Thread by @JohnArnoldFndtn

1/ A short rant on the deficit & Modern Monetary Theory. MMT states that since the US can print as much $ as it wants, it can never go bankrupt and deficits are generally not important. Thus, the US should run significant deficits to maximize productive capacity. All good so far.

2/ The problem is that the economic and political realities of how government works means that this policy will end badly. Even the leading proponent of MMT, Stephanie Kelton, believes the policy can be overdone.
bloomberg.com/opinion/articl…

3/ Intuitively, it must. Otherwise, we should cut taxes to zero and double all spending. If there are no negative ramifications to the deficit, then let’s go. But even Bernie Sanders, whom Kelton worked for, has a section on his website “How Bernie pays for his proposals.”

4/ After the Great Recession, many people believed quantitative easing & huge deficits would lead to significant inflation. Obviously, that did not happen. The result is that given no short-term ramifications, politicians from both parties have lost interest lowering the deficit.

5/ Rs appeal to their base by cutting taxes and increasing military spending. Ds do so by adding programs and entitlements. Both increase the deficit. In the recent budget compromise, Ds agreed to increase military spending in exchange for Rs increasing domestic spending.

6/ Look at what happened when Paul Ryan, once the most vocal critic of deficits, became speaker. He presided over tax cuts, military spending increase, and domestic spending increases. There is zero political incentive or will to propose anything that will decrease the deficit.

7/ On the contrary, political incentive is to keep passing policies that increase the deficit, at least until there are very salient negative ramifications, like inflation or market loses faith in future buying power of the $, causing a major devaluation that leads to inflation.

8/ Now remember, the budget deficit is already on pace to reach unprecedented levels if current law does not change from how it is today, even before any future policy changes justified by MMT or dynamic revenue effects of tax cuts.

9/ Until there are visible negative ramifications, politicians will keep pushing new negative budget policies. Why not? That’s the whole reason this process got started. In other words, politicians will keep making the deficit worse until there are negative ramifications.

10/ MMT supporters believe that whenever this happens, policy can be tweaked (largely by raising taxes) to taper inflation. I’d like to introduce the MMT supporters to the American political process. The govt has been shut down for 2 weeks fighting over a few billion $ on a wall.

11/ The idea that we can easily reverse the policies at the first whiff of negative ramifications is not realistic. It will take years of visible negative ramifications before politicians even stop proposing new policies that increase the debt.

12/ Politicians only get the political will for tough decisions when there is major crisis. There will be no interest in a bipartisan compromise mirroring the Grand Bargain until the economy is in crisis. But the natural response to a crisis is to cut taxes and increase spending.

13/ You really think that in the middle of an economic crisis, politicians will have any will to increase taxes and cut spending? Not a chance. The only lever then is for the Fed to jack up interest rates. It’s not hard to see how this leads to a horrendous period of stagflation.

14/ I’m sympathetic to 1-time stimulus during a recession & well below productive capacity. But to structurally change tax & entitlement policy bc the economy is running a little below productive capacity (like today) fails to appreciate the difficulty of unwinding those policies

15/ Further, the interest on future debts cannot be rescinded in Congress. That must be paid. Interest on the debt is the bathtub with no drain. So even if the fiscal policies could get reversed, the accrued debt and interest payments are a ball and chain on the future.

16/ Cutting taxes is easy. Raising them is very hard. Increasing entitlements is easy. Cutting an entitlement is almost impossible. For MMT to work according to theory, the political process of loosening and tightening fiscal policy has to be close to symmetric. They are not.

17/ In summary, the argument that we can increase deficits today because we haven’t seen significant negative ramifications yet fails to appreciate that this will inevitably lead to pushing this policy past the point of where even (the serious) MMTers believe is benign.

18/ So what’s politically viable answer for how to deal with the deficit? I don’t know. The way Rs passed the tax cut has poisoned the well for any deficit reduction in the near to medium term. Not a chance Rs agree to raise taxes or Ds agree to cuts for many, many years to come.

19/ But the saying ‘if you find yourself in a hole, stop digging’ applies. Yes, it was highly irresponsible for Rs to pass the tax cut. But the policy of Paygo, whereby no new spending can be passed unless the cost offset by new taxes or cuts in other spending, is a first step.

20/ If a new program is good policy, we should be willing to either have it replace an inefficient program or raise taxes. This policy doesn’t bind the hands of Democrats. The ACA, love it or hate it, passed under Paygo rules as it increased taxes to keep it budget neutral.

21/ Thoughtful critiques welcome, but please don’t respond with “but Japan…” (1) Japan is a very unique place with few similarities to the US (2) Japan has until very recently been in a 20+ year downturn (3) It remains to be seen if Japan follows the path above eventually.

22 and final/ MMT may or may not be a valid theory in an economics textbook. But I think there are huge risks of it in practice given its practical irreversibility that are not worth the potential benefits.