Wednesday, December 23, 2020

On Chapter 4 Of Stephanie Kelton's "The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economics"

At the post, Vicious Attack on Rand Paul By Stephanie Kelton, Dominick writes in the comments section:

Just read Chapter 4 in Kelton's book where she deals with government deficits and the "crowding-out" theory. She argues, in short, that "the crowding-out story doesn't work in countries (like the U.S.) that borrow in their own sovereign currencies." In short, no crowding out and the "proof" is that interest rates have gone down, not up. You will have to go to that chapter for the full analysis on why she thinks that this is so BUT the idea is not necessarily absurd on its face. Further, she does not assert that there are "no negative consequences" from deficits. According to her, deficits can be too large (or taxes too low) and the resulting spending splurge can certainly lead to inflation. So, Robert, I would be interested in your discussion of those two points. (You may have discussed them in your book which, alas, I have not yet read.)

RW response:

[S]he argues that the Federal Reserve can finance the government debt through printing additional dollars and thus, according to her, there is no crowding out. 

But there is a great failure here in her thinking. It is not going deep enough to understand what is going on. 

As we all know, there is a limited supply of resources on the planet. The entire amount of resources on the planet are bid for with money by economic actors across the land, either for consumer goods or capital goods.

If the Federal Reserve does print up new dollars to fund U.S. government deficit spending, this spending does not magically create new goods. It bids away goods from private sector actors. That is, it would bid higher than current purchasers for goods and services since that is the only way that it would be able to obtain the supply of goods and services that would otherwise be successfully bid for by private sector actors.

In other words, government debt financing via Fed monetization of U.S. debt results in the crowding out of both the private capital goods sector and the private consumer sector.

As for her statement that deficits can be too large (or taxes too low) and the resulting spending splurge can lead to inflation, I view this as similar to saying, "I am against the stabbing of someone at some point, but it should go on for now."

There is no good deficit and no good central bank-caused price inflation, and certainly no good money printing. So her fundamental perspective is way off but there is more. MMTers never tell you how much inflation is too much.

In my Problems booklet, I publish an email exchange I had with the founder of MMT, Warren Mosler, where he refused to state what too high inflation would be, after I asked him point-blank at what rate of inflation would he be concerned. He said it was a "political" judgment.

Kelton also provides no specific inflation rate in her book as to where she would be concerned.

From Problems:

[M]ost interestingly, nowhere in the book does Kelton provide a number as to how high price inflation would have to advance before she would see it as a concern.

One gets the sense from the book that Kelton’s price inflation danger point is something like that of an alcoholic who will fix his drinking problem tomorrow or the day after but certainly not today.

“Too little, not too much, inflation has plagued the US, Japan and Europe,” she writes.

Of course, coming from my perspective, that all monetary inflation is a distortion of the economy and shouldn't be going on at all, it seems hardly significant that Kelton and Mosler think there is some unstated point when the stabbing should stop.


  1. Great response from RW. Love the knifing analogy as it tends to emphasize the slow death that is inflation.

  2. Good argument RW but let's see whether it always applies. Assume the Covid 19 Relief package provides loans or actual money to owners of firms where employees have already been laid off. The money is printed out of thin air. The owner uses the money to produce new goods or services (the old goods he was producing 5 months ago are gone) and pay new income to workers (the old income that was generated 5 months ago is gone). So, first glance, I see new output and new income produced with the new money and I don't see any "bidding" away of labor resources from some alternative use. Who is "crowded out"?

    This is all part of an argument I use to reject out of hand. My assumptions was always: Everybody working; resources and the supply of savings relatively fixed: there had to be crowding out with deficits and monetization (and rising interest rates). BUT rates have been falling and have stayed down for a decade or longer...even long rates. The gov. and Fed. have engaged in massive deficit spending and monetization for the last 15 years through two sharp recessions. There has, of course, been some "inflation" in some (asset) prices but certainly NOT the sort of numbers we saw in the late 1970s and early 1980s were I remember borrowing money at 12%.