Marshall Auerback Interviews Bill Mitchell on Modern Monetary Theory

A very nice interview here with Professor Bill Mitchell by Marshall Auerback on Modern Monetary Theory (MMT), which was done at an Institute for New Economic Thinking (iNET) conference in April 2014 in Toronto, Canada. More details here.

Steve Keen on Modern Monetary Theory and the Law

Steve Keen (now head of the School of Economics, History and Politics, at Kingston University, UK) gives a talk here at a seminar at Sheffield University on the implications of Modern Monetary Theory for the law.

Randall Wray on the Basics of MMT

L. Randall Wray is interviewed here on the basics of Modern Monetary Theory (MMT) in terms of its theory of the origins of money and the state.




N.B. There should be a Part 2 of this interview, but I am unable to find it.

Some of my posts on MMT and the history of money are below:

“The History of Modern Monetary Theory,” January 3, 2012.

“The Origin of Money and Coinage in Western Civilisation: The Case of Ancient Greece,” April 5, 2013.

“Randall Wray on MMT and the US Economic Crisis,” May 24, 2012.

Stephanie Kelton on Modern Monetary Theory

A nice interview here on Capital Account with Stephanie Kelton on Modern Monetary Theory (MMT) and the fiscal cliff.

Scott Fullwiler on Modern Monetary Theory

Another talk on MMT: this time by Scott Fullwiler. Again this was held at the Fields Institute (Canada) on July 3rd, 2012.

Stephanie Kelton on Modern Monetary Theory

I post below a talk by Stephanie Kelton on Modern Monetary Theory (MMT), which was held at the Fields Institute (Canada) on July 3rd, 2012.

The History of Modern Monetary Theory

My last post got a bit hijacked by my attempt to write a digression on the origin of Modern Monetary Theory (MMT), which has also been called Chartalism, neo-Chartalism, the Kansas City approach, and soft currency economics. It strikes me that the subject deserves a post in its own right, so I will attempt one here (bear in mind there is some repetition).

Chartalism in the historical sense should be distinguished from Modern Monetary Theory. Chartalism was a theory of money developed by Georg Friedrich Knapp (1905; English translation 1924), which he called the “state theory of money.” This was taken up by Keynes in his Treatise on Money (1930). It appears to me that economists in the late 20th century associated with Post Keynesianism revived Chartalism as a theory, with the work of Alfred Mitchell-Innes (1913 and 1914) on credit money, including Charles A. E. Goodhart (although, strictly speaking, Goodhart does not regard himself as a Post Keynesian; see Goodhart 2005: 817).

Chartalism has been one source of MMT, and an early proponent L. Randall Wray appears to have used the term to describe the macrotheory he was developing. Randall Wray states:

“... somehow [sc. Chartalism] ... got the name Modern Money Theory. We think the first time those exact words were used might have been in a comment to Bill’s blog in 2007; if anyone can find that comment or a previous use, please send it along. It also looks like Bill used the term “modern monetary theory” in an academic paper in 2008.”
L. Randall Wray, “MMP Blog #30: What is Modern Money Theory?,” January 1, 2012.

The broader sources of Modern Monetary Theory are as follows:

(1) G. Frederick Knapp’s work (1905; 1973 [1924]);
(2) Mitchell Innes’s work (1913; 1914).
(3) Keynes;
(4) Abba Lerner’s functional finance model (1943; see also Lerner 1944; 1947; 1951);
(5) Post Keynesianism (with influence from both Keynes and Michał Kalecki), and
(6) Hyman Minsky’s work (e.g., the employer of last resort idea and the financial instability hypothesis).

Economists who stand out as inventors of Modern Monetary Theory include L. Randall Wray (1998), William F. “Bill” Mitchell, and Warren Mosler.

L. Randall Wray explains the origin of MMT:

“[sc. the origin of MMT] ... goes back to PKT (Post Keynesian Thought) in the early 1990s—the first internet discussion group I ever heard of. It started off with all the stars of heterodox economics—Paul Davidson, Herb Gintis, Michael Perelman, Ed Nell; even Hyman Minsky contributed a post or two. And then there was ... Bill Mitchell ... He had little tolerance for Keynes but otherwise I found myself agreeing with him more often than with anyone else. On Kalecki, on Marx, on fiscal policy, and especially against the Austrians that were slowly but surely killing PKT.

And one other guy stood out—a hedge fund manager named Warren Mosler who was continually pushing two things. First there was something he called soft currency economics. It sounded to me like good old Keynesian economics from the Treatise on Money, which followed Knapp’s state theory of money. ....

What Warren also added was a much deeper understanding of bank reserves and treasury bonds. I came at this from the PK endogenous money, horizontal reserves view of Basil Moore. There’s nothing seriously wrong with that, but it never understood why a sovereign government would sell bonds. Warren explained bond sales as a reserve drain, and lightbulbs went off. Exactly right: government sells bonds to hit the overnight interest rate target. I think it was Mat Forstater who brought the final piece of the puzzle: Lerner’s functional finance approach.”

Wray, L. R. 2011. “MMT: A Doubly Retrospective Analysis,” December 11.

By 1995, Warren Mosler called his theory “soft currency economics.” I quote Warren Mosler:

“The origin of MMT is ‘Soft Currency Economics’ .... I had never read or even heard of Lerner, Knapp, [Innes], Chartalism, and only knew Keynes by reading his quotes published by others. I ‘created’ what became know as ‘MMT’ entirely independently of prior economic thought. It came from my direct experience in actual monetary operations ... .”
http://mmtwiki.org/wiki/History_of_MMT

Mosler, as I understand it, has a connection with Paul Davidson (see also this interview for Mosler’s passing remarks about Charles Goodhart and the LSE). One of Mosler’s early publications was published in the Journal of Post Keynesian Economics (Mosler 1997-1998: 167-182).

Chartalism clearly was an important influence on other Modern Monetary Theory economists, but MMT, as it now exists, goes well beyond the original theories of Knapp or Mitchell-Innes.

The leading proponents of MMT hold that it is now an independent macroeconomic theory (by contrast, the Cambridge Post Keynesian Mark Hayes regards MMT as a sub-branch of Post Keynesianism). At the very least, Post Keynesianism can be regarded as the important macro-theory that stands behind MMT as one of its intellectual fathers, so to speak.

Perhaps it is even possible to think of MMT economists as a new generation of Post Keynesians—that is, as a younger generation that has developed Post Keynesian theory in new ways.

Appendix
I will end this post with a list of advocates and supporters of MMT (mainly academics):

Warren Mosler
Randall Wray
Bill Mitchell
Pavlina Tcherneva
Stephanie A. Kelton (formerly Stephanie Bell)
Mat Forstater
Ed Nell
Scott Fullwiler
Mike Norman

BIBLIOGRAPHY

Bell, S. 2000. “Do Taxes and Bonds Finance Government Spending?,” Journal of Economic Issues 34.3: 603-620.

Goodhart, C. A. E. 2005. “What is the Essence of Money?” (Reviewing: Geoffrey Ingham, The Nature of Money, Polity, Cambridge, 2004), Cambridge Journal of Economics 29: 817–825.

Keynes, J. M. 1930. A Treatise on Money, Macmillan, London.

Knapp, G. F. 1905. Staatliche Theorie des Geldes, Duncker & Humblot, Leipzig.

Knapp, G. F. 1918. Staatliche Theorie des Geldes (2nd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1921. Staatliche Theorie des Geldes (3rd edn.), Duncker & Humblot, Munich and Leipzig.

Knapp, G. F. 1973 [1924]. The State Theory of Money (trans. H. M. Lucas and J. Bonar), Augustus M. Kelley, Clifton, NY.

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. 1947. “Money as a Creature of the State,” American Economic Review 37.2: 312–317.

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

Mitchell, Bill, 2011. “MMT is Biased Towards Anti-Crony,” December 28.
http://bilbo.economicoutlook.net/blog/?p=17528#more-17528

Mitchell, W. and J. Muysken. 2008. Full Employment Abandoned: Shifting Sands and Policy Failures, Edward Elgar, Cheltenham.

Mitchell-Innes, A. 1913. “What is Money?,” Banking Law Journal 30.5 (May): 377–408.

Mitchell-Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2 (January–December): 151-168.

Mosler, W. 1995. “Soft Currency Economics,”
http://www.mosler.org/docs/docs/soft0004.htm

Mosler, W. 1997-1998. “Full Employment and Price Stability,” Journal of Post Keynesian Economics 20.2: 167-182.

Mosler, W. 2010. The Seven Deadly Innocent Frauds of Economic Policy, Valance Co., St Croix, U.S.V.I.
http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

Wray, L. R. 1998. Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar, Cheltenham.

Wray, L. R. 2011. “MMT: A Doubly Retrospective Analysis,” December 11.
http://neweconomicperspectives.blogspot.com/2011/12/mmt-doubly-retrospective-analysis.html

Keynesian Stimulus in New Zealand: 1936–1938

It is not widely known that New Zealand escaped the high unemployment and economic malaise caused by the aftermath of the Great Depression by Keynesian stimulus. I intend to briefly describe this turn to Keynesianism in New Zealand here.

The actual contractionary phase of the Great Depression lasted from 1931 to 1933 in New Zealand, and the country experienced a contraction in real GNP of 14.6% from 1929 to 1932 (Rankin 1992: 61). The country left the gold standard in 1931, as the UK did, and its experience of the depression was not as severe as the US, since New Zealand had no collapsing asset bubble in 1931-1933 that had been driven by high levels of private debt. Hence it escaped the severe type of debt deflationary spiral that destroyed the US, though New Zealand’s farmers and mortgage holders did in fact suffer a lesser form of debt deflation. One of the major causes of the collapse was the fall in the prices of export commodities from New Zealand on world markets (a major part of GDP), as this spilled over into falling earnings for the primary commodity sector in dairy products, meat and wool (Hawke 1985: 127-128), and into falls in private consumption and investment spending.

The centre-right United-Reform coalition that ruled New Zealand pursued a severe contractionary policy from 1931, cutting government spending and balancing the budget (Wright 2009: 48–49). The economic contraction worsened and debt deflation affected mortgage holders (Wright 2009: 49–50), and by 1933 around 30% of the labour force was unemployed, representing some 240,000 people completely unemployed or severely underemployed (Rankin 1995: 13; Wright 2009: 43).¹

After the actual contraction, unemployment began to fall as a recovery began in 1934 after Joseph Gordon Coates, the Minister of Finance, devalued the currency in January 1933 (promoting some export-led growth), introduced a Reserve Bank for New Zealand (established from 1 August 1934) and a public works program (Wright 2009: 54; Easton 1997: 62; he also restructured some mortgage debt, see Sinclair 1990: 216). The fiscal stimulus was greatly expanded by the new Labour government elected in November 1935 under Prime Minister Michael Joseph Savage (whom you can see in the photo below).

Michael Savage presided over the introduction of the welfare state in New Zealand, and the introduction of a universal health care system. His government also introduced a highly expansionary fiscal policy with public works and social spending in 1936, 1937 and 1938. The state of government expenditure and unemployment can be seen in the table below (the data is from Dimand 2002 [1946]: 198).

One can see above how government spending was cut from 1930 to 1933. Increases in expenditure began in 1934 as the recovery ensued. The government deficits were covered by bond sales but also by direct central bank money creation (or “central bank credit”):

“The extensive use of central bank credit ... [sc. in New Zealand was] extremely unorthodox; and the amount involved was, for such a small country as New Zealand, substantial.” (Plumptre 1940: 289).

In fact, the central bank money creation bears obvious similarities to policies advocated by Modern Monetary Theory, and the state credit was used in public works spending and state housing.²

After New Zealand adopted strong fiscal expansion, employment fell very rapidly after the stimulus was introduced in 1936: the number of those on relief programs fell from 38,000 in 1936 to only 8,000 by December 1937 (The New Zealand Official Year-Book, Volume 94, Govt. Printer, 1990). By the estimate of K. Rankin, real GNP soared by about 18% in 1936, 5.4% in 1937, and 7% in 1938 (Rankin 1992: 61), driving real GDP back to its trend growth path by 1937 (Wright 2009: 43; 57).

New Zealand created valuable public infrastructure in government public works programs, and that infrastructure significantly aided the private sector in its creation of wealth in the form of production of goods and services:

“... public works [sc. in New Zealand] may to a large extent be called both an industry in their own right and a powerful aid to industry and commerce in general. Public works have, of course, been used for many different purposes.

During the depression they were, among other things, part of an elaborate system of unemployment relief. In the hands of the Labor government in 1936 onward they became an instrument for organizing economic recovery by the injection of purchasing power in the community, while at the same time resuming their basic function of developing the resources of the country. Within a couple of years of Labor’s return to office the Public Works Department had been thoroughly re-equipped and was employing over twenty thousand men, with an annual expenditure in the region of twenty million pounds. The range of work done by the department is very wide, the main items being roads, railways, public buildings, land improvement, and hydro-electric development. This last has been, indeed, one of the state’s main direct contributions to the country’s industrial progress.” (Wood 1944: 121).

In addition, the government helped to finance home loans via central bank credit (Wright 2009: 57) which created a large stock of housing.

All in all, New Zealand’s recovery shows the success of Keynesianism in action.


Footnotes
(1) New Zealand’s population in 1933 was only 1,547,100.

(2) These policies might have inspired the New Zealand Social Credit Party (1953– ), which, however, is probably not very appealing to left-wing people owing to that movement’s association with the right.

Update:
Reading the original post again, I thought I left out some important economic data. So I have updated it.

BIBLIOGRAPHY

Chapple, S. 1994. “How Great was the Depression in New Zealand? A Neglected Estimate of Inter-war GNP,” New Zealand Institute of Economic Research (Inc), Wellington.

Dimand, R. W. 2002 [1946]. Origins of Macroeconomics. Vol. 10, Routledge, London.

Easton, B. 1997. In Stormy Seas: the Post-War New Zealand Economy, University of Otago Press, Dunedin.

Hawke, G. R. 1985. The Making of New Zealand: An Economic History, Cambridge University, Cambridge and New York.

Plumptre, A. F. Wynne. 1940. Central Banking in the British Dominions, University of Toronto Press, Toronto.

Rankin, K. 1992. “New Zealand’s Gross National Product: 1859–1939,” Review of Income and Wealth 38.1 (March): 49–69.

Rankin, K. 1995. “Unemployment in New Zealand at the Peak of the Great Depression,” University of Auckland, Working Papers in Economics No. 144.

Sinclair, K. 1990. The Oxford Illustrated History of New Zealand (new edn), Oxford University Press, Oxford.

Wood, F. L. W. 1944. Understanding New Zealand, Coward-McCann, New York.

Wright, M. 2009. “‘Mordacious Years’: Socio-Economic Aspects and Outcomes of New Zealand’s Experience in the Great Depression,” Reserve Bank of New Zealand: Bulletin 72.3 (September): 43–60.

Bill Mitchell and Randy Wray on Modern Monetary Theory 2

These are the final 4 videos of the interview.

Bill Mitchell and Randy Wray on Modern Monetary Theory 1

This is a really informative and extended interview of Professors Bill Mitchell and Randy Wray on Modern Monetary Theory (MMT). These are the first 5 videos below. I’ll link to the next 4 in the following post.

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

Galbraith versus Krugman on Deficit Spending

In a recent post, Paul Krugman has criticised James K. Galbraith’s view of deficit spending. The latter is obviously influenced by Modern Monetary Theory. For the relevant documents, see here:

Paul Krugman, “I Would Do Anything For Stimulus, But I Won’t Do That,” July 17, 2010.

James K. Galbraith, Statement to the Commission on Deficit Reduction, June 30, 2010.

Krugman’s complaint is as follows:

there’s a school of thought which says that deficits are never a problem, as long as a country can issue its own currency. The most prominent advocate of this view is probably Jamie Galbraith, but he’s not alone.

Krugman is undoubtedly referring to Modern Monetary Theory (MMT)/neo-Chartalism. However, he is wrong to accuse neo-Chartalists of thinking that “deficits are never a problem.” In fact, Modern Monetary Theory says that, even though deficits are not “financially” constrained, they face real constraints in available resources, capacity utilization, the unemployment level, the exchange rate, the external balance, and inflation rate.

This is quite different from saying that “deficits are never a problem.” Clearly deficits can be, if they cause excessive inflation and push the current account deficit to an unsustainable level. Investor confidence is also a factor influencing the exchange rate, but, since behaviour in these financial markets is fundamentally irrational and subject to panics, one cannot predict what they will do, and the government should not be held hostage by them.

Krugman has misunderstood Galbraith. If we look at what Galbraith actually says, it is very clear:

[sc there is a] common belief that the government must borrow in order to spend, and thus that the government faces “funding risks” in private markets. Such risks exist … for private individuals, for companies, for state and local governments, and for national governments such as Greece that have ceded monetary sovereignty to a central bank. But the situation of the United States government is quite different. The U.S. government spends (and the Federal Reserve lends) in a very simple way. It does so by writing checks – in fact simply by marking up numbers in a computer. Those numbers then appear in the bank accounts of the payees, who may be government employees, private contractors, or the recipients of federal transfer programs. The effect of government check-writing is to create a deposit in the banking system. This is a “free reserve.” Banks of course prefer to earn interest on their reserves. Thus they demand a US Treasury bond, which pays more interest without incurring any form of credit or default risk … The Treasury can meet that demand, or not, at its option – it can permit, or not permit, the stock of US Treasury bonds in circulation to increase. So long as U.S. banks are required to accept U.S. government checks – which is to say so long as the Republic exists – then the government can and does spend without borrowing, if it chooses to do so. And, if it chooses to issue Treasuries to meet the demand, it can do that as well. There is never a shortfall of demand for Treasury bonds; Treasury auctions do not fail …. Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system. The actual risks in this system are (to a minor degree) inflation, and to a larger degree, depreciation of the dollar.

http://www.angrybearblog.com/2010/07/professor-jamie-galbraiths-testimony-to.html

Galbraith is entirely right, and Krugman omits the words in bold, and from these words it is quite clear that Galbraith understands that there are real constraints on deficit spending, not phantom “financial” ones. Moreover, it is perfectly clear that Galbraith is talking about deficit spending during a period of high unemployment and low capacity utilization, and perhaps even in the face of a double dip recession.

In his response to Galbraith, Krugman adopts the flawed quantity theory of money and attempts to prove mathematically what is perfectly obvious: that hyperinflation can result from continuous budget deficits that are monetized by the central bank. But, since Modern Monetary Theory already acknowledges that inflation is a real constraint on deficit spending, Krugman’s analysis seems rather pointless.

Consequently, James K. Galbraith is correct.

UPDATE

Galbraith has responded to Krugman:

http://krugman.blogs.nytimes.com/2010/07/17/more-on-deficit-limits/

It is clear Krugman has misrepresented Galbraith. Modern Monetary Theory has always said that there are real limits to deficit spending, and inflation is one of them.