Modern Monetary Theory: The World’s Biggest Bullshit Sandwich (Part 3)

I was very lucky to get my first commenter on The Econ Rave. EVER. A shout out to Bentham’s Newsletter (check him out), who made an extremely erudite comment on the first article in this series:

“It just seems straightforward that money buys things. You can’t buy more stuff than exists, so printing new money can’t increase genuine prosperity.”

It's a shame he writes about philosophy. He’d have been an excellent economics writer. In fact, his comment reminded me of an observation made by one of my favourite economists, Vincent Geloso: 

“If a central bank puts more money in circulation, the inherent productivity of economic agents is unchanged. If productivity is unchanged, inflation is only reflecting the greater abundance of money” 

In other words, monetary expansions induce inflation by ramping up consumer spending, while doing nothing to enable the supply-side economy to readjust by increasing the availability of goods and services…….or do they?

An MMT-er would object to Mr Newsletter and Geloso with perhaps the strongest argument they could make to half support their theory. Recall the equation from the last post:

MV = PY

Assuming ‘V’ remains constant, let’s say an increase in M takes place. Two things could happen: either P could rise, or Y could (more realistically, of course, a combination). With access to the vast amounts of liquidity which monetary looseness may provide, said the MMT-er whose piece I focused on in the last article, entrepreneurs can make investments which raise economic output instead of boosting prices. In other words, says any reasonable Keynesian, expansionary monetary policy does raise output. And this conclusion is absolutely correct. But two things absolutely need to be said specifically to an MMT-er who adopts this argument.

Under an MMT regime, even if there was a rise in output, that would also be accompanied by significant inflation. This is the case, I think, and an honest MMT-er would admit so. Recall the first article in this series? No. Well that’s because you didn’t read it. Do that now. And subscribe. Anyway, we went through the MMT proposition that inflation is basically only ever down to resource constraints? Well, monetary-driven growth of this kind would instigate those very problems. This would happen for a fundamental reason:

Our institutional framework already constraints the supply of certain services, meaning ‘resource constraints’ would be hit pretty quickly in any money-binge. A perfect example is housing. Extensive empirical literature has demonstrated that zoning regulations, the product of NIMBYism, reduce the availability of housing, and have a fundamental driver of home price inflation. Thus, MMT money bingeing would do nothing to correct the fundamental supply inelasticity of housing, and home price inflation would intensity hugely due to excess demand. The already existing supply inelasticity would produce the confidence among investors for mass speculation on properties, intensifying real estate inflation even more. Sure, we could repeal those regulations. But I fear that’ll never happen anyway, because in the US particularly, they are enforced by a large nexus of state, local and municipal governments, virtually immune from aggressive federal diktats. 

Besides, money-driven growth often fails to lead to long-term, sustained increases in output. This is something economists like Hayek knew well: in lowering interest rates by growing the supply of money, the cost of credit is thus artificially suppressed. Cheaper credit therefore amplifies the opportunity cost of not investing in longer-term ventures. This leads to a surge of investment in those very ventures, perpetuating a long-term speculative bubble which, whether you like it or not, will eventually pop. This is because there is only so much time before speculators anticipate (rightly or wrongly) that the return on assets will begin to drop. This causes those very speculators to begin withholding investments, so that the goods (typically property) being speculated on experience less inflation. This amplifies investors’ fears of eventual collapse, so even more of them begin withdrawing from the market. And before you know it, the speculative bubble has popped.

This is essentially the story of the Great Depression. Throughout the 1920s, the Federal Reserve made a conscious effort to suppress the cost of credit through reducing fractional reserves on timed deposits and repeatedly slashing interest rates, fuelling an enormous bubble both in property and the stock market. All this collapsed in 1929, and the rest is history. 

An MMT-er could retort that their desired government wouldn’t just be utilising monetary policy to support growth - it goes all the way back to the first article. An MMT government incurs vast amounts of debt to fund fiscal ventures: like the jobs guarantee, massive infrastructure spending, whatever, whatever. But even if unintentionally, this would lead to a vast expansion in the quantity of money, for the reasons discussed in the first article (to repeat briefly, investors aren’t entirely just worthy of even a fiat currency’s invincibility, meaning debt monetization would eventually become necessary to pay off bondholders/domestic banks), and hence the economic malinvestment described would ensue. 

That begs the question, though, what does fuel economic growth? This is screaming to be given its own future post, but all I’ll say here is that it certainly isn’t money growth. Expansionary monetary policy is a very efficient way to raise aggregate demand in hard times, but is not what we need for long-run development. Recall Geloso’s earlier statement - money growth does nothing to alter the inherent productivity of economic agents - and without higher productivity, there are no structural changes to enable higher economic growth.