Palley on MMT

Ramanan is very impressed by Palley's MMT critique (pdf) and while I think there are good MMT critiques out there, I don't think Palley's is one. I also think, crucially, he missed why MMT has (what little) appeal that it does.

Palley is correct, though, in pointing out that a failure to phrase things in terms of DGSE means that the theory has not made headway in the academy. I know JKH hates the term "paradigm", but it was used by Kuhn in a particular way for a particular reason which is applicable here, and Palley lays it out very clearly in his introduction:

This question can only be answered by placing that power within a theoretical model and exploring its implications. For the last seventy years the language of macroeconomics has been small scale simultaneous equation models with dynamic adjustment mechanisms attached to explore issues of stability. Proponents of MMT have a professional obligation to provide such a model to help understand and assess the logic and originality of their claims.

I am not opposed to models at all, as I've stated repeatedly on this blog, but I also know that if you start with radically different assumptions you're not going to make progress and MMT attacks orthodox macro at the assumption level. Moreover, models are built within pre-existing interpretations, you do not write out a bunch of equations and then do what they say, and when you're changing the interpretation, beginning with equations may not help.

Before diving into the Palley paper more deeply, let me also say that the only reason MMT currently has it's current moment is because orthodox macro has failed. It's been failing in Japan for 30 years, but now that we have the same situation in the US, and we have the internet and write in English, the failure has become pretty clear. Palley is right in asking MMT to explain price stability and full employment, provide a credible theory of inflation, and justify monetary policy and it's effects; but frankly I think all of those questions can be turned on textbook macro as fairly, and with greater urgency since they are the ones in the drivers seat. Because right now there's a big gap between what's between the book jacket and what's outside the window.

Palley spends some time talking about how it is common knowledge that "sovereign issuers of money are not constrained financially in the normal sense". Great. And yet we hear continual talk about the US Govt running out of money. So it may be common knowledge for Palley, but it is not common knowledge more broadly, and if MMT is working to popularize that understanding he should be applauding it not yawning. A little support towards the common good, please.

Oddly, Palley makes no distinction between the US situation, where the deficit is in US$, and the EU situation where member country deficits are in euros. So there seems to be a real difference between the Palley view and the MMT view on this.

Like Palley, I am stunned by the claim that MMT rejects counter-cyclical fiscal policy. Certainly contrary to what I've heard, and if Wray really does take this position then we'd have to disagree. There's a longer post I keep meaning to write about "employment" where I want to talk about this further. However, I don't agree that MMT has no theory of inflation, nor do I think there is a single "theory of inflation" as the observed behavior can have different causes. The Phillips curve has, at times, not accorded with reality.

If I'm to engage with the model Palley sketched out (thanks!) it would be to point out several areas where his sketch conflicts with MMT.

1) Palley asserts that the deficit (D) be zero in a static economy, thus requiring T - G = D = 0. However, in MMT aggregate demand is conditional on the need for what I'll call "savings" for now to be met, "savings" defined as G-T. And this demand may be non-zero. It is, in fact, the very variability of this which Palley does not model, and so misses the core MMT contribution.

2) Palley also sets up a condition where Gmin cannot exceed Tmax. Again, in MMT, why? Certainly if the policy interest rate is set to zero, any difference between Gmin and Tmax can be made up by the consolidated fiscal and monetary authority (which Palley supports earlier) borrowing from itself, or running in overdraft conditions, depending on how you want to think about it.

3) And finally, I would ask that Palley himself puts forward a theory of inflation in his model beyond the footnote where he says "to avoid inflation the high-powered money stock must grow at the rate of growth". Why? What exactly is the automatic transmission mechanism between high-powered money (a stock) and inflation (necessarily a flow phenomenon)? There is no automatic mechanism, on a volitional one (spending) and it is here that MMT adds something beyond standard Keynesianism.

Finally, I too have concerns with ELR, but I don't believe they are part of MMT, merely a policy recommendation, and my concerns are different from Palley's, who attacks it from the Left.

To come: flexible exchange rates where I give first hand testimony from the great ruble crises of '98