Monetary Policy

How Modern Monetary Theory (MMT) gets resource constraints wrong


In a recent book review on money mechanics, I briefly critiqued Modern Monetary Theory (MMT). The central problem with it, I argued, is its failure to recognise resource scarcity:

“While there are several problems with the theory, the most fundamental is that it confuses money with resources. When the government spends, even with money “printed out of thin air,” it transfers real resources in the economy. For example, when the government builds a new factory, the cost is not in terms of dollars, but in terms of the scarce resources it soaks up – the machinery, raw materials, labor, and capital.

The relevant question therefore is not how much it costs or whether we can “afford it,” but what those resources would have done had they not been commandeered by the government. Put simply, supporters of MMT tend to either neglect or deny the fundamental problem of resource constraints.”

In an email to me, economist and MMT proponent Warren Mosler pointed out that the theory does in fact take into account resource trade-offs and provided a link to a paper of his which states:

“The essence of the political process is coming to terms with the inherent trade-offs we face in a world of limited resources and unlimited wants. The idea that people can improve their lives by depriving themselves of surplus goods and services contradicts both common sense and any respectable economic theory. When there are widespread unemployed resources as there are today in the United States, the trade-off costs are often minimal, yet mistakenly deemed unaffordable.”

In short, resource scarcity applies when workers are widely employed, but not when a significant number of workers are unemployed. In the former case government spending tends to merely shift resources from one use to another, whereas in the latter case government spending tends to put idle resources to work.

This distinction is important to properly understand the thinking behind MMT, so I thank Dr Mosler for taking the time to read my piece and point this out. However, even with the distinction in mind, I believe the critique in my original piece stands.

For one thing, all government spending, even in a depressed economy, involves at least some resource trade-offs. Why? Because it is nearly impossible to target only “idle” resources without inevitably consuming some productive ones in the process. For example, say the government “prints” money to hire unemployed workers to build a bridge. Even so, such a project requires resources like concrete, gasoline, rubber, machinery, and skilled workers like engineers and project managers, some of which (or whom) will be drawn away from productive areas of the economy.

But there is a deeper reason why government spending runs into resource constraints. Consider that after an economic slump, it takes time for the imbalances between supply and demand in the economy to match one another. For example, after entrepreneurs and businesses realise that the projects they have undertaken are unprofitable, when their products are not wanted by consumers and therefore go unpurchased, firms discontinue their plans, which throws workers out of their jobs. This period of “inactivity” constitutes a recession. It is during this time that businesses rely on the crucial information provided by pricing signals to determine how to reallocate capital productively going forward, so that they can hire, expand, and rebuild. But if the government decides to “print” money to employ unutilised resources, it distorts the very pricing mechanisms these firms and entrepreneurs depend on to deploy the resources at their command, meaning that the economy ends up with a disfigured resource structure. In other words, “idle” resources provide a vital price signalling function that government spending confuses. Because of this confusion, resources get shuffled into areas of the economy they otherwise would not have, had they been left to the private economy.

That is why MMT is predicated on a distinction that fails to yield a meaningful difference. On the one hand, and where it is right, it recognises the reality of resource constraints when the economy is booming; on the other, and where it is wrong, it argues that resource constraints do not apply when the economy is slumping. But the truth is they do. And that is something that no sound economic theory can ignore.

 

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