Rebuttal to Bob Murphy’s Critique of Modern Money Theory

I find it very laudable that heterodox economists are debating this topic so carefully and always with reference to facts. Here are my thoughts on Bob Murphy’s post The Upside-Down World of MMT:

In it he writes:

According to many proponents of MMT, “deficits don’t matter” when a sovereign government can issue its own fiat currency, and all the hand wringing over the government’s solvency is absurd.

Until I see what statement or MMT hypothesis specifically he is referencing here I have to call this a strawman argument. I don’t think any MMTer I’ve read has ever said “deficits don’t matter”. According to MMT, deficits are needed to provide the private sector with sufficient claims upon the public sector (= net private saving), but if deficits go beyond net private saving demanded by the private sector they can cause demand pull inflation, which most argue is indeed undesirable.

In fact, the MMTers claim that given the reality of a US trade deficit, a sharp drop in the government’s budget deficit would hamper the private sector’s ability to save. Thus, the Austrians are unwittingly calling for a collapse in private saving when they foolishly demand government austerity.

To be precise, MMT doesn’t say the private sector’s ability to save is hampered, but its ability to NET save. The reason net private saving is important is not arbitrary, it is because we observe that drops in net private saving tend to cause large indebtedness of the private sector to itself (household debt to income ratio rises), culminating in a depression or a severe recession. In fact, 7 of the 7 times the US federal government ran a budget surplus were followed by a depression (6 times) or a severe recession (1 time).

Bob Murphy then spends some time accurately figuring out that in this context MMTers are not talking about all private sector saving, but only net private saving, not exactly a new revelation, but it’s good to see he went through the mechanics of figuring it out.

Now Nick Rowe and the MMTers are certainly correct when they observe that “private saving net of private investment” can’t grow without a government budget deficit (again if we disregard foreign trade). But so what? The whole benefit of private saving is that it allows for more private investment.

He’s missing the benefit of a net private savings buffer that makes actors in the private sector more comfortable to spend and invest.

He also indirectly touches upon a common mistake made by orthodox economics and also Austrian economists: They think that banks need people to deposit savings before the bank makes loans allowing borrowers to invest. This is empirically not the case, and it turns the causality of saving vs investing upside down. Banks in a fiat money system don’t wait for people to deposit money with them before they can make loans. They make loans, which create deposits. Those bank checking deposits created out of loans are the savings generated in the private sector after a loan has been made. Now, in order for the loan to result in actual investment spending, the borrower needs to use his checking account deposit to purchase machinery, computers, build a factory, etc.

Banks make loans regardless of how much reserves they have on deposit. They obtain the reserves needed as per reserve requirement after the loan has been made, with a couple of weeks of time lag, and the central bank then accommodates the private banks’ demand for such reserves at all times, if needed. If this wasn’t the case the interbank lending rate would move outside of the Fed’s declared policy range which doesn’t happen in a floating fiat money system.

It should be pointed out that any savings generated by private bank lending is always matched by a corresponding private bank loan. This is why private sector savings generated out of private bank loans do not change the private sector’s net position against the public sector. Insufficient claims upon the public sector and excessive private debt in turn are precisely the economic conditions MMT warns about.

The fans of MMT should therefore stop pointing to those identities as if they prove the futility of government austerity during an economic downturn. Those tautologies, and the cherished equations of the three sectors, are consistent with post-Keynesian and tea party economics.

I don’t think any MMTer has ever claimed that those accounting identities prove anything. They are a helpful starter, but Murphy doesn’t even begin to talk about the private sector’s empirical demand for the net savings buffer I’ve explained above.

As a final way to illustrate the non sequitur of the equations involving government budget deficits, note that we could do the same thing with, say, Google. Go back through all the equations above, and redefine G to mean “total spending by Google.” Then C would be “total consumption spending by the-world-except-Google,” and so on.

After doing this, we would be able to prove — with mathematical certainty — that unless Google were willing to go deeper into debt next year, the world-except-Google would be unable to accumulate net financial assets, in the way MMTers define that term. The proper response to this (perfectly valid) observation is, Who cares?’

This is an invalid comparison because Google is not the issuer of the currency and doesn’t have the power to unilaterally impose arbitrary tax debts upon others. This is the whole point of the sectoral balance identity: we define the different actors in the fiat money economy based on their relation to that fiat money: the issuer of the money (public sector), the user of the money (private sector), and issuers/users of other fiat monies (foreign sector). Murphy thinks these definitions are arbitrary, when they are not at all.

Finally, in the section “Not All Spending and Income Are Created Equal” Murphy explains to us that purely looking at numbers and GDP figures doesn’t tell us much about the work actually performed and the value actually created inside the economy. This is true, and fortunately nobody competent in MMT has ever made any claim to the contrary as far as I’m aware.

MMT doesn’t claim that government spending can create infinite wealth, just that if you start a monetary economy by imposing a tax on people, there are reactions on the part of the taxed people, and those have to be taken into consideration in all your pertinent models and theories.

I have made the case before that for the past 5000 years we’re aware of ALL monetary economies have been started in that manner. Bitcoin may be a very recent exception to that rule, and I’ve written about how Bitcoin imitates the fiat money system in some ways.

Austrian economists by and large ignore this causality because they believe in the barter theory of money, where you can indeed hallucinate into existence an economy that functions without taxation and government spending, such as the one Murphy elaborates on in this article, where he neatly imagines how Robinson Crusoe could easily save up coconuts without any government deficit spending. This model is helpful if you’re ever stranded on a lonely island with coconut trees. It isn’t if you’re trying to understand the workings of a complex monetary production economy.

I have been guilty of this myself so I’m not speaking from a pulpit by any means. I’m just pointing out where empirical evidence has helped me correct my thinking on some aspects of fiat money economics.

By the way, here’s where you can read my full post about Modern Monetary Theory.

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