My Final Attempt

I have spent a few years trying to reconcile heterodox and orthodox views on fiscal policy. Here is my final attempt. In the wake of the dishonest IGM survey on MMT, I am not optimistic that there is common ground to be had. However, I would like the record to reflect that I was willing to debate in good faith. 

First, MMT or related schools of thought do not claim that the government can spend an unlimited amount in real terms.  A real resource constraint exists. A large increase in nominal spending will put significant inflationary pressure on the economy is the output gap is small. A real resource constraint exists. 

We shouldn't pay for a Green New Deal or Medicare for All with MMT, or a printing press. Or at least doing so would create lots of inflation, and if it didn't, it would mean some big exogenous shock pushed output well below potential. (That is, something really bad happened to the US economy.) I sincerely hope we never get to a point where the economy is in such dire straits that we could increase deficits by trillions of dollars a year without sparking inflation by pushing the economy beyond its a capacity. Again, real resource constraint. 

Nothing so far ought to be controversial. And for most orthodox economists, it isn't. However, unlike heterodox economists, the mainstream establishes a second target for economic policy, namely, debt sustainability. Here it is important to note that the definition of debt sustainability that has been widely accepted has changed over time. Classical economics asserts that there is a strict solvency constraint. 

Future taxes > Future Debt + Future Spending 

Under this condition, future surpluses must offset all debt. Note that this is a much stricter constraint than the currently accepted debt-to-GDP boundedness constraint. As I have pointed out earlier, the latter rule implies that large amounts of debt and interest can be refinanced indefinitely so long as interest rates are low, or growth is high. This greatly raises the fiscal capacity of the government. 

So the fiscal rule you choose for your definition of debt sustainability has tremendous implications for fiscal policy. At its core, MMT and other chartalist schools simply further relax the government's budget constraint.  Specifically, it asserts that some path of government spending and taxing will deliver full employment and price stability, but that this path isn't subject to any financial constraint for governments that borrow in their own currencies. 

Governments should not spend unlimited amounts in nominal terms just because no financial constraint exists for monetarily sovereign governments. At the same time, we shouldn't be worried about achieving some arbitrary condition for budget sustainability. The focus must be on macro outcomes like employment and price stability. In practice, we shouldn't hesitate to spend whatever it takes to combat a recession. Again, I truly hope that there is never so much turmoil in the world economy that we need to run 20 percent of GDP deficits for several years. But make no mistake, if such a shock hit the economy the government could and should act. 

Finally, I would like to address the issue of interest on the debt. Some may argue that excessive debt levels may leave future policy makers with little room to manuover even if no technical financial constraint exists. If the price level is determined by the deficit, high interest costs might force future generations to cut primary spending in order to keep the deficit contained so as not to stoke inflation. I have two arguments against this thoughtful line of reasoning. 

First, the nominal interest rate on the national debt is a policy variable. At high levels of debt, changes in the interest rate, and not primary spending, largely determines the deficit. Therefore, central banks can ironically stave off inflation by cutting interest rates to stabilize the debt/deficit. Second, primary spending moves real resources from the private to the public sector. Interest payments do not. Thus, paying interest does not directly raise the cost of labor or capital, unlike primary spending. (Effectively, primary spending imposes a pecuniary externality on the private sector by bidding up the price of labor and goods.) Furthermore, the revealed preferences of bond holders are to save and not consume. It stands to reason that a much larger portion of the income earned from interest on the public debt is saved relative to income earned by government workers and vendors. Interest spending is therefore much less inflationary. And even if it becomes a problem, our central bank can fix it. 

The stakes are huge. Fear mongering about the national debt watered down stimulus in the depths of the Great Recession.  Republicans' recent embrace of deficits is hypocritical given the damage they did to the economy in the early part of the decade. However, persistently low inflation has signaled that the economy has room to run. The recent fiscal push has helped heal lingering wounds of the economy and the labor market. Yes, we'll need more taxes to enact single payer health-care or to fund parts of the Green New Deal. No, we can't run unlimited deficits if we care about price stability. But we shouldn't let unfounded fears of debt or deficits to prevent us from creating an economy that works for everybody.