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Modern Monetary Theory: What it means for Canada

Arun Dubois' blog post on Modern Monetary Theory (MMT) has prompted me to write my own take on the subject. For those interested, an interesting thumbnail sketch of MMT, essentially functional finance augmented by a full understanding of monetary operations, is explained here.

While MMT deals with the details of monetary and fiscal matters, the implications of its analysis are much broader, especially in current political times. MMT shows that if we have the resources, money is no obstacle to a government that issues its own flexible exchange-rate fiat currency. It is not saying that creating money magically creates goods and services. It is saying that it is nonsense to think affordability for such a government could be about money rather than resources. It shows that assertions questioning the capacity of the FEDERAL government to pay for programs, usually prefaced with the call for ''adult conversations,'' and couched in terms such as fiscal sustainability, solvency, and unfunded liabilities, are red herrings that will lead to needless reductions and privatizations of public programs in health care, elder care, pensions and so on.

For example, in the debate over how to address the aging population, it should be obvious that the only way to address this issue is to increase future productive capacity. This involves the application of real resources now to research, infrastructure development, education (including in areas relevant to servicing an aging population), etc. So while more resources will probably be needed in the future to attend to a larger cohort of elderly people, it does not follow that if the government "saves" money now, this will somehow help to address the needs of the aging population in twenty years time, say. Indeed, why on earth would cutting spending now increase the availability of the real resources required in the future: workers, buildings, energy, or metals and plastics for joint replacements? Similarly, how will privatizing services make more available to the elderly? It WILL make access to them more unfair as those with a greater ability to pay will be able to buy a larger share of what's available.

And then, what of the great waste of our most precious resource -- our people? According to Statistics Canada, in July 2011 there were 1.4 million people unemployed who were ready and able to work. When the more comprehensive R8 measure is used, one that includes the under-employed and others, the number rises to 1.7 million. All these people and so much for them to do: improve public transportation, infrastructure, daycare, homecare, etc, etc. For MMT full employment is a priority to be addressed by increasing growth and devising targeted non-inflationary employment programs. The mainstream long ago abandoned the notion of full employment, believing that some non-inflationary level of unemployment is the best we can manage.

Interestingly, central MMT points regarding interest rates and solvency made over many years have been confirmed very publicly by the U.S. debate over the extension of the debt ceiling. High-profile people such as Alan Greenspan and Warren Buffett have noted that solvency cannot be at risk for a country that controls its own free-floating fiat currency. The dark view that bond vigilantes are imminently threatening to cause a steep rise in U.S. interest rates was exploded by the precipitous DROP in U.S. interest rates immediately after the U.S. debt downgrade by Standard and Poors. Of course, Japan has had 0-2% interest rates for twenty years despite deficits and debt far higher than most other countries but, being on the other side of the world, it could be ignored.

So then why reduce deficits in the face of high unemployment as so many governments, including ours, say is so imperative? There is no risk of insolvency or high interest rates. Deficit hawks now say, as one did to me a month or so ago, the danger is inflation. Well, perhaps, one day, but not now -- maybe not for many years. Why prepare for inflation now when the current danger is unemployment and deflation? A possible explanation comes from Paul Krugman (a non-MMTer) in a recent blog post: ''what we're seeing in practice is that defending the interests of a small wealthy slice of the population takes priority over a possible recovery strategy.'' While this may help explain why the Harper Conservatives and their corporate backers are not interested, it does not explain lack of interest by others.

One difficulty of gaining greater acceptance of MMT is that some of its conclusions are quite jarring and counter-intuitive, since they do not agree with our everyday experience. For example, the fact is that government of Canada bonds are not issued to fund expenditures but rather to help establish the overnight interest rate ... meaning that the federal government does not borrow to spend and could dispense with issuing bonds entirely! When I explain this* the reaction of most people is: no that just can't be, or, it is just printing money, or, it's too hard to understand, or, even if true it'll just confuse people because it doesn't apply to the provinces, or, simple stares of disbelief. There is no doubt that explanations of monetary operations are complicated and ways to get many of the MMT ideas across need to be developed.

An interesting point, alluded to by Arun, is that in the midst of the confusion about the ongoing economic crisis the main MMT practitioners have shown remarkable clarity of understanding and made repeated correct calls on economic developments, especially with respect to monetary operations.This has resulted in Warren Mosler and Marshall Auerback, and others, becoming advisers to some of the largest financial trading companies in North America. Clearly, some of the people responsible for investing hundreds of billions of dollars in financial markets have adopted MMT due to its analytical track record.

MMT provides a way to run the economy at near full capacity without triggering much additional inflation, although the inflation rate could rise somewhat if the economy boomed. MMT is not just theoretical. In effect its greatest practitioner, without admitting to it, has been the Republican Party in the U.S., but only when in power: it cuts taxes to the wealthy and increases spending on prisons, the military, and war, and lets the deficit increase. And it works. When the economy is depressed, economic growth, job creation and deficits increase, and inflation and interest rates remain low. Progressives would not want to use MMT that way. We would want more jobs, producing civilian goods and services, fairly distributed, while subject to the constraint of potential output. And we would have the federal government spend tens of billions more annually on the programs and infrastructure we so desperately lack.

This article was first posted on The Progressive Economics Forum.

*A short technical explanation is as follows: If federal government deficit spending is not offset by bond issuance, deposits accumulate in peoples' and firms' bank accounts and are booked as excess settlement balances in the overnight market. This would drive the overnight rate to the floor set by the Bank of Canada. If the Bank sets the floor at a low number, possibly zero, the banks would not like this at all as they would be forced to hold a zero or low earning asset, totaling potentially the full amount of the deficit. This was partially done (to the tune of $3 billion) for about a year by the Bank of Canada during the depths of the economic crisis, is partial practice in the U.S. due to "quantitative easing" and has been partial practice in Japan for many years and accounts in part for their very low interest rates.

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