Former RBNZ economist Michael Reddell reviews Modern Monetary Theory where fiscal policy is the key lever rather than monetary policy; He argues monetary policy is still best for cyclical stabilisation

By Michael Reddell *

Last Friday, an outfit called Strategy2040 New Zealand, together with Victoria University's School of Government, hosted a lunchtime address by an Australian academic, Professor Bill Mitchell of the University of Newcastle. He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

Mitchell attracted some interest on his trip to New Zealand. He apparently did two substantial interviews on Radio New Zealand and attracted perhaps 150 people to the lunchtime address -  a pretty left-liberal crowd mostly, to judge from the murmurs of approval each time he inveighed against the "neo-liberals". In fact, the presence of former Prime Minister Jim Bolger was noted -  he who, without apparently recanting any specific reforms his government had put in place, now believes that "neo-liberalism has failed New Zealand". Following the open lecture, 20 or so invitees (academics, journalists and economists -  mostly of a fairly leftish persuasion) joined Mitchell for a roundtable discussion of his ideas. Perhaps a little surprisingly, I didn't recognise anyone from The Treasury or the Reserve Bank at either event.

Mitchell has it in for mainstream academic economics. Quite probably there is something in what he says about that. Between the sort of internal incentives ("groupthink") that shape any discipline, and the inevitable simplifications that teaching and textbooks require, it seems highly likely there is room for improvement. If textbooks are, for example, really still teaching the money multiplier as the dominant approach to money, so much the worse for them. But as I pointed out to him, that was his problem (as an academic working among academics): I wasn't aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously. He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand. And if very few people correctly diagnosed what was going on just prior to the financial crises in some countries in 2008/09, that should be a little troubling. But it doesn't shed much (any, I would argue) light on the best regular approach to macroeconomic management and cyclical stabilisation. Perhaps especially so as (to us) he was talking about policy in Australia and New Zealand, and neither country had a US-style financial crisis.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend. They can simply print (or -  since he doesn't like that word - create) the money, by spending funded from Reserve Bank credit. But he isn't as crazy as that might sound. He isn't, for example, a Social Crediter. First, he is obviously technically correct -  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt. And he isn't arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I'm pretty sure he'd be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending). Taxes make space for the spending priorities (claims over real resources) of politicians. And he isn 't even arguing for a much higher inflation rate -  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn't a very effective tool, and fiscal policy should be favoured as a stabilisation plicy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go. As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation. It was never anywhere near that dominant in practice -  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses -  but in the literature it was once very important, and then passed almost completely out of fashion. For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool. And one could, and did, note that in the Great Depression it was monetary action -  devaluing or going off gold, often rather belatedly, that was critical to various countries' economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy. It did so for a simple reason -  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero. Some see a big role for quantitative easing in such a world.  Like Mitchell - although for different reasons -  I doubt that. Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can't be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven't done so since. Monetary policy could have been  -  could be -  used more aggressively, but wasn't.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09. According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn't. Perhaps he just didn't have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy -  when they were the key advocates of the policy -  isn't very convincing. And I've illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were reamrkably similar during that period. And although unemployment is one of his key concerns -  in many respects rightly I think -  he never mentioned that Australia's unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced -  GDP -  didn't).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge. He didn't say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time. As a model it isn't without precedent -  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s. It isn't necessarily disastrous either. But in many ways, it also isn't terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources. And he was quite explicit that the full employment he was talking about wasn't necessarily a world of zero (private) unemployment  -  he said it might be 2 per cent unemployment, or even 4 per cent unemployment. He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment. I bit my tongue and forebore from asking "and who do you think it was that generated the unemployment?" -  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy). But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don't share  that view -  perhaps don't even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling. On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work. But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent -  Australia's is higher again. Those should be, constantly, sobering numbers: one in eight people. But some of them are people who are already working -  part-time -  but would like more hours. That isn't a great situation, but it is very different from having no role, no job, at all. And many of the unemployed haven't been unemployed for very long. As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact. Others will have been out of work for months, or even years. But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force). We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one's worry one might look first to problems with the design of the welfare system.

Mitchell's solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally. He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee. Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing "work of public benefit". I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer. That seems simply seriously wrong. Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the "underutilisation category", all of whom would presumably welcome more money. Perhaps there are a few malingerers among them, but the minimum wage -  let alone "the living wage" - is well above standard welfare benefit rates. There would be plenty of takers. (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit. It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs. Or the PEP schemes of the late 1970s. Mitchell responded that it couldn't just be "digging holes and filling them in again". But if it is to be "meaningful" work, it presumably also won't all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels. Modern jobs typically involve capital (machines, buildings, computers etc) -  it accompanies labour to enable us to earn reasonable incomes -  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation). If the work isn't "meaningful", where is the alleged "dignity of work"  -  people know artificial job creation schemes when they see them -  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work. The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively. For all his scepticism about monetary policy, it was noticeable that in Mitchell's talks he gave very little (or no) weight to the expansionary possibilities of exchange rate. But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment. And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP. I don't see the case in New Zealand - where monetary policy still has capacity -  but equally I couldn't get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can't be the answer either. Most OECD countries - including the UK, US and Australia -  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound. Some of it probably is the point Mitchell touches on -  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow. But much of it was probably also some mix of bad forecasts -  advisers who kept believing demand would rebound more strongly than it would -  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that -  issues that Mitchell simply didn't grapple with. For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass? And perhaps I might support the government spending on my projects, but not on yours. And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life. Perhaps too, publics just don't believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending. They are all real world considerations that reform advocates need to grapple with -  it isn't enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don't have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two. A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference -  even if, in many respects, it comes at longer term costs.

Unlike Mitchell, I still think monetary is, and should be, better placed to do the cyclical stabilisation role. That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy. Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention -  commands too little empathy -  from those holding the commanding heights of our system. But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue. How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking -  or why we are relaxed that so many more, not meeting those narrow definitions, can't get the volume of work they'd like  -  is beyond me. Work is the path to a whole bunch of better family and social outcomes -  one reason I'm so opposed to UBI schemes -  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I'm pretty sure Mitchell's prescription isn't the answer.


* Michael Reddell is a Wellington-based independent economist and commentator on economic and financial affairs, blogging at He recently left the Reserve Bank where he had held various economics and management positions over many years, including Head of Financial Markets and manager responsible for economic forecasting. This article was first published on Croaking Cassandra and is used here with permission.

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My understanding of the MMT argument is that fiscal policy means putting money in people's pockets by the government taxing back less than it spends. This is on the basis that government creates money when it spends it and destroys it when it taxes it back out of circulation. So it is just as effective to stimulate with a, say, 4% budget deficit created by taxing less as it is by spending more. Why is this option not mentioned?

A simple and uncontroversial way to put more money into the economy in a downturn is just to put up the tax thresholds aggressively for lower earners. For some reason this is routinely overlooked by economists. Neither Bill Mitchell nor Michael Reddell mention it. The stimulus thus created is also self correcting when things pick up and wages rise.

There has been an obsession with fiscal austerity/rectitude on the one hand, and monetary stimulus/stupidity on the other. Surely it makes more sense for fiscal and monetary stimulus to be applied together and withdrawn together.

Who are these people? Why do they think that fiscal stimulus means more government spending/wastage/stupidity?

But as I pointed out to him, that was his problem (as an academic working among academics): I wasn't aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously. He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand.

Is that so? - The Reserve Bank, private sector banks and the creation of money and credit

That RBNZ paper repeats the Fractional Reserve Banking and money multiplier myths. Balance sheet accounting proves that banks create deposits by making loans. No reserves required.

You can't use a single tool to control both inflation and unemployment; inflation is monetary problem and unemployment is a fiscal/policy problem. The central bank should control the money supply to an inflation level specified by parliament and the government should control unemployment through various methods such as limiting who can work and how long they can work to ensure the available work is distributed evenly, funding infrastructure to support the creation of new private business, etc

MMT seems to think there is no limit on a sovereign government issuing money, but there is, it is called inflation, and the higher the inflation (or deflation) rate the more unstable the economy becomes.

You clearly have no knowledge of MMT. MMT says that the limit to Government spending is inflation, not financial. Your assertion that fiscal policy can't deal with unemployment and inflation is also wrong. Central banks were only given control of inflation in the 1980s, there is no reason for this to be the case.
MMT's core goals are full employment and price stability, in that order. Governments can use fiscal policy to first address unemployment, and then inflation, by spending to create employment, and then taxing to reduce inflation. Whether that leaves a budget deficit or surplus is irrelevant, but for most countries it will be a deficit, since they also run a current account deficit. For small, commodity-based economies that run a current account surplus (Norway), the budget will be in surplus.

Well let me pose two questions: By what mechanism will the government be constrained from insufficiently raising taxes to combat inflation (i.e. what happens if the government stops following MMT)? And by what paths will the government provide jobs (i.e. what type of jobs will they be and what do you do if people are excessively slack on the job)?

Central banks controlling inflation provides a quasi-independence from government and voters and allows them to be easily punished if they fail to control inflation.
Government guaranteed jobs would be guaranteed to have a very low productivity rate.

"it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt"

Yes, most economists do believe that there is a hard limit on currency issuance, and that fiat currency governments will default when they "run out of money". Just read any Moody's or S&P report about local debt default rating. Even if an economist acknowledges that the government can issue money, they will immediately see it as some kind of sin.

Also, in most countries, politicians and economists have some sort of fetiche about nominal or primary surpluses. They will pursue surpluses even when unemployment is skyrocketing and inflation is negative (deflation). They don't see government spending as stimulus to economic activity

So Mitchell's message is a powerful attempt to change the current world view praised in economic theory.

"But do we really need all the infrastructure of a job guarantee scheme?"

We do! There are 24 million unemployed or underemployed people in my country, and plenty of work to do at the local and state level. Education and public healthcare is poor. Building infrastructure like railroads would also be essential. Why don't the governments employ people to do the so needed work?

"And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life."

100% agreed. In my opinion, that's the biggest challenge that some Job Guarantee program would face. The corruption/incompetence risk is overwhelming. But we can't forget that the private sector is also not some kind of paragon of virtue. There is a lot of corruption and illegal activities there too.

The condescending tone aside, I don't see much substantive criticism of the actual policy stances of MMT in your piece. There are fundamental differences between your view of how the economy works and MMT's real world approach that you apparently are unable to address.
Your insistence on teaching the money multiplier myth for example.