Elizabeth Warren — Seize Your Moment
Elizabeth Warren is the intellectual heart of the Democratic contest for President for 2020. She is making meaty, interesting policy proposals that might be a very tough lift but could conceivably become reality given a shift in the Senate towards the Democratic party.
She’s surrounded by candidates who don’t want to take a position on anything really meaningful (Beto, Boot-edge-edge); “centrists” who want to run on the New Democrat platform of 1992 (Biden, Harris, etc.); or Bernie Sanders who wants unpossible things.
Despite her credentials and national name-recognition she’s trailing in the pools and doesn’t seem to be getting the traction needed to be a top-tier contender for the nomination.
She has a unique moment to really grab the narrative and that opportunity is to come out in full throated support of Modern Monetary Theory. It could be the game-changing message she needs to vault past her competitors.
The Supply-Side Effect
When Supply-Side Economics hit the Republican party, it changed everything about the way the party campaigns for office. Supply-Side Economics gave Republicans an intellectual framework that allowed them to call for massive tax cuts while still appealing to the part of the party that wants fiscal discipline. Long after the point where rational outside observers have concluded that it doesn’t work, the Republican orthodoxy is that it does, thus almost any tax cut is supported by the party stalwart and suggesting a plan to raise taxes is death to a Republican candidate.
From Supply-Side Economics flowed two generations of actual policy. The Republicans have restructured the tax code making it simpler and massively more progressive (the portion of the income tax paid goes up as a percentage of income steeply, with the top 3% of taxpayers now paying 50% of all the income tax collected). They’ve lowered taxes on capital gains and dividends. They’ve lowered taxes on business income. They take a “no new taxes pledge” which is almost a requirement to win an election as a Republican.
Modern Monetary Theory
Modern Monetary Theory could have the same transformative effect within the Democratic party and on economic policy.
A quick summary of Modern Monetary Theory (aka “MMT”) is that instead of allowing inflation to be managed by a central bank via its interest rate policies, inflation should be managed by the government through tax policy.
Most economists believe that inflation happens when the money supply is larger than the economic activity that money supply supports, or when the cost inputs for labor and raw materials in the economy rise.
Inflation is both a benefit (in small amounts) and a catastrophe (in large amounts). In small amounts, inflation provides impetus to make purchases today rather than delay them into the future which keeps the economy humming. In large amounts inflation wipes out the value of savings, renders lending incredibly risky (and expensive for the borrower), and generates waves of disruption as wages and prices must be continuously revised. “Run-away” inflation creates a feedback loop that can swiftly destroy an economy.
Since the early 20th century most advanced economies have tried to manage inflation by controlling the money supply via an independent central bank. The central bank can grow or shrink the money supply using its power to set prime interest rates. Rising interest rates constrict the money supply, lowering interest rates expands it.
MMT suggests that an alternate mechanism could do the same job, and provide a beneficial effect on the government’s fiscal situation.
The World We Think We Live In
In the classic economic world that we all (think we) live in, governments have a profit and loss statement. The amount of money they spend is offset by the amount of money they take in via taxes. If they spend more than they take in they run a deficit. To finance the deficit, the government sells bonds to raise extra cash.
To induce lenders to fund the government, the government must offer them a profit on their lending — the interest rate paid on that debt. The more bonds a government issues, the more it pays in interest. The bonds governments issue are time-limited, and when they mature the debt must be rolled over into new bonds if the fiscal position of the government doesn’t allow the debt to be retired. If interest rates go up over time, the cost that the government pays to borrow money goes up as well.
MMT proponents want to abandon this system completely. They argue that the classical economic picture of how a government operates is wrong.
Instead what they propose is that some governments(*) have the power to operate without a profit and loss statement. If a government has the power to pay its bills in currency it creates, then it can manage its affairs with an entirely different system.
Such a government (like the US Federal government) can focus on controlling the inflation rate, not on managing debt.
This approach separates the expense and income halves of fiscal policy. The government spends whatever it sees fit, simply making the money necessary to pay its bills.
The downside of doing that is the almost certain appearance of inflation, then run-away inflation feedback loops and the destruction of the economy. Classical economics says that when the government “devalues the money” by making more of it than it takes in via taxes or debt, the normal reaction of the market is to become inflationary.
What MMT proponents believe is that the government can control this inflationary tendency using tax policy. If the government creates money to pay its bills, then when it takes in money via taxes it should destroy that money too. The purpose of taxes isn’t to pay bills, it’s to reduce the money supply to keep inflation under control.
Maybe Classical Economic Theory Is Just Wrong
You might scoff that this seems like magical thinking. But the MMT proponents will counter with a couple of facts that are uncomfortable.
First, classical economic theory doesn’t seem to work. The current system, where central banks manage inflation via setting interest rates, has not proven effective at actually managing inflation. The central bank of Japan, for example, has been trying for nearly 30 years to use its monetary policies to increase inflation in the Japanese economy, and failing. The United States central bank (the Federal Reserve) has tinkered with interest rates endlessly since the 1970s yet there appears to be no strong coupling between its interest rate actions and the inflation rate. There’s no evidence at all that the central bank’s power to manage interest rates actually controls the inflation rate in the real economy.
(What central bank policies have proven quite adept at is creating asset bubbles, which lead to recessions when they pop. When money is “cheap” (i.e. interest rates are reducing) people gamble on upside. When money is “expensive” (i.e. interest rates rise) people discover that their gambles were bad and they go bust (bankrupt). The most famous central banker of our age, Alan Greenspan, famously told the market it was “overheated”, but then proceeded to bail it out whenever external forces caused stress which created a series of asset bubbles culminating in the real estate asset bubble of 2007–2008 which when popped caused the Great Recession.)
Second, most advanced economy governments have been injecting money into the economy via monetary creation for decades, with no ill effects. Currently, the Federal Reserve system owns 16% of all the public debt outstanding to the US Federal Government. Since the Federal Reserve controls the money supply, when it buys government debt it creates money to make the purchase. This is de facto the same thing that would happen if the government just created that money itself. Classical economists will argue that because the Fed expects that debt to be eventually repaid, the economy doesn’t react as if the currency has been devalued and go into an inflationary spiral. Do you think that the US government will be paying down its debt and retiring it any time soon? Neither do I, nor does any rational actor in the economy. That money has just been created with no ill effects.
The above paragraph talks about “public debt”. That distinction is necessary because 27% of the total debt of the US Federal Government is held by the US Federal Government or US state governments. 48% of the debt held by the government is owed to the Social Security Trust Fund. For decades, workers paid into the Trust Fund and the government took that money out of the Trust Fund and spent it. The obligations of the government to the Trust Fund are notarized in a special class of Treasury Bills — basically bonds like those the government sells to raise money to finance the deficit. Classical economists will argue that because the economy believes that the government will redeem that debt as retirees are paid their benefits the injection of cash created by using the Trust Fund to pay the bills of the government across all those decades has no inflationary effect. Do you think that people in the 1980s made decisions about the price level they charged for their goods or services based on the belief that sometime in the late 2020s the US government would repay a debt? Me neither.
How Does MMT Stop The World From Ending
The MMT proponents say that since we’re living in a world where governments are making money to pay their bills, and inflation is not in run-away feedback loops, something else must be keeping the economy from imploding. They believe that mechanism is tax policy.
In an MMT world, taxes can serve the same purpose as the interest rate mechanism in classical economics — if inflation seems to be too high, increase taxes to pull money out of the economy. If inflation seems to be too low, reduce taxes to slow the rate money is being removed from the economy.
Elizabeth Warren If You’re Listening — Take A Huge Leap of Faith!
Here’s where Elizabeth Warren comes back into the picture.
She’s using classical economic theory to explain her policy ideas. She started with proposing a Wealth Tax; a tax on people’s assets separate from their income. She believes that tax will generate $2.75 trillion dollars in increased revenue to the Treasury. Next, she’s making a series of policy proposals that spend that money in various ways (such as child care and reducing student loan debt). In other words she’s trying to explain how she’ll “pay for” her policy ideas.
The problem with this approach is that it allows the Republicans to run their playbook against her and they’re really really good at doing that. They’ll claim that the tax won’t raise as much revenue as projected because wealthy people will take actions to shield their wealth from the tax; they’ll claim that taxing that wealth will reduce innovation and risk taking which will cost jobs and open the door for foreign competition; and they’ll play on the American voter’s general dislike of taxes — we’re the people who went to war in the first place over tax policy we didn’t like, remember?
She’s going to spend time defending the economics of the tax increase instead of explaining what good her policy plans will do.
Instead she should become the first mainstream candidate to wholly embrace MMT.
Instead of announcing “how she’ll pay for her programs”, all she has to say is that she’ll “advocate a tax policy to control the inflationary effects of the spending”. Don’t get bogged down in the details of how to account for how you spend every dollar the tax generates or even how many dollars it generates. Separate the two parts of the plan entirely. Warren wants to spend money to do good things. And Warren wants to avoid inflation that might be caused by the creation of the money used to fund those programs.
MMT has the potential to revolutionize how the Democrats talk about their economic plans. Instead of being trapped in a zero-sum game where the Republicans always win (“don’t raise my taxes” is a winning argument, even if the taxes being raised aren’t yours), the Democrats can defer the argument about what taxes to raise and by how much until there are signs of inflation in the economy. And they decouple the benefits of the program from the potential problems of the tax. They won’t make voters consider tradeoffs. “Is this college tuition forgiveness thing worth this wealth tax?” becomes “Do I think this college tuition forgiveness thing is good policy?”
It would probably be great for the Democrats to have a tax policy platform to answer critics that would suggest they would let the economy burn down around them in pursuit of their policy goals. For example, they could propose a law which automatically incremented taxes by some amount in response to changes in the inflation rate; essentially reducing the role of the inflation brake to an algorithm (which ironically is one thing that many conservative economists wish the Federal Reserve would do anyway).
What’s The Worst That Could Happen?
If she continues on her current trajectory, Warren is going to be eliminated as a serious contender for the nomination sometime in the first or second months of the primary season. She isn’t going to get enough early state traction to be credible and she won’t have enough delegates to be a player even in a brokered convention.
If she doesn’t do something spectacular now to get some distance between herself and the field she’s going to fizzle.
The downside to an embrace of MMT by Warren is mostly reputational. She’s made a career out of being a tough-talking economically literate provocateur. If she goes full MMT a portion of that community is going to write her off as a crackpot and never take her seriously again (unless of course she wins and changes the Democratic party’s fundamental approach to economics!)
Plus, it’s not clear that she really believes it. Warren may simply not be able to convince herself that MMT isn’t just voodoo economics. And I’d respect her if she held to that conviction; but then I respect George H.W. Bush who coined that phrase in the first place too and his opinion about it didn’t stop him from embracing Supply-Side Economics once elected.
The Big Asterix
(*) If this MMT thing is so great why doesn’t every government do it?
In order to work, MMT requires that the government be able to create the money it uses to pay its bills. Most governments cannot do that. The State of Washington has no power to create money. Greece does not have the power to create money. China can pay its internal bills with Chinese renminbi, but it has to buy oil from OPEC using US Dollars. So it’s only partially able to use MMT (and there’s plenty of evidence it has done so, having injected massive amounts of money into its economy to fight the Great Recession without any inflationary feedback loops or real plans to extract that money from the economy).
The United States Dollar is particularly unique in that it is a “reserve currency”. That just means that other countries keep dollars in their accounts as a store of value because they trust that it won’t be eroded by inflation. As a result there’s a well known and trusted conversion rate from US Dollars into almost every other currency in the world (which fluctuates but within a fairly narrow band). You can use a US Dollar to pay almost any debt obligation anywhere in the world; often all the way down to paying for personal commercial transactions in stores. So of all the governments that could attempt to manage themselves using MMT, the United States is best positioned to try.
