Modern Monetary Theory and Practice

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William Mitchell, L. Randall Wray and Martin Watts. Modern Monetary Theory and Practice: An Introductory Text. Callaghan, Australia: Centre of Full Employment and Equity: 2016.

Blogging about a textbook is not something I normally do. This text represents a perspective that is especially relevant to current economic policy discussions, and the proposal for a “job guarantee” in particular. That’s been getting a lot of attention both on Wall Street and in progressive policy circles, two realms that don’t usually find much common ground. Here’s a short Huffington Post article on that issue.

Most people are vaguely aware that there are theories underlying the various policy proposals they hear, but they have trouble connecting the dots between theory and policy in any explicit way. We have all heard politicians say that cutting taxes will stimulate the economy, raising interest rates will control inflation, putting high tariffs on imports will save American jobs, or that allowing higher government deficits will impoverish future generations. We need to know how many serious economists agree with such claims.

This is a textbook on macroeconomics, the study of the workings of the economy as a whole, as opposed to microeconomics. the study of economic units like business firms or households. “Macroeconomics focuses on a selected few outcomes at the aggregate level and is rightly considered to be the study of employment, output and inflation in an international context.” I can’t cover this whole textbook–and I’m sure my readers don’t want me to–but I will try in this and the next few posts to explain how a contemporary group of economic theorists arrive at their policy recommendations.

The neoclassical orthodoxy

Let’s begin with a few basic assumptions. The authors describe two broad approaches to macroeconomics. They distinguish the more orthodox tradition, commonly called “neoclassical,” from a heterodox tradition with no single agreed-on name. They call it the “Keynesian/Institutionalist/Marxist approach. In this text, I see a lot more Keynes than Marx.

Keynesian and institutionalist perspectives were very popular in the early twentieth century, but the more orthodox approach had a resurgence in the 1970s as economists and policymakers shifted their focus from boosting employment and wages to fighting inflation. Theories in the neoclassical tradition have dominated public policy since then, but the authors of this text are among those trying to change that.

The neoclassical orthodoxy defines economics as “the study of the allocation of scarce resources among unlimited wants.” The non-government sector of the economy, which neoclassicists like to call the “free market,” has a natural, rational way of functioning that is both efficient and fair. Individuals pursue their self-interest, trying to maximize their utility–their use of the things they want. They compete in the market for various resources, goods and services, exchanging the things they have for the things they don’t have, using money as a medium of exchange. As they do so, they arrive at price points where supply meets demand and everything is efficiently allocated. If the price of a welder’s labor is too low because the supply of welders exceeds the demand, then that encourages workers to enter occupations where their labor is needed. In the end, what you get will reflect the market value of what you give.

Neoclassical theories acknowledge the role of government but limit it. Government has to perform certain basic functions like protecting national security and enforcing law and order. But when it intervenes in the market to set wages or promote one industry over another, it’s more likely to produce distortions and inefficiencies than to make the economy work better.

Although neoclassical economics provides an elegant model of how an idealized, perfectly-competitive economy might work, less orthodox economists question how well it applies to any real economy, especially a modern one:

Claims are sometimes made that a “free market” economy comprised of individuals seeking only their own self interest can operation “harmoniously” as if guided by an “invisible hand.”…In fact, economists had rigorously demonstrated by the 1950s that the conditions under which such a stylised economy could reach such a result couldn’t exist in the real world. In other words, there is no scientific basis for the claim that “free markets” are best.

In any case, these claims, even if true for some hypothesised economy, are irrelevant for the modern capitalism economies that actually exist. This is because all modern capitalist economies are “mixed”, with huge corporations (including multinational firms), labour organisations and big government.

Modern monetary theory

Modern monetary theory (MMT) relies on a less orthodox definition of economics: “the study of social creation and social distribution of society’s resources.” It does not assume any one natural way to run an economy, since economic organization depends on variable cultural norms and social institutions. Right away, this way of thinking makes more sense to sociologists like me.

Societies haven’t always favored self-interested competition over social cooperation, as the neoclassicists consider natural. That assumption may reflect the preferences of early English capitalists who wanted to pursue their self-interest unencumbered by traditional constraints imposed by English kings and their “feudal lord cronies.”

In the modern economy with its large and dominant organizations, prices are not set through free competition among many small economic actors, but mostly by big players with superior market power or political clout. The price you can get for your labor, for example, is not necessarily the price that will employ it most productively. It may be the price fixed by powerful employers who profit by keeping wages low, or by agreeing to devalue certain classes of workers, such as women or minorities. That leads to unnecessarily low incomes, low aggregate demand, and an underutilization of labor that hurts both the economy and society in general.

People working together in society can cooperate to create resources such as a skilled and fully employed labor force. And people can also influence how social benefits are to be distributed among employers, workers, and others, such as by supporting collective bargaining rights. Government is a major player in these decisions, not as some alien force that interferes with the economy, but as a means of taking collective action to influence economic outcomes. Collective action can produce aggregate outcomes more favorable than self-interested individuals could have achieved working independently.

The “key goal of macroeconomics” is “using the available macroeconomic resources including labour to the limit.” The authors relate the value they place on labor to the United Nations Declaration on Human Rights, which asserts that “everyone has the right to work, to free choice of employment, to just and favorable conditions of work and to protection against unemployment.” Lack of access to employment impedes full participation in society and undermines many of the other rights asserted in the Declaration. It is also associated with a long list of personal and social pathologies, such as physical and mental health problems, crime, and drug abuse.

From this perspective, macroeconomics and enlightened public policy are inseparable. Policymakers need to get it right because the stakes are very high.

Coming up…

What I will be trying to do in the next few posts is describe in fairly plain English how modern monetary theorists think the economy works. I will emphasize, as the authors do, the many forms of government influence: spending and its impact on output and income; taxation and transfer payments; the creation and management of money; and financial balances interconnecting government and non-government sectors. What I like about macroeconomics is that a few fundamental principles yield surprising insights.

Then I will turn to the the authors’ critique of recent public policy and their recommendations for new directions.


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