Making your nut: MMT is really not Monetarism

A while ago I posted why I thought, contra Interfluidity, that MMT was not monetarism. I stand by this assertion. Interfluidity countered by saying that Sumner (sort of an idiot-savant of the Monetarist school) supported a payroll tax holiday and gave a couple of links in the comments. Here's one.

In actuality, Sumner advocates for an employer side cut after holding his nose and saying it's "far less efficient than monetary stimulus". In my opinion, this is a far cry from the MMT position as a payroll tax holiday immediately as monetary stimulus is a fairy tale, but you can make up your own mind. What's more interesting is the reasoning, which shows why MMT and Monetarism as, in fact, like chalk and cheese.

Monetarist believe that the Fed can control the price level (really -- "The Fed controls the price level") although the mechanism they use for this, controlling the quantity of reserves, has no way to enter the real economy because reserves are used to payment settlement, and bank lending is not reserve constrained.

So, why do Monetarists believe an employer side payroll tax holiday will be helpful at all?

For very complicated reasons it is hard to directly cut the nominal wages of workers. But you can cut the nominal labor costs to companies very easily—just reduce payroll taxes. Now that the Keynesian fiscal stimulus has not worked, the Obama team is looking at new ideas. They are rediscovering the merits of sticky-wage theories of the business cycle, which I am one of the few economists to still adhere to

"Sticky wage theories of the business cycle" means that, since employees will not accept nominal wage cuts, in deflationary environments where real prices are falling, sticky nominal wages means that the real marginal cost of labor goes up, and employers can only respond by firing people -- hence unemployment.

It's true that nominal wages are sticky downwards, but employers fire people when sales fall because demand is not there. There's a straightforward story for why nominal wages are sticky downwards, and it should be obvious to anyone who has taken out a loan -- debt (and interest) is nominal. People carrying debt have to make a nominal nut every month.

If you have a loan which requires a payment every period, that loan balance and monthly nut is nominal, and will not change. In a deflationary environment, the real burden of nominal debt grows, which is what triggers defaults. When loans default, banks write down capital, which constrains their ability to extend further credit as bank lending is capital constrained (not reserve constrained, as Monetarists believe). As credit contracts, prices fall further, as assets that are traditionally bought on margin have a different cash price and leveraged price. Houses would cost less if mortgages were outlawed.

This is the "debt deflation" spiral and Monetarists miss it because they don't, ironically, have debt in their models. The ignore it by thinking it's just a transfer. As MMT gets bank lending right, it understands the horizontal component of money, and thus avoids this mistake.