Would Keynes have endorsed Modern Monetary Theory/Neochartalism?

There are a number of academics and commentators who appear to believe that Keynes was not actually a Keynesian, whatever that assertion is supposed to mean.

However, I don’t wish to examine this specific question in detail. In the sense that Keynes, for a good part of his life, was a monetary economist, it might be said that “Keynes was not a Keynesian.”

But in truth such an idea is fatuous. By the same type of reasoning, we might as well say that Newton was not really a “Newtonian,” because he only published his scientific classic Philosophiae Naturalis Principia Mathematica in 1687 when he was 45 years old and had lived for more than half of his lifespan of 84 years. Clearly, we have to take account of the mature and considered opinions of someone to determine how to characterise their thought in an historical sense. It can also be noted that Keynes was certainly not an advocate of the neoclassical synthesis Keynesianism that became mainstream macroeconomics after the Second World War. Keynes was himself far closer to the modern Post Keynesian school of thought on many issues.

My purpose in this post is to ask: what would Keynes have thought of neochartalism/modern monetary theory (MMT)?

It must be emphasised that modern monetary theory (MMT) is not simply classical Keynesianism or neoclassical synthesis Keynesianism, where the budget is balanced over the business cycle. MMT is far more radical than classical Keynesian economics.

MMT developed from Abba Lerner’s theory of functional finance, as well as G. F. Knapp’s theory of chartalism, as propounded in his book The State Theory of Money. I consider modern monetary theory (MMT) to be a branch of Post Keynesian economics (others might disagree). Neochartalism/MMT provides the best theory and empirically-sound explanation of how our modern fiat monetary systems actually work. MMT tells us that the government is the monopoly issuer of its own currency. Hence the government is not revenue-constrained. Taxes and bond issues do not finance government spending. No entity with the power to create and destroy money at will requires anyone to “fund” its spending. Having said this, one must immediately say that, even though deficits are not “financially” constrained in the normal sense, they do face real constraints in the inflation rate, exchange rate, available resources, capacity utilization, labour available (= unemployment level), and external balance. But these constraints are very different from the fictional “financial” constraints imposed on governments in the modern world, where monetising budget deficits (itself an inaccurate and redundant expression and a relic of gold standard thinking) is hysterically denounced from virtually all quarters. MMT says that governments should have the power to create money to “fund” a budget deficit in whole or in part, without the need for issuing bonds. The purpose of government deficits and spending is to manage the economy and create full employment and stabilise demand. Whether a budget deficit is necessary or not depends not on the state of the business cycle, but on other factors such as maintaining full employment and ensuring that the nation can reach its potential GDP (see Bill Mitchell, “Deficit spending 101 – Part 1,” 21 February 21, 2009).

According to MMT and even in Abba Lerner's earlier theory of functional finance, it is not even necessary to balance the budget over the course of the business cycle, since the government can exercise its powers of money creation to ensure that the stock of government debt and the interest on that debt does not reach problematic levels. In the quite memorable words of L. Randall Wray, “the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion” (see L. Randall Wray, “Paul Samuelson on Deficit Myths, Time to Drop that Old-Time Religion,” April 30, 2010). This of course does not mean that the government should let its debt rise to too high a level or that it should run deficits during periods of full capacity utilization and full employment. On the contrary, in these periods, when inflationary pressures occur, the government should run a budget surplus and destroy money, a process which can contract demand and cool the economy down.

One could also say that there will probably always be a need for government bonds as risk-free financial assets, so that retirees or people saving for retirement do not have to gamble their money on casino-like financial markets and asset price speculation. Government bonds can thus be considered a type of welfare instrument, so that completely eliminating the stock of such bonds would just hurt savers looking for safe financial assets.

As we have seen above, one of the founders of neochartalism/MMT was a Keynesian economist called Abba Lerner (see Bill Mitchell, “Functional finance and modern monetary theory,” 1 November, 2009), who was also probably the first to recommend Keynesian deficit spending and demand management as a clear and consistent economic policy (see Lerner 1944 and 1951).

Abba Lerner described the fundamental ideas of functional finance in an article called “Functional Finance and the Federal Debt” (Social Research 10 [1943]: 38–51).

Now we come to the main question: what did John Maynard Keynes think of Abba Lerner’s functional finance theory, the early form of MMT?

My discussion is based on the fundamental article by David Colander on this subject (“Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4 [1984]: 1572–1575).

In 1943, Keynes gave a lecture at the Federal Reserve, and apparently disagreed with Lerner’s post-war policy recommendation of classic Keynesian deficit spending to induce enough spending in the private economy. Later, according to Abba Lerner, Keynes withdrew this opposition (Colander 1984: 1572–3).

There is some evidence that Keynes might eventually have agreed with Abba Lerner on functional finance (if of course Keynes properly understood the argument of Lerner’s 1943 article), and that he may have been sympathetic to what later became Modern Monetary Theory.

I quote from the article of David Colander:

“As Lerner said …, Keynes retracted his characterization of Lerner’s ideas as ‘humbug.’ According to Lerner, ‘in reading … [The Economics of Control] later, at leisure, … [Keynes] found the logic less escapable and the resistances more obvious’ … Keynes admitted to being at least a closet Lernerian in a letter to Lerner (September 1944) congratulating him on The Economics of Control. Keynes wrote:

I have marked with particular satisfaction and profit three pairs of chapters-chap. 20 and 21, chap. 24 and 25 [where Lerner had discussed functional finance], chap. 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going-probably impossible. I shall have to temper its austerity where I can. I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!

It was not only in this letter that Keynes retracted his initial remarks about Functional Finance. In 1945, when Keynes again visited the United States, he repeated his praise of Lerner at another Federal Reserve Seminar. In this meeting Keynes spoke in glowing terms of Lerner’s contribution and ‘without any provocation, he held forth a panegyric on Functional Finance’ … Later that evening, at a dinner Alvin Hansen had arranged for Keynes, Lerner and Keynes had another exchange which is also worth noting. Lerner approached Keynes and asked: ‘Mr. Keynes, why don’t we forget all this business of fiscal policy, public debt and all those things, and have some printing presses.’ Keynes, after looking around the room to see that no newspaper reporters could hear, replied: ‘It’s the art of statesmanship to tell lies but they must be plausible lies.’”

David Colander, “Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4 (1984): p. 1574.

I would draw attention to the last exchange between Keynes and Lerner (see D. C. Colander and H. Landreth (eds), The Coming of Keynesianism to America: Conversations with the founders of Keynesian economics, E. Elgar, Cheltenham, 1996, p. 202, for another account of this exchange).

Was Lerner by his “printing press” remark suggesting that the government should create its own money to fund deficit spending (in whole or part, as required), a principle that he certainly advocated in Lerner 1943: 40–41?

And what did Keynes mean by his remark: “It’s the art of statesmanship to tell lies but they must be plausible lies.” Was Keynes saying that the idea of having a central bank create money for government spending was too radical an idea for the public and contemporary politicians, and that the government could not do it in practice because it was too unconventional? And was Keynes even hinting at his own essential agreement with Lerner on the issue of functional finance?

And that raises the question: if Keynes were alive today would he have supported MMT?


BIBLIOGRAPHY

Colander, D. 1984. “Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4: 1572–1575.

Colander, D. C. and H. Landreth (eds), 1996. The Coming of Keynesianism to America: Conversations with the founders of Keynesian economics, E. Elgar, Cheltenham.

Lerner, A. P. 1943. “Functional Finance and the Federal Debt,” Social Research 10: 38–51.

Lerner, A. P. 1944. The Economics of Control, New York, Macmillan.

Lerner, A. P. 1951. The Economics of Employment, New York, McGraw Hill.

Mitchell, B. “Functional finance and modern monetary theory,” 1 November, 2009.
http://bilbo.economicoutlook.net/blog/?p=5762

Mitchell, B. “Deficit spending 101 – Part 1,” 21 February 21, 2009
http://bilbo.economicoutlook.net/blog/?p=332

Wray, L. R. “Paul Samuelson on Deficit Myths, Time to Drop that Old-Time Religion,” April 30, 2010
http://neweconomicperspectives.blogspot.com/2010/04/paul-samuelson-on-deficit-myths.html