The One Paragraph That Exposes the Many Problems with Modern Monetary Theory

Updated with 1931 quote from Mises.

James K. Galbraith, MMTer and a professor at the Lyndon B. Johnson School of Public Affairs, University of Texas at Austin, writes at Project Syndicate in defense of Modern Monetary Theory:

But the issue with budget deficits isn’t interest rates, which remain under government control. Nor is it the possible crowding out of private investment, which assumes that the pool of finance is fixed. The issue is real resources. Here, MMT’s proposed job guarantee would keep real resource use exactly at the level required for full employment – not less, but also not more.

This Galbraith paragraph more than any other I have seen encompasses the key problems with MMT.

First, interest rates are not entirely under government control. During a period of high price inflation, there is enormous upward pressure on interest rates that a government central bank may not be able to counter fully. The tiger by the tail problem.

As the great twentieth-century economist Ludwig von Mises wrote in December 1931 in Neue Freie Presse:

The permanent lowering of the interest rate can only be the outcome of increased capital formation, never the result of any technical banking measures. Attempts to achieve a long-term lowering of interest rates by expanding the circulation credit of the banks ineluctably result in a temporary boom that leads to a crisis and to a depression.

Second, no one is making the claim that the pool of investment is fixed rather that it is limited.

If the private sector is seeking ten billion dollars of investment money but the government steps in seeking a billion,  ceteris paribus, interest rates will climb. This will draw out additional funds but also cause some private sector money seekers to drop out of the market at the higher rates. The dropping out of private sector borrowers is crowding out.

It is, of course, possible for a central bank to monetize government debt by funding it in some fashion, which does nothing but distort the economy in favor of government. This results in crowding out of a more complex fashion that benefits government spending at the expense of both the private consumer and capital goods sectors.

Finally, there is no "real resource" problem whereby spending must be created. This perspective at its core rejects basic supply and demand economics. Markets clear. There is no real resource problem. This is a Keynesian aggregate demand myth.

-RW