Professor Bill Mitchell is one of the key developers of Modern Monetary Theory (MMT). [i3] Insights visited Professor Mitchell in Newcastle to discuss how the theory came to be and what it says about government debt, inflation and the Green New Deal.
In 1994, Professor Bill Mitchell received a phone call from a United States hedge fund owner. This person said his investment strategy would have failed if it had been based on standard macroeconomic reasoning in relation to money, a theory Mitchell opposed.
Could they get together and speak?
The phone call, alongside earlier internet discussions, played an important part in the creation of a body of work that today is referred to as Modern Monetary Theory (MMT).
“I received a phone call from an American, who said he was in Sydney and would like to speak with me. This was Warren Mosler,” Mitchell says over lunch near his current workplace, the University of Newcastle, where he is Chair of Economics and Director of the Centre of Full Employment and Equity, cheekily abbreviated as CofFEE.
“So we got together and started speaking about these ideas. I was an academic and I worked out part of the story from first principles, but Warren had worked this out from an operational point of view.”
Mosler founded Illinois Income Investors in 1982 and made several trades through his firm that seemed to align with the principles of MMT.
One example is a trade he made during the early 1990s, where he took a contrarian view to the commonly held prediction that the Italian government would default on its bonds. He predicted correctly that this was not possible as Italy still issued its own currency: the lira.
This trade relates to the core of MMT, which argues a government that issues its own currency can’t default on its debt and, in fact, can also issue far more debt than is generally thought possible. Moreover, the debt does not fund the deficit spending – it is the other way around.
“Warren said to me: ‘If I had traded in the markets using mainstream neoclassical economics, I would have never made any money.’ That is sort of how our conversation started,” Mitchell remembers.
Why Governments Can’t Save
At its core, MMT makes the argument that a government that issues its own currency manages its balance sheet very differently than a household or a corporation.
From this point of view, it makes no sense to say a government that issues its own currency is saving when it runs surpluses. There is no savings account where governments can stash their unspent budgets and keep the money for a rainy day.
Instead, MMT argues that government deficits and surpluses directly affect the level of wealth in the private sector. Any budget surplus drains wealth from the private sector, while deficits mean money flows into the pockets of the private sector.
But wait a moment, isn’t government spending paid for by taxes?
Well, no, MMT says. Taxes don’t pay for anything. Taxes are used to reallocate resources from the private sector to the public sector, a subtle yet important difference, Mitchell says.
“What do taxes do? Taxes create, what I call, the ‘real resource space’, in which governments can spend and not cause inflation,” he says.
“The government doesn’t have any resources; we have the resources in a modern economy. We own labour and capital. How does the government get that to run its programs and mandate? Well, it’s got to deprive us of using those resources in one way or another.
“Think about how they do that: taxation. You don’t need taxation to spend; you need taxation to create the resource space in which they can spend, without causing inflation. Now, that is a fundamental difference from how people think.”
MMT says government spending is restrained by the available resources in the economy, not by the amount of taxes raised, and this means a government can often spend more than is commonly thought prudent. Inflation is not so much caused by government spending, but rather by supply and demand shocks.
“Sure, inflation is a problem, but it is an inflated fear,” Mitchell says.
“Governments have to make sure they manage their expenditure to not generate it, but that doesn’t mean you have to run austerity.
“A classic example is the hyperinflation in Zimbabwe. People say: ‘Well, that was because [former President Robert] Mugabe went on a spending spree.’
“What most people don’t understand is that the hyperinflation there had nothing to do with fiscal deficits. If you understand the history of that time, you would know that Mugabe led the freedom fighters against the British, against Rhodesia, and liberated what is now modern Zimbabwe.
“You will know that during the colonial period land tenure was extremely unequal, with incredible land disparities. And quite reasonably, Mugabe decided to reward his freedom fighters, but quite unreasonably he decided to reward them in the wrong way by expropriating the white farmlands and giving them to his former soldiers.
“Zimbabwe was at the time the food bowl of Africa; its farming was incredibly efficient and productive. What happened within a very short time was that farm output collapsed by 60 per cent. In an agricultural society that is devastating.
“To avoid starvation the central bank of Zimbabwe imposed foreign exchange controls and rationed their foreign exchange holdings to buy food because their food supply had fallen. That deprived manufacturers from essential capital.
“So there were lots of events that caused a supply-side shock. It wouldn’t have mattered if the government would have run a surplus, you would still have had hyperinflation.”
Standing on the Shoulders of Giants
MMT wasn’t created from scratch, but builds on the work of various economists, tracing back mainly to the work of British economist Abba Lerner and his concept of ‘functional finance’ and ultimately to John Maynard Keynes.
“There is very little [in MMT] that is original in the sense of pure originality. It is about adding ideas to what is already there,” Mitchell says.
“One of the main building blocks is from Abba Lerner, who in the 1940s created functional finance. It was part of the new way of thinking of the role of government after the great depression.
“What functional finance was addressing was what was called in those days ‘sound finance’. Sound finance is what we today would think of as neoliberalism: that governments had to balance budgets or run surpluses and if they didn’t, then bad things would happen, and that public debt was a burden for their grandchildren.
“What Abba Lerner said is the way we should really conceive of government is in functional terms: what it does. We shouldn’t assess their fiscal position, whether it is a two per cent deficit or a two per cent surplus, but we should assess it in terms of what we want the government to do on our behalf and assess the state of the fiscal position in relation to the functions of government.
“It didn’t make much sense to run a two per cent surplus if you have 10 per cent unemployment. Sound finance would say that is good, but functional finance would say it is a disaster because what we really want government to do is to make sure there is not 10 per cent unemployment. The fiscal position has to be whatever it is to achieve your functional goals.
“Functional finance recognised that governments really don’t need to fund their spending in the way that we think they do, in the way that sound finance says they’ve got to tax or borrow.”
Mitchell, together with Mosler and several other economists, has been adding to the MMT framework since the early 1990s and he is somewhat amused it is now starting to receive attention from Wall Street and mainstream economists.
“It is finally starting to get attention because we are starting to break into politics now,” he says.
“It is only since Alexandria Ocasio-Cortez [the US Representative for New York’s 14th congressional district, also known by her initials AOC] has embraced MMT. That has given it a boost, but it has been building for some years.
“We’ve now got a textbook and we’ve got a program that I’m teaching at the University of Helsinki.”
But he is grateful for the attention it has received from US politicians and supports the Green New Deal, a series of infrastructure projects proposed by Ocasio-Cortez and others to help the economy transition to a low-carbon economy.
“The Green New Deal sounds fancy, but if you go back to the 1950s after WWII, Australia was quite a poor country and the public sector was huge,” he says.
“We were building a nation on the back of the government: the roads, telecommunication systems, the transport systems, schools and hospitals. There were massive public investments going on as part of that phase of nation-building.
“I see the Green New Deal as another example of nation-building. We’ve reached a point in our evolution that requires the next big public injection of infrastructure investment. Now, it is not an MMT project, I think everybody should own it, but what an MMT understanding tells you about it is that the government has the financial capacity to do the infrastructure spending.
“Then you hear critics say: ‘MMT says you can have it all for free.’ Well, no you can’t. The Green New Deal would be a massive transformation of real resource usage in our economies and we are going to have to deprive existing users of resources, such as [users of] coal, internal combustion car manufacturers, farmers using land clearing that is unsustainable and phosphates.
“There is going to have to be a massive redirection of resources. That is not an easy thing to do. The government is going to be able to fund that; that is not the problem. But it is a societal shift; that is the challenge of the Green New Deal. It has to be a very well managed and very politically delicate process.”
He points out Newcastle, where our conversation is taking place, is a prime example of some of the difficulties the Green New Deal is facing.
“You are within half a kilometre of the world’s largest exporter of coal: Newcastle Port. Well, this whole region will have to stop producing coal. How do you do that? That is the Green New Deal,” he says.
“It is not that the government can’t stump up the cash. It is about what instruments are you going to use to stop coal production. Are you going to regulate it? Are you going to bring in a carbon tax? These are all questions that need to be asked.
“I’ve been calling for this region, the Hunter, for years to become a hub for renewable energy production and technology. This is a trade region, it’s skills-based, but a lot of these workers aren’t doing anything now that BHP Billiton has closed [its steelmaking plant].
“The Green New Deal is a 50-year project, or at least a very long project. It will need elaborate transition frameworks to make sure that workers in this region have opportunities. But this is not going to happen overnight.”
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.