Happy New Year!
I’ve enjoyed writing this newsletter and expect to have a lot to say on a wide range of topics in 2022. Last year, I devoted a lot of space to the legislative process and how the “pay for game” gummed up the debate over President Biden’s economic agenda. I also wrote about the fiscal response to COVID, supply-chain problems, why we need to think harder about inflation, and more.
I’ve gotten a lot of questions about the current bout of inflation and what—if anything—it teaches us about Modern Monetary Theory (MMT). Did Congress “experiment” with MMT, and does the run-up in inflation mean that MMT has “failed”? Now that inflation is here, what does MMT tell us to do about it?
This post tackles those questions.
The Hills Are Alive With Economists Arguing About Inflation
The second chapter of my book, The Deficit Myth, is titled ‘Think of Inflation.’ From the very beginning, MMT has rejected the conventional approach to fiscal sustainability. While mainstream economists were warning of a looming debt crisis here in America, MMT economists were explaining that the relevant constraint facing currency-issuing governments (like the US, the UK, or Japan) is inflation, not bond vigilantes or insolvency.
It’s been a long time since the world’s major economies had to wrestle with the problem of high inflation. For most of the last decade—and longer in Japan’s case—central banks have been struggling to push inflation higher not lower.
Now that inflation is here—and running well above target in the US, the UK, Canada, across the Euro Area, and beyond—a fiery debate has erupted over what sent prices soaring and what should be done to rein them back in.
Some blame monetary policy—i.e. the Federal Reserve—for stoking the fire by holding interest rates too low for too long and for ‘pumping too much liquidity’ into the system via the Fed’s massive bond-buying program. Others mainly fault Congress and the White House—i.e. fiscal policy—for sending out too many checks to too many people for too many months, sparking an “excess aggregate demand” problem. Occasionally, someone will even assert that the run-up in inflation is the natural consequence of having embarked on an “MMT experiment,” by which they usually mean the combination of quantitative easing (QE) and massive deficit spending.
On one level, I think it’s fair to say that policymakers did experiment with MMT. But I’m not talking about about QE, which was never championed by MMT economists. What I mean is that the fiscal response to the pandemic differed in important ways from what was done in the wake of the Great Recession, when people like Larry Summers and Jason Furman were helping to shape the Obama administration’s (inadequate) economic policy. Back then, both men pushed hard for deficit reduction, with Furman touting a White House budget that would “show that we can live within our means” by bringing “spending down to the lowest share of the economy since Eisenhower was president.” He delivered those remarks in February 2011, when the unemployment rate (U3) stood at 9 percent and headline inflation (CPI-U) was running at just 2.1 percent.
But this time around, it looked like Congress—Democrats and Republicans—had grown more comfortable with the idea of allowing fiscal deficits to cushion the downturn and sustain the economic recovery. And it was the robust fiscal response that came out of the late-Trump/early-Biden administrations that reflected a shift toward a more enlightened understanding of our monetary system and the spending capacities of the federal government—i.e. MMT. Instead of cowering in fear of debt and deficits, as it did during the Obama years, Congress went big. Not once, not twice, but repeatedly, committing some $5 trillion in fiscal support in the first year of the pandemic alone.
March 2020: CARES Act ($2.2 trillion)
December 2020: Consolidated Appropriations Bill ($900B)
March 2021: American Rescue Plan Act ($1.9 trillion)
It happened, as MMT always maintained it could, without the need for higher revenue to “pay for” it. Congress simply voted to authorize the spending, and the Federal Reserve worked with the rest of the financial system to get that money out the door. While Senator Kennedy (R-LA) lamented the shift away from worrying about deficits, others saw it as a clear “win” for MMT.
As governments embraced the use of robust fiscal policy, a growing number of commentators started to assert that “We Are All MMTers Now.”
Unfortunately, many of them conflated MMT with QE or “helicopter money,” prompting numerous corrections like the one below from MMT economists Yeva Nersisyan and L. Randall Wray or this one from me.
So here’s what the so-called “MMT experiment” has shown: (1) The mechanics of government finance work precisely the way MMT has always described. (2) The federal government is not revenue constrained. (3) There was no need to raise taxes in order to finance trillions in new spending. (4) Interest rates do not spike as a natural consequence of rising debt and deficits. (5) There was no crowding out of private spending and no difficulty finding buyers for new US Treasuries. The “experiment” confirmed these core tenets of MMT.
There was, however, a big move up in inflation following the passage of the March 2021 fiscal package.And this has led some people to ask whether the emergence of high inflation means that the MMT experiment has failed. The answer is an unequivocal no.
Because MMT offers a descriptive framework—a lens—through which to evaluate fiscal and monetary policy. MMT did not urge the Fed to do $120 billion in asset purchases every month. MMT did not write the $2.2T CARES Act. It did not advise Congress to launch the payroll protection program, to send out $1,200 checks or to provide $600/week in federal unemployment compensation. A framework cannot do those things. An MMT economist can.
But MMT economists—like Post Keynesians, Monetarists, etc—are not a monolith. Just as Paul Krugman and Larry Summers (two Keynesian economists) held differing views about whether Biden’s $1.9T rescue package was good public policy, MMT economists had different ideas about the best way to respond to the pandemic-induced economic meltdown.
All of us wanted Congress to avoid repeating the mistakes of the Obama years, so we all encouraged a robust fiscal response. I pushed to keep workers out of the workplace but attached to their current employers, backstopping payrolls like many European countries were doing.Other MMT economists stressed the need for a federal job guarantee to re-employ millions at risk of losing their jobs. I suggested sending out small, recurring payments in the form of prepaid debit cards to every household in America (along with test kits and face masks). Other MMT economists thought it was a bad idea to send cash to people who had suffered no disruption in earnings. Each time Congress passed a COVID relief package, it included provisions that many of us supported, as well as some we didn’t.
The point is, you can’t blame “MMT” for stoking inflation any more than you can blame an optometrist if her patient runs off the road while driving without wearing their prescription lenses. MMT doesn’t tell us that the world is an open road, free of hazards or the need for caution. It doesn’t reject fiscal responsibility, it redefines it so that our eyes stay focused on the real limits on spending. Here’s a passage from the introduction to the paperback edition (March 2021) of my book:
“Do I believe the solution to all our problems is to simply spend more money? No, of course not. Just because there are no financial constraints on the federal budget doesn’t mean there aren’t real limits to what the government can (and should) do. Every economy has its own internal speed limit, regulated by the availability of our real productive resources—the state of technology and the quantity and quality of its land, workers, factories, machines, and other materials. If the government tries to spend too much into an economy that’s already running at full speed, inflation will accelerate. There are limits. However, the limits are not in our government’s ability to spend money, or in the deficit, but in inflationary pressures and resources within the real economy. MMT distinguishes the real limits from delusional and unnecessary self-imposed constraints.”
And this brings us to inflation and the big argument that many economists are having today.
Why did inflation accelerate in 2021? Was it because the Federal Reserve was too accommodative? Was it because Congress stomped too hard on the accelerator with the last big COVID rescue package? Was it mostly about lingering supply-chain disruptions and other COVID-related shortages (including labor)? Will it turn out to be transitory—i.e. a problem that largely goes away on its own when the pandemic fully recedes? Are corporations with monopoly pricing power using the pandemic as cover to gouge consumers simply because they can? And are the supply-chain problems themselves a byproduct of a decades-long trend in corporate consolidation, deregulation, and the offshoring of US manufacturing? Will inflation penetrate the psyche of the American people, shifting inflation expectations in a way that sends inflation whirling out of control? The hills are alive with economics debating these questions.
My Favorite Things
Alongside the debate over what caused the current bout of high inflation is a debate about how to resolve the problem. A number of people have asked me for the MMT solution. There isn’t one. Let me explain.
Before the pandemic, when inflation was consistently running below 2 percent, I was often asked what MMT would tell us to do if inflation ever became a problem. I have probably answered that question a hundred times, and I always try to separate my response into two parts.
The first part of the answer reminds people that the goal is to fend off inflation before it becomes a problem—i.e. the MMT framework aims to promote price stability. The second part of the answer addresses the question of how to deal with inflation after prices begin to accelerate.
Here are my favorite pre-emptive measures. First, instead of relying on a pool of unemployed workers (NAIRU) to keep inflation in check, MMT relies on a buffer stock of employed workers—and a wage anchor—to promote price stability. This has always been the first line of defense against inflation in the MMT framework. The idea is to create a new automatic stabilizer that triggers a powerful counter-cyclical response to changing economic conditions.Instead of allowing millions of people to fall into unemployment each time the economy falters, workers could transition into a public service job that replaces some or all of their lost income. The program enhances price stability by maintaining a supply of employable labor from which employers can hire (at a small premium) as conditions improve. The program facilitates bigger deficits (or smaller surpluses) when the economy softens and smaller deficits (or larger surpluses) as demand strengthens.
The other way to fend off inflationary pressures before they emerge is to change the way Congress currently evaluates proposed legislation. Instead of asking the Congressional Budget Office (CBO) to assess the budgetary impacts of a proposed legislation, lawmakers should seek to identify—and mitigate— any inflationary pressures before voting to authorize the spending (or tax cuts). As MMT economist Scott Fullwiler put it, this is about replacing the budget constraint with an inflation constraint.
As I’ve said literally hundreds of times, the best way to fight inflation is before it happens—i.e. ex ante. You don’t want to cause an inflation problem and then chase after it ex post.
Here’s how I put it in The Deficit Myth:
“If the government wants to boost spending on health care and education, it may need to remove some spending power from the rest of us to prevent its own more generous outlays from pushing up prices. One way to do this is by coordinating higher government spending with higher taxes so that the rest of us are forced to cut back a little to create room for additional government spending. That can help manage inflationary pressures by balancing the strain on our economy’s real productive capacity. More than any other economic school of thought, MMT emphasizes the importance of deciding when tax increases should accompany new spending and which taxes will be most effective at restraining inflationary pressures. Raising taxes when it’s not necessary can undermine fiscal stimulus, and raising the wrong kind of taxes can leave a nation vulnerable to accelerating inflation.”
Taxes should be part of the inflation-fighting toolkit, but the goal is to build them into legislation (as needed) ahead of time, not to reach for them in an act of desperation after prices begin to accelerate. As I wrote with my colleague Randall Wray many years ago, MMT does not rely on raising taxes to fight inflation after it takes hold.
So what is the MMT solution to dealing with inflation ex post—i.e. once the problem is here? There isn’t one. And I’d suggest running fast and far from anyone who offers you a quick and easy prescription for dealing with any and all inflation.
Mainstream economists, of course, offer just such a solution. The Federal Reserve will fix it! After all, it’s already their job (dual mandate), and they can act quickly and “independently,” tightening policy without fear of any backlash at the ballot box. I don’t know of a single MMT economist who agrees with this view.
Why? For one thing, we don’t think rate hikes work to constrain inflationary pressures the way mainstream economics teaches. It might even be possible, as Warren Mosler and Randy Wray have argued for years, that raising interest rates does more to push inflation higher rather than lower.
The way I see it, inflation is a complex and dynamic process, with potentially many underlying drivers. It takes a certain hubris to assert that by nudging a single price—the federal funds rate—higher, the entire economy can be shifted back onto to a stable inflation path. My view is that any effort to rein in inflation must start with an autopsy of the problem.
Here’s what I’ve said to reporters (and others) over the years, when I’ve been asked how MMT would handle inflation if it ever became a problem. I start by saying:
“Imagine I go downstairs to my basement after we finish speaking, and I find it flooded with water. I know I have a problem on my hands, but I don’t know why I have a problem on my hands. Did a pipe burst? Did a toilet overflow? Did the sewer backup? Before I know what to do about the problem, I have to identify the source of the problem.”
This is basically how I have always thought about inflation. It doesn’t follow from any core tenet of MMT. It’s just common sense. As any medical doctor or auto mechanic surely knows, you have to figure out what’s causing a problem before you can resolve it. Prescribing antibiotics to fight a viral infection or replacing the alternator to stop the radiator from overheating won’t improve the situation. To successfully deal with an inflation problem, you have to get the diagnosis right.
That’s why the debate over what caused our current bout of inflation is so important. In my view, the White House was on the right track with this attempted autopsy in July 2021. If firms are abusing their market power and gouging customers to earn “excessive” profits, then it’s important to know that. If the main drivers are mostly related to bottlenecks and the pandemic, then it’s important to understand that too. While Biden has repeatedly invoked the independence of the Federal Reserve, his administration has also looked for ways to proactively address some of the inflationary pressures on its own.
Economists like Larry Summers and Jason Furman have downplayed global supply-chain problems and criticized the Biden administration for invoking antitrust and calling out corporate greed. In their view, what we have is mostly an excess demand problem, fueled by an excessively accommodative central bank and excessive income support from the $1.9 trillion COVID package. With that diagnosis in hand, their recommended solution is for the Federal Reserve to tame consumer spending by tightening monetary policy: a quicker tapering of asset purchases, followed by an unwinding of the Fed’s balance sheet and a series of interest rate hikes. In the battle against inflation, they’re basically content to stick with the conventional weaponry. I guess it makes sense. When all you have is an interest-rate hammer, every inflation looks like an excess demand nail.
I’m not content with that solution. And neither are a growing number of others.
Earlier this month, one economist triggered a huge controversy by wondering aloud in the pages of The Guardian newspaper whether strategic price controls might be helpful. I don’t know a lot about price controls. They’re mentioned once in my book—in a footnote. They’re not part of the MMT playbook, and certainly not the “front-line solution” to inflation, as one blogger recently claimed. But that’s because there is no MMT playbook to deal with ex post inflation. There are only MMT economists with differing ideas about how to tackle inflation right now.
Here’s what Warren Mosler recently proposed. (This post is already running long, so I’ll save the explanation for how he sees each of them working for another day. In the meantime, you can hear some of his thoughts on inflation here.)
Here’s what Professor James Galbraith (I’d call him MMT-adjacent) recently suggested:
"The focus should be on stabilizing energy prices, cracking down on speculators, cutting the Pentagon budget, unclogging the ports, and ensuring that sorely needed wage increases go mainly to the lowest-paid workers."
And if you want to drink from a firehose, MMT economist Fadhel Kaboub offers a sweeping range of inflation-fighting ideas here.
The point is that there is no one-size-fits all policy solution in MMT because every inflation is different. As my husband (a history professor) recently put it, “If you’ve seen one inflation, you’ve seen one inflation.” And that’s a point that Fed Chair Jerome Powell seems to appreciate.
During his confirmation hearing last week, Powell noted that the supply-chain collapse and labor force shock were unprecedented in our history. He also explained that the Fed’s tools are intended to work on the demand-side, not the supply-side, of our economy. And he admitted that the “pressures we’re facing are mostly coming from the supply-side.” “We don’t have much ability to affect the supply side,” he told lawmakers. Even “the price of a hamburger [is] outside the range of our tools.” And on the subject of hamburgers, Sen. Warren (D-MA) asked about the fact that just four meatpackers control more than 80% of the market. Powell responded by calling it “a competitiveness problem" and not something the Fed can address. He talked about the price of gas, food, and heating oil, explaining, “when it comes down to energy and food, those are largely and importantly influenced by supply-side.”
In the early months of the pandemic, Chairman Powell used to repeatedly say, “the Fed can lend, but the Fed can’t spend.” It was his way of explaining the limited capacity of monetary policy to restart a stalled economy. Now that the recovery is underway and attention has shifted to fighting inflation, Powell has found himself explaining once again that the Fed can’t do what the Fed can’t do. He’s obviously got greater faith in his toolkit than an MMT economist has, but we should respect his assessment of the limitations of monetary policy.
So Long, Farewell
So where does that leave us? How and when can we bid farewell to inflation?
Financial markets appear to be betting that the Fed will guide us onto a more stable inflation path this year. And while Powell is mainly talking about “removing accommodation,” it’s clear that he sees inflation abating on its own, provided we bring the global pandemic under control. That’s my view as well, and it’s what Paul Krugman believes.
So far, then, I’m still on Team Transitory: I think things are looking more like 1951, when inflation briefly hit 9.3 percent, than 1979. And if we finally get this pandemic under control, the inflation of 2021 will soon fade from memory.
I count myself part of Team Transitory as well, but that’s because I always defined “transitory” this way:
That doesn’t mean that we shouldn’t be looking for ways to actively dampen inflationary pressures as we work to beat the global pandemic. The White House has put forward some ideas, MMT economists have offered suggestions, and many others have as well. But as Powell stressed, “getting past the pandemic is the single most important thing we can do” to solve the inflation problem.
It’s sometimes said that MMT only applies to the United States or to a handful of countries that issue globally-important fiat currencies. You might have heard someone argue that MMT doesn’t apply to countries that fix their exchange rates and/or carry significant external debt. That is wrong. MMT is a framework (or a lens) that can be used to analyze the policy options available to governments under any monetary regime. It is a general analytical framework, as described by Mosler and Forstater here.
Although discretionary—i.e. active fiscal policy interventions—and non-discretionary—i.e. slowdown-induced automatic stabilizers—pushed the deficit sharply higher in 2020, consumer prices rose just 1.4 percent that year, reminding us that deficits are not inherently inflationary.
A version of this was tried—with mixed results—in the form of the Payroll Protection Program (PPP). A lot of money went where it wasn’t needed, and many small businesses that desperately needed funding found it impossible to get. In some ways, this was inevitable. Unlike, say, Germany, the US didn’t have the institutional arrangements in place to roll out a paycheck protection scheme when the crisis hit. So it cobbled something together on the fly. It should be a lesson for next time.
It is intended to work in conjunction with existing automatic stabilizers—like unemployment insurance (UI), food stamps, and other social safety net programs—not to replace them.
In Canada, when the first Trudeau govt embarked on fighting inflation with interest rates after wage and price controls, I wrote to them and pointed out that they were trying to use gasoline to put out a fire.
It was my belief then and now that in addition to other unfair impacts, higher interest rates contributed to higher prices at every step of the supply chain as businesses experienced higher credit costs for manufacturing and shipping their products to retailers who also experienced higher credit costs while awaiting the market to clear their “shelves.” Those higher credit costs would find themselves a part of prices forcing another cascade of effects on labour costs and hours of work.
I could see that to reduce the credit charges, retailers will clear their shelves by lowering prices but that will have limits.
Thanks! Your clearly written perspective on inflation is quite helpful. The various news channels either sensationalize inflation or revert to simplistic sophistry.