Skip to main content

Palley on the spurious victory claims of MMT

Thomas I. Palley (orginally posted here)

Led by Randy Wray (see this and this), supporters of so-called Modern Monetary Theory (MMT) are declaring that they were the first to identify the problems of the euro and that MMT has now proved itself to be the correct approach to monetary theory.

As regards these two claims, permit me to quote the following:
“5.3 Will capital still be able to veto policy?

…First, financial capital may still be able to discipline governments through the bond market. Thus, if financial capital dislikes the stance of national fiscal policy, there could be a sell-off of government bonds and a shift into bonds of other countries. This would drive up the cost of government borrowing, thereby putting a break on fiscal policy (Palley, 1997, p.155-156).”
MMT is a mix of old and new. In my view, the old is widely understood by old Keynesians and the new is substantially wrong. The above quote from my 1997 paper shows two things:

(1) MMT'ers were not the first to predict the structural flaw in the euro’s design regarding possibilities for conduct of fiscal policy.

(2) Old Keynesians fully understood that if you remove the national central bank, national government is reduced to the status of a province and may be unable to run deficit based fiscal policy if bond markets refuse to finance it.

With regard to theoretical weaknesses, MMT lacks a convincing theory of interest rates, over-simplifies the economy by assuming an L-shaped supply schedule that ignores the effects of sectoral bottlenecks and imbalances, lacks an adequate theory of inflation, and ignores expectations and exchange rates. These omissions lead it to overstate the powers of monetary and fiscal policy.

In this regard, I offered an early critique of MMT in the context of its twin policy proposal for an employer of last resort (see Palley, 2001). I am not necessarily against an ELR. However, because of their reliance on MMT, supporters of ELR tend to oversell the proposal and ignore problems that may be considerable. This illustrates how the theoretical short-comings of MMT can promote dangerous over-simplifications of important and complex policy issues.


Palley, T.I., "European Monetary Union: An Old Keynesian Guide to the Issues," Banca Nazionale del Lavoro Quarterly Review, vol. L, no. 201 (June 1997), 147‑164.

Palley, T.I., “Government as employer of last resort: Can it work?" Industrial Relations Research Association, 53rd Annual Proceedings, 2001, 269 – 274.

PS: A previous post on the topic here.


  1. Even continuous claims that deficits do not matter as long as they bring full employment are also dangerous. While Japan does have 200% debt to GDP, it is all latent demand which can be easily triggered into serious inflation and this will destroy MMT overnight. Because MMT over-assumes the flexibility of fiscal policy. The lags of fiscal policy might be shorter than that of monetary, but they are still long enough to react to real time economic developments.

    And the issue of exchange rates is definitely under-played.

    Having said that, MMT does provide an excellent framework for beginners to understand macro. With relevant disclaimers it should probably be a standard course macro for economic non-majors.

    1. Fiscal deficits in domestic currency are no problem, provided they do not generate a level of activity with an unsustainable current account deficit. For the US, since debts are in dollars always, that limit does not occur, but if you are Argentina or Greece, then is a different story. And flexible exchange rates are not always a solution. A devaluation might solve your BOP problem just as a result of a contraction. And yes MMT, PK ideas, prices of production, full cost, etc should be more widespread.

    2. Sure, this is how the argument goes. But I am not convinced on it. Why does private sector need 200% GDP of savings? And why should "we" tolerate it? Is there economic or pure political benefit? Who is that private sector? And how can "we" ask the question "why"?

  2. Why does private sector need 200% GDP of savings?

    Where do you suppose those savings went?

    1. Not sure what you mean. Savings are a flow of income, which results from spending. Savings as a share of GDP are in the US in the one digit level. You mean more likely an injection of liquidity to banks, which is money, that is, a stock. Arguably injected to avoid systemic risk. Of course the injections could have been done in more sensible ways, nationalizing banks, and rescuing home owners.

    2. I mean where does he think those savings have come to rest? Savings implies money just sitting, as in not spending.

      The economics definition of savings is income not spent on consumption or investment.

      in the MMT vernacular savings (or net savings) is the stock of net financial assets, bonds and cash, that exist in the non-government. Accumulated financial wealth is not useful to an economy based on spending, particularly if the stock is ever-increasing.

      This mode of saving is not the same thing as savings in NIPA or FoF context, but IMO much more meaningful.

      My comment was directed to Игры рынка July 25, 2012 2:25 PM though.

      "You mean more likely an injection of liquidity to banks, which is money, that is, a stock"

      No this isn't what I meant. This kind of injection is invisible to an observer in the non-government unless you think that increasing reserves somehow forces people to borrow.

      By "nationalizing banks and rescuing homeowners" I assume you mean write-downs.

      This would be a fiscal operation, adding net financial assets (dollars without an off-setting liability) to the non-government. Credit expansion can't add net financial assets to the non-government.

    3. "Where do you suppose those savings went?"

      To purchase even more political power. I am afraid that this is an almost intentional consequence of MMT's fiscal position. And it goes very much contrary to the main social line of full employment etc. If we take an extreme example then slavery was also about full employment but there was hardly anything good in that economy/society.

    4. Paul, be careful with your own definitions. If savings is income not spent (correctly so), and income is a flow (measured over a period of time), then savings cannot be a stock (measured at a point in time). What you meant is that any flow, including savings, do accumulate as a stock, and yes being private flows of income they accumulate as private assets (Wynne called it the Net Acquisition of Financial Assets, NAFA). I did work for the guy for two years. Stocks and flows. Get those right.

    5. Matias,

      Not meaning to be contentious - my original question to commenter Игры рынка was inquisitive.

      Turns out he had the answer i was looking for but then he turns around and manages to blame MMT, which, from my view as an engineer is unfair since the differences attributable to MMT are nothing more than a mathematical description of the underlying system flows in the economy as currently arranged.

      It's like blaming gravity when somone falls off of a ladder and gets hurt.

      And ,yes I do know the difference between a stock and a flow and should have used the term Level instead of stock, as i was alluding to the running total of NFA. That said, NFA does not behave as a flow in the typical sense as it tends, or most of it tends to be held in a relatively few hands and doesn't move around through the economy very much. So the behavior is more a kind of inert "stock" of financial assets in the broader sense.

      Once NFA reaches this position there is very little movement or flow except in the sense that Игры рынка alluded to.

    6. Paul, there is no natural limit to how much money private sector wants. Unlimited wants etc. Therefore I find arguments that public sector has to satisfy those unlimited wants very strange. Why? Public sector also acts on my behalf giving away those monies which end up with people who can/will use for purposes which I do not always find charitable. While economically we both understand the underlying idea, from an engineering perspective it is difficult to tolerate such inefficiencies. Especially since they have a high potential for all types of undesired side effects. It is not that I argue against MMT as such. I rather do not like such a politically short-sighted insistence on deficits and resistance to taxes. What for?

    7. Again not sure what you mean by inert stock. Part of the point of having the consistent set of stocks and flows is that you get the interactions of the system correctly, and may see unsustainable debt trajectories, which is what Wynne did, for example, in his "Seven unsustainable processes."

    8. Игры рынка… :…there is no natural limit to how much money private sector wants. Unlimited wants etc. Therefore I find arguments that public sector has to satisfy those unlimited wants very strange…"

      No natural limit but the private sector must save which leads to decreased spending and must be offset by increased NFA. The economy as it is requires spending and credit cannot provide that spending alone except over the short term because credit expansion has a functional limit.

      I don't disagree with the idea of taxation in lieu of bigger deficits if we tax the right groups, but that won't account for leakages like saving and CA deficits.

      Seems to me most people discussing economics are unaware of the hard realities of closed-system arithmetic.

      "Again not sure what you mean by inert stock"

      Matias: Calling a stagnant flow inert doesn't change the arithmetic. In a closed system (the net quantity of dollars/bonds cannot be increased or decreased from within the system) like the U.S non-government - the machine must have input. The input is spending and without spending there is no economy. Can we agree on that?

      The natural flows of funds in a capitalist economy are towards a group that is relatively tiny , meaning that over each business cycle more money is extracted from the system than is invested into it. If that weren't the case no one would go into business. If the money supply isn't replenished by deficit spending or by taxation/redistribution over time the system will tend towards decay (again, natural behavior of a closed system). Credit expansion is a bubble machine that can't be counted on over the long term to maintain economic activity because of functional limitations. To argiue otherwise is to argue for perpetual-motion. Natural leakages are frictions that must be accounted for or they will bring a system to rest.

    9. Matias:

      Short answer: Leakages are flows that don't go anywhere from the perspective of an observer from within the system, hence inert for lack of a better word. If we shot $5 Trillion into outer space, that would be an inert stock of dollars.

      I didn't think the idea was that complicated.

    10. This comment has been removed by the author.

    11. Paul, the question is not about whether the system is closed or not and in what terms. You can not manage economy based purely on this approach. You need to take next steps. And if you take the perspective of the private sector then budget deficits represent its net income. It is already here that I start missing the MMT argument that budget deficits have to fulfill savings desires which is equivalent to saying that budget deficits have to satisfy net income desires. Well, income desires on behalf of the private sector are generally ... unlimited. How do you fulfill them? The more income you provide the higher the savings "desire" will be. They go hand in hand. Savings is unspent income. It is an ex post left-over from consumption and NOT an ex ante decision to save or not to save. Even MMT is clear on that. And yet it keeps on saying that there is some bounded desire which budget deficit has to fulfill.

    12. Игры рынка:

      …the question is not about whether the system is closed or not and in what terms. You can not manage economy based purely on this approach.…"

      You can't manage an economy ignoring this approach either, and the closed system argument trumps all others because it is the underlying property of the system. So which is more important?

      "…some bounded desire which budget deficit has to fulfill."

      The deficit is an ex post accounting record. Deficits don't have to fulfill anything, they are a mathematical outcome of economic performance.

      If ex post budgets are not "funded" then the economy will tank. It's a choice but the outcome is predictable.

      It seems that in your view we should just sit back and let stuff happen and everything will work out. People won;t be able to save, people won't have jobs, etc.

      The only alternative I see is tax back wealth accumulation above a certain threshold and manage the level of savings. That's not going to happen in the current environment so…

      What is your solution to maintaining flows at levels necessary to account for population growth and the CA deficit (US) that is over the half-trillion mark annually?

      Do you think that will fund itself?

    13. It does not trump anything. It is just an accounting identity and a minor input, if at all, into decision making. In reality economics is mostly about politics. You can hardly make a politically neutral economic statement.

    14. "…It is just an accounting identity and a minor input…"

      Closed system dynamics is hardly an accounting identity. So far no one has ever observed behavior that defies entropy. No wonder economics has been such a colossal failure…

      "…You can hardly make a politically neutral economic statement…"

      Maybe so but politics can't change the laws of arithmetic. In the meantime enjoy the disaster that is th eEurozone as it circles the drain.

      Unless the ECB writes the check it will fail. Actually, it's already failed, it's nearing collapse.

  3. With respect to all parties in dispute, I find this kind of confrontation between heterodox economists disheartening and frankly, appalling.

    On the subject of priority, which seems more directly related to Palley's post, the WSJ original note claims Godley formulated in 1997 the same predictions Palley claims he formulated in 1997.

    And, apparently, on similar grounds.

    If both claims are true (and I have no reason to doubt it), I'd say both authors equally deserve the kudos.

    I'd further say that any unilateral claim of priority, either directly by the claimant or by its associates, is out of place. And this cuts both ways.

    1. Sure. Some of Wynne stuff is published in this blog regarding early criticism of the euro. On the more substantive discussion about MMT I disagree. Whether all countries are like the US and you do not need to manage the exchange rate or have capital controls in the periphery, is actually an important issue. I don't see a debate between heterodox authors as necessarily bad. Of course we all agree on Effective demand (meaning the need for expansionary fiscal and job creation programs), endogenous money, and cost driven inflation to name a few things. That's why we have blogs. To debate.

  4. Hello Mathias,

    Two things . .

    1. MMT never said they were first. The WSJ did and Randy merely re-posted their article; perhaps in hindsight he should have qualified their praise, but who knew it would make some people so upset? Randy's point in this series were particular details about the Eurozone that MMT discussed that he hadn't seen elsewhere and which were important to understand why Randy thought Sergio's critique of MMT was incorrect.

    2. Regarding this: "Whether all countries are like the US and you do not need to manage the exchange rate or have capital controls in the periphery," MMTers have never, ever said "you do not need to . . . have capital controls in the periphery." They have frequently said the opposite, in fact.

    Scott Fullwiler

    1. Scott, actually I had several conversations with randy over the years were he said that flexible exchange rates rendered the need for capital controls unnecessary. That was actually Warren's position. If they have changed their views I'm glad to hear it. On prices, I participated on several discussions in Ed Nell's group in the 1990s, when some of the ELR things were being analyzed, and the point made was that if you fix the wage of the ELR there are no inflationary pressures. A proposition that is difficult to support. But again, if views changed I'm glad. As I said I think it is important to have these debates, and that's why I reposted Tom's post.

  5. NK and all,

    Although I understand this subject of priority has faded to the background (which I think it's a very good thing), I have seen claims that one Peter Kenen, working in optimum currency area theory, stated in 1969 the conditions necessary (but in fact unfulfilled) by the European Monetary Union to function properly.

    If one believes the evidence offered by the claimant (not Kenen himself), this claim would seem reasonable.

    The reference to Kenen was made by one Mark A. Sadowski. You can find the specific comment by searching at the comments section (page 2) to a post by Nick Rowe (link below). Use Sadowski's name or the date and time the comment was published (July 30, 2012 at 01:52 AM) as search string:

    "Can you please read a first year textbook?"

    To be perfectly honest, I've never heard of this Kenen, or of his alleged predictions. Neither have I heard of Sadowski, the claimant. I'm no economist.

    Has anyone heard of this and can anyone here confirm or refute it? Any comments?


    Incidentally, while I really don't like Rowe's overly condescending and patronizing tone, I have to agree with him that heterodox economics amateurs (like yours truly) would gain from learning some basics of mainstream economics.

    If there were no other reasons, so that we can most effectively criticize them.


Post a Comment

Popular posts from this blog

A few brief comments on Brexit and the postmortem of the European Union

Another end of the world is possible
There will be a lot of postmortems for the European Union (EU) after Brexit. Many will suggest that this was a victory against the neoliberal policies of the European Union. See, for example, the first three paragraphs of Paul Mason's column here. And it is true, large contingents of working class people, that have suffered with 'free-market' economics, voted for leaving the union. The union, rightly or wrongly, has been seen as undemocratic and responsible for the economics woes of Europe.

The problem is that while it is true that the EU leaders have been part of the problem and have pursued the neoliberal policies within the framework of the union, sometimes with treaties like the Fiscal Compact, it is far from clear that Brexit and the possible demise of the union, if the fever spreads to France, Germany and other countries with their populations demanding their own referenda, will lead to the abandonment of neoliberal policies. Aust…

A brief note on Venezuela and the turn to the right in Latin America

So besides the coup in Brazil (which was all but confirmed by the last revelations, if you had any doubts), and the electoral victory of Macri in Argentina, the crisis in Venezuela is reaching a critical level, and it would not be surprising if the Maduro administration is recalled, even though right now the referendum is not scheduled yet.

The economy in Venezuela has collapsed (GDP has fallen by about 14% or so in the last two years), inflation has accelerated (to three digit levels; 450% or so according to the IMF), there are shortages of essential goods, recurrent energy blackouts, and all of these aggravated by persistent violence. Contrary to what the press suggests, these events are not new or specific to left of center governments. Similar events occurred in the late 1980s, in the infamous Caracazo, when the fall in oil prices caused an external crisis, inflation, and food shortages, which eventually, after the announcement of a neoliberal economic package that included the i…

What is the 'Classical Dichotomy'?