Modern Monetary Theory -- and why it matters
A while ago I tripped over an economic theory called "Modern Monetary Theory (MMT)." I thought is was interesting, and talked about it a bit, because, you know, weird ideas.
A few days ago I came across a short book on the subject (Free PDF here, Amazon Kindle format just a buck, here) It's written named Warren Mosler. He's an American broker, banker, economist, and sports car engineer.
The heart of the book is about 50 pages. So not too long a read. But MMT makes a bunch of arguments that go completely against intuition and prior education -- that seem completely wrong -- until you change your intuition.
Then it's all completely obvious. Until then, it might seem nutty.
I read it. It changed my intuition. It's now completely obvious. Maybe it's wrong, but not in a way that's obvious to me any more. Such is the price of new intuitions.
And it's caused me to think that maybe my opinion of the economic policies of Reagan and Clinton, to name only two, should be reversed. Reversed. Another price of new intuitions.
I strongly recommend reading it.
And before reading it, I recommend reading what I've written below because I think it will help you prepare your mind for reading something that MAKES NO SENSE at first.
Also I spent a bunch of time writing it, so I think you owe me that.
MMT runs against our intuition and it's against the experience on which our intuition is based. So why even consider something that you will find goes against both -- aside from the fact that I recommend it?
Because sometimes our intuition is wrong, and our experience does not apply. And in this case our (possibly wrong) intuition can lead us to make (possibly wrong) decisions about who to vote for, or what to tell our friends who are on the edge. So it's important to have the right theory and the right intuition.
We've got good intuition about the way things like baseballs behave. Our intuition is based on lots of experience with baseballs, rocks, and other similar objects. And it helped our ancestors survive. But if you believe that science knows what it is talking about, then you must believe (along with science) that the intuitive laws of physics that we are familiar with, the ones that seem so right, that we have depended on for so long, are wrong because they don't match the observed behavior of objects at quantum and relativistic scales.
(If you don't believe science knows what it is doing when it comes to relativity and quantum physics, then stop here, because really, we have nothing to talk about.)
But if you are still with me, I'm going to start by talking about how scientists evaluate theories -- especially ones that go against intuition. And how evaluating theories in sciences -- like physics -- is different from evaluating theories in sort-of-kind-of-wanna-be-sciences -- like economics.
Then I'm going to talk about retraining intuition and why it's important to retrain it to arrive at a correct understanding of the world. And how hard it is -- so you don't give up on MMT just because some parts don't make sense. I hereby give you permission to give up if experiments based on MMT don't give the predicted results. But you can't give up because you can't get your mind around it. Well, you can. But I'll be disappointed in you. I think you're better than that.
Then I'll tell you why I'm thinking about reversing some of my prior political opinions based on my new intuition. Said more clearly: I'll tell you why MMT makes me think I might have been wrong.
Why not change right away? Because it's hard for me to conclude that I have been so wrong. So I'm sort of sidling up to the idea.
And then I'll remind you again to read the book, and provide the links, so if you have gotten all the way through my wall of words and you're convinced that it's worth reading that which was so inspiring to me, you won't have to scroll all the way back and find the links. They'll be right there.
MMT is a theory of how money works.
Like every theory, it's useless if it doesn't contain a set of principles that can be used to explain or predict things. Like every theory, it's wrong if it doesn't (mostly) explain the past. It's wrong if it doesn't (mostly) predict the past. And it's wrong if -- once invented -- if people who use it can't (mostly) correctly predict the future.
How do you predict the past? You take everything known up to a certain point in time, then use your theory make a prediction about what should happen next. If the prediction turns out to be true, then you've predicted the past. But you have to be careful: if your theory includes data from the past to "tune" the theory, then you are using the past, not just your theory, to predict the past. That doesn't make it wrong, but it does make it suspect. Many mathematical models of the stock market and the economy do this. They're parametric and tuned from the whole of the past, so when you test them on a part of the past they do pretty well. But when you test them on the future, then, to use the correct technical term, they "suck."
Why "mostly explain?" "Mostly predict?" In the hard sciences a theory has to precisely, not mostly, explain and predict within the limits of measurement. But the hard sciences rely on controlled, experimental settings. And "controlled experimental setting" doesn't just mean just something well organized. To have a controlled experiment you need to run two versions of the experiment, identical except for the the factors you are trying to study. Outside a controlled experimental setting -- a.k.a in real life -- theories "mostly" predict things "pretty accurately." Technically we're not dealing with science anymore, but with engineering. Good engineering is based on good science. It's just more forgiving.
If you've got two methods to consider, in science and in engineering, the better one makes predictions that are more often more accurate than the worse one. So that's how you can decide what's better. Same with economic theories.
Large scale economics, which is what MMT is about, is different than laboratory physics. You can't do controlled experiments because you can't run two versions of the economy to see how a change in one policy changes the outcomes. But there are experiments you can do to verify basic principles. And there are measurements that you can make that can tell you whether you can mostly predict things most of the time or whether a monkey with a dart would do better than you do.
Many widely held economic theories -- at the MMT scale -- fail the monkey-dart test.
Prediction timing is also important. This is often misunderstood and lets people get away with saying "I was right" when actually they were wrong. I'll call this the stopped clock principle, after the famous stopped clock that's right twice a day.
Say the stock market (or some measure of economic goodness) is at 5,000 and your economic theory predicts a crash. But it doesn't crash. It goes up to 7,000 and the you say My theory still says it's going to crash; it just hasn't happened yet. Wait and see. It will crash." Then it continues to go up and up and up, and gets to 15,000. And then, finally it crashes to 10,000. You can't say: "See I was right!" Well, you can say that. But you're an idiot. Because the fact is that when you made the prediction, the market was at 5,000, and sometime later it ended up at 10,000. The fact that it was 15,000 in the meantime is a footnote. If it crashed, it crashed up.
Many widely held economic theories -- at the MMT scale -- fail the stopped-clock test.
So far, in the investigations I have made, MMT does pretty well as a theory. It has a simple -- but completely counterintuitive -- set of principles. Once you figure out what they are saying, you can use the principles to predict things. The principles can -- and have -- been tested in experimental settings, and seem to work in those settings.
It does (in many cases I've looked at) succeed in explaining many things that happened in the past. It does (in many cases I've looked at) predict the past. People who are its adherents have used it to predict the past the future, and so far -- reviewing their past predictions and later outcomes -- they've done a lot better than most other theories.
It's hard to change intuition, but if the data you collect goes against you intuition enough times, you've got to change your intuition.
Actually you don't have to. There's another option. You can learn a new, correct rule and use it -- ignoring your intuition, and get correct answers, despite the fact that they don't intuitively seem right.
Actually, there's a third option. You can stubbornly continue to use your old intuition, and your old rules, even if the data doesn't match. You can do it, but if you do, you're an idiot. If you've gotten this far, I assume you are not an idiot, but that's just a theory. I could be wrong.
If you learn the correct rule but don't change your intuition to match, then you're not an idiot, but you are missing an opportunity to think more clearly.
Our intuition tells us that the earth stands still and the sun rises and sets, and that's what our ancestors believed for thousands of years. Now, most of us know that the earth spins and it also circles he sun, and that explains the apparent rising and setting of the sun. We can shift from one set of intuitions to another when we have to.
Some of us have learned, and believe that the sun is rotating along with the rest of stars in the Milky Way galaxy; that it changes its position within the galaxy; that the galaxy itself is moving at an enormous velocity relative to other galaxies, and so on. But most of us don't have any intuition to match. Which is OK. What's not OK is to say: the stars don't seem to be moving, so they're not.
Back when I was in college I minored in physics. I took relativistic physics and heard the arguments and learned the formulas. They go against intuition, and I knew that. But I learned the rules faithfully, and got an A in my physics course. Or maybe a B. The point is that I believed my intuition was wrong and I learned the laws of motion at near light speeds. But I never developed any intuition about what I was doing. I just cranked out answers the formulas and my teachers said they were right and so I passed the course. I really think with an A.
In case you are unfamiliar with the laws of motion at relativistic scales, here's the short form: when you measure things that are moving really, really, really fast, they appear shorter in the direction of motion and more massive than at rest, and clocks run slower; and rays of light bend when they travel near something really, really massive; and space stops being flat.
Intuitive, right? No. It's nonsense. Nonsense! But science has demonstrated that it's true, over and over. Every time we use a GPS device -- just one important example -- we depend on the accuracy of these weird calculations that go wholly against our intuition.
A couple of years ago when I took a course at Acadia Senior College, and decided to see if I could understand why relatively was intuitively correct. By hard work, and thanks to a bunch of YouTube videos, it not only became obvious why relativity worked, but why it should work, and why something like the laws that Einstein formulated them MUST be true.
But it was hard. To begin with, there is no reason -- absolutely no reason -- that the laws of motion should be different at one scale than at another. Classical physics tells you that the laws of motion are are thus-and-such, period. It does not matter what speed something is moving at. And it doesn't matter how much mass is around. The laws are the laws.
So why should things be any different at relativistic scales -- high speeds and large masses.
Think about it.
If someone throws a baseball at 1 mile per hour from a train speeding toward you at 60 miles an hour, intuition tells us that the baseball is going to seem like it is moving at 61 miles an hour (ignoring friction and such). And as carefully as we can measure, our intuition is correct. You can measure the speeds to as many decimal places as you can and you will find that 60 + 1 = 61. All the time.
Your intuition doesn't tell you whether light is a wave or a particle because we don't experience light as wave-like or particle-like. But scientists discovered that light behaved like a stream of particles, each now called a photon. Then they discovered that light behaved like a wave. So which is it? The answer is both. Not intuitive. But, if you believe in science, it's correct.
Intuition tells us that the light particles emitted by the headlights of an oncoming car at 60 miles should be travelling at 60 miles an hour faster than light particles from a car at rest. We know that the speed of light is about 186,000 miles per second. According to Google, or your calculator, that's about 669,600,000 miles per hour. To detect the difference between light travelling at 669,600,000 miles an hour and light travelling at 669,600,060 miles an hour you'd have to have a speed detector capable of detecting a differences of 0.000009%.
Now what about the speed of light from an object moving away from us very, very, very, very fast. like a fast moving galaxy or star. Again, intuition told us that galaxies and stars were fixed in place. They were called "fixed stars" for a reason. When people measured the speed of light from stars that are said to be moving at a measurable fraction of the speed of light they get the same speed as light from a stationary object. So the measurement: no difference in speed of light -- matches intuition -- stars are not moving.
But here most of us would -- now -- believe that our measurement is correct, and our intuition is wrong. Because our intuition has changed -- at least a little.
Our intuition tells us, and our ancestors believed, that the earth is not moving and the sun and the moon move around the earth. Now most of us believe that the sun is stationary (relatively) and the earth moves around it. But that new intuition turns out not to be exactly right, either.
The reason that the heliocentric view took over from the geocentric view is because the math needed to explain the motion of all the planets in the solar system is (relatively) simple if you assume that the heliocentric view -- the earth is moving and the sun is not -- despite your intuition that says otherwise. And math needed to explain these same facts is gawdawful complex -- to the point of impossibility -- if you assume the geocentric view.
So we've fixed our intuition (some of us) to believe the better model. But according to relativity, it's perfectly OK to assume that any point or any object in the universe is fixed and the rest is moving. That's why it's called relativity. One of Einstein's insights was to show that if two things are moving relative to one another you can't tell which one is moving and which one is still and the laws of motion must be correct whatever, in your head, you decide is true.
So, according to relativity, it's perfectly legitimate to think that you are at the center of the universe! Physics can back you up. It's just that if you doing the math for the movement of the planets relative to you, you're going to have a hard time.
(Side note: in case anyone wants to know, I believe I am at the center of the universe. I call this the me-ocentric view This may help explain some of my behavior. I'm not in this alone. You can be the center of the universe, too. Same universe, different center. You-o-centrism. Expect us to agree on mathematical outcomes because we are -- as far as I know -- in the same universe. But expect us to do slightly different numerical calculations to get there.
So earth moving. Sun moving, doesn't matter. Me center, you center, doesn't matter.
When people measured the speed of light moving from the sun, from the planets, in different directions and from different objects moving at different speeds, they discovered that the speed of light (in a vacuum) was always the same. In every case. Regardless of how fast they were moving toward or away from the light source, or how fast the light source is moving toward or away from them, the measurement has always been the same (within measurement accuracy).
So the laws of motion for baseballs thrown from moving cars and the laws of motion for photons emitted by moving stars appear to be different. Seems like there should be one set of laws and they should be the intuitively obvious ones. But the universe says otherwise.
When these results were first discovered some people said: "Well, it makes no sense at all, so it's not true." But it was measured over, and over, and over and always with the same result (within measurement error.) People believed one thing. The universe said something different. Hint: when you are arguing with the universe, the universe wins.
Intuition was wrong -- under certain conditions -- and the laws of motion based on that intuition -- under those same conditions -- was wrong.
Einstein's first act of genius in developing the theory of relativity (he had other, prior acts of genius) was to start by developing a new intuition. He did it by making up a series of thought experiments to train his intuition. Then -- with his new, better, more correct intuition he started to make up theories that matched both data and his new intuition.
Later, after Einstein discovered the governing laws. other people created other, even better thought experiments. And then they turned them into YouTube videos. And by watching the videos, and doing those thought experiments myself I was able to get past my old, wrong intuitions, and develop new intuitions that made relativistic behavior seem more like common sense.
It was hard.
It's not easy to change your intuitive view of how the world works, even when you believe the science that says your intuition is wrong. Even when you've done dozens of problem sets based on the correct theory. You have to work at it.
So everything I've said is just to prepare you for the idea that to understand MMT you're going have to work hard to change your intuition about money. Thought experiments will help, and be necessary, but my experience with relativity and my experience with MMT tells me that intuition will fight you all the way.
MMT tells us our intuition about money and debt is correct at the scales at which we normally have experience. Like physics at normal scales, our intuition matches reality.
Our intuition about money is largely correct at the personal level, at the family finance level, at the company level. At the town, and city, and state level. But at the scale of a sovereign nation or any sovereign entity that can create a currency and levy taxes -- like the United States, or China, or the Euro zone (but not any country in the Euro zone) --- MMT says that the laws operate differently, and out of line with our experience and intuition.
At the scale of the sovereign, Modern Monetary Theory says that certain things that are intuitively correct, and correct at smaller scales are no longer correct, and other laws become dominant.
The test: just as with physics, you make predictions, and test results. You look for situations where MMT says X should happen and where other economic theories say that Y should happen, and you see whether X or Y is the actual result. I've started doing that, and MMT has scored really well.
The other test: just with physics, once you've got a good theory, you look for places where you can do experiments. After Einstein predicted clocks would slow down if you move faster and speed up if you reduced the force of gravity, some scientists took clocks for airplane rides to test the theory:
The Hafele–Keating experiment was a test of the theory of relativity. In October 1971, Joseph C. Hafele, a physicist, and Richard E. Keating, an astronomer, took four cesium-beam atomic clocks aboard commercial airliners. They flew twice around the world, first eastward, then westward, and compared the clocks against others that remained at the United States Naval Observatory. When reunited, the three sets of clocks were found to disagree with one another, and their differences were consistent with the predictions of special and general relativity.
According to this being a frequent flier is not a life-extension strategy. Fliers actually apparently age more quickly than folks on te ground. It just seems like the flight is taking forever.
So here are some things that MMT says that were went against my prior economic -- and political -- intuition and on which I'm in the process of changing my mind.
Reagan (along with a spendthrift Democrat congress) ran up the public debt by both reducing taxes and increasing spending. MMT says that would be good. The result was a fast recovery from the recession that happened when Reagan came into office.
Clinton (along with a fiscally conservative Republican House) balanced the budget and ran a surplus. MMT says that would be bad. It resulted in the economy starting to tank at the end of his term.
Bush inherited the Clinton economy and then got 9/11 besides. he started to run up the public debt and the economy started to get better. Then came the 2008 credit crunch. I am not sure how MMT explains that, and I have some clues. Stay tuned.
Following that, Obama tried to spend and tax cut the US' way out of it. And the Fed did Quantitative easing which conventional economics says is wrong, while Europe did austerity, which conventional economics says is right. The US recovered faster and better the Europe, which is now doing their own version of deficit spending to get out of their slump.
It's hard to rely on counterfactual arguments, but I'm going to make one: MMT says that if EITHER the Republicans had their way and increased tax breaks OR if the Democrats had their way and increased spending on infrastructure, education or whatever -- either of which would have run up the debt -- we would be better off. But each party kept the other from doing what MMT says would have been most helpful.
Why write so much about this. As I said at the top, having a correct understanding leads you to make correct decisions, and convince other people to make correct decisions. And having other people read this stuff and point out the gaping holes that I have missed would be helpful. Embarrassing. But still helpful.
Anyway, here are the links to book, I promised at the top (Remember? Free PDF here, Amazon Kindle format for a buck here.)
And to whet your appetite (or turn you off) here are the things that are intuitively true, that MMT says are WRONG:
1. The government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow. Intuitively right. MMT says wrong.
2. With government deficits, we are leaving our debt burden to our children. Intuitively right. MMT says wrong.
3. Government budget deficits take away savings. Intuitively right. MMT says wrong.
4. Social Security is broken. Intuitively right. MMT says wrong.
5. The trade deficit is an unsustainable imbalance that takes away jobs and output. Intuitively right. MMT says wrong.
6. We need savings to provide the funds for investment. Intuitively right. MMT says wrong.
7. It’s a bad thing that higher deficits today mean higher taxes tomorrow. Intuitively right. MMT says wrong.
I'd apologize for the length of this piece, now around 4,100 words, but I'm too proud of it to apologize. Even if it's wrong I think it's a nice piece of writing. Thanks to writing advice here from my hero, Scott Alexander at SlateStarCodex.