Is Inflation Disproving Modern Monetary Theory?

May 31, 2022

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Economic events sometimes have a way of discrediting popular economic theories. The Great Depression of the 1930s challenged many neoclassical economic ideas and encouraged Keynesian thinking. In turn, the stagflation of the 1970s challenged many Keynesian ideas and helped popularize Milton Friedman’s brand of monetarism. Today, some economists are trying to use the current inflation to discredit a newer theory with Keynesian roots, the Modern Monetary Theory (MMT) championed by Stephanie Kelton and others. In this case, however, the theory under attack can hardly be said to have been tried, so the rumors of its failure or demise may be greatly exaggerated.

The argument we now hear goes something like this: MMT is distinguished from mainstream economic theories by its higher tolerance of federal budget deficits. The Biden administration has been running large deficits, so its policies are a test of MMT. The recent surge of inflation is an ill effect of those policies, so that provides evidence of failure for both deficit spending and the theory that encourages it.

In this vein, Karl W. Smith writes:

In response to Covid, the federal government spent trillions of dollars on relief, and the Fed pushed interest rates to zero. The idea was that these policies would be short-lived. But as the pandemic wore on, they were kept in place.
In effect, America was putting MMT into practice. Congress borrowed and spent with little concern for long-term limits, and the Fed supported that borrowing by keeping interest rates at zero. As a result, MMT proponents are fond of pointing out, the U.S. economy bounced back stronger than any of its peer nations.
Yes, they admit, the U.S. has also had stronger inflation. But MMT proponents note that they had always acknowledged that possibility, and that inflation was more a result of the unusual circumstances of a pandemic than of any particular aspect of MMT.
Both of these answers are unsatisfying. In truth, MMT is failing precisely as its more sanguine critics predicted.

Furthermore, critics like Clive Crook complain that MMT “offers no plausible solution” to inflation, since it rejects the most orthodox solution of interest-rate hikes by the Federal Reserve.

Although these concerns about Modern Monetary Theory are certainly worthy of debate, I believe that they exaggerate some features of the theory while almost completely overlooking others.

MMT’s tolerance of deficits

The part of this popular critique that contains the most truth is that MMT is indeed unusually tolerant of federal budget deficits. Orthodox economic theories have at most a grudging acceptance of deficit spending to stimulate a sluggish or recessionary economy. And yet, the federal government has run a deficit almost continuously for the past fifty years, only balancing the budget between 1998 and 2001. Is that a policy mistake, or an implicit recognition that deficits help stabilize the modern capitalist economy most of the time?

MMT’s understanding of deficits is based on “flow-of-funds” accounting that distinguishes three economic sectors: the public sector, the private domestic sector, and the foreign sector (our trading partners). The key point is that a deficit in any one sector is balanced by a surplus somewhere else, and vice versa. MMT economists reason that the U.S. must run a deficit at least as large as its current account imbalance with its trading partners (that is, the foreign sector surplus); otherwise, the domestic private sector has to be in deficit instead. Its total income will be less than its total spending, and its financial assets will decline relative to its debts. This makes the economy more vulnerable to financial crises resulting from boom-and-bust cycles, as it was in the housing boom and bust of the 2000s. The recommended course of action is to run a government deficit even larger than any current account imbalance, to give the private sector added protection against economic downturns. “In the long term, the only sustainable position is for the private sector to be in surplus. An economy can absorb deviations from that position but only for short periods” (Mitchell, Wray and Watts, Macroeconomics, p. 89).

In The Deficit Myth, Stephanie Kelton argues that a government that controls its nation’s currency does not have to budget like a household, that the national debt is as much a private asset (held in treasury bonds) as a public liability, and that the country has no good reason to pay it off. She says that “a government that borrows in its own sovereign currency can always maintain the critical condition for sustainability,” which is that the interest rate on the debt is no greater than the growth rate of the economy. But these views do not sound fiscally responsible to economic traditionalists.

MMT’s view of inflation

What MMT most certainly does not say is that the government can spend as much as it likes without worrying about the inflationary consequences. On the contrary, it says that the possibility of inflation, rather than the budget deficit itself, is exactly what the government should be worried about. While rejecting as a myth the idea that “deficits are evidence of overspending,” Kelton immediately adds, “For evidence of overspending, look to inflation.” And later, “Once the economy exhausts its real productive capacity, the only way for the government to get the construction workers, architects and engineers, steel, concrete, paving trucks, cranes, and so on that it needs is to bid them away from their current use. That bidding process pushes prices higher, giving rise to inflationary pressures.” Few economists would argue with that.

The key phrase is “once the economy exhausts its real productive capacity.” The classic definition of inflation—too much money chasing too few goods—reminds us that inflation is a relationship between monetary demand and real supply. MMT is especially interested in cost-push inflation, when shortages of key resources push up prices. It attributes the high cost of gas partly to our failure to develop alternative energy sources, the high cost of housing partly to our failure to build enough of it, the high cost of food partly to production interruptions from war and pandemic, and the high cost of labor partly to shortages of qualified workers (and of the child care they need to take jobs). Although government spending can stimulate the demand side of the economy, it can also address shortages on the supply side, helping to keep costs down. To the extent that government invests in expanding the nation’s resources along with the nation’s money supply, it is acting responsibly and working against inflation.

What kind of deficit?

This line of reasoning implies that all deficits are not equal in their inflationary impact. It matters what specific fiscal policies are creating the deficit.

Since the budget deficit is the gap between revenue and spending, critics of the deficit could just as well complain about “deficit revenue” as “deficit spending.” Economists who blame the deficit for inflation should question President Trump’s tax cuts as well as President Biden’s stimulus checks. In truth, Modern Monetary Theory is not enthusiastic about either tax cuts or stimulus checks, since neither is sufficiently targeted to expand the productive capacity of the country. When Karl W. Smith characterizes MMT as “a school of economics that advocates the kind of policy that has brought the U.S. economy to this point,” he is overlooking most of what economists like Kelton would really like to see done. One cannot have it both ways, attacking MMT as a dangerous new theory and then claiming that it’s already established policy.

One Biden initiative that does appeal to proponents of MMT is the infrastructure bill. Improvements in things like transportation and the energy grid can help grow the economy while cutting costs for producers and consumers. When the government offsets that kind of spending not with taxes, but with sales of treasury bonds, it is not acting irresponsibly, but just asking the public to invest in the nation’s future. Democrats managed to pass the infrastructure bill with support from only 12% of Congressional Republicans. Biden’s “Build Back Better” proposal, which has been called a “human infrastructure” bill, has not passed. It contains initiatives in the areas of preschool education, family and medical leave, health care, affordable housing, and clean energy, all of which are arguably relevant to developing our national resources. The great majority of Republicans opposed both bills, attacking the first for adding to the deficit and the second for raising revenue by rolling back some of the Trump tax cuts. MMT may be having some impact on the administration’s thinking, but it remains to be substantially implemented.

Modern Monetary Theory tries to broaden our conception of fiscal responsibility by considering not only how to pay for programs but what the programs actually accomplish. Deficits that serve to expand the country’s resource base are not as inflationary as deficits that just put more money in people’s pockets. But fiscal policy still has limits, since the resource base is not infinitely expandable, especially in the short run. Kelton says:

To be clear, MMT is not about removing all limits. It’s not a free lunch. It’s about replacing our current approach, one obsessed with budget outcomes, with one that prioritizes human outcomes while at the same time recognizing and respecting our economy’s real resource constraints. In other words, MMT redefines what it means to engage in fiscally responsible budgeting…“It’s the economy’s real resources, stupid!” We are a nation rich with real resources—advanced technologies, an educated workforce, factories, machines, fertile soil, and an abundance of natural resources.

MMT’s budget priorities

When asked in a recent interview for her number-one policy recommendation, Kelton said:

It has to be climate. I don’t see a bigger threat challenge before us than climate change… Climate change is gonna massively disrupt life in so many ways, right? It is going to be an irritant. It is going to be a hardship. People are going to be feeling pain in ways they haven’t even imagined in their lives, in their pocketbook as a result of climate. So again, I think, you know, the kind of inflation we’re dealing with now is mild in comparison to what lies ahead, if we don’t get our arms around this.

When faced with such a serious challenge, responsible budgeting requires more than just deficit reduction. It demands spending what we need to in order to develop alternative energy resources, so that we can avoid the catastrophic costs of environmental damage and energy shortages. We can, of course, include taxes on fossil fuels to encourage the transition, if we can summon the political will to pass them. But we can also do what we’ve done in time of war, sell more treasury bonds and rely on a growing economy to keep the debt manageable.

Another budget priority for MMT—although one that’s a harder sell—is a federal job guarantee for workers who are otherwise unemployed. Many politicians and orthodox economists reject it out of hand as another costly program the country cannot afford. But MMT theorists point to the enormous costs imposed on the country by chronically high unemployment, especially in poor communities. Leaving people who would like to work unemployed is counterproductive, since the longer they are without work, the less qualified for work they become. The well-documented damage includes not only loss of relevant skills, but poor health, psychological harm, social isolation, antisocial behavior, and deterioration of family life. Greater investment in human capital development through health and educational programs can help, but acquisition of good work habits and job skills through actual employment is essential.

MMT argues that a federal jobs program could help stabilize the economy by counteracting fluctuations in private employment. In times of economic contraction, the government wouldn’t just give out money, but hire more workers and produce some useful services for the money it spends. That would be the alternative to—in Kelton’s words—“pulling out the bazooka, the money bazooka, and just spraying it across the economy and saying, we gotta blow a bunch of money into people’s hands because we don’t know what else to do.” In times of economic expansion, the private sector could draw on a larger pool of experienced workers, so that the cost of hiring good workers wouldn’t rise so quickly. Economists might not have to assume that getting unemployment below 5 percent or so is impossible without triggering inflation.

Fighting inflation

So, how would Modern Monetary Theory respond to the current inflation? Admittedly, the theory is less focused on immediate measures to control prices than on long-term investments to develop resources and reduce costs. Public policy may be able to address some current supply problems, such as shortages of baby formula or supply-chain bottlenecks. More comprehensive measures, like developing more of the country’s human capital, will take much longer.

MMT does not deny that raising interest rates can fight inflation from the demand side by discouraging borrowing and spending. However, it is a crude instrument that may slow overall economic growth. raise unemployment, and risk recession. That’s why the stock market reacts so badly to the slightest hike in rates. To the extent that federal budget deficits are contributing to inflation, some fiscal tightening may be called for. That has the advantage of being able to target particular forms of taxing or spending, making changes that do less harm than others. Most MMT proponents would rather raise taxes on millionaires than eliminate spending on new energy initiatives. But MMT’s focus on fiscal rather than monetary policy is hardly without impact. The federal deficit, which was 12% of GDP in 2021, has already come down to about 5% due to a winding down of emergency stimulus programs.

In general, MMT has more to say about preventing future inflation than curing existing inflation. Its general message is the optimistic one that economic growth with price stability is possible if the country makes wise investments in resource development and management. MMT’s support for public spending is admittedly an easier sell when the market economy is faltering and Keynesian stimulus measures are on the table. Once the economy is growing again, conventional economists turn their attention to moderating demand, while MMT recommends continued attention to expanding long-term supply. This does not have to be an either-or proposition; the interest in one does not preclude or invalidate the interest in the other.

To say that Modern Monetary Theory has failed is grossly misleading. For the most part, it has yet to be tried. Maybe we would have a more productive and less inflation-prone economy if it were.


A Sharp Right Turn on Abortion (part 2)

May 10, 2022

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Having discussed—and questioned—the legal reasoning in Justice Alito’s draft opinion intended to overturn Roe v. Wade, I now turn to the political processes that brought the Supreme Court to this impending decision.

Because of the separation of church and state, citizens can hold strong religious beliefs about matters of sexuality, marriage and reproduction without expecting those beliefs to be written into law. They can be morally opposed to premarital sex, adultery, homosexuality, divorce, contraception or abortion in their personal lives without expecting their elected leaders to ban or criminalize those behaviors. Historically, states have often written Christian morality into law, but in modern times religious pluralism and broader interpretations of personal freedom have worked to liberalize such laws. The liberalization of abortion law that was already underway before Roe v. Wade was part of this general movement. That raises the fascinating question of how and why one of our major political parties would take up the anti-abortion cause and make opposition to Roe a litmus test for selecting Supreme Court justices.

A striking difference between the 1972 Roe decision and Justice Alito’s draft Dobbs decision is that the Roe decision was much more bipartisan. It was decided by a 7-2 majority, including five justices appointed by Republican presidents and two by Democratic presidents. The current decision comes only from the five most conservative justices, all appointed by Republican presidents. (And the last four of those appointments were made by presidents initially elected without winning the popular vote.)

In 1972, Roe v. Wade was somewhat controversial, but it did not initially provoke the firestorm of protest that Alito’s leaked opinion is provoking now. Some states were already moving toward legalization, again in a bipartisan way. One of the most liberal laws was passed by the state of California in 1967 and signed by its Republican governor, Ronald Reagan. At the time, California was a heavily Republican state. It voted Republican in 9 of 10 presidential elections between 1952 and 1988, only becoming reliably Democratic in the 1990s.

In 1972, even evangelical Protestants were not solidly anti-abortion. Many of them thought of abortion as mainly a Catholic issue, like contraception. When the country elected John Kennedy as its first Catholic president in 1960, he had to assure Protestants that he would respect the separation of church and state and not uphold the Catholic position on contraception. Few Protestants objected when the Supreme Court struck down Connecticut’s contraceptive ban in 1965. In 1971, the Southern Baptist Convention passed resolutions supporting abortion in cases of rape, incest, fetal deformity and threats to the health of the mother.

Fifty years ago, the Republican Party was known much more for its economic conservatism than its moral or religious positions. Traditionally, most Catholics in the North and evangelical Protestants in the Deep South had been Democrats. If Republicans had a moral crusade, it was mainly against “godless Communism.”

What changed all this was the rise of the Religious Right in the 1970s and 80s and its strong alliance with the Republican Party. Contrary to popular belief, the first issue to encourage that allience was not abortion, but rather the desegregation of religious schools. (See Randall Balmer’s “The Real Origins of the Religious Right” and Robert B. Horwitz’s America’s Right.)

Because the Bible Belt consisted mainly of the former Confederate states (along with Missouri, Oklahoma and southern portions of several midwestern states), evangelical religion was closely associated with racial segregation. Southern churches had a long history of finding Biblical justifications for slavery and segregation. In the 1970s, the IRS started rescinding the tax exemptions of segregated religious schools. The case that got the most attention was Bob Jones University, which lost its exemption in 1976. Republicans sided with the schools and denounced the Carter administration, although the IRS policy had actually begun during the Nixon presidency. Courting evangelical voters became part of the “southern strategy” by which Republicans attracted voters disenchanted by the strong Democratic support for civil rights. But framing the issue as religious rather than racial allowed Republicans to claim some higher moral ground.

Taking a strong stand in favor of “family values” and against abortion was even more useful to the Republican Party. It was less associated with segregation and appealed to Northern Catholics as well as Bible-Belt Protestants. Republicans aligned themselves with televangelist Jerry Falwell’s “Moral Majority.” Falwell had also opposed school desegregation in the 1950s, saying, “When God has drawn a line of distinction, we should not attempt to cross that line,” but by the 1970s he was better known for strong stands against abortion and homosexuality. Republicans also supported the National Right to Life Committee founded by the Catholic bishops. James Bopp, the general counsel of that organization, wrote the anti-abortion plank of the 1980 Republican Party platform. Who ran on that platform? Ronald Reagan.

Republican politicians could use abortion as a cultural wedge issue to help get their candidates elected, while still pursuing what I regard as their primary mission—economic policies favoring corporations and the wealthy. That helps explain the peculiar combination of economic libertarianism and moral authoritarianism in Republican thinking today. Republicans seem determined to force poor pregnant women to give birth, but equally determined to make them fend for themselves once they do so. In saying this, I am not questioning the sincerity of religious people who believe that a human soul is created at conception. I am saying that many politicians appeal to those believers not because they share their deep moral convictions, but because they need their votes to implement a very different agenda. Donald Trump is perhaps the best example of someone who “got religion” purely for the sake of political expediency.

While the “pro-life” movement has succeeded in making the abortion issue far more salient than it was in 1972, it has not succeeded in actually turning most Americans against legal abortion, especially in early pregnancy or pregnancies resulting from nonconsensual sex. Supporters of Roe outnumber opponents by almost two-to-one. Republicans have had to be very lucky—and somewhat underhanded—to get so many Catholic, anti-abortion conservatives onto the Court. (All five of the anti-Roe justices were raised Catholic and/or educated in Catholic schools. Gorsuch and Kavanaugh attended the same Jesuit school, Georgetown Prep.)

Both the electoral college and the composition of the Senate overrepresent small, rural states like Wyoming in comparison with large, urban states like California. Given a sharply divided electorate, Republicans have used these advantages to control the presidency and/or the Senate even when they failed to win an actual majority of the presidential or congressional vote. Republicans have won the popular vote in only one of the last eight presidential elections (George W. Bush’s reelection in 2004), and yet they hold six of the nine presidential appointments to the current Court. In 2016, Senate Majority Leader Mitch McConnell blocked the Senate from even considering President Obama’s last Supreme Court nominee, making up a rule that nominations shouldn’t be considered in an election year. In 2020, he reversed his position so that President Trump’s nominee could be rushed through several weeks before the election. These machinations gave Trump the most appointments in a single term since Reagan and created the most radically conservative Court in almost a century. Republican nominees also misled Senate moderates by expressing support for Roe as a precedent to be respected, then revealing their judicial radicalism once they were on the bench.

All this has resulted in a most peculiar situation, where the American people are now asked to believe that the Supreme Court was simply mistaken in pronouncing an important women’s right fifty years ago. Justice Alito’s protestations to the contrary notwithstanding, that opinion also calls into question an entire set of sexual, marital and reproductive rights recognized over the past six decades, rights that most Americans would like to keep. While this may not be as critical as Republican attempts to weaken voting rights, it is hardly good news for our democratic values and institutions.


A Sharp Right Turn on Abortion

May 6, 2022

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I could also title this “A sharp turn away from abortion rights.” The gist of Justice Samuel Alito’s leaked opinion on abortion is that women do not have a constitutional right to an abortion, and never did. The Supreme Court’s 1972 decision in Roe v. Wade was “egregiously wrong from the start.”

To back up a step, the Court is working on an abortion case from Mississippi, Dobbs v. Jackson Women’s Health Organization. Court watchers have long speculated that the new conservative majority might take this opportunity to reverse Roe v. Wade (as well as another key decision, Planned Parenthood of Southeastern Pennsylvania v. Casey) and leave states free to write their own rules. Justice Alito’s draft opinion does exactly that: “We now reverse these decisions and return that authority to the people and their elected representatives.” Although it is only a draft, it must be taken very seriously, since its very existence indicates that Alito has been chosen to convey the majority opinion in the case.

Since the Constitution says nothing explicitly about abortion, the constitutional debate centers on the question of whether the right to terminate a pregnancy is implied by other rights, such as other provisions of the Bill of Rights or the due process clause of the Fourteenth Amendment. Alito bases his argument against abortion rights on the idea that any such implicit right must be “deeply rooted in this Nation’s history and traditions” and “implicit in the concept of ordered liberty.” Alito finds that at no time before Roe did the nation recognize a woman’s right to an abortion.

While Alito’s historical account emphasizes how often abortion has been criminalized, it also reveals some important variations. “American law followed the common law until a wave of statutory restrictions in the 1800s expanded criminal liability for abortions.” Under common law, criminalization occurred mainly after “quickening–i.e., the first felt movement of the fetus in the womb, which usually occurs between the 16th and 18th week of pregnancy.” Although Alito doesn’t make the point, the decriminalization of first-trimester abortions by Roe does bear some resemblance to the situation in many colonies, states and territories before the trend toward full criminalization ran its course by around 1919. Alito may be overstating the case a bit when he speaks of “an unbroken tradition of prohibiting abortion on pain of criminal punishment.”

The larger problem with Alito’s historical argument is that it sets the bar so high for recognizing rights that it calls into question many other modern rights as well. The Supreme Court recognized the right to use contraceptives in Griswold v. Connecticut (1965), the right to racial intermarriage in Loving v. Virginia (1967), the right to engage in consensual sex acts in Lawrence v. Texas (2003), and the right to same-sex marriage in Obergefell v. Hodges (2015). Like abortion rights, none of these rights is explicitly in the Constitution or deeply rooted in US history. The argument that we do not have any implicit constitutional rights except those that have been recognized for a very long time would seem to rule out any modern expansion of such rights.

Justice Alito is aware of this problem, and he tries to get around it by arguing that abortion raises a more “critical moral question” than any of these other decisions. Here I find his argument rather slippery and unconvincing. On the one hand, he claims that “our decision is not based on any view about when a State should regard prenatal life as having rights as cognizable interests.” On the other hand, he says:

What sharply distinguishes the abortion right from the rights recognized in the cases on which Roe and Casey rely is something that both these decisions acknowledged; abortion destroys what those decisions call “potential life” and what the law at issue in this case regards as the life of an “unborn human being”…None of the other decisions cited by Roe and Casey involved the critical moral question posed by abortion.

With the careful phrasing, “what the law at issue in this case regards as the life of an ‘unborn human being’ (emphasis added), Alito manages to avoid embracing the view that a newly conceived embryo has the same value or right as a more fully developed and viable fetus; yet he acknowledges such a belief as a basis for considering abortion a particularly critical moral question. Apparently, that is his justification for reserving the authority over pregnancy to the state, while denying that pregnant women themselves have any rights in the matter.

I see at least two problems with this reasoning. First, it does not really distinguish the question of abortion from other questions of rights as clearly as Alito might hope. One could argue that any decision to have sex while avoiding bringing a child into the world raises a critical moral question. Certainly the Catholic Church has condemned as mortal sins not only abortion, but artificial methods of contraception, same-sex sexuality and nonmarital sexuality. And second, even if the abortion question is a weightier moral question than many other personal decisions, how does that confer on the state the right to make the decision for everybody, without regard to the beliefs, desires and circumstances of its individual citizens? By what reasoning do we come to the conclusion that individual citizens have no rights with regard to the most critical decisions affecting their lives? Alito seems to assume it, but he does not explain it.

To illustrate the problem, consider living wills. Many citizens make living wills in order to participate in decisions regarding their end-of-life care, often to refuse medical interventions that will prolong their life without regard to the quality of that life. These life-and-death decisions certainly raise critical moral questions. But the idea that this justifies letting the state make those decisions for us is a dangerous notion, and one that is offensive in a modern democracy. Remember all of the Republican fuss about “death panels,” just because Obamacare originally offered to pay for end-of-life counseling?

Missing from Justice Alito’s attempt to supplant personal rights with states’ rights is any requirement that states justify their abortion laws by any legitimate public purpose. He does not claim that banning abortion benefits the nation in any particular way, such as maintaining a high birth rate. (Those democratic countries that have worried about low birth rates have more often promoted family life with paid parental leaves, subsidized child care, family allowances and so forth. In this country, on the other hand, the same “pro-family” politicians who support coerced childbearing often turn their back on families the moment a child is born.) In the absence of any practical argument for denying women the right to choose, Alito is left with the argument for following historical tradition and the argument for reserving critical moral questions to the state. The first argument discourages the courts from interpreting the Constitution in the light of modern experience. The second invites religious traditionalists to legislate their morality for everyone in their state. I think that few constitutional scholars will find these arguments sufficient.

I have always found it interesting that the political party most known for favoring liberty, small government and limited regulation is also the party most eager to legislate sexual and reproductive morality. In my next post, I will discuss the political processes by which the anti-Roe minority in this country came to dominate the Republican Party and capture the majority of seats on the Supreme Court.

Continued


Building Back Better—Economically

November 29, 2021

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Democrats and Republicans are even more divided over President Biden’s “Build Back Better” bill than they were over the infrastructure bill. When BBB passed the House last week, all Democrats except one supported it, while every Republican opposed it. House Speaker Nancy Pelosi called it “historic, transformative and larger than anything we have ever done before.” Minority Leader Kevin McCarthy called it “the single most reckless and irresponsible spending bill in our nation’s history.” The bill now goes to the Senate, where it will need the support of every Democratic senator to pass.

The benefits

Of the concerns about the bill I have heard, far more raise doubts about whether the country can afford it than about the substance of the proposals. Most of the specific provisions are popular with the general public, although we do hear some of the usual complaints about Big Government “taking over” health care or child care or whatever. Here are the bill’s main components:

Universal preschool: The bill would subsidize preschool and child care programs for three- and four-year-old children. Any public or private program could qualify if it met federal standards. The cost to families earning less than 2.5 times a state’s median income would be no more than 7% of their personal income, much less than many families are paying today.

Child tax credit: The bill extends the child tax credit for another year. It also makes it permanently refundable for low-income families, which means that they can continue receiving it even if they have no tax liability.

Family and medical leave: The bill would provide four weeks of paid leave to be used for caregiving or personal illness. The pay would be up to 90% of regular pay, with higher percentages for lower earners than higher earners.

Expanded ACA funding: The bill increases the subsidies for those who obtain health insurance through the Affordable Care Act. It also provides coverage for the low-income people who were previously excluded by their state’s refusal to participate in the expansion of Medicaid.

Expanded home care: The bill provides additional funding for Medicaid’s home health care program, in order to alleviate a backlog of applicants who qualify but are on waiting lists.

Drug price control: The bill would allow Medicare to negotiate lower prescription drug prices, but only for drugs that have been on the market for at least nine years. It also sets a new $2,000 limit for out-of-pocket expenses under Medicare Part D and caps the price of insulin at $35 a month.

Affordable housing: The bill will contribute to the construction and preservation of low-cost housing units, and also provide assistance with down payments and rent.

Clean energy: The bill authorizes grants, loans and tax credits to encourage businesses and consumers to develop and use clean energy, such as wind turbines, solar panels and electric vehicles. It also funds a Civilian Climate Corps to create 300,000 jobs in environmental protection and restoration.

Costs and revenues

The Build Back Better bill would pay for these new or expanded programs mainly by imposing new taxes and improving the enforcement of existing tax law. For personal income taxes, it would place a 5% tax surcharge on income above $10 million, as well as an additional 3% surcharge on income above $25 million. For corporate taxes, it would set a minimum tax of 15% on companies with over $1 billion in profits, aimed especially at corporations that have been managing to avoid paying any taxes at all. It would also place a 1% tax on corporate stock buybacks, a response to concerns that companies were using their 2017 tax cut to boost stock prices for shareholders instead of investing in economic growth.

The bill provides funding for stricter tax enforcement, to recover hundreds of billions of taxes lost to tax evasion. IRS audits have dropped substantially due to Republican budget cuts, a “penny-wise and pound-foolish” exercise if there ever was one.

A “scoring” of the bill by the Congressional Budget Office concluded that tax revenue would pay for about 85% of the bill’s $1.75 trillion cost over ten years. The White House was aiming for 100%, with the discrepancy due mainly to uncertainty about the increased revenue from stricter tax enforcement. Any shortfall would add to the annual budget deficits.

Although the CBO evaluated the budgetary impact over a ten-year period, as is customary, many parts of the bill call only for temporary funding for proposed programs. Universal preschool is funded only for six years, and increased ACA subsidies only for four years. If Congress were to continue these programs through the full ten years, it would either have to impose new taxes or accept larger deficits than currently projected.

Concerns about the bill focus mainly on the question of fiscal responsibility. Conservative politicians and some economists worry that it calls for too much taxing, too much borrowing, and/or too much spending. Let’s consider each of these in turn.

Too much taxing?

Most voters support raising taxes on the rich. Americans with the highest incomes and accumulated wealth have been the main beneficiaries of economic trends and public policies over the past 40 years. Corporate profits and executive compensation have risen faster than general wages. Top-bracket income tax rates have been cut, along with estate taxes and capital gains taxes. Corporate tax cuts have mainly benefited corporate shareholders, and the richest 10% of households hold about 90% of the corporate stock. Since 1990, the share of the national wealth held by the richest 10% has increased from 60% to 70%, as the U.S. has become one of most unequal countries in the developed world.

The tax code is mildly progressive, in that the wealthy pay a somewhat higher rate of tax when all taxes are considered. But the superrich pay a lower-than-average rate because they are very good at taking advantage of loopholes (which is legal) and opportunities for tax evasion (which is not). One study found that the 400 richest families paid only 8.2% in income taxes from 2010 to 2018. That’s a lower rate than a person earning only $10,000 a year has to pay.

Defenders of low taxes on the rich argue that they help the economy by leaving the rich with more money to invest. In Arguing with Zombies, Paul Krugman makes a case that tax cuts for the wealthy have been a “fizzle” because too much of the money has gone to boost the price of existing assets instead of financing new investment. The Keynesian view is that investment is driven more by aggregate demand, and that government spending stimulates the economy more than tax cuts. In any case, economic and public opinion seems to be turning against the Republican policy of generosity toward the rich and austerity for the rest of us.

Too much borrowing?

Whenever the government spends more than it collects in taxes, it runs a budget deficit. Stephanie Kelton’s The Deficit Myth is a good source for correcting common misconceptions about deficits, and it has informed my recent thinking on this topic.

When the government runs a deficit, it normally raises money by selling government obligations like treasury bonds. Although people often think of the resulting public debt as analogous to private debt, there are important differences. A private household or business that accumulates debt runs the risk of default—or even bankruptcy—should its income fall below expectations. A government with monetary sovereignty like the U.S. government need never default on an obligation or go bankrupt, since it has the authority to issue currency and collect it in taxes. Also, U.S. bonds are in great demand because of their security, and people will buy them even when they pay low rates of interest. The government does not have to pay off its debt, but can continue rolling it over from lender to lender indefinitely if it chooses to. The national debt is a public sector liability on which the government pays interest, but it is also a private sector asset on which bondholders earn interest.

According to neoclassical thinking, government borrowing can “crowd out” private investment by competing with businesses for a limited supply of savings. Government borrowing adds to the demand for “loanable funds,” pushing up interest rates (the price of money) and making it more costly for businesses to finance investment. Keynesians counter this argument mainly by focusing on the situation where the economy is running below full capacity. Then deficit spending can boost national output and income, which also increases the savings from which government can borrow. As Krugman and Wells explain:

When the economy is at far less than full employment, a fiscal expansion will lead to higher incomes, which in turn leads to increased savings at any given interest rate. This larger pool of savings allows the government to borrow without driving up interest rates. The Recovery Act of 2009 was a case in point: despite high levels of government borrowing, U.S. interest rates stayed near historic lows.

Modern Monetary Theory adds the argument that any increase in the public-sector deficit must be balanced by an increase in the private-sector surplus, other things being equal. (The relevant other thing held constant here is the current account balance with our trading partners.) As the gap between government spending and tax revenue widens, so does the excess of private-sector income over spending, and that’s where the money to buy treasury bonds comes from. What makes that hard to see is that the connection is indirect, since the immediate recipients of the government spending are not usually the ones buying the bonds. A long chain of financial links may intervene, such as that government spending increases employment, which increases consumer income, which increases consumer spending, which increases business revenue, which increases business profit, which increases investor income, which provides extra savings with which to buy treasury bonds.

In this scenario, the government’s demand for loanable funds does not have to crowd out private investment. Instead, government spending increases the loanable funds. And interest rates do not have to rise, unless the Federal Reserve chooses to raise them in order to fight inflation.

Too much spending?

What keeps this constructive use of government borrowing and spending from becoming a definitive solution to economic problems is the threat of inflation. Economists generally agree that additional government spending becomes inflationary when the economy reaches its potential output, the point where it is producing as much as possible with the available resources and technologies. Then spending more than taxing drives up prices by creating too much demand for too few goods and services. Taxing the rich to spend on the nonrich—which is Biden’s main way of financing his plan—could have a similar effect, since it takes from those more likely to save in order to spend on those more likely to consume.

Although the idea of stimulating the economy with government spending has come back into fashion since the global financial crisis of 2007, economists still debate how often and how much to use it. Many accept a cyclical Keynesianism that supports a stimulus only when the economy is very weak and inflation is under control. From this perspective, the government may want to cycle between stimulus and austerity, engaging in more deficit spending in a contracting economy, but running a surplus and paying down debt to slow an “overheated” economy. (These fiscal fluctuations would be in addition to the Fed’s monetary policy of manipulating interest rates, which has become the most common way of influencing the economy.) But how does one tell whether an economy has reached its potential output? “Full employment” is a common answer, but how exactly is that defined?

Mainstream economists associate potential output not with zero unemployment, but with a “natural rate of unemployment” that includes some frictional and structural unemployment. Workers who are currently between jobs are classified as frictionally unemployed, while those who live in the wrong place or lack the skills employers want are classified as structurally unemployed. The argument is that during an economic expansion, the economy can reach a limit on real growth in output even when unemployment remains as high as 5 or 6 percent. Then further stimulus is inflationary, since it just increases what employers have to pay for qualified labor or what consumers have to pay for goods and services.

This line of reasoning is not without its critics. One problem is that potential output is a moving target, since it changes with increases in productivity. Estimates of the rate of natural unemployment also vary, and some economists reject the concept altogether. Modern Monetary Theory argues that we can employ as many workers as we are willing to train to do something useful, so the level of unemployment is mainly a matter of social policy.

Although Paul Krugman accepts the idea that stimulating the economy when it has reached potential output creates inflation, he warns against turning to austerity prematurely when the economy still has room for growth. This is the mistake many countries made in the aftermath of the global financial crisis, which made the recovery longer and harder that it needed to be. While the threat of inflation is always a concern, cutting government spending and raising interest rates at the first sign of inflation is a formula for subpar economic performance or even recession.

In the present situation, we can hardly say that the economy is already running at full capacity. Unemployment is below 5 percent, but that number leaves out many people who have yet to return to the labor force since the pandemic. Much of the current inflation seems to be due to temporary shortages of supply, not overstimulation of demand. Krugman compares the situation to 1947, when the postwar demand for consumer goods temporarily got out ahead of producers’ capacity to convert to peacetime production. Producers abhor empty shelves as much as nature abhors a vacuum (which is why the makers of Beanie Babies are chartering airplanes to bring them in from China, avoiding the bottleneck in container shipping). Inflation is not always a result of government spending, as critics of Big Government would like us to believe. Time will tell, but we can hope that inflation will subside even as government spending increases, if we spend wisely.

A deeper issue

A more fundamental question than where we are in the current business cycle is what we should be doing to address our structural problems, which I would describe more generally as mismatches between what markets supply and what today’s society actually needs.

Consider structural unemployment, when the labor market isn’t supplying enough workers with the qualifications that employers need. The orthodox perspective sees it as a pricing problem that arises because the supply of unskilled or poorly located workers exceeds the demand. The orthodox solution is to lower the price of such labor, on the assumption that anyone can get hired if they will work cheaply enough. Krugman and Wells’ macroeconomics text reflects that thinking when they say, “Until the mismatch is resolved through a big enough fall in wages of the surplus workers that induces retraining or relocation, there will be structural unemployment.” Trouble is, price rigidities in the labor market like minimum wage laws, unemployment compensation, and union contracts—and maybe just plain refusal of workers to work for peanuts—keep surplus workers from being hired. So we can’t really have full employment without inflation, and must settle for a “natural rate” of unemployment. But this argument assumes that if we removed the price rigidities, the unemployed could get what they needed to qualify themselves for today’s jobs.

A less orthodox macroeconomics text, by Mitchell, Wray and Watts, puts the responsibility for the mismatch on employers, saying that “the notion of structural unemployment arising from ‘skills mismatch’ can be understood as implying an unwillingness of firms to offer jobs, with attached training opportunities, to unemployed workers whom they deem to fall short of their ideal profile.” Employers prefer to “externalize” the costs of human capital development, expecting society to send them qualified workers from whom they can profit at low cost. But from the workers’ perspective, the goods and services market isn’t supplying enough education and training (and other human development services like affordable health care, drug treatment programs and mental health services) to enable them to become the kinds of workers employers want. The market is also failing to provide enough affordable child care and affordable housing in the cities where the jobs are. Under these market conditions, the idea that we must lower wages to force devalued workers to improve themselves is a cruel joke. Government, however, can use its spending power to increase economic demand for what society really needs.

The challenge of transitioning to cleaner energy is also a structural problem, a mismatch between what we produce and what we need. The current spike in energy prices is partly a result of temporary shortages, as energy producers resume production in the aftermath of the COVID recession. But it’s also a sign that the transition to cleaner energy is not going very well. Investments in fossil fuel production are falling faster than investments in renewable energy are rising. If the resulting inflation becomes an excuse not to spend on the transition, that would be seriously counterproductive. As The Economist editorialized recently:

The panic has…exposed deeper problems as the world shifts to a cleaner energy system, including inadequate investment in renewables and some transition fossil fuels, rising geopolitical risks [especially global dependency on energy-producing countries with autocratic regimes] and flimsy safety buffers in power markets. Without rapid reforms there will be more energy crises and, perhaps, a popular revolt against climate policies.”

Government spending doesn’t just have cyclical consequences—a stimulus when an economy is slumping and possible over-stimulus and inflation when it reaches potential output. It also has structural consequences, since it can create more potential by developing human and natural resources. This is consistent with Stephanie Kelton’s conception of Modern Monetary Theory: “MMT is about identifying the untapped potential in our economy, what we call our fiscal space.” Think of the fiscal space as the room to grow before we reach the limit of our economic potential. If we can produce more with a well qualified labor force and new forms of energy, we can also spend more without inflation. We practice a false economy if we refuse to consider the spending that would develop the potential.

When the House Budget Committee passed the Biden plan, it issued a statement, “The Build Back Better Act: Transformative Investments in America’s Families & Economy.” The statement included these claims about the economics of the plan:

The Build Back Better Act makes essential investments in family care, health care, and combatting climate crisis. It will overhaul and reimagine sectors of our economy and society so that everyone – not just those at the top – benefit from a growing economy. The Build Back Better Act will implement key reforms to make our tax system more equitable. This plan is prudently paid for by ensuring the wealthiest Americans and most profitable corporations pay their fair share of taxes. Americans making less than $400,000 a year will not see their taxes increase by a penny. Additionally, it is estimated that the Build Back Better Act will ease longer-term inflationary pressures and stimulate future economic growth, further offsetting the cost of the plan.

Building Back Better is not just about getting back to the phase of the business cycle that preceded the COVID recession. It’s about using the democratic process—what’s left of it—to assert what people need, and using government spending to help make it happen. If that entails a wiser use of our human and natural resources, it can be economical in the best sense of the term.


Bipartisanship Lives—Barely

November 8, 2021

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Congress has now passed the so-called “bipartisan” infrastructure bill proposed by President Biden. This is the physical infrastructure bill, not to be confused with the “Build Back Better” bill containing proposals to help working families, such as funding for preschool and paid parental leave. This bill includes money for a wide range of infrastructure projects: roads and bridges, public transit, passenger and freight railways, airports and ports, electric vehicles, universal broadband access, electric grid modernization and environmental remediation.

How bipartisan was the support, really? When the bill came to a vote in the Senate, 19 Republicans joined all 50 Democrats to pass it. However, that was only after Republicans had united to block consideration of the original bill by filibustering it. The result was a smaller bill, not funded by tax increases. In the House of Representatives, Democrats supported the bill 215 to 6. They needed 3 Republican votes to put it over the top, and they got 13. The other 200 Republicans voted against it.

Combining the two houses of Congress, 98% of Democrats (265 of 271) voted yes, while 88% of Republicans (230 of 262) voted no. If this is bipartisanship, it is a bipartisanship of a very minimal kind. Fortunately, it was enough to get something done—this time.

The physical infrastructure bill has solid majority support among the public, although with a noticeable partisan divide, and most economists think it will be good for the economy. Why then would such a large percentage of Republican politicians oppose it?

Republicans routinely oppose tax increases, so their opposition to Biden’s original spending proposals is understandable. (Most of the public, however, now supports raising taxes on the wealthy.) What is interesting is how few Republicans changed their minds even when Democrats proposed to fund the bill by other means, especially repurposing money left over from various pandemic relief programs. Many were concerned that the Congressional Budget Office still found that the bill would add to the budget deficit. But that explanation doesn’t hold much water, considering how happy Republicans were to put their deficit concerns aside when they wanted to cut personal and corporate income taxes. The idea that tax cuts are good, while spending increases are bad is not very good economics. Economist Paul Krugman has accused Republicans of perpetuating “zombie” ideas “that should have been killed by contrary evidence, but instead keep shambling along, eating people’s brains.” Some forms of deficit spending are actually good, especially when the economy is recovering from a recession. Economists do agree that excessive deficits can be inflationary, but infrastructure spending is less dangerous in that respect, since it adds to the nation’s productive capacity as well as its income and aggregate demand. It is exactly the kind of targeted spending that economists like Minsky have recommended, since it can stimulate both the supply side and demand side of the economy.

I don’t think that the Republican opposition to infrastructure spending has much to do with economics at all. What it reveals is that Republicans are more interested in making this administration fail than in addressing pressing national needs. They can’t wait to blame Biden for his failure to deliver the bipartisanship he promised, so they can return to power and get on with their project of one-party rule. Democrats can be frustrating too, as when they delayed the infrastructure bill because they hoped to tie it to other legislation that had even less Republican support. But at least they now have a coherent economic agenda, with proposals that are generally popular and economically useful.

I wish I could see the infrastructure bill as a new beginning for bipartisanship. Instead, it may represent the end of bipartisanship for this Congress and this administration. If Republicans cannot get behind a no-brainer like infrastructure repair—which President Trump advocated but didn’t accomplish—what chance do any other progressive proposals have? I do not expect Republican cooperation with even the most reasonable and popular of President Biden’s initiatives, such as allowing Medicare to negotiate lower prescription drug prices, or joining the rest of the developed world in providing paid family leave. Some bills could squeak through if Democrats can get around the filibuster with the tricky budget reconciliation procedure. Most will probably require more Democrat success at the ballot box.