President Biden’s proposed $6 trillion budget will not be fully paid for with tax increases or other spending cuts. It will increase the deficit, according to Stephanie Kelton, and that constitutes an implicit if not explicit adoption of the principles of modern monetary theory (MMT)
Kelton is a professor at Stony Brook University and was an economic advisor to Bernie Sanders for his two presidential campaigns. She spoke on June 3 at the FPA NorCal conference, which was held virtually.
She is also the author of The Deficit Myth and is an outspoken advocate of MMT. I last wrote about her here.
Before I get to her comments about Biden’s policies, l will review what she said about the underlying assumptions and framework of MMT.
Kelton described MMT as a macroeconomic school of thought or paradigm that explains how a sovereign country that controls its currency behaves. It does not apply to countries that are part of a common currency, like the euro, or with non-fiat currencies that are convertible into, for example, gold.
MMT has come under intense scrutiny from prominent economists, but Kelton said that it has been mischaracterized. Paul Krugman wrote that deficits don’t matter, and Larry Summers said MMT means governments can spend forever. She called those statements, “deliberate attempts to mischaracterize MMT.”
Deficits matter, she said, but not the way we are taught. You cannot think of government budgets as a personal budget because governments get to issue their own currency, whereas ordinary citizens are users of it.
“We cannot assume that persistent deficits are unsustainable or that interest rates will eventually go up,” she said, “increasing the likelihood of a default.”
Kelton reviewed the last 15 years of economic policy. She said that the fiscal response to the 2008 crisis was insufficient. As a result, the Fed, led by Ben Bernanke, stepped in with quantitative easing. A debt crisis ensued for countries in southern Europe (the “PIIGS”), and that motivated President Obama to heed the warnings that the U.S. could face a similar fate. That led to the formation of the Simpson-Bowles commission, which recommended tax cuts to “pay” for the deficit. It lacked support, and the deficit continued to grow. There were increases in the debt ceiling with accompanying promises to “get our fiscal house in order,” she said. Sequestration began in 2013, which meant automatic budget cuts to constrain the deficit. Bernanke responded with QE3, the most aggressive iteration of quantitative easing. But QE is not very powerful, she said, and it didn’t stimulate the economy sufficiently. President Trump eliminated sequestration and implemented tax cuts. Summers and Krugman warned against those cuts, she said, as leading to a disaster, which did not happen. Under Trump, there was modest growth, low inflation, but no terrible consequences of the deficit.
The upshot of that 15-year history, in Kelton’s telling, is that successive administrations have spent through fiscal policy and grown the deficit, yet the U.S. has not faced the consequences that Krugman, Summers and others have warned against.
In 2020, the presidential candidates all had bold proposals with plans to pay for their spending, she said. But COVID hit, and Congress spent aggressively without a plan to pay for it.
“If the votes are there,” Kelton, said, “the money goes out.”
Has there been a paradigm shift? Will Congress consider different constraints, other than the budget and deficit, on its spending?
The Biden White House has proposed a $6 trillion budget, which will keep deficits above a trillion for the next 10 years, she said. Biden wants to pay for it, but not it the usual ways. Revenue will come in slower than spending, so the deficit will rise.
“He is owning this,” she said.
But those MMT-like policies will deliver good outcomes. Biden says unemployment will fall from 6.1% to 4.1% in a year and will stay below that level. Inflation will stay below 2.3%, according to Biden.
Summers is now worried because of “overheating,” she said, because of the growth of spending. Summers has said Biden’s policies will unleash a “wave of spending” that will create inflation, according to Kelton. Inflation is the relevant risk, she said, and Summers is worrying about something appropriate.
Inflation is evidence of too big a deficit, Kelton said. But inflation does not mean that there is too big a deficit; it can be due to “excessive demand pressures.” That is what is happening, according to Kelton, with temporary shortages of goods like computer chips and lumber that will soon self-correct.
The inflation we are experiencing is related growing pains, and that does not mean it will lead to higher interest rates. The way to fight rising costs, such as in health care, is to control them, not to raise interest rates.
The Fed has loosened its 2% inflation target to allow for temporary periods above that level, as long as the average is 2%. But the Fed hasn’t said over what time period that average will be calculated, so a transitory spike in inflation will not be met with rate hikes, according to Kelton.
Deficits are completely normal and almost always necessary, she said. We need deficits to offset those “actors” in the economy who have a propensity to save. Government deficits are the mirror image of private sector surpluses. During the Clinton era, the private sector “leveraged up,” she said, spending more than it earned, causing the federal deficit to go into surplus.
The reverse happened during the Obama presidency, when government deficits exploded, but the private sector was in surplus.
“The government deficit is nothing more than a financial surplus that goes to another part of the economy,” Kelton said.
The national debate has shifted away from deficit phobia to whether and how to pay for spending. But what does that mean? For every dollar spent, we don’t add to the deficit. The financial constraint does not exist and should be replaced by a resource constraint. Only MMT centers on the inflation risk, according to Kelton. Congress should worry about increasing inflationary pressure when it spends.
Every deficit is good for someone. The $1.9 trillion tax cut passed under Trump benefited corporations and the wealthy, she said. The COVID rescue package was good for another constituency. The question for any spending package is, “For whom and for what?”
MMT changes the way we think about tax increases. Recounting her experience in Washington, Kelton said that, for those in the “beltway,” all taxes are the same in that they pay for spending. Nobody cares about the source of the revenue as long as it matches the spending. Lawmakers should think differently about how to approach spending, she said, and inflation is the relevant risk.
Investors have been anticipating higher rates for the last 20 years, Kelton said, and they keep getting lower. Maybe rates won’t go higher, she mused.
For the last 20 years, the Fed has responded to recessions by lowering its target Fed funds rate. But it has started and ended with lower Fed funds rates than the previous recession. That signifies that the Fed has shifted to a new framework where interest rates won’t and can’t be used to stimulate economic activity or to control inflation, according to Kelton.
You want good economic outcomes: low inflation low unemployment. Those are the goals of the Fed and of macro policy, according to Kelton. But we have relied on one lever, monetary policy, to do the “heavy lifting.”
Monetary policy, by lowering rates, forces the private sector to take on debt and eventually causes a recession. We don’t use the other lever of fiscal policy to supplement it, according to Kelton. Bernanke, when he was Fed chairperson, acknowledged that monetary policy is not an ideal tool.
Fiscal policy is getting a more permanent role in the economic toolkit.
Robert Huebscher is the founder and publisher of Advisor Perspectives.
Read more articles by Robert Huebscher
President Biden’s proposed $6 trillion budget will not be fully paid for with tax increases or other spending cuts. It will increase the deficit, according to Stephanie Kelton, and that constitutes an implicit if not explicit adoption of the principles of modern monetary theory (MMT)
