{"id":11471,"date":"2015-01-13T11:37:39","date_gmt":"2015-01-13T16:37:39","guid":{"rendered":"http:\/\/multiplier-effect.org\/?p=11471"},"modified":"2015-01-13T11:37:54","modified_gmt":"2015-01-13T16:37:54","slug":"replacing-the-budget-constraint-with-an-inflation-constraint","status":"publish","type":"post","link":"https:\/\/blogs.bard.edu\/multiplier-effect\/replacing-the-budget-constraint-with-an-inflation-constraint\/","title":{"rendered":"Replacing the Budget Constraint with an Inflation Constraint"},"content":{"rendered":"
by Scott Fullwiler<\/strong><\/h5>\n

Tim Worstall has a post<\/a> decrying the dangers of MMT ever being used in the real world\u2014even as he recognizes or at least suggests that it might be the correct description of how the monetary system works\u2014and is particularly concerned about Stephanie Kelton\u2019s new appointment<\/a> as Chief Economist on the Senate Budget Committee. (Note: Randy Wray also posted<\/a> a critique of Mr. Worstall\u2019s post.)<\/p>\n

Mr. Worstall\u2019s main issue is one we\u2019ve heard hundreds of times before\u2014because MMT explains that currency-issuing governments operating under flexible exchange rates and without debt in a foreign currency do not actually have budget constraints, this opens the door to all sorts of problems if put into practice. We can\u2019t trust our government with this information, in other words\u2014it must <\/em>be required to match spending with revenues over some period (whether each year, over the business cycle, etc.) or at least plan over some period of time to not allow the debt ratio to rise beyond a modest level.**<\/p>\n

Mr. Worstall notes the frequently heard MMT argument that the point of taxes is to regulate the economy\u2014and takes particular issue with the view that taxes can be increased\/decreased in real time. Note, though, that this is simply a metaphorical or simplified explanation\u2014it blends the Chartalist argument that \u201ctaxes drive money\u201d with the functional finance view of using the outcomes of the government budget position as the criterion by which to judge it (rather than the state of the budget position itself). It is not intended as a literal point\u2014no MMTer has ever made a specific proposal for raising\/lowering income tax rates in real time to manage the economy. (Though Ray Fair does offer a sales tax proposal and shows that it would be stabilizing here<\/a>\u2014I simulated it along with the Job Guarantee and another transfer payment rule here<\/a>.)<\/p>\n

As argued bazillions of times, the real point MMT is making is that the government\u2019s budget constraint is the wrong constraint\u2014the correct constraint is whether or not a particular budget position will raise inflation beyond an official target rate (say, 2%, which seems to be the choice of most central bankers).<\/p>\n

Let me explain to Mr. Worstall and others how this could work rather easily\u2014just as the CBO and OMB now evaluate government budget proposals regarding their effects on the budget stance, the CBO and OMB could instead shift focus on evaluating these proposals against the inflation target (I argued the same thing here<\/a>, printable version here<\/a>). Much like how policy makers supposedly take estimates of effects on the budget position rather seriously in making budget conditions, they could replace these with projections of inflationary effects. An inflation constraint provides more fiscal space than a budget constraint, but in no way does it provide unlimited fiscal space (again, as we\u2019ve always argued).<\/p>\n

We could add quite a bit of detail here if we want, but I\u2019ll just say a few more things. First, it\u2019s quite clear that economists don\u2019t have much expertise modeling how to use the government\u2019s budget stance to manage the macroeconomy via a functional finance rule\u2014but this is largely because they have come to view monetary policy as the main macroeconomic policy tool, not because it\u2019s not possible.<\/p>\n

Note, though, that functional finance isn\u2019t less specific than, say, the Taylor Rule\u2014Taylor\u2019s Rule says to adjust the interest rate to manage the macroeconomy; functional finance says to manage the budget position to do this. Consider the never ending debate among policy makers at the Fed, Fed watchers, and economists on what the Fed should do next, when it should do it, how it should communicate what it\u2019s going to do, and so on. If Taylor\u2019s Rule were really that useful, we wouldn\u2019t need most of this debate and there wouldn\u2019t be so much disagreement among the various parties.<\/p>\n

Second, concerns that government policymaking is necessarily less \u201cefficient\u201d than monetary policy are unpersuasive to me (even aside from my view that monetary policy traditionally understood as manipulations of the overnight rate isn\u2019t a good idea). What if some of the thousands of economists currently working on understanding monetary policy started to try and understand how to build automatic stabilizers? They might help us understand which taxes (or tweaks to them, like indexing marginal tax rates to the inflation target rather than inflation) or spending priorities (or tweaks, like indexing spending to the target rate) are most consistent with functional finance\u2014we don\u2019t need to adjust tax rates in real time as much as build in a significant amount of stabilization automatically (i.e., more than we already have). MMT has its own proposal\u2014the Job Guarantee\u2014which we have argued in dozens if not hundreds of publications possesses macroeconomically significant stabilization properties if well designed.<\/p>\n

For sure, times like the last several years may call for more than just automatic stabilizers (or it may instead call for better financial regulation to avoid a speculative bubble and then a deep recession in the first place). However, while I am under no illusions that we could ever get totally rid of some of the messy politics of fiscally-driven stabilization, it\u2019s not as if monetary policy even when set by a small group of \u201cexperts\u201d (like the FOMC) has been apolitical (and, as noted above, it\u2019s been highly contentious among even the true believers in monetary policy which strategy is\/was the appropriate one).<\/p>\n

In sum, let\u2019s stop pretending that replacing a budget constraint with an inflation constraint is so hard. It involves a change in perspective, nothing more and nothing less. It doesn\u2019t give license to policy makers to do whatever they want. It does<\/em> mean<\/em> CBO will finally be doing something useful with its deficit projections\u2014namely, building models to understand how deficits will affect the macroeconomy (while its current practice<\/a> is to assume an economy at full employment and warn of impending financial ruin as a result of deficits). Stephanie\u2019s appointment gives reason to hope at least a little that this change might actually one day be possible, for the benefit of all of us (including Mr. Worstall).<\/p>\n

**The latter is actually what neoclassical economics argues\u2014contrary to popular understanding, there are no economic theories that require the government to ever <\/em>balance its budget. What they argue is that the government must eventually keep its debt ratio at a modest level, which does allow modest deficits on average forever<\/em>. What this does require is primary<\/em> surpluses (i.e., budget position before accounting for debt service) to offset primary deficits if<\/em> the interest on the national debt is above the economy\u2019s growth rate. In fact, though, this condition hasn\u2019t been met on average in the post WWII period<\/a>; only the 1979-2000 period saw average interest on the national debt rise above the economy\u2019s growth rate.<\/p>\n

(cross-posted from New Economic Perspectives<\/a><\/em>)<\/p>\n","protected":false},"excerpt":{"rendered":"

by Scott Fullwiler Tim Worstall has a post decrying the dangers of MMT ever being used in the real world\u2014even as he recognizes or at least suggests that it might be the correct description of how the monetary system works\u2014and is particularly concerned about Stephanie Kelton\u2019s new appointment as Chief Economist on the Senate Budget […]<\/p>\n","protected":false},"author":202,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[49,112,40],"tags":[1131,39,151,1135,452,142],"class_list":["post-11471","post","type-post","status-publish","format-standard","hentry","category-fiscal-policy","category-modern-monetary-theory","category-monetary-policy","tag-fiscal-policy","tag-inflation","tag-mmt","tag-modern-monetary-theory","tag-stephanie-kelton","tag-taxes"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11471","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/202"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=11471"}],"version-history":[{"count":6,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11471\/revisions"}],"predecessor-version":[{"id":11477,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/11471\/revisions\/11477"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=11471"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=11471"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=11471"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}