...against fictions and other tall tales

Sunday, 25 November 2012

Old Keynesian themes in Modern Monetary Theory

Readers of this blog know I'm generally supportive of the views espoused by proponents of Modern Monetary Theory (MMT). The reasons are fairly simple. First, MMT considers unemployment to be an important problem that must be quickly and effectively addressed by the government authorities.  I agree with that.  Also, MMT makes a good case on the important role of fiscal policy in ensuring stable and equitable economic growth.  Again, I agree with that.

But there is another reason I'm generally in agreement with MMT on many issues.  This has to do with the fact that MMT builds on some pretty solid economic thinking, much of which was well understood and accepted by earlier generations of Keynesian economists.  As someone who has a lot of respect for and who finds much insight from this earlier Keynesian tradition, I'm quite pleased to see MMT, a more recent school of thought, disseminate these views.

I was reminded of some of these - let's call them - "Old Keynesian" tenets in a recent blog post by Paul Krugman, in which he discusses a trifecta of issues relating to (1) the benefits of monetary sovereignty (i.e., where a nation issues and uses its own currency), (2) the debate on the supposedly inflationary nature of deficit spending financed via money creation or bond issuance and (3) the recent controversy regarding the potentially expansionary consequences of a "loss of confidence" in US government bonds by international investors .

The first of these views concerns monetary sovereignty, a central MMT theme.  This was also a well understood concept by earlier Keynesian economists.  For instance, monetary sovereignty was a key aspect highlighted in the work of economist Robert Eisner, who brilliantly described in his book The Misunderstood Economy (1994:74) why the US greatly benefits from being a currency issuing nation:
[One] point that is widely misunderstood or unrecognized is that this debt, relatively small as it is, is all owed in its own currency, US dollars.  We pay interest and principal in US dollars.  And our Treasury and Federal Reserve can always create all the dollars we need.  One may object that such money creation or the monetization of the interest-bearing debt may have undesirable consequences, particularly greater inflationary pressure.  But it may also have the desirable effect of stimulating the US economy if that is in order. In any event, the fact that US debt held by foreigners is virtually all denominated in US dollars rules out the possibility of unvoluntary default on US government obligations.

We are not in the position of many third world or other debtor nations that sadly had obligations in foreign currencies, frequently the US dollars.  The only way they could service their debt was to obtain foreign currencies. [...]

The "world's greatest debtor nation" gave the American public visions of the US going bankrupt.  Since the debt was essentially in our currency, however, this made no sense.  We could "print" out own money to pay it off or, in more sophisticated fashion, have the Federal Reserve create the money. (1994:74)
Several other Keynesian economists also held similar views, including economist Lorie Tarshis who emphasized this point in Elements of Economics (1947), the first Keynesian textbook to be published in the US.

Secondly, concerning the ever-lasting debate on the supposedly inflationary nature of deficit spending financed via money creation or bond issuance, MMT considers that the latter should be viewed as more inflationary than the former since the interest payments paid by government on its debt results in a greater expansion in the money supply (in the long run) than if the deficit is financed by money creation.

On this point, it may be instructive to recall that economists Alan Blinder and Robert Solow demonstrated long ago that the "potency" of deficit spending via money creation or bond issuance is not strictly related to the manner of financing.  In fact, Blinder and Solow demonstrate in "Analytical Foundations of Public Finance" (1974) that deficit spending financed via issuance of bonds has under normal, steady-state equilibrium conditions a greater fiscal multiplier than deficit spending via monetary financing in the long run:
When we correct an oversight committed by almost all previous users of the government budget constraint, a still more odd result emerges.  The error has been to ignore the fact that interest payments on outstanding government bonds are another expenditure item in the budgetary accounts. [...]

Under a policy of strict monetary financing, [in a stable system, the long-run government expenditure multiplier is simply the reciprocal of the marginal propensity to tax].  But the issuance of new bonds means a greater multiplier in the long run. (1974:50). (original emphasis)
Finally, as for Krugman's contention that a loss of confidence in US government bonds by investors may have potentially expansionary consequences for the US economy, economist Bill Vickrey presented a similar argument in his article entitled "Fifteen Fatal Fallacies of Financial Fundamentalism" (1996).  On whether a sell-off of US government bonds by foreign investors would have a detrimental effect on the US economy, Vickrey suggested the following:
It is not intended that the domestic government debt should be held in any large quantity by foreigners.  But should foreigners wish to liquidate holdings of this debt or any other domestic assets, they can only do so as a whole by generating an export surplus, easing the domestic unemployment problem, releasing assets to supply the domestic demand, and making it possible to get along with smaller deficits and a less rapidly growing government debt.  The same thing happens if domestic investors turn to investing in foreign assets, thereby reducing their drain on the domestic asset supply.
All that to say that, in my opinion, both Paul Krugman and proponents of MMT stand on solid ground regarding these issues.


Blinder, Alan and Robert Solow, "Analytical Foundations of Fiscal Policy," in A. S. Blinder, et. al., The Economics of Public Finance, The Brookings Institution, 1974, pp. 3-115.

Eisner, Robert, The Misunderstood Economy: What counts and how to count it, Boston: HBSP, 1994.

Tarshis, Lorie, The Elements of Economics, New York: Houghton Mifflin, 1947.

Vickrey, William. "Fifteen fallacies of financial fundamentalism: A disquisition on demand-side economies", Proceedings of the National Academy of Sciences of the United States of America, Vol. 95, No. 3, February 1998, pp. 1340-1347.


  1. Great post! Of course, we're big fans of Eisner, Tarshis, and Vickrey. Thanks for the Blinder/Solow cite--hadn't seen that, but I might be the only one.

    Scott Fullwiler

  2. It's important to insert MMT within a broader Keynesian tradition. What's significant is that too many proponents forget that much of the narrative had been written with different nuances and different emphases. I like to read Scott's appreciation of the uncredited many. I'm still waiting for someone to nod Lombra and Torto, besides yourself, for mapping new channels, eons ago.

    Well done circuit. You're configuring a more credible and unpartisan history of the variant.

    @Scott: You're not the only one! But you are exceptional: you're too generous towards others. Alan is by far the most misread thinker of that community.

  3. I'll go along with Scott and GC: it's a great post!! But I do want to remind MMTers that without Paul Krugman propogating the variant, as GC calls it-in passing, I like that 'nuance', MMT folks would still be hiking along local trails rather than flying across oceans. Paul Krugman did the the variant an unimaginable favor, and someone besides Circuit and FRB should recognize the man. He gave them an global audience and a global podium Well done PK!!!

  4. @Scott: I agree with GC regarding Prof Blinder. I, for one, have learned tremendously from his work on counter-cyclical fiscal policy. Also, I should add that Prof Blinder is co-author of the best economics textbooks in Canada. The other co-authors are Profs Baumol, Lavoie and Seccareccia.

  5. Yes, Marc and Mario gave me a copy of their book. It's very good--far better than anything in the states.

    Blinder's book on asking about prices is very good, too. And what a novel concept--going out and LOOKING at how prices are set (!!).

    Of course, even without PK's recent epiphanies we've been traveling oceans for years already (I'm not one of the MMT biggies, but even I shared a keynote panel with Skidelsky almost 4 years ago before the blogging started). But there's no doubt the agenda (and in the end it's about the agenda, not who's pushing it, MMT or otherwise) requires the inner reaches of the academy to take it on at some point, or at least to gain legitimacy as one of the debated approaches. And PK is about as good as it gets in that respect.

  6. Don't undersell yourself Scott. You're one of the biggies is as far as I'm concerned.
    Circuit, my understanding is even Keen has come on-board with MMT, he still has a few little nitpicks but that's what the MMT/Circuit discussion has all been about - MMT really just expands on Circuit theory. So I was wondering if we can call jump aboard the united Modern Monetary Train whether under the banner of MMT or MCT/TCM but mostly I was wondering about if YOU would?

  7. Thanks for that quote about the external sector. I've been pushing that point over the last few weeks myself.

    The problem with classical economics is that it portrays the external sector as some Old Testament God - able to dish out punishment without any effect on itself.

    That is impossible.

    If you have a world full of export-led economies pushing policies that are absolutely mainstream and the IMF is supporting those policies then there simply cannot be a bond led impact on an import-deficit country.

    It would be like nuclear war. Mutually assured destruction.

    Again this shows a lack of understanding that there are two sides to a balance sheet. For my currency exchange value to go down *everybody elses* has to go up.

  8. I think PK still believes money-financed deficits to be much more inflationary due to the multiplier effect. So bond issuance ads ~5% to the spending due to interest payments, while the monetary base increase multiplies ~10x and trumps the inflationary effect of bond issuance. That was his last post on MMT from August 15th, 2011.

  9. @Senexx: I agree that Scott's work is excellent. Check out his "Social Matrix" paper. Best institutional analysis of the Fed in recent years.

    As for me, I'm on board as long as we keep focusing on what truly matters: a common goal regarding the need for greater fiscal policy right now is essential. On that note, keep in mind that Randy mentioned in a post this summer that he agrees with about 90% of what Prof Krugman says. That's pretty good in my books. Let's focus in that 90%. As B.Swells is implying, there's an opportunity here to move things forward.

    Just curious: where does Keen say he's on board with MMT (minor a few things)? Interesting development, indeed.

  10. Replies
    1. Thanks for your support. It's very encouraging to get feedback from readers.

  11. Outstanding post. We are all Keynesians now.

  12. @Circuit !
    I'm not at all surprised that your latest post highlights Jim Tobin's trademark 'Old Keynesians',(1992&1993) nor am I surprised that most of your regular readers are most probably quite at ease with the label, although Mankiw (not sure if he's a reader) says he can't tolerate labels, he certainly enjoys his spokesmanship of 'New' Keynesianism.

    I think there's more to the Oldies than meets this and the last Keynesian generation reading of the tradition" Some Newies may have suffered from Miltonian élan. As GC mentioned, and you have nodded over the year- MMT has still neglected to nod Lombra and Torto. One wonders why. Maybe some of the newies are just browsers, and skipped the early chapters of the canon.

    There are gems in the Old literature. You're digging them out,and polishing them very well, and designing some very powerful craft.

  13. I agree it would be a good idea to do a paper on Lombra/Torto. They nailed it long ago and it would be enlightening to others probably to see it in practice. Of course, there were many in the PK/Circuit tradition getting it right back then or earlier, too.

    Another would be one of my profs, Wally Peterson, who was writing much the same in his intermediate macro text as is stated in the above quotes from Solow, Eisner, etc.

    Some might take note that MMT'ers published a few edited volumes years ago of Vickrey's work, and were citing Eisner early on. I still have my copy of "The Misunderstood Economy" in my office next to my macro textbooks (such as Wally's!).

    1. btw, Wally passed away earlier this year, fyi. http://journalstar.com/lifestyles/announcements/obituaries/peterson-wallace-c/article_267153c6-ffc4-56f0-a3cf-ad3cd2bdaac5.html

  14. Anyone got a link for the Blinder stuff? Can't find it.

  15. @Edmund: Thanks for the note. As for the quote, I got it straight from the book.

    @Scott: I read Peterson's book on Social Security not too long ago. It's very good. I can see the influence on your work. Also, I could always tell Eisner influenced Randy, for instance (his '98 book, in particular). I would venture that there is a link with Krugman here. I'm sure he's familiar Eisner's work.

    @MI: I once told Jorge "You must be reading my mail". This would apply to you too! I agree there's some great older literature that should be tapped into these days. I like the expression "Miltonian élan" - must remember that.

  16. At the time of writing I was relaying some information I obtained from Keen's students - however I believe he's onboard now with his youtube on continuous and discontinuous injection of money, I think it may have been the one he did at the Fields institute.

    My reading of the situation though is he still has a differing understanding of the role of government debt. He has not been explicit on this point, so its hard to tell.

    1. OK, thanks. I'll check out the You tube video. Appreciate the response.

  17. Anyone whom stands with Freddy Krugman, is an affirmed Socialist...