MODERN MONETARY THEORY: CAUTIONARY TALES FROM LATIN AMERICA.

• Author: Edwards, Sebastian

During the last few years an apparently new and revolutionary idea has emerged in economic policy circles in the United States: "Modern Monetary Theory" (MMT). The central tenet of this view is that it is possible to use expansive monetary policy--money creation by the central bank (i.e., the Federal Reserve)--to finance large fiscal deficits, and create a "jobs guarantee" program that will ensure full employment and good jobs for everyone. (1) This view is related to Abba Lerner's (1943) "functional finance" idea, and has become very popular in progressive spheres. According to MMT supporters, this policy would not result in crowding out of private investment, nor would it generate a public debt crisis or inflation outbursts. (2)

MMT runs against received wisdom among economists, and has been resisted by Keynesians and monetarists alike. Respected and influential academics such as Paul Krugman, Kenneth Rogoff, and Larry Summers, among others, have stated that MMT makes little sense. Krugman (2019b) has written that the principles behind MMT are "indefensible," and that the arguments made by its supporters are "sophistry." According to Rogoff (2019), MMT is "nonsense" based "on some fundamental misconceptions." And Summers (2019) has contended that embracing "modern monetary theory' is a recipe for disaster."

MMT supporters have responded by saying that their critics don't truly understand how modern monetary economies work. According to them, in countries with a currency of their own, governments don't face a hard budget constraint; the government can always print additional money to pay for higher expenditures. (3) According to Stephanie Kelton (2019), "The government budget is not like a household budget because the government prints its own money." Along similar lines, Forstater and Mosier (2005) have argued that in a "fiat money" system the natural rate of interest is zero; the role of the monetary authority is to push the actual rate to zero, through the purchase of government securities. If long-term equilibrium interest rates are equal to zero, then r

MMT supporters have argued that, in order for these policies to work, the country in question does not need to have a "convertible currency"; all is needed is sovereign fiat money that economic agents have to use to pay taxes. Thus, MMT would still work in emerging countries with a currency of their own, including in many of the nations of Asia and Latin America. Wray (2015: 127-28) makes this point explicitly, when he writes:

The United States (and other developed nations to varying degrees) is special but all is not hopeless for the nations that are "less special." To the extent that the domestic population must pay taxes and other obligations in the government's currency, the government will be able to spend its own currency into circulation. And where the foreign demand for domestic currency assets is limited, there still is the possibility of non-government borrowing in foreign currency to promote economic development that will increase the ability to export. MMT supporters have also posited that their policies would work best in countries that do not have a fixed exchange rate (Wray 2015: 124-29).

Efforts to evaluate the merits of MMT have run into two types of difficulties. First, there is no unified and generally accepted description of how the MMT model is supposed to work in detail. This is not due to a lack of publications. In fact, MMTers are prolific authors, and have published a large number of papers, pamphlets, and books, including some primers. However, these works contain very few (if any) equations or diagrams; MMT authors have generally avoided the language that, for better or for worse, has become dominant in scholarly conversations among professional economists. (5) By doing this, MMTers have left themselves open to the criticism that their views and models lack clarity. According to Paul Krugman (2019a) MMT supporters "tend to be unclear about what exactly their differences with conventional views are, and also have a strong habit of dismissing out of hand any attempt to make sense of what they're saying."

A second difficulty in evaluating MMT is that its supporters have offered very little empirical evidence on how the policy would function, especially in the medium and longer run. (6) Although some authors have argued that Japan during the last decade or so provides evidence that the approach works, most critics--including the governor of the Bank of Japan, Haruhiko Kuroda--disagree with that contention (Beynolds and Nobuhiro 2019). When discussing the applicability of MMT to the United States, Irwin (2019) has argued that it is important to have the policies first implemented in a small country, as an experiment. He wrote:

It would be nice to have some proof of concept before it is put in place in the largest economy in the world--also home to the world's reserve currency. ... It would be genuinely fascinating to watch a small country--with its own currency-- govern itself according to the [MMT] theory's principles.... If those smaller countries can work out the kinks of economic governance in an MMT world, and achieve a higher standard of living, maybe then scale it up to a midsize country? It turns out that MMT--or some version of it--has been tried in a number of emerging countries. Although most cases have taken place in Latin America, there have also been episodes in other parts of the world, including in Turkey and Israel. MMT-type policies were also attempted in France during the Mitterrand presidency. Almost every one of the Latin American experiments with major central bank-financed fiscal expansions took place under populist regimes, and all of them ended up badly, with runaway inflation, huge currency devaluations, and precipitous real wage declines. In most of these episodes--Argentina, Bolivia, Brazil, Chile, Ecuador, Nicaragua, Peru, and Venezuela--policymakers used arguments similar to those made by MMTers to justify extensive use of money creation to finance very large increases in public expenditures. (7)

In this article, I analyze some of Latin America's episodes with MMT-related policies and show that all these cases ended up in major macroeconomic disasters. The analysis uses the framework developed by Dornbusch and Edwards (1990, 1991) for studying macroeconomic populism. The rest of the article is organized as follows: First, I present the basic principles of Latin American populism and compare them to MMT. Next, I analyze three specific Latin American episodes with major central bank-financed fiscal expansions: Chile during President Salvador Allende's socialist experiment (1970-73), Peru during the first Alan Garcia presidency (1985-90), and Venezuela under Hugo Chavez and Nicolas Maduro (1998-present). These are the "cautionary tales" referred to in the title of this article. Finally, I provide some concluding remarks, including a brief discussion of MMTs weakest points.

Latin American Populism

Macroeconomic populism is usually defined as a set of policies aimed at redistributing income by running high fiscal deficits, financed through an expansive monetary policy. (8)

The Mechanics of Latin American Populism and MMT

In the language of textbook macroeconomics, these are policies where the government shifts simultaneously, and significantly, the IS and the LM curves. (9) In every Latin American experience with populist policies the government granted wage increases--both public-sector and minimum wages--that exceeded significantly what was justified by improvements in productivity. Just as MMTers, populist politicians present heterodoxy as the solution to the nation's ills, and in particular to the suffering of the middle and lower classes. (10)

For populists, one of the features of capitalist economies is the existence of substantial idle capacity. Thus, in their view, large and persistent fiscal deficits financed through money creation do not result in serious imbalances, high inflation, and, eventually, crises. For populists the contrary is true: large fiscal deficits expand demand and encourage output, allowing firms to exploit economies of scale and to use resources fully. For them the combination of large deficits with redistributive policies results in a decline in inflation. Populists tend to dismiss possible collapses in the demand for domestic money, and increases in the velocity of circulation; in this, their perspective is, again, very similar to that of MMT supporters."

These views are clearly captured by the following quote from Daniel Carbonetto (1987: 82), the economist behind Alan Garcia's populist policies in Peru in the second half of the 1980s: "If it were necessary to summarize the strategy adopted by the government since August 1985 with two words, they are control (meaning control of prices and costs) and spend, transferring resources to the poor so that they increase consumption." Carbonetto (1987: 83) then added that budget constraints had to be ignored: "It is necessary to spend, even at the cost of a large fiscal deficit, because, when this deficit transfers public resources to increase consumption of the poorest, they demand more goods and this will bring about a reduction in unit costs. Thus the deficit is not inflationary."

This statement is very similar to what Stephanie Kelton, one of tire most prominent supporters of MMT, stated: "The government budget is not like a household budget because the government prints its own money" (Walsh 2018). It is also similar to what Wray (2015: 104) writes in his primer on MMT: "The following statements do not apply to a sovereign currency issuing government.... Governments have a budget constraint... Government deficits drive interest rates up, crowd out the private sector, and lead to inflation."

In addition to rejecting fiscal balance and sound monetary policy, Latin American populists reject markets, competition, and...