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Return of the Neo-Keynesians

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from the magazine

Return of the Neo-Keynesians

Leftist Democrats are charmed by magical thinking. Spring 2019
Politics and law
Economy, finance, and budgets

Medicare for all, full employment, and a complete overhaul of American infrastructure can all be achieved simply by printing more money, according to a new generation of Democrats. Their spokesperson is Congresswoman Alexandria Ocasio-Cortez, while the brains behind their movement is economist Stephanie Kelton, an advisor for Bernie Sanders’s 2016 campaign. Democrats who subscribe to this way of thinking embrace Modern Monetary Theory, or MMT—a name chosen in direct opposition to the widely accepted Monetary Theory, initially articulated by Milton Friedman.

As Kelton explains the new theory, governments can create money according to their needs because a state cannot go bankrupt. Of course, some do go bankrupt, as Argentina did most recently. But for the sake of argument, let’s acknowledge that the United States is unlikely to go bankrupt: Why not print all the money it wants, so as to satisfy any public goal?

In fact, MMT is not just a theory, and not really new; it has been put into practice many times—with uniformly disastrous results. Around 1300, King Philip IV of France reduced the quantity of gold and silver in circulating currency, without changing its name or notional value. The difference in weight would supposedly replenish the treasury. Today, we would call this “devaluation.” As an unintended but predictable consequence, all prices for goods on the market rose to compensate for the degraded value of the new coins; the people knew that they were being cheated. This was inflation avant la lettre.

Philip’s failure did not prevent future governments from succumbing to the temptation to create money heedlessly. Germany’s Weimar Republic began churning out Papiermarks in order to buy hard currency to repay its reparations debt to France and Belgium; my father, who lived in Berlin then, told of how he needed a suitcase of banknotes to go shopping. Venezuelans face this same plight today. A decade ago, it was Zimbabweans, in a country where annual inflation reached 79 billion percent.

Contemporary American proponents of MMT acknowledge that money creation can spark inflation, but they appear not to recognize how serious a disease inflation is. Under inflation, rising prices kill the incentives to invest, to save, and to work. Many societies—like Venezuela today—have been destroyed by inflation. During the Carter years, inflation brought the U.S. economy to a standstill and damaged the country’s social fabric.

The solution to the problem of unchecked inflation, according to MMT advocates, is to transfer the power to print money from the Federal Reserve to Congress. Congress could then create money as it needs it. If inflation became a threat, Congress could increase taxes in order to keep monetary balance in the economy. MMT’s internal logic recognizes no limits on government spending, an approach that leads logically to a Soviet-style society. Why keep any private sector, when Congress can simultaneously appropriate money for any program and create the money to pay for it?

Again, if a state cannot go bankrupt, by definition, what about the story of Greece over the last decade? The government got used to spending far beyond its means. Eventually, no one in the financial markets wanted to buy Greek bonds. Then Greece restored a balanced budget, inflicting major suffering on the middle class. Social democrats denounced these “austerity” measures as class warfare, but in a market economy, you can’t run debts indefinitely that you will never be able to repay. A more honest term for austerity, in the market context, would be “common sense.”

Sophisticated MMT advocates declare themselves to be neo-Keynesians. Perhaps they are; they certainly are not original Keynesians. In his 1932 General Theory, John Maynard Keynes proposed that recessions are caused by a lack of demand. Consequently, he suggested that governments should compensate for the weakness of private demand, through publicly funded programs, on a brief, stimulatory basis—like an electric shock. Governments should save money in times of growth and spend it in times of recession, Keynes believed. Countercyclical budgeting would help to attenuate economic cycles.

Keynes’s theory was never truly applied. Public officials picked those parts of the theory that were politically convenient, especially deficit spending. When Presidents Lyndon Johnson and Richard Nixon boosted public spending to finance the Great Society and the Vietnam War, they used Keynes as an alibi. “We are all Keynesians now,” Nixon purportedly said. He ought to have said “neo-Keynesians.” The result was the crippling inflation that plagued the American economy in the 1970s.

The Federal Reserve System was founded to protect Americans against political manipulation of the currency. The U.S. dollar is the most trusted money in the world because it is managed by an independent institution, not by Congress. After the dreadful hyperinflation of the 1970s, nearly all nations established independent central banks, based on the U.S. and German models. India and Ethiopia, among others, prospered after their currencies became reliable: the poor could save their money instead of rushing to convert it into staples, and the wealthy could invest at home instead of exchanging their money for stable assets.

Theoretical arguments aren’t needed to counter MMT. History suffices to demolish its precepts. It is regrettable that a new generation of American political leaders has attained influence without any understanding of economics. Once again, we are reminded that magical thinking can be more attractive than scientific knowledge. We should deplore the fact that so many elected representatives appear not to recognize that independent institutions like the Federal Reserve Bank, among others, have helped make the United States the most powerful and successful economy in world history.

U.S. economist Stephanie Kelton (Photo: Wikimedia Commons)

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