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Bond MarketMMT After The Pandemic Shock

MMT After The Pandemic Shock

It is likely that I will be participating (remotely) in an academic panel about Modern Monetary Theory (MMT), with a “pro” and “con” side at a Canadian academic conference. This article is my initial thinking, and is a way of soliciting feedback. The “story” behind the panel is whether we learned anything from the pandemic shock.

(Note: I have been tied up with some consulting work, so my writing output has been down. That project is wrapped up, so I should have more writing time.)

Media Appearances Died Down

There was something resembling a “media frenzy” regarding MMT (well, as much of a “frenzy” an economic theory can get) for a few years — first, the views of U.S. Representative Alexandria Ocasio-Cortez (“AOC”) started things, and then the publication of Stephanie Kelton’s The Deficit Myth got a lot of attention.

We had a lot of “What is MMT?” articles, along with “MMT Is Nonsense!” articles by MMT critics. Although this helped my book sales (which are a lot less than Kelton’s), I am not saddened by the passing of this phase. I hit my tolerance limit of seeing critics lie about MMT.

Although some critics have used the quieting of discussion to argue that “MMT is dead,” my feeling is that we are just reverting to where we were in the late 2010s (there was an earlier burst of enthusiasm in the economics ‘blogosphere’ during the early 2010s due to austerity debates). The popular strength of MMT came from debates about austerity and fiscal policy, and those are currently not the main topic of economic debate. However, it seems unlikely that fiscal conservatives have given up completely on their project. (My books are waiting for that eventuality.)

Why MMT?

From an academic perspective, the question then arises: why am I in the MMT camp? For those readers who are unfamiliar with my background, I am an ex-academic (control systems theory) who jumped into fixed income quantitative analysis. I initially worked for an economic/financial consultancy, then a fund manager. I picked up my macroeconomic knowledge on the job, with the theory following behind the empirics. Spending 15 years staring at the same time series plots of yields, inflation, and growth tends to give you a pretty good grasp how they behaved.

Although some of the MMT analysis matched what I saw in fixed income (an experience that some other fixed income people have had), MMT also won by default. The ugly reality about academic macroeconomic theory is that the entire field is dysfunctional. (As a disclaimer, I have no interest in economics outside macro.) The problem is exactly what I expected as a very ex-academic: the “publish or perish” imperative means that publication counts outweigh analytical usefulness.

The dysfunction is that macroeconomic theory is a publishing strategy, not a way to increase knowledge of macroeconomics. Neoclassical macro is dominant in terms in the number of researchers — especially when we add in central bank researchers. There is a deluge of publications that consist of the addition of yet more epicycles to the same general equilibrium models. However, this is not purely a neoclassical problem — heterodox research has also become quite arcane and self-referential; however, it is largely literary and not mathematical model-driven.

The dysfunctionality showed up market research. Even though fixed income quants almost entirely have doctorates in applied sciences and mathematics, highly mathematical and “scientific” neoclassical macro makes almost no impression. To summarise the fundamental issue, the theories rely on non-directly measurable variables like r* and y* (“potential GDP”). The estimates for these hidden variables move too much, and essentially just provide an explanation for past history — making them non-falsifiable and useless for forward-looking applications. In any other field of applied mathematics, the first thing one should do is go pick up a popular undergraduate or graduate level textbook covering the subject. This is not a useful strategy if one is interested in macroeconomics.

From my perspective, what is interesting about MMT is that the original proponents did a “back to basics” approach — what do we know about fiscal policy, and then worked on offering a clean explanation as well as policy recommendations based on the theory. The key is that we need to recognise that macroeconomic theory has far more publications than advancement in knowledge, and so theoretical dogma needs to be re-examined.

Pandemic Lessons?

From my perspective, the economic fall out of the pandemic had a great deal of uncertainty, but it was not particularly “surprising.”

  1. From my perspective, the main uncertainty was how many firms would fail due to pandemic/lock-down disruptions? I was too pessimistic, and expected there to be a significant wave of failures.

  2. However, it was straightforward that there was an unprecedented shock to the economy that implied that any forecast needed to have large error bars. But assuming the absence of major business failures, it was clear that if demand is supported and supply is constrained, we should expect that shortages would happen. In the absence of price controls/rationing (e.g., as in World War II), some kind of inflationary shock was going to happen, but with very large error bars around the predicted shock.

  3. Given the institutions that were in place in 2020, it silly to argue that there was a policy mistake. Policymakers needed to avoid the mass bankruptcy scenario, and so needed to hit the economy with stimulus. There was no easy way to calibrate the stimulus given the lack of precedents. Meanwhile, the neoclassical consensus was building toy DSGE models, not studying actual institutions in the economy, so policymakers ended up flying blind.

Anyone complaining about MMT proponents’ forecasts post-pandemic needs to get a grip. Here’s the Bank of Canada Monetary Policy Report in January 2021, where the worry was excess supply (link):

CPI inflation has risen to the low end of the Bank’s 1-3 percent target range in recent months, while measures of core inflation are still below 2 percent. CPI inflation is forecast to rise temporarily to around 2 percent in the first half of the year, as the base-year effects of price declines at the pandemic’s outset — mostly gasoline — dissipate. Excess supply is expected to weigh on inflation throughout the projection period. As it is absorbed, inflation is expected to return sustainably to the 2 percent target in 2023.

Then, by October 2021, the transitory narrative took hold.

The recent increase in CPI inflation was anticipated in July, but the main forces pushing up prices – higher energy prices and pandemic-related supply bottlenecks – now appear to be stronger and more persistent than expected. Core measures of inflation have also risen, but by less than the CPI. The Bank now expects CPI inflation to be elevated into next year, and ease back to around the 2 percent target by late 2022. The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.

I was busy publishing my book — which was too bearish on the North American economies — to push back on the Bank of Canada forecast either way. My belief is that inflation is hard to forecast, so I cannot get too excited about Bank of Canada forecast misses. That said, I would guess that a significant portion of Bank of Canada economists would sneer about MMT’s (alleged) lack of mathematical models — their models were not exactly helpful, were they?

What would have been helpful for the pandemic is having more resources invested in studying the potential for supply chain disruptions as well as the effect of fiscal policy on inflationary pressures before it happened. That is a “policy framework prescription” of MMT, although I imagine the staffing for such an effort would come from a variety of theoretical backgrounds.

Going Forward?

My feeling is that other areas of macroeconomics beyond fiscal policy needs a “back to basics” approach. This could either be done by MMT proponents, or by researchers from other schools of thought that are willing to ditch theoretical dogma. The advantage of MMT in this context is that the people involved are less attached to theoretical dogmas.

In an ideal world, academic macroeconomic theory would be less dysfunctional. Instead of making stuff up about MMT in op-eds. academics would (gasp!) read each other’s primary journal articles, and they would have actual debates in said journals. (Given that academics spend their working days obsessing about journal publications, it is rather impressive that neoclassical economists refused to cite the primary literature of MMT proponents in their “critiques.”)

Canada-Specific Issues

From a theoretical point of view, the MMT critiques of conventional fiscal policy analysis have led to some retrenchment. Canada is somewhat of an exception, with the “1994 Canadian Fiscal Crisis” being engrained in the conventional economist consensus. “Oh no, the bond/currency vigilantes will destroy us unless we stop spending on poor people! Imagine the chaos if the Wall Street Journal calls our currency ‘the Canadian Peso’ again!”

It is unclear to me whether the rather hefty deficits run courtesy of the pandemic have injected anything resembling common sense into Canadian discussions of fiscal policy.

The other Canadian issue is that a lot of policy experimentation is driven by the provinces. Although this makes political sense, provinces do face fiscal constraints that the Federal Government does not.

Concluding Remarks

The path of least resistance for academic macroeconomics is to keep doing exactly what they have been doing since the 1980s to keep publications flowing. One of the reasons that MMT has caught attention is because the proponents are trying to do something different. To me, that is the key lesson to be learned, even if one is skeptical about MMT itself.


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