Larry Summers: Modern Monetary Theory is a recipe for a disaster
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Former Treasury Secretary Larry Summers expands on the argument he made in his Washington Post op-ed on modern monetary theory.
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Secretary Summers argues that modern monetary theory is a dangerous misconception that will lead to hyperinflation if adopted, and that while fiscal stimulus is appropriate, it must be balanced against the arithmetic reality that governments cannot indefinitely finance spending through money printing.
- Multiple countries (South America, France 1981, Germany late 1990s, UK) attempted monetary financing and faced hyperinflation or currency crises
- Reserve currency status is not permanent and can be lost if monetary policy is abused, as happened when the US abandoned the gold standard after Vietnam spending
- Fiscal stimulus is justified and useful, but MMT's claim that deficits never matter conflates two different propositions
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If the focus of US-China trade negotiations is on reducing the bilateral trade surplus, then something foolish is happening because bilateral trade surplus is easily manipulated through reorganizing trade flows without creating real economic benefit—for example, the US could sell natural gas to China while China buys it from elsewhere, creating statistical surplus reduction without real trade change.
“if the focus is on the bilateral trade surplus then you'll know that something foolish is happening because that's something that's easily manipulated just by reorganizing trade they buy natural gas from us we sell our natural gas to them somebody else buys the natural gas from somewhere else that otherwise would have been traded”
Latin America has seen many attempts at monetary financing policies and the consistent result has been hyperinflation, providing another set of cautionary examples for why modern monetary theory is unrealistic.
“we've seen these kinds of policies in Latin America many times and the result has been hyperinflation”
The United States will not have the reserve currency forever if it pursues monetary financing, and historical precedent shows this: the US had reserve currency status when the dollar was tied to other currencies, but then the US 'spent indiscriminately' on the Vietnam War and lost reserve currency status.
“why can't they if we have the reserve currency that everybody wants right now we won't have the reserve because we won't have the reserve currency forever if we do that we had the reserve currency and it was tied and all the other currencies were tied two hours and then we spent indiscriminately churning the Vietnam more and then we didn't and we saw it”
France was forced to back off from monetary financing policies in the 1980s, and the United Kingdom pursued these kinds of policies and had to call in the IMF, demonstrating that reserve currency status or developed-economy status does not insulate a country from fiscal constraints.
“the French thought they had a strong currency with the franc but they were forced to back off from these kinds of policies in the 1980s the United Kingdom pursued these kinds of policies and had to call in the IMF”
Modern monetary theory's claim that government can print money to finance itself without worrying about paying its bills is not a realistic calculus because countries all over South America have tried it with disastrous results, France's socialist government tried it in 1981 and had to reverse it, Germany tried it for six months in the late 1990s and had to reverse it.
“countries all over South America have tried it with disastrous results it was tried by the socialist meter on regime in 1981 in France and they had to reverse itself it was tried for six months in the late 90s in Germany and they had to reverse themselves”
Rather than implementing new taxes like wealth taxes, the government should first pursue closing existing tax loopholes: taxing carried interest, eliminating special benefits for real estate entrepreneurs, collecting tens of billions in taxes that are owed but not paid, and going after corporate tax shelters.
“I'd sure rather tax carried interest I'd sure rather get rid of special benefits for real estate entrepreneurs like the president sure rather collect tens of billions of dollars a year in taxes that are owed but not paid and sure rather go after corporate tax shelters those seem like things that would make the economy more efficient and would fit with everybody's concept of fairness I think we ought to look to those sources first”
Disallowing interest deductions associated with stock buybacks would be a good policy because while buybacks themselves are acceptable, borrowing to finance buybacks with government tax subsidy is wrong.
“if we found ways to disallow interest deductions associated with buybacks that would be a good thing there's nothing it's okay to buy back stock but if you borrow money and get government subsidized to do it I think that's the wrong thing to do”
Modern monetary theory's idea that government can guarantee jobs for everybody or provide Medicare for all by relying on money printing to finance it is quite a dangerous approach because it ignores the arithmetic constraints that apply to sovereign finances.
“this modern monetary theory idea where we can guarantee jobs for everybody or I've Medicare for all and just rely on money printing to finance it I think that's quite a dangerous approach”
A wealth tax would be very difficult to administer and difficult for some people to pay because their assets may be very valuable but may not produce any liquidity or cash that can be used to pay the tax, unlike income taxes.
“they may not produce any liquidity any cash that can be used survey the tax so I wouldn't start with wealth taxes”
It would have been much better to fix the country's bridges than to provide a tax cut that is mostly financing stock buybacks, which represents a better use of fiscal resources when policy is expansionary.
“I think it would have been much better to fix the country's bridges than it was to provide a tax cut that's mostly financing stock buybacks”
The distinction between saying appropriately managed fiscal stimulus is good and embracing a theory that all government debts can be paid by printing money is crucial and these should not be conflated—the latter idea involves holding interest rates fixed and overwhelming the central bank.
“it's one thing to say that appropriately managed fiscal stimulus is a is a good idea and it's a quite different thing to embrace a theory that all government debts can be paid by printing money and it's that latter idea that you should just hold the interest rate fixed that you should overwhelm central bank”
All things in economics are a matter of balance and there is a balance to be struck between different fiscal and monetary policies—the advocates of austerity aren't right, but this doesn't mean we can rely on money finance for everything.
“look you know all things economics as a matter of balance and there's a balance to be struck the avatar's of austerity aren't right either but that's not the same thing as saying we can rely on money finance for everything”
Meaningful accomplishments in US-China trade negotiations would involve actual changes to intellectual property rules and rules governing business entry into China, not just symbolic language changes or statistical adjustments to trade balances.
“we'll have to see whether there are meaningful changes in intellectual property rules we'll have to see whether they're meaningful changes in the rules on businesses entering”
Every American ought to support the laws of arithmetic, which don't say you cannot borrow money and indeed often suggest it's a good idea to borrow money, but they do constrain how much borrowing is sustainable.
“one thing that every American ought to support is the laws of arithmetic and laws of arithmetic don't say you can't borrow money and indeed often it's a good idea to borrow money”
The Trump tax cuts engaged in 'tax shelter creation' that primarily benefited the wealthy rather than middle-class families, making it a worse allocation of fiscal resources than direct support for middle-class families would have been.
“I think it's much better to support middle-class families than to engage in the kind of tax shelter creation that the Trump tax cuts in gay engaged it”
Whether the risks of economic turmoil during the trade war period were risks worth bearing depends on whether the agreement that results produces genuine benefits, and Summers would be surprised if the unilateral US trade approach is judged wise in retrospect.
“whether the risks of the economic turmoil we've had during this trade war period whether those were risks that were worth bearing I'd be surprised if our unilateral approach is judged wise”
Modern monetary theory is 'the new voodoo economics' in the same way that the Laffer curve and supply-side economics from 40 years ago was voodoo economics—it starts with a valid insight (taxes have incentive effects / money printing has uses) and transmutes it into an invalid conclusion (cutting taxes raises revenue / governments can finance anything by printing money).
“what my column points out is that it's sort of the new voodoo economics that there was a valid idea 40 years ago the taxes had incentive effects which got transmuted into the invalid idea that you could cut taxes in order to raise revenue the Laffer curve supply-side economics all of that that turned out to be very costly and it had to be reversed when the United States tried it and I think something very similar is true with respect to modern monetary theory”
When the next recession comes, we will need significant fiscal stimulus to support the economy, but this should be designed intelligently rather than financed through the MMT approach of unlimited money printing.
“whenever the next recession comes we're going to need a lot of fiscal stimulus”
Closing tax loopholes and collecting existing owed taxes makes the economy more efficient and fits with everyone's concept of fairness better than implementing new taxes like wealth taxes.
“those seem like things that would make the economy more efficient and would fit with everybody's concept of fairness”
Over the last decade, more fiscal stimulus would have been appropriate to support economic recovery and growth, representing a genuine disagreement with austerity advocates.
“I've been arguing for most of the last decade for more fiscal stimulus I think it would have been much better to fix the country's bridges”
Even if China does implement meaningful changes to IP rules and market access, and even if these changes benefit some American corporations, most of those corporations aspire to produce in China not in America employing Americans, so the actual benefits to American workers and employment would be limited.
“even if we do see some changes and even if they do benefit some American corporations most of whom are aspiring to produce in China not produced in America employing Americans how large the benefits will be”
Treating the dropping of the phrase 'Made in China 2025' from the Premier's address as an achievement in trade negotiations is foolish, because the actual substance of agreements—intellectual property rules, rules on business entry, and real behavioral change—matters far more than symbolic language changes.
“I think it's a good example of the foolishness of much of this that it's being treated as an achievement to get them to stop using the words made in 2025 what's up I think not and there but much of this discussion”
Summers is concerned that modern monetary theory is gaining more adherents and sees this as dangerous because it combines the appeal of idealistic policy (job guarantees, Medicare for all) with a flawed theoretical framework.
“I'm sorry to see that it's gaining more adherence”
Treasury yields are very low and the Fed has paused rate increases while the economy is slowing, which might suggest that fiscal stimulus is working or that the constraints on government borrowing are looser than expected.
“the ten-year Treasury yield is super low the Fed has now been on pause and we are running back up against one trillion dollar deficits”
President Trump funded a $1.5 trillion tax cut during a time of economic growth, and the market does not seem worried about this, which represents a case where the laws of arithmetic do not seem to be constraining policy in the way they should.
“president Trump funded his one and a half trillion dollar tax cut at a time of economic growth and market doesn't seem that worried about it”