What’s wrong with MMT?

As Marc Lavoie and John Quiggin have noted, there are ‘two MMTs’. Scholars such as Randy Wray, Eric Tymoigne and Scott Fulwiler have contributed to debates on monetary economics, institutional structure and fiscal policy. I disagree with much of what they claim, but have also learned a lot from them.

In contrast, pop MMT is disseminated through non-academic books, blogs and YouTube channels. It crops up endlessly on social media, and like AI slop, increasingly pollutes discussion and impedes debate.

In criticising pop MMT, some accuse me of elitism and condescension towards people who are trying, without academic training, to get to grips with difficult material. I am sympathetic. Media coverage of economics is shockingly bad. It is little wonder that people turn to ‘relatable’ content on YouTube. And the influence of pop MMT hasn’t been all bad: it has provided useful pushback against silly discussions of fiscal policy which fail to distinguish between government and household budgets, assume that taxation must mechanically match spending, and unthinkingly treat public borrowing as harmful.

But pop MMT is increasingly unhelpful. It twists concepts, relies on slogans and semantic tricks, and ultimately contributes to miseducation. In response to complaints about pop MMT, I’m often asked for something accessible that explains the errors.

The readership for this will be relatively limited. For those already unconvinced (or enraged) by pop MMT, I won’t add much. To the devout, I will only demonstrate, once again, my ignorance and intellectual dishonesty; I can only apologise in advance in the hope of limiting the flow of correspondence. This is for the few who are in neither camp: the lay reader who has come across pop MMT, finds the arguments intriguing, but would like to consider the counter-arguments.

Mostly correct?

A lot of MMT, including pop MMT, is straightforwardly correct. Oddly enough, this makes it harder to criticise the parts that are wrong. Proponents are keen to present MMT as a radical new theory which fundamentally changes our understanding of economics and presents a radical break with ‘neoclassical’, ‘neoliberal’, or ‘mainstream’ economics (these terms are used interchangeably without much care for accuracy). In reality, much of MMT is neither new nor wrong: it’s just pretty standard economic theory presented in different language. Proponents are unwilling to acknowledge this.

The central claim of pop MMT is that the government cannot run out of money. Once the consequences are recognised, we are told, this changes everything.

The reality is less exciting. It is true, in a narrow sense, that a government like the UK cannot run out of money, because the Bank of England, a public institution, issues money. However, this changes precisely nothing because it is already well understood by economists (although perhaps not by politicians). Pop MMT proponents often proceed on the basis that economists don’t realise that the central bank issues the currency or, in their preferred, more imprecise, description, that the ‘government creates money’.

There are problems with how conventional economics deals with monetary issues. Nonetheless, the fact that the central bank issues money has been recognised and incorporated into economic theory for at least a hundred years. The disagreement with MMT arises not over whether the government can compel the central bank to finance its spending, but to what extent the government should do this.

The pop MMT obsession with the money-issuing capacity of the public sector leads to an important confusion. While proponents claim to focus on real resource constraints, the opposite is the case: all of the focus is placed on the narrow question, ‘where does the money come from?’. Instead of considering the complex combination of factors that go into determining spending, taxation, borrowing and interest rate setting—production, distribution, employment, inflation, credit, debt, and so on—pop MMT regards the question of provisioning government as nothing more than finding the means of payment. Once one recognises that the government has a printing press, paying for government spending becomes a triviality.

The pop MMT semantic trick

Conflation of ‘means of payment’ with ‘means of provisioning’ is the basis of a semantic trick at the heart of pop MMT. It can be illustrated with an example:

Cats make good house pets. Tigers are cats. Therefore tigers make good house pets.

This is a classic argument structure: there are two premises and a conclusion. Both premises appear to be true and the conclusion follows logically from the premises. However, the conclusion is false. What’s going on?

The fallacy arises from the ambiguity of the word ‘cat’: the word is used with two different meanings. In the first statement, ‘cat’ means ‘the species of small domesticated creatures’. In the second it refers to the larger category of ‘mammals in the family Felidae’. Replace each use of the word ‘cat’ with the appropriate expanded meaning, and the flaw in the argument becomes apparent.

The same fallacy is committed in the following statement:

The central bank issues money. Therefore government spending is not dependent on taxpayers’ money.

The word ‘money’ means two very different things in this argument. The premise refers to the narrow sense of ‘the medium used to make payment’. In the conclusion, ‘taxpayers’ money’ has a broader meaning encompassing issues relating to employment, inflation and more: the reason that taxes are imposed is not to obtain banknotes for the government but for broader economic reasons. Pop MMT partially acknowledges this with the slogan ‘taxes control inflation’ but then obfuscates it by conflating taxes with means of payment.

Consider another example. When I go to the supermarket, I pay for my children’s food using a debit card. It is also the case that I pay for food with my wages: by going to work, I earn money to buy food. Taking it a step further, my labour pays for my children’s food.

These statements—’I pay for food with my debit card’ and ‘I pay for food with my labour’—are separately true. However the argument ‘I pay for food with a debit card, therefore I don’t need to go to work’ is nonsense.

The whole of pop MMT, and the slogans it deploys, rest on this fallacy: by conflating the immediate means of payment with broader economic and political issues, pop MMT brushes aside difficult issues of political economy. One of the silliest pop MMT slogans, ‘money doesn’t grow on rich people’, relies on this fallacy to argue against taxing the wealthy.

While economists understand that central banks issue money, this is not the case for the media and politicians: much debate is conducted on the implicit basis that taxation must mechanically match spending, pound for pound. This is incoherent and dangerous. As already noted, the standard of public debate on these issues is atrocious. But the determination of pop MMT to conflate the idiocy of political and media discussion with the views of all economists who don’t sign up to MMT is profoundly unhelpful.

The deceptions of pop MMT go beyond this fallacy. The claim that MMT is ‘just a description’ of how monetary economies work is straightforwardly untrue. Complex legal and institutional barriers prevent central banks from financing government spending directly. In claiming that central banks currently do finance government spending, pop MMT conflates description with prescription: rather than a description of how things currently work, ‘governments create money when they spend’ is a proposal for how the system should work, according to pop MMT. The normative question of whether governments should routinely rely on central bank financing should be kept separate from supposedly descriptive statements about how current institutional structures operate. I’ll return to that question in a subsequent post.

Hunt versus headroom

Rob Calvert Jump and Jo Michell

Just over a year ago, ahead of Jeremy Hunt’s first Autumn Statement, we published a report on how UK public finances are managed and discussed. At the time, the media was awash with claims of a ‘black hole’ in the public finances. We pointed out that this was incoherent because the so-called black hole was nothing more than the difference between an arbitrary fiscal rule and an uncertain forecast.

We also pointed out that forecasts of public debt are highly sensitive to the assumed path of variables such as nominal GDP growth. The latest Autumn Statement and its accompanying OBR projections provide a case in point.

In the run up to the Statement, the media focus had switched from black holes to ‘fiscal headroom‘. This was reported to be around £20bn, and is a measure of the size of the fall in the public debt in the fifth year of the OBR’s forecast – a ‘black hole’ with the sign reversed.

The figure below shows the last three forecasts of public debt from the OBR, along with the historical data published at the time of the forecast. Since the Autumn Statement a year ago, the level of public debt in the final year of the forecasts has fallen from 97.3% of GDP in the November 2022 forecast, to 92.8% of GDP in the most recent one. This forecast revision amounts to nearly £150bn of 2028-29 GDP.

Is this £150bn improvement in the forecast the result of policy actions taken by the government? And if so, why is all the talk of £20bn of headroom, rather than £150bn? The answer to the first question is a firm ‘no’. These shifts in the forecast have nothing to do with policy, and are driven entirely by data revisions and changes in the OBR’s macroeconomic forecasts.

Recent revisions to GDP have shown a stronger recovery from the pandemic than previously thought, alongside higher than expected inflation. As a result, nominal GDP is substantially higher than it was a year ago, and so the debt to GDP ratio is lower.

In the space of a year, data revisions and revised expectations about inflation have, therefore, swamped any change in the debt level driven by policy. Shifts in the positions of the series are far greater than the marginal change between the final two data points – the so-called ‘headroom’ which receives so much attention.

What about the second question? Why are we not talking about £150bn of headroom? The answer to this is unclear, but it is probably the case that the Chancellor of the Exchequer is not actively considering every possible trajectory for the public debt that satisfies his fiscal rules. If he did so, he could substantially increase public spending in a manner that would leave debt falling, as a percentage of GDP, by the end of the OBR’s forecast period.

Consider, for example, the OBR’s November 2023 forecasts for the main fiscal aggregates, displayed in the table below. Public sector net debt, as a percentage of GDP, falls from 93.2% in 2027-28 to 92.8% in 2028-29. Public sector net borrowing is less than 3% of GDP in 2028-29. As a result, the government’s two fiscal targets are met.

year	gdp	gdp_centred	psnd	psnb	gilt_rate	psnd_pct	psnb_pct
2022-23	2552	2650	2251	128.3	3.13	84.94	5.03
2023-24	2726	2761	2458	123.9	4.5	89.03	4.55
2024-25	2798	2841	2603	84.6	4.52	91.62	3.02
2025-26	2887	2938	2724	76.8	4.55	92.72	2.66
2026-27	2995	3051	2845	68.4	4.62	93.25	2.28
2027-28	3106	3162	2947	49.1	4.74	93.2	1.58
2028-29	3218	3274	3039	35.0	4.88	92.82	1.09

OBR forecasts in the November 2023 Economic and Fiscal Outlook.

Now, consider a counterfactual increase in public investment, by £10bn in 2024-25, £15bn in 2025-26, £20bn in 2026-27, £28bn in 2027-28, and then £10bn in 2028-29. This looks something like the Labour Party’s proposed green new deal, in which annual public investment would increase to £28bn over a single parliament. For simplicity we assume multipliers of zero and no impact on inflation, so that nominal GDP is unchanged from the OBR forecasts.

How would this affect public sector borrowing? In 2024-25, it would increase (relative to the OBR’s baseline forecast in table 1) by £10bn. In 2025-26 it would increase by £15bn plus interest payments on the previous year’s £10bn. In 2026-27 it would increase by a further £20bn, plus interest payments on the previous two years’ borrowing, and so on. The resulting time paths for borrowing and debt are displayed in table 2, below.

year	gdp	gdp_centred	psnd	psnb	gilt_rate	psnd_pct	psnb_pct
2022-23	2552	2650	2251	128.3	3.13	84.94	5.03
2023-24	2726	2761	2458	123.9	4.5	89.03	4.55
2024-25	2798	2841	2613	94.6	4.52	91.97	3.38
2025-26	2887	2938	2749.46	92.26	4.55	93.58	3.2
2026-27	2995	3051	2891.63	89.58	4.62	94.78	2.99
2027-28	3106	3162	3023.84	79.31	4.74	95.63	2.55
2028-29	3218	3274	3129.59	48.75	4.88	95.59	1.51

Counterfactual government spending path based on OBR forecasts.

Public sector net debt, as a percentage of GDP, now peaks at a higher level: 95.63% rather than 93.25%. But it is still falling between 2027-28 and 2028-29, and public sector net borrowing is still less than 3% of GDP in 2028-29. As a result, the government’s fiscal targets are still met.

This counterfactual trajectory of debt-to-GDP, alongside the OBR’s recent forecasts are plotted in the figure below. Our counterfactual trajectory is not dissimilar to the OBR’s forecast from March 2023. The end of forecast debt/GDP is around two percentage points of GDP lower than in the November 22 forecast, in which Hunt had defeated the black hole and met his fiscal rules. Given that this was regarded as a success only a year ago, on what basis could our counterfactual trajectory be rejected?

It is clear that ‘headroom’ as reported in the media is not simply a measure of the amount of money that the Chancellor could spend without breaching his fiscal rules. In fact, given its complicated nature, there is no single number that summarises the amount of extra spending consistent with a headline fiscal rule defined by the rate of change of debt-to-GDP at a future point in time. It depends on the distribution of extra spending over the forecast period, as well as the time path of interest rates.

Moreover – and this is, perhaps, more important – it depends on the volatility of the forecasts themselves. The difficulties involved in forecasting economic and fiscal aggregates over a five year horizon is illustrated by pre-budget forecasting exercises published by the Institute of Fiscal Studies and the Resolution Foundation. Their estimates of public debt as a share of GDP at the end of the forecast period differ by nearly 10 percentage points – over £300bn. Minor adjustments to the assumptions that generate these forecasts lead to outcomes an order of magnitude greater than the ‘headroom’ which attracts so much attention.

This is not a rational basis on which to conduct the planning of long-term spending and taxation. It is clear that Hunt’s budget is an exercise in gaming the system. Current nominal tax cuts are ‘paid for’ by creating ‘headroom’ which results from imprecisely specified cuts to government spending towards the end of the forecast period. Moreover, the widely-quoted ‘headroom’ figures have no correspondence whatsoever to the amount of extra money the Chancellor could spend while meeting his rules, and any policy effects are swamped by revisions to the data and forecasts.

As Paul Johnson, head of the Institute for Fiscal studies says, “Aiming for debt to fall in a particular year is not a good fiscal rule”. Simon Wren-Lewis puts it even more bluntly: “falling debt to GDP is a silly rule”.

Happy Christmas from the Office of Budget Responsibility

Image reproduced from here

The sectoral balances approach to economic forecasting has come under scrutiny recently. It is certainly the case that when used carelessly, projections based on accounting identities have the potential to be either meaningless or misleading. This will be the case if accounting identities are mistakenly taken to imply causal relationships, if projections are presented without a clear statement of the assumptions about what drives the system or if changes taking place in ‘invisible’ variables such as the rate of growth of GDP are not identified (balances are usually presented as percentages of GDP).

Used with care, however (or luck, depending on your perspective), the approach is not without its merits – as I have argued previously. If nothing else, the impossibility of escaping from the fact that in a closed system lending must equal borrowing imposes logical restrictions on the projections that can be made about the future paths of borrowing in a ‘closed’ macroeconomic system.

Which brings us to the Chancellor’s Autumn Statement and the OBR’s rather helpful projections. As Duncan Weldon notes, the OBR are likely to receive a rather warmly written card from the Chancellor’s office this Christmas. While true that the OBR have, in the past, been less than helpful to the Chancellor, one can’t help but wonder about the justification for announcing the OBR projections at the same time as the Chancellors’ statements. Why are the OBR projections not made known to the public at the same time that they are made available to the Chancellor?

But back to sectoral balances. The model used by the OBR produces projections which comply with sectoral balance accounting identities. Four are used: those of the public sector, the household sector, the corporate sector and the rest of the world. The most closely watched is of course the public sector balance. The headline result of the OBR forecasts is that the public sector will run a surplus by 2019. What has so far received less attention (at least since Frances Coppola examined the projections from the March 2015 OBR forecasts) is the implication of this for the other three balances. The most recent OBR projections are shown below.

Since the government is projected to run a small surplus from mid-2019, the other three sectors must collectively run a deficit of equal size. The OBR projects that the current account deficit will fall from its current level of around five per cent of GDP to around two per cent of GDP. The UK private sector must be in deficit. Interesting details lie in both the distribution of this deficit between the household and corporate sectors, and in the changes in figures since the last OBR reports in March and July.

In order to show how the numbers have changed since the previous forecasts, I have collected the data series from all three releases into individual charts.

The OBR series from these three releases for the public sector financial balance are shown below. Other than postponing the date at which the government achieves a surplus (and some revisions to the historical data) there is little difference between the three releases.

Changes to the projections for the current account deficit are more significant. The latest projections include improvements in the projected deficit of between 0.5% and 1% of GDP, compared with the July predictions. With the current account deficit at record levels in excess of 5% of GDP, I think it is fair to say the projections look optimistic. I note that in each of the three OBR series, the deficit starts to close in the first projected quarter. Put another way, the inflection point has been postponed three times out of three.

Things start to get interesting when we turn to the corporate sector. Here the projections have changed rather more significantly. Whereas the previous two data series showed the corporate sector reversing its decade-long surplus in 2014 and finally returning to where many think the corporate sector should be – borrowing to invest – the new series contains significant revisions to the historical data. As it turns out, the corporate sector has remained in surplus, lending one per cent of GDP in Q2 2015. The corporate sector is not now projected to return to deficit until Q3 2018.

Since the net financial balance for any sector is the difference between ex post saving – profits in the case of the corporate sector – and investment, these revisions imply either falling corporate investment, rising profits, or both.

The data series for corporate investment are shown below. The historical data have been revised down significantly. Investment in Q2 2015 is 1% of GDP lower than previously recorded. (This is hard to square with Osborne’s statement that ‘business investment has grown more than twice as fast as consumption’.) The reduction compared to previous forecasts widens in the projection out to 2020. Nonetheless, it is hard to escape the conclusion that the projections are extremely optimistic. By 2020, business investment is expected to reach twelve per cent of GDP, higher than any year back to 1980.

What of business profits? These are shown in the table below, taken from the OBR report. It seems that corporate profit grew at 10% year-on-year in 2014-15, despite GDP growth of around 2.5%. While projected growth rates decline, corporate profit is expected to grow at over 4% annually in every year of the projection out to 2021 (in a context of steady 2.5% GDP growth). There is not much sign of Goodhart–Nangle in these projections.

So, to recap: by 2020 we have government running a surplus just under 1% of GDP, a current account deficit of 2% of GDP and a corporate sector deficit around 1% of GDP. Those with a facility for mental arithmetic will have already arrived at the punchline – the household sector will be running a deficit of around 2% of GDP. In fact, given data revisions, the household sector appears to be already running a deficit close to 2% of GDP – a deficit which is projected to remain until 2021 (see figure below).

As a comparison, note that in the period preceding the 2008 crisis, the household sector ran a deficit of not much over 1% of GDP, and for a shorter period than currently projected.

The OBR has this to say on its projections:

Recent data revisions have increased the size of the household deficit in 2014 and we expect little change in the household net position over the forecast period, with gradual increases in household saving offset by ongoing growth of household investment. Available historical data suggest that this persistent and relatively large household deficit would be unprecedented. This may be consistent with the unprecedented scale of the ongoing fiscal consolidation and market expectations for monetary policy to remain extremely accommodative over the next five years, but it also illustrates how the adjustment to fiscal consolidation assumed in our central forecast is subject to considerable uncertainty. (p. 81)

Perhaps there is something to the sectoral balances approach approach after all. One can only wonder what Godley would make of all this.

Jo Michell

Corbyn and the Peoples’ Bank of England

Jeremy Corbyn’s proposal for ‘Peoples’ Quantitative Easing’ – public investment paid for using money printed by the Bank of England – has provoked criticism, including an intervention by Labour’s shadow Chancellor Chris Leslie. It seems the anti-Corbyn wing of the Labour party has finally decided to engage with Corbyn’s policy agenda after several weeks of simply dismissing him out of hand.

Critics of the plan make two main points: that the policy will be inflationary and that it dissolves the boundary between fiscal policy and monetary policy. It would therefore, they claim, fatally undermine the independence of the Bank of England.

The first point is inevitably followed by the observation that inflation and the policy response to inflation – interest rate hikes and recession – hurts the poor. As ever, the first line of attack on economic policies proposed by the left is to claim they will hurt the very people they aim to help. Leslie falls back on the old trope that the state must `live within its means’. It is well-known that this government-as-household analogy is nonsense. But what of the monetary argument?

Inflation is not caused by printing money per se. It is instead the result of a combination of factors: wage increases, supply not keeping pace with demand, and shortages of commodities, many of which are imported.

By these measures, inflationary pressure is currently low – official CPI is around zero. Since this measure tends to over-estimate true inflation, the UK is probably in deflation. There is finally evidence of rising wages – but this comes after both a sharp drop in wages due to the financial crisis and an extended period in which wages have grown at a slower rate than output. The pound is strong, reducing price pressure from imports.

More importantly, the purpose of investment is to increase productive capacity and raise labour productivity. Discussion of monetary policy usually revolves around the ‘output gap’ – the difference between the demand for goods and services and the potential supply. Putting to one side the problems with this immeasurable metric, the point is that investment spending increases potential output as well as stimulating demand, so the medium-run effect on the output gap cannot be determined a priori.

The issue of central bank independence is more subtle – certainly more subtle than the binary choice presented by Corbyn’s critics. That central banks should be free from the malign influence of democratically elected policy-makers has been an article of faith since 1997 when the Labour government granted the Bank of England operational independence. But, as Frances Coppola has argued, central bank independence is an illusion. The Bank’s mandate and inflation target are set by the government. In extremis, the government can choose to revoke ‘independence’.

More relevant to the current debate is the fact that the post-crisis period has already seen significant blurring of the distinction between monetary and fiscal policy. In using its balance sheet to purchase £375bn of securities – mostly government bonds – the Bank of England has, to all intents and purposes, funded the government deficit. The assertion that the barrier is maintained by allowing debt to be purchased only in the secondary market is sleight of hand: while the government was selling new bonds to private financial institutions the Bank was simultanously buying previously issued government bonds from much the same financial institutions.

At this point, critics will object that the Bank was operating within its mandate: QE was enacted in an attempt to hit the inflation target. This is most likely true, although during the inflation spike in 2011, there were suggestions the Bank was deliberately under-forecasting inflation in order to be able to run looser policy; as it turned out, the Banks’ forecasts over-estimated inflation.

None of this alters the fact that quantitative easing both increases the ability of the government to finance deficit spending and has distributional consequences; QE reduced the interest rate on government bonds while increasing the wealth of the already wealthy. Crucially, there won’t be a return to ‘conventional’ monetary policy any time soon. At a panel discussion at the FT’s Alphaville conference on ‘Central Banking After the Crisis’ featuring George Magnus and Claudio Borio among others, there was consensus that we have entered a new era in which the distinction between monetary and fiscal policy holds little relevance; there will be no return to the ‘haven of familiar monetary practice‘ in which steering of short-term interest rates is the primary mechanism of macroeconomic control.

The issue which has triggered this debate is the long-term decline in UK capital expenditure – both public and private. An increase in investment is desperately needed. Corbyn isn’t the first to suggest ‘QE for the people’ – a number of respectable economic commentators have recently called for such measures in letters to the Financial Times and Guardian. Martin Wolf, chief economics commentator at the FT, recently argued that ‘the case for using the state’s power to create credit and money in support of public spending is strong’. Former Chairman of the Financial Services Authority, Adair Turner, has made similar proposals.

I agree, however, with the view that it makes more sense to fund public investment the old-fashioned way – using bonds issued by the Treasury. Where I disagree with Corbyn’s critics is on the sanctity of `independent’ monetary policy; the Bank should stand ready to ensure that these bonds can be issued at an affordable rate of interest.

Why has Corbyn – supposedly a throwback to the 1980s – proposed this new-fangled monetary mechanism? Rather than some sort of populist gesture, I suspect this reflects a status quo which has elevated the status of monetary policy while downgrading fiscal policy. This, in turn, reflects the belief that the government can’t be trusted to make decisions about the direction of the economy; only the private sector has the correct incentive structures in place to guide us to an optimal equilibrium. Monetary policy is the macroeconomic tool of choice because it respects the primacy of the market.

Given that the boundary between fiscal and monetary policy has broken down at least semi-permanently, that status quo no longer holds. It is now time for a serious discussion about the correct approach to macroeconomic stabilisation, the state’s role in directing and financing investment and the distributional implications of monetary policy. It is to Corbyn’s credit that these issues are at last being debated.