Olivier Blanchard, former IMF chief economist and professor at Massachusetts Institute of Technology, who wrote a book on macroeconomics, waded into treacherous waters on Tuesday — the simmering debate on modern monetary theory.
The theory, known as MMT for short, has captured the imagination of left-wing Democrats because it seems to offer the opportunity for the Federal Reserve to fund ways to combat economic inequality.
Since the start of the 2020 presidential campaign, there has been a low-grade social media war among economists about what MMT actually is and what it isn’t.
During a panel discussion on the outlook for fiscal policy at an event sponsored by the Peterson Foundation, the moderator of the panel, Greg Ip of the Wall Street Journal, summed up MMT as the view that the U.S. “can borrow and spend as much as we wish to get the economy to full employment because we control our own currency and we can’t go broke.”
What MMT gets wrong, Blanchard said, is the notion that the Federal Reserve can just print money to pay for this increase in spending.
“The notion that you can finance this [spending] by money is wrong, is plain wrong,” he said.
The Fed did purchase trillions of dollars in assets, known as quantitative easing, to lower long-term interest rates and pull the economy out of the Great Recession of 2008.
But this was not printing money, Blanchard said.
It was essentially just buying long-term bonds with short-term debt, creating bank reserves at the Federal Reserve, that still paid an interest rate, he said. In effect, QE was government debt transformation.
“If [the Fed] issued money at zero rate, then we’d have hyperinflation. But we’re basically issuing a new form of debt, which is bank reserves,” he said.
“The notion that for some magical reasons you can do this through money is wrong,” he said.
The one exception, which has caught the eye of MMT advocates, is Japan, where interest rates are zero.
“When you are at zero, debt and money are the same thing,” he said.
But this can’t last forever.
“The day on which Japan has to pay a positive interest rate on bonds, it will have to pay a positive interest rate on the money, otherwise people will not hold it, or there will be hyperinflation,” he said.
On the surface, Blanchard seemed like a natural ally for modern monetary theory supporters. He caused a stir at the American Economic Association earlier this year when he said there was too much concern about government debt levels given the new low-interest-rate global economy.
Read: Leading economist says high public debt ‘might not be so bad’
He argued that, with interest rates low, public debt was not “crowding out” more productive investment, which was the long-time fear about high government borrowing.
At the moment, Blanchard said the best course for U.S. fiscal policy is a slow reduction in the deficit, taking care not to damage the economy.
If there is a recession, the Fed does not have the firepower to fight it alone and fiscal policy will have to be used, adding to the debt, he added. This will not be catastrophic, he added.
And Blanchard said lawmakers should “start now” to make the necessary spending decisions to keep the debt from exploding from the expected higher costs of Social Security and other entitlement programs.
“I have no desire to see debt increase to 150%” of GDP, he said.