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Stephanie Kelton has found herself at the center of a blossoming debate over a provocative economic idea known as Modern Monetary Theory (often called MMT) — a theory that seeks to flip much conventional economic wisdom on its head. As one of the foremost advocates and articulators of the theory, she has just come out with a new book called “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.”
And as fortune would have it, the book couldn’t be more timely. The U.S. federal deficit is swelling as tax revenues are expected to plummet and Congress has authorized heroic rounds of new spending to cushion the blow of the coronavirus-induce recession. Refocusing on the nature, power, and limits of government fiscal capacity — and challenging our assumptions about it — is exactly what we need.
So I interviewed Kelton, a professor of economics and public policy at the State University of New York at Stony Brook, about the ideas in her book and their relevance to our present economic disaster. We discussed her views on what people misunderstand about government debt, how fiscal policy can be used to fight the downturn, and why her views differ from more orthodox economic thinkers like Paul Krugman. What follows is the transcript of our discussion, lightly edited for clarity and length.
Cody Fenwick: What drives the biggest misunderstandings about government debt in our national conversation?
Stephanie Kelton: Everything is wrong. The way we talk about federal government debt is, from my perspective, we say things like we’re borrowing from China and foreigners. Hillary Clinton said when she was secretary of State that it’s a national security threat. People talk about it representing a liability to all of us, so we hear people talk about “your share [of the national debt],” a burden on future generations, that it ultimately has to be paid back, that it’s going to require higher taxes in the future. I could keep going.
So what connects all these misunderstandings? Are we thinking of the government too much like a household or a business?
Yes, of course. We think that the government has borrowed, and we think that this is real debt. And neither of those things is correct. I say in the book that if I walk into a bank and borrow money, I’m borrowing money because I don’t have it. Right? That’s why I got to the bank to take out a loan. The federal government is not borrowing money because it needs money. It’s not borrowing because it doesn’t have the capacity to finance whatever it wants to spend money on. It has the fiscal capacity; it can just spend. And not only that, the government sells the bonds. And by the time the government sells the bonds, the spending has already taken place. So the bonds cannot possibly be the tool with which the government raises money in order to spend. It’s selling the bonds after the spending had already taken place. Why does it do that? It doesn’t need to borrow, it has already financed the spending.
So we don’t really understand — the public and most economists get this wrong — we don’t even understand what the purpose of selling bonds is. We treat it as a borrowing operation. It’s not. The purpose of selling the bonds is to drain off the reserves, the dollars, to remove some of the dollars the government has spent into the economy and replace them with treasuries. It’s a subsidy to the rich, is what it is.
How did we find ourselves in a place where, in your view, so many people in government, and so many people who study it, don’t understand why basic government financing operations work the way they do?
That’s a good question. You know, I would have found myself in that place, if I hadn’t taken the time to study the actual monetary operations, to look under the hood, and understand the mechanics of the federal government’s fiscal operations. Nobody taught me this stuff in my conventional economics training through grad school. I had to come to this from some outside of the academy, someone who was in financial markets who thought about things. And then when I encountered his work — and I’m talking about Warren Mosler — then I started thinking: could this be right? Could we have it backwards?
And I had to convince myself. So I started reading Treasury manuals and Fed manuals and studying the actual workings of between the Treasury and Fed. I talked to officials at both of those agencies, and I worked out for myself, and I wrote it up, and it was my first published, peer-reviewed article as an academic. But most of us don’t take the time to do that.
The great strength of MMT is its superior understanding of monetary operations. You get the monetary operations right, you’ll avoid making a lot of mistakes and saying a lot of silly things. But most economists do not study the intricacies of government finances at that kind of government level.
The purpose behind bonds is to support interest rates. It’s an interest-rate maintenance operation, not a financing operation. Then you start looking at bonds very differently, and that means you have to look at the national debt very differently.
We didn’t issue all these treasuries because the government needed the dollars to finance spending. That’s not why it’s there. So we view that stockpile of treasuries that people name the “national debt” — it’s unfortunate, that’s a horrible name. We shouldn’t call it that. We look at that stockpile of U.S. treasuries as a historical record. It’s just a number that tells us — what? How many dollars the government spends into the economy that it didn’t tax back that are currently being saved in the form of U.S. treasuries.
But we give it a label: “The debt.” And as soon as you call it that, everybody’s anxiety goes up.
It’s just part of the net money supply of the United States. Some of our dollars are interest-bearing — those are treasuries — and some aren’t. That’s really all this comes down to.
What does this theory tell us about government policy in time we find ourselves in, with a pandemic-induced recession?
Everyone can see, when Congress feels compelled to act, when there’s a sense of urgency, Congress can push legislation. They passed four bills in short order. The biggest was the CARES Act — $2.2 trillion. If Congress wants to pass legislation — it can be big, it can be bold — the important point is that yesterday’s deficits don’t matter. What happened to the national debt last year doesn’t matter. It doesn’t stop up from acting if we want.
And that’s important because a lot of big names, very mainstream — including former Treasury secretaries — they were all warning that if Republicans passed these tax cuts in December 2018, then it was going to leave us basically incapable of using fiscal policy. One of them said: “If the Republicans pass these tax cuts, the United States will be living on a shoestring in the days to come. We will not be able to respond if the economy goes into a recession, we won’t have the fiscal capacity to expand fiscal policy, we’ll be unable to defend ourselves militarily…”
Now, that was clearly proven wrong. Because they passed the tax cuts, the economy did get weak, and Congress has been passing trillion-dollar pieces of legislation.
So we’re going to do 5, 7 trillion? Who knows? The point is that, leaving MMT aside, we should all be able to witness what is happened: The past deficits, and the addition to the debt, do not preclude further use of fiscal policy tools, more ambitious spending. We could do it on education, we could do it on health care, we could do it on climate, we could do it on infrastructure.
And the reason that Congress can do all this big ambitious stuff right now, without having to worry about deficits, is couple of things: One, it can commit to spending money it does not have. That’s what it means to be a currency issuer. You have your own central bank. Whatever bill Congress passes, as soon as it passes, it’s paid for. The votes fund it. That’s where the money comes from — it comes from the votes. As soon as Congress commits to spending those dollars, it’s effectively telling the Federal Reserve: Get ready. You’re about to mark up some bank accounts. You’re going to carry out the payments on behalf of the Treasury. And that’s what MMT teaches.
All government spending is always paid for through money creation. So people often mischaracterize MMT — almost always — and say MMT says we should print money. No, it doesn’t. MMT says there’s only one way for the government to spend, always, and that is newly created, digital — I don’t want to say money — bank reserves. We credit bank accounts.
And then taxes do the opposite. They debit bank accounts. They change the numbers down. So a deficit is nothing more than the difference between two numbers. How many times did you change numbers up, and how many times did you change numbers down? And when you run a deficit, it means you’re marking up accounts more than you’re marking down somebody’s bank account. So the government deficit posits a net contribution of dollars into some part of the economy.
The reason we can do a lot of that right now is because the economy is depressed. If we had a very, very tight labor market, and we were operating our economy very close to full employment, then that takes away policy space. If the government just kept crediting bank accounts in an environment like that, well, you’re just inviting an inflation problem. But right now, what I hope people learn is the government can sustain not only the current level of fiscal support, but it can do more. And it can sustain the level of support that’s needed until the economy is fully recovered. And only then does fiscal support get withdrawn. And most of that will happen automatically. Because, as the economy recovers, as people become re-employed, spending to support a weak economy will automatically be reduced. Taxes will automatically be increased. The deficit will automatically shrink.
Critics of this view often warn that your view of fiscal policy inevitably leads countries to default or hyperinflation, as in the cases of pre-war Germany or Zimbabwe. What do you say to those skeptics?
What you have in both of those cases is a major collapse in the supply side of the economy. So in the case of Germany, Germany loses World War I, war reparations are imposed, much of the productive capacity of the country is decimated — so when you think about the conditions that give rise to that hyperinflation, you have a lot of things going on there that we don’t have. It doesn’t translate here. If you’re printing money to pay war reparations, and at the same time, you can’t produce, because your productive capacity is destroyed, it’s very easy to see how a country could get in a situation where, Milton Friedman would say: Too much money chasing too few goods. Well, it’s the “too few goods” part of that.
And in Zimbabwe, [Robert] Mugabe comes to power. And he takes land away from whites, farming the land, it’s an agricultural economy. He redistributes the land to blacks, to reward the freedom fighters, understandably. Initially, giving the land to people who don’t have any experience farming the land, couldn’t grow crops, so you have massive food shortages. And you’re an agricultural economy, so food prices spiral out of control. You’re trying to import food, you get hyperinflation.
What MMT is about is striking the balance between the inflation risk and the potential gains from additional spending. So MMT isn’t about pushing beyond limits. In fact, it’s the exact opposite. We’ve been paying attention to the wrong thing. We think the deficit is the limit.
There are limits. But the limit is not deficits. It’s not the size of the national debt. The limit is our economy’s real productive capacity. That’s the case in Zimbabwe, that’s the case in Germany. Push beyond your productive capacity, and you can get accelerating prices.
Do I think we can cause hyperinflation in the U.S.? That’s a pretty big stretch.
What MMT is saying is before you authorize any new major legislation, trillions of dollars of spending, you have to evaluate the inflation risk associated with that spending. It’s fine to do that now, in an economy where you know, 40 million people filed for unemployment in the last seven or eight weeks. But you can’t do that in an economy that’s at full employment. We are very much centering inflation so that it is a clear and present danger when it comes to expanding spending. It’s not default risk; it’s inflation risk. Let’s all just recognize that that’s the legitimate punishment for excessive spending.
You’re not going broke. You’re not going to default. Who defaults? U.S. doesn’t default on its debt. The U.S. isn’t going to default on debt that’s denominated in its own currency. The U.S. will always have the ability to pay our creditors because we borrow in dollars.
So it seems to me the theory takes responsibility for controlling inflation away from the Fed and gives it to Congress. Is that right?
Not necessarily. If you believe that changing the overnight interest rates, 25 basis points here, 25 basis points there, is a powerful tool to steer inflation, then, it’s perfectly welcome to continue with that practice. [But] central banks around the world have revealed that they can’t control inflation. Look at the Bank of Japan. What, 30 years the BoJ has been trying to hit a 2 percent inflation target? We watched Bernanke and then Yellen try for nine years, 10 years, to get inflation to 2 percent? Unable to do it. At some point, I think we should just give in to reality that it works well in a textbook. It’s fine on paper to say that central banks control the rate of growth of the money supply, and through that the rate of inflation — that’s in all the mainstream money and banking textbooks. It just happens to not be the case when you look around the world.
So to the extent that MMT recognizes the limitations with respect to the central bank’s ability to control inflation, then what other things should be in the toolkit? That’s what we’re saying.
MMT would say figure out what is giving rise to the inflationary pressure and then tailor the policy response. Because a rise in interest rates isn’t always going to help. In fact, it may do the opposite; it may push inflation higher. A tax increase isn’t going to be the right response all the time, or spending cuts. So there are a lot of other things that we could do.
So what are your main disagreement with economists like Paul Krugman, who agrees with you on the need to use fiscal policy to fight recessions but doesn’t buy in to MMT?
[Krugman] has a piece around the time of the Republican tax cut called: “Deficits Matter Again.” And in that piece, he subscribes to the loanable funds theory. In my book, I completely reject the loanable funds model. So if you’ve got government deficits require the government to borrow? OK, MMT says no, they don’t. Borrowing is a secondary and an optional thing.
So, their story is government deficits require the government to borrow to finance the deficit. MMT says no. When the government borrows, it has to compete for a limited supply of loanable funds, or savings? No, it doesn’t. They say that competition for finite available supply financing drives interest rates higher. MMT says not necessarily — interest rates will go higher if the central bank moves them higher, but that’s not how it works. Then they say rising interest rates lead to declining private investment, and that’s the crowding out, so that’s the trade-off.
So [Krugman] and I had this back-and-forth about this trade-off. MMT says — and frankly, even broader heterodox literature — what about a crowding-in effect? Don’t assume that rising interest rates happen because of government deficits. And don’t assume that, in an environment where interest rates are rising that private investment may not also be rising. There are so many disagreements.
He likes to pretend that there aren’t, that MMT is not saying anything new, it’s all in ISLM. And the truth is it’s different from A to Z. There are differences that run throughout. If you read the book, it should be clear. The way we think about role of taxes: they think taxes are financing government spending. He thinks that fiscal policy is something that you break out when interest rates are at the zero bound. So monetary policy can do more, but it becomes what he’d say “ineffective.” Then you’d use fiscal policy. Otherwise, you could safely rely on central banks to steer economies to full employment and stable inflation. We don’t agree with that at all, that central banks have a powerful steering wheel and a reliable tool. Somehow, mainstream economics has taught that if the central bank just picks the right price, if we get the interest rate right, we can set the economy in balance.
There are a couple of the economy that are very interest-sensitive: housing and automobiles… but, beyond that…
What do you make of the Fed’s actions to support the economy, supposedly, since the recession started to hit? My impression has been that it really has boosted the stock market, at the very least, and given investors perhaps undue confidence that things are going to be alright. Do you agree with that?
Yeah. And I think liquidity is critically important, so lending facilities, provision of liquidity to financial markets, I think it’s probably the case that the Fed’s actions have delayed — I will say — some corporate bonds from default. Overall, I’m going to say that I applaud the Fed’s efforts. They have acted very quickly, very boldly, and having lived through the experience of the financial crisis and the policy response to that, and just knowing how frustrating it was for Bernanke at the time to be pushed into QE3 — which I don’t believe he wanted to do, I think he got pushed into the open-ended bond buying. Which is basically just the Fed shoving the chips all in and saying: “If our fiscal partners aren’t going to get in the game, that leaves us the only game in town.”
I think that Chairman Powell has been more open, and his rhetoric has been clearer to Congress about how important it is that they stay in the game. In other words, he didn’t want to end up like Bernanke, where the Fed is asked to do more and more for longer and longer because they can’t get Congres to provide enough fiscal support to be a partner in bringing about a recovery. And that’s what the shame was last time. We really just left it all to central banks.