An excerpt from Chapter 5 of Can Heterodox Economics Make a Difference, published by Edward Elgar in 2020. Here is a link to the Table Of Contents, and a link to the biographies of all those interviewed for the project.
“If the question is ‘what determines the price level?’, which I do take to be a useful question, I’m probably in bed with modern monetary theorists. My view is that beliefs determine the price level. But the reason that I’m able to make that statement and live in two worlds at the same time, is because the equilibrium models I build contain lots of interacting agents of different types.”
“There are many pluralistic views. I’m not sure why anyone would put a label on themselves, I refuse to be labelled as anything. I don’t know why anyone would want to be labelled as an ‘MMT person’ as opposed to someone who seriously considers the ideas in Modern Monetary Theory and tries to integrate them with other things that they found useful. ”
PA: You remind me of Charles Goodhart, who also has sympathies and criticisms of various schools. I’d like to turn next to Modern Monetary Theory. You’re a very experienced economist, I’m interested to know what you’ve picked up about MMT? If you’ve not come across MMT, that tells me a lot about its outreach.
RF: It has very little outreach in terms of mainstream economics and my initial reaction to the definition is that it’s confused. [1] My work is heavily influenced by conventional neoclassical economics – that makes me mainstream. And with my mainstream hat on; I insist on constructing coherent models that are based on individual maximising behaviour.
When you start thinking about monetary theory and monetary economics in that context, what you might say immediately is, “Yes, but general equilibrium theory has no role for money”, which is partly true. But to the extent that it forces you to construct logical chains of reasoning, the arguments about endogeneity of money – that’s where I’ve met MMT – I find critiques of mainstream monetary theory to be misplaced. Of course, money is endogenous! But what does that mean?
If the question is ‘what determines the price level?’, which I do take to be a useful question, I’m probably in bed with modern monetary theorists. My view is that beliefs determine the price level. But the reason that I’m able to make that statement and live in two worlds at the same time, is because the equilibrium models I build contain lots of interacting agents of different types.As a consequence, I end up with situations where the model is not determining prices, I need something else. So there’s clearly room for a marriage of that idea with notions of endogenous money from modern monetary theorists, and I suspect that if I actually sat down with Stephanie Kelton, or you, or some other modern monetary theorist, and had a debate about that, we’d find that we had a lot in common. I’m simply more willing to use the apparatus of traditional microeconomic theory to explain those ideas.
PA: Yeah, I get the feeling, having heard you speak before, that you are open to dialogue with what I would call heterodox views. More so than most.
RF: I think that’s essential!
PA: One of the things about MMT- which leads me onto my next point – is its ‘unique selling point’ in the non-academic world: this idea that taxes drive money, the idea that the government must spend money before it can tax. For modern monetary theorists, taxes have two functions: one, to give value to state debt, because without taxes underlying the value of the currency people wouldn’t accept state money in payment for delivering services to the state. And secondly, by adjusting spending and taxes, the government can adjust aggregate demand. The government, in order to fund spending, must acquire money from the private sector and/or borrow it.
RF: I believe that this is related to the debate, in the standard theory, on the Fiscal Theory of the Price Level. Government spending, taxation and borrowing are connected by an accounting identity. In any period of time, the difference between the amount the government spends and the amount it takes in in taxes has to be funded by issuing some kind of debt. It could be money, it could be short bonds, or it could be long bonds. Treasuries spend and create liabilities. Central banks decide on the composition of those liabilities between the different categories.
There is currently a lot of angst in modern macro circles about what determines the price level. And the government accounting identity can be viewed in two ways. In one way it’s a budget constraint, which the government has, just like you and I have budget constraints. We spend, we borrow, we get income, we die, and as a consequence of eventually dying, over our lifetime we can’t spend more than we earn. That places a constraint on how much we can borrow.
Now you and I can shift resources over time by borrowing and lending, so one way of seeing the government accounting identity is that it’s just the analogue of what you and I do. Now, that’s clearly false because the government doesn’t die, and the revenues are coming in from different people from those who benefit from the spending.
One group of economists sees the government accounting identity as analogous to a household constraint. Government spending plans must be consistent with its income plans over a very long horizon. In this view, the government must make spending plans that are consistent with taxation. There is an extreme version of that argument, called Ricardian equivalence, which says that it doesn’t matter whether a given government expenditure plan is financed by debt or taxes. Different plans simply rearrange the timing of the payments, and the representative agent who must pick up the tab, is the other side of that borrowing and lending. Now, most people think that’s probably wrong.
PA: Yeah, certainly MMT-ers!
RF: Indeed. Now, the other way of looking at this accounting identity is that it is a debt valuation equation. The government has a stream of primary surpluses that it will be running for the conceivable future. It has some existing debt in dollar terms. The price level must adjust to make sure that the value of the nominal debt is equal to the discounted present value of the surpluses. So, the sequence of accounting identities is a price level determination equation. I suspect that some of these issues arise in modern monetary theory. Perhaps you could say more about what modern monetary theorists mean by money?[2]
PA: Well, I think that what modern monetary theorists would argue is that money is credit and nothing but credit.
RF: Fine, so a treasury bill is money. Or not?
PA: Well, no – a treasury bill isn’t money, because money is simply a ledger entry. For example, what a modern monetary theorist would conceptualise is that there is no government budget constraint, it’s simply an ex-post description of what’s happened. So, in other words, if the government wants to spend, if you want to conceptualise as a model, the first thing it has to do is spend by issuing new money, i.e. new debt, and that doesn’t have any corporeal existence.
RF: You said new money and new debt in the same breath.
PA: For a modern monetary theorist, credit and debt are the same thing, made at the same time. Therefore, new money is new debt.
RF: Perfect, I’m totally on board. In the models I write down, that’s true because there are multiple equilibria and because the actions the government takes help to select one of the equilibria. Maybe I should write a paper called ‘Modern Monetary Dynamic Stochastic General Equilibrium Theory.’
PA: If the government spent money, what would you think would happen to the balance sheets and the economy, or do you not think in those terms? So if the government bought, say, a new nuclear submarine from a private defence contractor, what would be the monetary movements in that?
RF: The government has a bank account that it uses to purchase new nuclear submarines. I’m honestly bemused by the question.
PA: A modern monetary theorist, would say that if the government buys a new submarine, its balance at the Bank of England goes down. The receiving bank’s reserves would go up, which would mean there’s an internal transfer on the liabilities side of the Bank of England, there’s a reduction in the reserve account of the government, and an increase in the reserves held by the receiving bank. The asset total value of the Bank of England balance sheet remains the same.
Regarding the bank which holds the account of the company that makes the submarine, that bank’s balance sheet will expand. It will have liabilities – say it was £5 billion, and now that company has a liability at its own bank of £5 billion and on its assets side, the receiving bank’s reserves have gone up. That’s how a modern monetary theorist thinks. But you won’t be surprised to know that when I ask economists that question, they don’t answer it in those terms.
RF: How does a modern monetary theorist deal with the difference between the world we live in now and the Gold Standard?
PA: Under the Gold Standard, the government’s ability to issue debt, or to spend, is limited by its gold stocks. Because, for example, if the government runs a deficit under the Gold Standard - say it’s spent a billion pounds and took in £800 million, there would be £200 million’s worth of convertible gold currency.
RF: So, its an entirely different world.
PA: Yes. Under the Gold Standard, the interest rate was determined by the central bank to compete with the option of conversion, which is why big deficit countries under the Gold Standard would raise the bank rate.
RF: So, the question about buying a nuclear submarine would have very different implications in an economy under the Gold Standard than it would under the current standard.
PA: Yes, it would. I don’t know if you’re familiar with the employer of last resort (ELR) policy?
RF: No, I’m not.[3]
PA: Modern monetary theorists don’t believe that the main policy tool for maintenance of price stability should be interest rates, they don’t believe this approach is effective. And an ELR also maintains full employment. Under an ELR policy the state offers an unlimited number of jobs and hence, unemployment effectively falls to zero. If a person were unemployed, the government would provide one. It is, in effect, a stock control policy – in times of recession – people move into the employed labour buffer stock.
RF: I am sympathetic to both points. I agree that the state has a responsibility for maintaining full employment. But full employment is not easily defined. It is possible to have too much employment just as it is possible to have too little employment. A job for everyone who wants one is a meaningless concept for someone who thinks in terms of search.
You ask, “Do you consider the employer of last resort policy to be a viable means to ensure full employment and price stability?” I’m certain it could be a successful means of ensuring full employment, we saw that in Soviet Russia. I don’t think it was very efficient – the state allocating people to jobs is not my ideal society. Also, I don’t think that full employment, implemented by this policy, would guarantee price stability.
PA: The final question is what role do you consider that MMT might have to play in the practise of heterodox, or indeed any economics? Do you see it as something that’s so far from what economists are thinking about that you don’t even see it on the horizon?
RF: There are many pluralistic views. I’m not sure why anyone would put a label on themselves, I refuse to be labelled as anything. I don’t know why anyone would want to be labelled as an ‘MMT person’ as opposed to someone who seriously considers the ideas in Modern Monetary Theory and tries to integrate them with other things that they found useful.
PA: Well, that, in a sense, is just as good an answer as any other. That if you kind of pick apart the question, that’s really what I want to do with the questions, if you see what I mean. Well, that concludes the formal interview. Many thanks, Professor Farmer.
[1] This statement was true when I spoke to Philip in 2018. A lot has changed since then and MMT is now being more widely discussed as a policy approach to government finance.
[2] For a more complete account of my views on the Fiscal Theory of the Price Level see my recent working paper with Pawel Zabczyk (Farmer & Zabczyk, 2020).
[3] I certainly know now as a consequence of the impact of MMT on the 2020 US presidential campaign.