Kelton begins chapter four with a discussion of crowding out, which she basically dismisses as a myth in the context of MMT. The idea of crowding out is pretty standard in elementary textbooks in economics. Since it is so basic and since she also describes it, I will not further describe it here. Anyone unfamiliar with the idea can look it up on Wikipedia. Now the problem of crowding out is probably not the Achilles heel of MMT, but it still deserves far more serious attention than she seems willing to give it.
Even though our monetary authorities are potentially the source of unlimited cash and spending, the way things actually work is much more constrained. The Fed does not simply print the money, or create it on some ledger, and then turn it over to the Treasury to fund whatever the fiscal authorities might like. Instead, the bond market acts as an intermediary. This means that fiscal spending relies upon bond investors. Now unlike a government with fiat money, the bond market relies upon investors with finite supplies of cash. Even though the banks originally floating the bonds to investors don’t need money to perform their function, the investors buying the bonds require money that already exists. Kelton seems to gloss over this reality. Yet this is exactly where crowding out comes into effect. Since investors have finite resources, not all investments can be made. So governments are forced to offer terms that will be attractive to investors in the context of other possible investments, which adds to the cost of government borrowing. And insofar as the government makes terms attractive to draw investment funds, other possible investments will not be made. That is, government spending crowds out other investing that would have taken place in an environment with more moderate needs for cash to fund debts. MMT’s fiat money must not be regarded simply as free money for socially desirable spending until inflation becomes a problem. Too much government spending necessarily becomes a problem for the financing of private industry. Crowding out in the context of high debt creates a real constraint upon private enterprise.
One thought on “Crowding Out”
MMT orthodoxy denies the importance of crowding out by claiming that the monetary authorities can essentially disregard existing realities in the bond market and the constraints on non-governmental investors. Kelton notes that during WWII the Fed managed both long and short rates in order to for the government to borrow at favorable rates, even though this practice was mostly curtailed in 1951. She, and other MMT folks, then note that the Bank of Japan manage the interest rates of Japanese debt and the Japanese have floated a lot of debt relative to GDP over the years. So what’s the problem?
The problem is that this country has a monetary authority independent of fiscal authority, at least before 2008. I believe that our monetary authorities still pretend to be independent. So fiscal and monetary policy are not both conducted for the benefit of the government. MMT would have the Fed manage rates for the benefit of the Treasury. I’m far from confident that most policy makers would or should take this step. Taking this step essentially takes the determination of interest rates out of a market environment. Interest rate determination then becomes governmental policy, which must ultimately become a political choice. This seems reckless, at least to me. (Historians and people as old as I am may recall the unfortunate history of Arthur Burns, the Fed Chair who knuckled under to Nixon, and the troubles that then ensued for the country, for a cautionary tale.) Moreover, allowing the government to directly fund itself with scant regard to market discipline opens the door more fully to a centrally planned economy more than most Americans would probably find comfortable . I worry that a government with the open access to funding MMT advocates may impede the necessary discomfort inherent in a capitalistic economy, which is largely ruled by competition. Removing the independence of monetary authorities will bring fundamental political and economic consequences. These consequences should be clarified, not obfuscated. Are the MMT advocates clarifying rather than obfuscating this distinction, or am I overly suspicious?
And finally, I note that the twin objectives of MMT, reaching full employment without suffering the ravages of inflation, are also statutory obligations of the Fed. As appealing as MMT political goals appear, I fear political temptations might overwhelm sound economic judgement should the Fed loose its independence. The Fed is imperfect, like all human institutions, but I like its putative independence.