Modern Monetary Theory – Will it Work?

The concept of Modern Monetary Theory (MMT) is gaining traction around the world, and the visit of Bill Mitchell last week has given a boost to these ideas locally. There are a bunch of things where MMT has a similar view of the world to conventional economists. It also debunks a few of the popular narratives about government surpluses and deficits, particularly challenging the idea that the government’s books are the same as running a household. Whether or not the ideas will work depend a lot on the circumstances, and while MMT has a lot to offer we don’t think New Zealand is ready to apply it – yet.

We will start by looking at what we agree with MMT on before looking at the ultimate question of whether it would work. 

What we agree on

MMT is not particularly new, and is grounded in many of the same ideas as conventional economics. MMT proponents point out that the school of neo-liberal economists have fallen into “group-think” and are blind to some aspects of their own theories, which is probably a fair point. The core MMT thesis is that the government can spend whatever it likes, there is no limit because it issues money, and by implication the whole notion of balancing budgets or running permanent surpluses is a conservatism that condemns our economy to underperformance.

1/ Money is just a tool

MMT is right to point out that money is just a tool, and that governments that issue their own currency are ultimately not constrained in their spending; as long as that spending is in the same currency! Claims that we ‘can’t afford’ to do something are wrong; anything is possible if you make it a priority.

2/ But there are still real limits

That doesn’t mean you can do everything you want to. While money has no limits, the real economy does. Employment and output are constrained by the quantity and quality of inputs, and there are environmental limits too. Once you use money to push beyond those limits, you just get inflation.

There are two upshots to this. Firstly if there is unused capacity in the economy, then the government can conceivably stimulate the economy without causing inflation. That is the case regardless of the government’s debt levels, because the government can create money. 

Secondly, whatever we do, we need to be sure that we are getting the best possible return on investment. If government is going to do something, we need to be sure that it is worth doing, and that the government can invest the money better than the private sector can.

Would MMT Work?

So far, so good. But how does this apply to the modern New Zealand economy? There are two tricky issues that need to be dealt with before we even look at MMT. And even when we have done that, there are still some tricky questions to answer.

Tricky Issue #1 - Housing Speculation

The fact is that our property tax loophole already constrains monetary policy from doing more. Many economists agree that in recent years interest rates should have gone even lower here than they have. The Reserve Bank has been unable to lower interest rates further for fear of stoking the housing crisis.

The big risk of New Zealand running a MMT-style deficit right now would be that the extra money would simply push up house prices even further. We need to reform the tax system and close the tax loophole on property before we think about implementing any of these ideas. MMT experts like Bill Mitchell acknowledge this issue.

Tricky Situation #2 - Sorting our Long Term Risks

MMT proponents point out that the Establishment Parties in New Zealand are overly obsessed with balancing the books. There is one good reason for this; because we have a whole lot of liabilities that aren’t on the government’s books. New Zealand Superannuation, a rising prison population and increasing health costs are the best examples. Meeting these costs will cause challenges for future generations in resource terms, regardless of what they do with money supply. The real economy is real, remember? We simply can’t make enough goods and services to meet the needs of the elderly.

If we took care of these long-term issues as TOP is suggesting, then we agree with MMT that the fiscal austerity being shown currently by National, Labour and the Greens would be completely unnecessary. Free of those constraints, and faced with unemployment still at 5%, as well as a range of shocking social dysfunction trends (child poverty, homelessness, mental illness, youth suicide, bullying) TOP is confident that a relaxation of fiscal austerity would be possible so the major driver of these failures – lack of income – can be addressed. The question is how?

Does MMT offer anything for New Zealand?

The key point of MMT is that we shouldn’t allow capacity to sit unused, regardless of the fiscal situation. Mitchell favours a Job Guarantee Scheme that gives everyone who wants it, a minimum wage job.

This idea makes sense in the USA and UK context, where during the Global Financial Crisis there were high levels of unemployment. When interest rates got to zero they lent money to banks at zero interest (so-called quantitative easing). In an economy with low interest rates and spare capacity why would you give money to the banks? On the face of it, it would have been much better to use the money to provide jobs for the unemployed.

Of course the question is whether it is really possible to get those people to do something useful, and therefore whether it really expands the capacity of the economy or simply causes inflation. This is an empirical question, and is certainly worth investigating. In our view in the modern economy it will be more and more difficult to ‘provide’ meaningful work for everyone. The failure of Winston’s Work for the Dole scheme from the 1990s is a testament to that. In the modern economy we prefer the simple approach of paying everyone an Unconditional Basic Income and trust that they will get on with pursuing an industrious and fulfilling life. MMT may prove useful here in the long-term in terms of funding a UBI.

However, at the moment New Zealand’s economy is near full employment and still has positive interest rates. Bill Mitchell would argue that unemployment and underemployment (people working less than they would like) is still higher than it could be. However, unless public investments can increase the real capacity of the economy as a whole, then more government spending would have an impact on the private sector – it would crowd it out – if only through pushing up interest rates faced by the rest of the economy (businesses and households). Such an outcome risks undermining people’s confidence in the long-term value of the currency, encouraging people to invest their money in gold or overseas currency. That doesn’t mean we shouldn’t do it; the public may be willing to accept higher interest rates in exchange for greater public investment if it is well spent. But right now there is no free lunch.

So really MMT is saying to Bill English that the social investment approach is the right one to take. In fact, if we find good investments to make, we shouldn’t be constrained by affordability. And fundamentally, TOP agrees with that.

In short, MMT provides a useful alternative way of thinking about our economy and society. It shows that government should make good investments, regardless of affordability. It opens up a way of thinking that we need to explore, particularly because if interest rates stay low then monetary policy may become pointless in the next recession. But it doesn’t remove the real economy and the need to deal with some tough long-term issues. As with most economics, there is no free lunch.