By W. David Montgomery
executive orders have been issued in the first days of the Biden
Administration, but today I want to discuss a central feature of its economic
policies. That is the implicit, and by
some loudly shouted, belief that it is possible to pile up ever growing
deficits by borrowing from the Federal Reserve.
This belief must be spiked.
in economics that likes to refer to itself as Modern Monetary Theory, or MMT to
the insiders, holds that the amount of borrowing by the Federal government is
meaningless. It can always be accommodated, according to this cult, by the
Federal Reserve creating money
that it lends to the Federal government.
All policymakers need to do is keep watch on inflation, and if it
appears all that money is beginning to cause price levels to rise, the solution
is to increase taxes high enough to siphon off the excess money being spent by
consumers. As long as inflation is
stubbornly low, despite zero interest rates, the Federal government can spend
all that Democrats dream of and really has no need to raise taxes. Members of Congress, whether Democrats or
Republicans, love it. The Democrats love
to spend the money; the Republicans love to cut taxes. It seems like a free
lunch for everyone.
the facts that the originator of this theory, Warren Mosler, was a Wall Street
trader with negligible training in economics, and that even the rabid
anti-Trumper Paul Krugman debunks it, economists in Bernie Sanders’ camp and
AOC use it as their excuse for unimaginably expensive programs (while
Republicans go along with the game since it can “justify” tax cuts). .
Mickey Levy, a member of the Shadow Open Market Committee, reject the theory, but they grant that some of the
claims of MMT are consistent with recent economic data. Inflation has remained extraordinarily low
despite the massive increase in the money supply created by the Fed to fund
extraordinarily high deficits.
But a reckoning
is coming. We can cut through the
puzzles of banking and finance by concentrating on two things: 1. the capacity
of the economy to produce goods and services and 2. the resources available to households and
business to purchase those goods and services for investment and
consumption. If households and
businesses have the resources to purchase more goods and services than the
economy (and this includes foreign exporters to the US) can produce, prices of
everything rises and we have inflation.
If they do not have the resources or want to save rather than spend, the
Even as some businesses grew, like online sales and supporting infrastructure, others declined even more rapidly so that total output fell and unemployment grew. As a result of extended unemployment compensation and stimulus payments in the Trump Administration, the drop in personal income was less than the drop in output. However, due to unemployment and concern about the future, saving by households and businesses increased.
run up during the Trump Administration to provide “stimulus relief” should have
produced inflationary pressures with lockdowns constraining output increases,
but because of increased savings, aggregate spending stayed roughly within the
capability of U.S. businesses (and exporters to the U.S.) to supply.
factor preventing trillions of dollars of stimulus money (and paper profits in
the stock market) from producing inflation has been the unwillingness of US
households to spend the windfall that they received from stimulus
payments. But that saving has also
created an overhang of financial assets that could be spent whenever households
choose. This overhang will only be made
worse if the Biden Administration follows through on its promise to forgive student
debt. Loan forgiveness will give a
massive increase in net worth to indebted college graduates, waiting for those
wealthier middle- and upper-class graduates to use their windfall.
Democrats get their way, these government transfers will continue growing far
faster than the real productive capacity of the economy, so that the overhang will
grow. The more slowly lockdowns are
removed (or if they are tightened), the more sluggish the economy will be in
responding to increased demand and the greater the danger will become.
question then is when the added purchasing power created by unspent government
transfer payments will be released into the economy, relative to the amount of
idle capacity that could respond to the surge in demand. If consumer spending increases while
lockdowns are still in place, there would be the perfect storm. The lockdowns would constrain increases in
output, aggregate demand would exceed available supply and inflation would
is only a little less if lockdowns are removed, because that is likely to
increase consumer confidence and trigger spending of hoarded stimulus
payments. Removing lockdowns would allow
some increase in output, but the risk of inflation would still be there. Increasing output creates additional income
for workers and owners, over and above the hoarded purchasing power from
stimulus payments. Thus additional
productive capacity is used up by additional spending from increased
income. The overhang of savings will
remain, ready to drive demand over available supply when its holders start to
spend. The perfect storm of rising income and use of accumulated savings will
still push aggregate demand well above the capacity of the economy to
only one possible result: rapidly increasing inflation, at least to the point
at which the financial assets built up with stimulus checks are destroyed. In one sense, MMT is right. The only sure way to reduce the pressure is
to raise taxes and cut spending to drain off the excess purchasing power that
was built up during the period of stimulus payments. But that takes concerted action to do what
members of Congress will not do – face up honestly to the problem and tell
their constituents that they must tighten their belts.
concerned that by building up huge deficits, we are shifting the burden of our
current policy mistakes onto our children and grandchildren. My opinion is that the day of judgment is
much closer. The classic operations of
supply and demand are most likely to hit us, not our grandchildren, with
massive inflation and its consequences.
 I use the word “create” rather
than “print” money to dispel the misconception that the Federal Reserve runs
printing presses to expand the money supply.
Few transactions involve paper money today, what the Fed does is
purchase Treasury securities and create bank deposits that the US Treasury can
draw down. Since those securities
constitute assets for the Federal Reserve and its member banks, those banks can
then loan more to everyone. That keeps
interest rates close to zero and lets the government send out stimulus checks
and spend in excess of the taxes it collects.