Saturday, February 27, 2016

Limits of MMT

The Modern Monetary Theory (MMT) idea – or at least the idea shared by some supporters of MMT online – that imports are only ever a benefit and MMT is a viable policy for all nations are badly mistaken ideas.

Now MMT would work for the US, Western Europe, Australia, Japan, South Korea or Taiwan, but not for much of the Third World.

That is, MMT-style policies are best suited for advanced capitalist nations, not necessarily for Third World countries, because most of them face severe balance of payments constraints. Increasing aggregate demand would, for many Third World nations, simply cause a balance of payments crisis, as imports surged. Moreover, a huge stream of imports from the developed world tend to cripple the development of a domestic manufacturing sector in developing world nations, just as in the 19th century our Western civilisation smashed up so much of the Third World by free trade and the de-industrialisation caused by pushing our manufacturing exports on them (Bairoch 1993: 88–89). What is needed for much of the Third World is heterodox development economics, not MMT.

And, unfortunately, MMT has its limits even in the developed world. Imports aren’t always a good thing. Domestic production matters a lot. Self-sufficiency is a good thing in many commodities, e.g., food, agricultural and primary industries. Energy independence matters a lot.

Exports matter a lot even for some developed countries, because exports bring in foreign exchange if you can’t attract foreign exchange via the capital account (that is, via people bringing in foreign exchange to buy your domestic financial and real assets).

Finally, manufacturing matters – a lot. You can’t be a really great power and maintain great wealth and an advanced modern economy without manufacturing.

The US – despite what some people think – needs to remain a manufacturing colossus to remain a great power, and to be politically independent. Self-sufficiency in many commodities and a huge manufacturing sector translates into national power. You need national power to exist in a hostile world, to make credible trade deals, and to make sure you are not the victim of aggressive, bullying policies by other national powers.

Otherwise, any large enough trading power can start a trade war and cripple you by cutting off imports.

If you think imports are only a benefit, look at the devastating de-industrialisation of large parts of the Western world, e.g., in the US, look at the hollowed-out inner cities, devastated crime-ridden communities, the de-skilled, long term unemployed workers, and the collapse of all the related industries that rely on manufacturing.

Bairoch, Paul. 1993. Economics and World History: Myths and Paradoxes. Harvester Wheatsheaf, New York and London.


  1. Nice post LK.

    Also remember the success of nations itself is a consequence of balance of payments dynamics in the past. So rich nations are rich because they gained early advantage and are highly competitive.

    What I mean to say is that saying "MMT works for advanced nations" gives it too much credit. Because the advanced nations themselves became advanced because of external trade in the past.

  2. Indeed a nice post LK

    I recommend you to make a post about infant industry substitution and how it helped to almost all the prosperous countries to prosper.

    Ha joon chang wrote a lot about that.

    1. Have some stuff on that here:

  3. Can you expand on "Increasing aggregate demand would, for many Third World nations, simply cause a balance of payments crisis, as imports surged. "?

    Suppose a Third World nation decided to boost AD by increasing its budget deficit. This may indeed increase demand for foreign goods as people have more money to spend. But if they also have a floating exchange rate why would this cause a crisis rather than just a depreciation in their currency (that would be should lived if the MMT-style policy succeeded and boosted outut and productivity.

    1. Because if the depreciation is really high people will stop to invest in the economy of third world countries.

    2. The problem is that currency depreciation doesn't always solve balance of payment crises in developing countries, due to the price elasticity of imports and exports. In fact, currency devaluations can actually make the trade deficit worse if a country's imports are highly price inelastic (such as oil), and there is little or no capacity for domestic production.
      For example, if Sri Lanka devalued its currency, the import bill would actually grow because the consumption of oil (their main import) would not change, in spite of the price increase. Rich countries such as Sweden or Canada can use devaluation to balance their trade accounts because they have highly diversified economies and are capable of substituting away from imports in a flash. Countries like Sri Lanka or Malawi cannot, at least not without triggering a recession.

    3. False: "if Sri Lanka devalued its currency, the import bill would actually grow".
      In terms of foreign currency (which is what matters in this context) payments for oil etc. would DECLINE, albeit only slightly with inelastic price elasticity of demand.

  4. Like most others who critic MMT, you miss the other half of the statement about "imports are a benefit and exports are a cost" which is - At Full Employment.
    Bill Mitchel has addressed your concern about MMT and its application to lessor developed nations -

    1. But he concedes my point, actually:

      "Clearly, when an economy that experiences a depletion of foreign exchange reserves has to take some hard decisions in relation to its external sector, especially if it is reliant on imported fuel and food products. In these situations, a burgeoning CAD will threaten the dwindling international currency reserves.

      In some cases, given the particular composition of exports and imports, currency depreciation is unlikely to resolve the CAD without additional measures.

      The depreciation, in turn, raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, depreciation leads to expectations of further depreciation and fuels the run out of the currency. There may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default.

      In the short run there is probably no alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default. ....
      If a country has a chronic and crippling shortage of foreign reserves, then the government should negotiate with the multilateral agencies to develop a program that would allow the country to service its external debt, and gradually reduce its trade deficit until it reaches a more manageable level. ....

      Finally, where imported food dependence exists – then the role of the international agencies should be to buy the local currency to ensure the exchange rate does not price the poor out of food. This is a simple solution which is preferable to to forcing these nations to run austerity campaigns just to keep their exchange rate higher. The IMF would do well to reform its charter and adopt this role instead of the destructive role it currently plays around the world."

      Also, since a number of weaker Eurozone nations are constrained in much the same way as nations were under the gold standard MMT weren't work there.

    2. MMT as a framework shows exactly why weaker Eurozone nations have constraints.
      As others have mentioned in the comments, you are missing the point of MMT - the logical way of looking at the current monetary systems. MMT doesn't "work everywhere", but it shows logically why it works and doesn't work.

  5. Wouldn't any spending boost flowing indirectly into imports, be limited by inflation targets cutting government spending?

    Increased Imports -> Depreciation -> Inflation of imported good prices -> Inflates domestic prices dependent on imported goods -> pushes towards inflation target

    Maybe that's wrong, just how I've usually viewed it.

  6. A bit disappointing really. I'm not quite sure why PKs struggle with the way floating rate exchange systems work.

    I presume you've seen Bill's posts of a couple of weeks ago that addressed these points directly. I don't really see any incorporation of them into the narrative. The same strawmen still seem to be there.

    1. Neil,

      Is it your belief that no Third World nation with (1) a floating exchange rate and (2) increased government spending has ever had a balance of payments crisis?

      Also, Bill Mitchell himself seems to acknowledge this problem:

      "But a nation might have a food supply problem just because of location. Then they have to import food. For example, in Kazakhstan where I am working at the moment, they face really significant problems in winter getting fresh vegetables and fruits. Many of these nations also have very little that the World wants by way of their exports. The fact that such a country’s national government is sovereign in its own currency and can spent how ever much it likes in that currency will not solve the problem – there is not enough goods and services (in this case) food for the sovereign government to purchase.

      In those situations, a country requires foreign goods and they need to export to get hold of foreign currency or receive development assistance from the rest of the World. In the latter case, I see a fundamental change is required in the role of the IMF (more or less back to what it was intended to do in the beginning). Where are country is facing continual current acccount and currency issues as a result of the need to import essential goods and services, the IMF might usefully act to maintain currency stability for that country."

      His response that Third world nations need massive reforms of the IMF and international payments system simply concedes my point, as I said.

      Unfortunately, there are many Third world nations that fit his description here: nations that are poor, little productive capacity, reliant on imports, nobody really wants their currency.

    2. "A bit disappointing really. I'm not quite sure why PKs struggle with the way floating rate exchange systems work."

      Did it ever occur to you that it could be the other way round Neil?

    3. I agree with Neil on this. Afaik the above post does not accurately represent the MMT position (if there is such a thing as THE MMT position), far from it. For example, I have read posts by Warren Mosler where he explicitly makes the case for self-sufficiency in industries of strategic importance (e.g. defense), even if this requires shielding said industries from international competition because they cannot compete globally.

    4. People don't understand MMT's point on this because it's extremely unclear. The MMT assumptions about behaviour of floating exchange rates appear to be linear but nobody actually says anything to confirm this. All Kaldor did initially was to take Keynes linear model and translate it.

  7. This post misunderstands MMT, which is not a policy, but "merely" a successful attempt to speak economics in a consistent way that makes sense. Saying MMT only applies to advanced nations is like saying logic only applies to advanced nations. It's not a viable policy, because it is not a policy.

    If you go to a grocery store, and buy eggs, the seller is exporting them to you. That is a cost to him. You are importing them, that is a benefit to you. You become indebted to the store, and you must repay the debt by an opposing transaction, say by exporting to him a dollar bill, which he imports.

    This is what MMT means by "imports are a benefit". You have to be off your rocker to disagree. There would be no need to say such things but for the fact that most, widespread economic beliefs in fact are filled with such "off your rocker" beliefs.

    As Rob Rawlings points out above, the concept of "balance of payments crisis" makes no sense in a floating rate environment. And all money is "floating" "fiat" "credit" money. There isn't any other kind. People just put kooky constraints on money like fixed rates to fit kooky theories, and pretend that it magically changes "fiat" money into something else.

    MMTers are well aware of all the matters you point to, are all for import substitution policies whatever when they are needed for poorer countries - some have worked with and advised countries. But the existence of such problems is no reason to stop using economics that makes sense = MMT very broadly defined, and go back to incoherent "economics" that doesn't.

    1. "If you go to a grocery store, and buy eggs, the seller is exporting them to you."

      Um, no, that analogy is wrong, because you are using the same currency.

      International trade happens between different nations and currency areas.

    2. Floating exchange rates are a mechanism for adjustment, but it certainly doesn't work in an equilibrium-type setting where trade balances always tend back towards 0. First there's the idea that exchange rates don't do as much as theory says they do (in part because it relies on what your export sector has to sell, and whether you have willing buyers). Secondly there's the fact that other countries engage in mercantilist policies and make it difficult to export to, or engage in currency manipulation (including strengthening the opposing currency using reserves gained from exports, like Japan buying US Bonds). And thirdly simply because some nations have a better capacity and credibility to maintain larger trade deficits like the US, and receive capital flows in its stead instead of having its currency weaken.

  8. Right, and also since we're discussing Verdoorn's Law more on the blogosphere thanks to Friedman, MMT would hurt in that regards if they're okay with shrinking domestic manufacturing. It may mean that they there's less productivity and less innovation if the export sector in manufacturing is neglected.

    It's definitely something to worry about in regards to countries like the US, UK, Australia and France.

    Plus there's the basic issue of Political Economy. Trade deficits acts as a "leakage" of demand so to speak, and requires either higher public deficits or higher private investment and consumption (coming from either savings or private debt) to make up that lost demand while maintaining full employment and full output. Instinctively, people don't like large public deficits, although this depends to some degree with how much Elite interests control the debate in the media. But even if MMT were to become widespread, there'd still be a natural instinct among the public to shun large public deficits. Thus we'd get a lack of congressional support for higher public deficits, and in its place bigger credit bubbles which end disastrously.

    It's just easier to not have big trade deficits than to suffer through credit bubbles.

  9. Without the data you’re just another person with an opinion - W Edwards Deming

    So what does the data say?