green New Deal in the USA, says Noah Smith. That has got people worried about how to pay for such largesse and the size of the government’s debt. But what if none of that matters? 

A new theory of money 

That is the provocative thesis of an unorthodox if not entirely new economic theory that has gained traction on the left – “modern monetary theory”, or MMT. The central argument is that the US government doesn’t really have a budget constraint and thus that taxes are never really needed to pay for federal spending. Why? Because it can just print all the dollars it needs. 

Suppose the government piles up an infinite amount of debt. What bad thing could happen? Debt-service costs rise. But instead of raising taxes to cover that, the government could just borrow more. The Federal Reserve, the US central bank, could lower interest rates to zero, thus eliminating interest costs. This is basically what has happened in Japan. 

What if rising debt levels also cause investors to pull back on lending to American companies? No problem: by lowering interest rates, the Fed can ensure that the cost of capital doesn’t get too high. At a pinch, it could buy corporate and mortgage debt. 

This would muscle out private sector activity, which might reduce productivity, but MMT advocates aren’t too worried about that – indeed, a federal job guarantee, which could do the same, is a centrepiece of their plans. What could possibly go wrong? 

Hyperinflation takes off 

Hyperinflation, perhaps? If the funding for federal debt dries up, the Treasury’s borrowing will be funded by printed money from the Fed. This is the MMT endgame – the government pays for as much as it wants with the endless supply of money it creates. But a real constraint surely remains – the limitation of real resources. Eventually, if the government keeps paying for more and more things, whether unemployed workers or natural resources, we’ll run out of them. What happens if the government keeps trying to buy things then? Hyperinflation is one common theory. See Venezuela to see how disastrous that will be. Many MMTers scoff at the idea that hyperinflation would result. It didn’t, despite warnings it would, when the Fed embarked on quantitative easing (QE). But just because inflation remains subdued doesn’t mean it couldn’t rise suddenly. Inflation might have remained low despite QE and big deficits because businesses believed that it would eventually end. A wholehearted embrace of MMT would signal that this is no longer the case. That would be a huge gamble on the idea that hyperinflation could not happen in the US.