MMT: It's the Rave Now

Modern Monetary Theory (MMT). Really, it isn’t so modern. I can remember learning MMT at Georgia Tech from Bill Schaffer in the 1960s. It was a special case of the Keynesian Model. Without going through all the history of who John M. Keynes was, let’s just say he was the father of macroeconomic theory. He was also married to a ballerina. Pretty cool guy.

Professor John Hicks penetrated Keynes’ impenetrable writings, especially what he wrote in the General Theory. Whew, the hardest reading I have ever done. But Hicks figured it out and created something called the IS-LM model. This had nothing to do with religion. The IS curve modeled the goods and services market (Investment equals Saving). The LM curve was all about money (demand [L] and supply [M]). Putting IS and LM together was almost as cool as Joe Biden touching Madonna’s hair.

The IS-LM model was the way we explained the economy and discussed monetary and fiscal policy. One very special and weird case of the model was when the IS curve was vertical and the LM curve was as flat as the tires on my 1956 Mercury in 1964.

These extreme assumptions led to a policy conclusion that fiscal policy was all powerful and monetary policy had no impact on the real economy. And this is exactly what these modern-day MMTers are saying. They say, forget about monetary policy. 

What we need to do to keep the economy humming, according to MMT, is to have the government create stimulus with its fiscal policy. That is, raise government spending and reduce taxes so spending grows. If there is a role for monetary policy, it is to not get in the way. As the economy expands, the Fed should create as much money as is needed.

So here’s the cool thing. Back when Hicks and Dick Froyen were explaining all this stuff to us young'ns, they explained that the assumptions for that variant of the model were an infinite demand for money and a zero elasticity of aggregate demand with respect to interest rates. Viola – with those assumptions all money gets gobbled up to be held and never gets spent. With those assumptions, even if bigger government deficits caused interest rates to rise, they would not harm interest sensitive spending like autos and capital goods. Sweet. Let government deficits soar and pump as much money as needed.

Why did Hicks invent this special case? What was he smoking? Basically, this was supposed to be the Great Depression Case of the model. Hicks mimicked Keynes by saying that in very extreme times like a Great Depression, people acted really weird. And thus he and Keynes believed that money would not rescue us in the 1940s but they thought fiscal deficits would.

My question: Why are we assuming the same assumptions hold in 2019? If MMT is based on behaviors that are typical in a Great Depression, why would we want to make those assumptions now when the unemployment rate is low and output is growing? Seems kinda weird to me. Who moved my JD?