Wray V Edwards: A Discussion on MMT.

Recently, there has been a debate on whether economies should subscribe to the model of the Modern Monetary Theory (MMT). L. Randall Wray, an enthusiast of the Modern Monetary Theory, promotes the model in his 'Congressional Testimony: Reexamining the Economic Costs of Debts' as he refutes critics' claims of MMT dismissing the importance of government budget deficits. Wray's 'Congressional Testimony', to a moderate extent, succeeds in its intended objective in promoting Modern Monetary Theory. Meanwhile, Sebastian Edwards poses as the opposition towards Modern Monetary Theory through his 'Modern Monetary Theory: Cautionary Tales From Latin America' paper. Edwards' effort to dissuade interest from the Modern Money Theory succeeds to a somewhat extent, as the economist based his concerns of MMT upon the analysis of Latin American economies (like Argentina, Peru, Chile and Venezuela) use of macroeconomic populism in the 1970s.

Summarizing: L. Randall Wray’s ‘Congressional Testimony: Re-examining the Economic Costs of Debts.’

L. Randall Wray's 'Congressional Testimony: Reexamining the Economic Costs of Debt' intends to disprove criticism against Modern Monetary Theory, specifically of the model dismissing the importance of government budget deficits. Wray emphasizes how government deficits can 'impact the economy in important ways' through its endogenous nature. (Wray, 2019) For instance, a decrease in the government deficit, either through an increase in tax or decrease in government spending, would lower growth. Hence, it would result in less tax revenue and more spending on transfers. Wray further showcases the endogenous nature of budget deficits through the graphical illustration under Figure 1.1.

Figure 1.1. (Wray, 2019)

 

 Under Figure 1.1, Wray describes that through an increase in tax (or less government spending, government budget deficit increases from point A (3% deficit ratio and 4% growth rate) to point B (10%b budget deficit). As a result, 'growth collapses' at point B and, despite the tax increase, tax revenue also decreases. (Wray, 2019) Moreover, Wray provides empirical evidence and statistics of the direct relationship between government budget deficit and economic growth. For instance, in the 2007-2008 Global Financial Crisis, Federal Deficit, as shown in Figure 1.2., skyrocketed to 9.8% while US economic growth plummeted simultaneously to '-1.8%'. (Wray, 2019)In post-GFC, The US slowly recovered as deficit reached a ‘low of 2.4% in 2015 before increasing back up to 3.8% in 2018.’ (Wray, 2019) Nominal Growth also ‘averaged about 4% over 2010-2018.’

Figure 1.2. (Wray, 2019)

 

Furthermore, with Wray establishing the importance of government budget deficits under Modern Money Theory through demonstration of its endogenous nature, Wray perceives that MMT allows economists to 'evaluate government (fiscal and monetary) policy actions based on the private sector.' (Wray, 2019)Through sectoral balance identity, Wray claims that 'government deficit spending can create wherewithal for government bond purchase since deficits add to private sector surpluses.' (Wray, 2019)He provides historical data of this sectoral balance identity, for example, in the third quarter of 2017, US government balance was at a deficit of 5.6% of GDP while 'private sector held a surplus of 3.2% of GDP.' Then, both government deficit and private sector surplus increased in the fourth quarter of 2019. Respectively to 7% of GDP and 4.63% of GDP. (Wray, 2019). 

With his effort of demonstrating sectoral balance identity, Wray recommends 'supporters of fiscal consolidation should indicate that it would lower growth and lower private sector net saving.' (Wray, 2019) Under Modern Monetary Theory, the private sector should form as the basis for policy action assessment as 'deficit or debt ratio is not a good indication of economic performance' and provides 'a vague metric. (Wray, 2019)'

Summarizing: Sebastian Edwards’ Modern Monetary Theory: Cautionary Tales From Latin America'

Sebastian Edwards' 'Modern Monetary Theory: Cautionary Tales From Latin America' paper aims to deter interest of the Modern Monetary Theory through the analysis of the catastrophic outcomes from the Latin American economies (like Argentina, Chile, Peru and Venezuela) employment of an earlier version of MMT. Edwards observed that Latin American countries, like Argentina, Peru, Chile and Venezuela, developed their (own) fiat currency and increased their budget deficits through expansionary monetary policy and fiscal policy. In the long run, this early version of Modern Monetary Theory, also recognised as 'macroeconomic populism', brought upon harmful ramifications, such as falls in average real wages and currency value and excessively high or hyperinflation.

Edwards' analysis of the 'four Latin American episodes' practising macroeconomic populism observed empirical evidence of 'incomes collapsing, hyperinflation, and a dramatic loss of currency value.' (Edwards, 2019) Throughout his paper, Edwards provides plentiful empirical evidence of the calamity within Latin American economies after the use of macroeconomic populism. Money supply growth accelerated initially after the expansion of fiscal and monetary policy stance. Simultaneously, fiscal deficits became 'very large.' (Edwards, 2019) In the long run, inflation grew dangerously high. Chile reached '500% in 1973' while Peru suffered from hyperinflation of '7000% in 1990. Additionally, 'Venezuela surpassed 1000% in 2017' while Argentina experienced 41% in 2016. (Edwards, 2019) In terms of real wages, Edwards observed Chile's average real wages falling by '39% between 1970 and 1973.' Peru and Venezuela suffered a similar fate, a 41% decrease between 1985 and 1989 and a 21% decrease between 1999 and 2013, respectively. Argentina was the only beneficiary in regard to real wage levels, as average real wages increased by 13% 'between 2002 and 2016' due to improving export prices during the time. With regards to the impact on currency value, all four economies that practised macroeconomic populism suffered 'very severe currency devaluations.' Chile's peso lost '93% of its value in 1973' while the price of foreign currency increased by 'more than 8000% between 1989 to 1990.’ (Edwards, 2019) Additionally, Argentina's price of foreign exchange jumped from 3 pesos per dollar (2003) to 20 pesos per dollar (2016) while Venezuela's Bolivar currency loss of value was absolute, leading to the introduction of 'a new cryptocurrency to replace it.'

Critique: L. Randall Wray’s ‘Congressional Testimony: Re-examining the Economic Costs of Debts.’

The objective of L.Randall Wray's 'Congressional Testimony: Reexamining the Economic Costs of Debt' is to promote Modern Money Theory refuting critiques of the model overlooking inflationary consequences of limitless spending and being indifferent to government budget deficits. To a moderate extent, Wray's 'Congressional Testimony' achieves its intended objective. Wray succeeds in demonstrating the significance of government budget deficits under Modern Money Theory. He emphasizes the endogenous nature of government budget deficits with a graphical illustration in Figure 1.1. Figure 1.1. showcases how a tax increase, in which it would increase the deficit, would cause slower economic growth, and hence a loss of tax revenue. Wray validates the illustration in Figure 1.1. by providing recent empirical evidence. He observed a direct relationship between US government budget deficits and economic growth during the midst of the 2008-2009 Global Financial Crisis. With the aid of Figure 1.2., Wray emphasizes a dramatic increase of Federal Deficit to '9.8%' with a simultaneous decrease of economic growth rate to '-1.8%'. (Wray, 2019)

Wray also argues for the use of Modern Money Theory as it would allow policymakers and economists 'to evaluate government (fiscal and monetary) policy actions based on the private sector, rather than on some vague metric of what is an acceptable level of deficits and debt.' Unfortunately, this argument brought upon by Wray is limited in appeal. Modern Money Theory incorporates the 'Sectoral Balance Identity' within its model, where the private sector surplus is rooted in the financial assets delivered by government budget deficits. Wray proves the Sectoral Balance Identity with empirical evidence, as recent as 2017 to 2019. US government deficit (5.6% of GDP) and private sector surplus (3.2% of GDP) increased from 2017 to 2019 (respectively 7% of GDP and 4.63% of GDP). (Wray, 2019) Despite proving sectoral balance identity, Wray does not provide evidence on the effectiveness of evaluating 'policy actions based on the fluctuations within the private sector.'

Critique: Sebastian Edwards’ Modern Monetary Theory: Cautionary Tales From Latin America

Sebastian Edwards' 'Modern Monetary Theory: Cautionary Tales From Latin America' paper aims to discourage present economies from subscribing to Modern Monetary Theory based on his analysis on the use of macroeconomic populism by Latin American economies in the 1970s. Edwards' effort in deterring economies from using the model succeeds to a somewhat extent.

Edwards does well in showcasing how conducting macroeconomic populism, in his perception an earlier form of Modern Monetary Theory, was harmful towards the likes of Argentina, Chile, Peru and Venezuela. He displays plentiful amounts of empirical evidence and statistics where Latin American economies suffered from harmfully high inflation, currency devaluations and dramatic decreases in average real wage level (except for Argentina who experienced the opposite due to strong export prices). However, macroeconomic populism is not the MMT at its fullest. Populism overlooks a core element of MMT, that is the 'increase in taxation intended to regulate growing inflation.'. (Edwards, 2019) As a result, the validity of Edwards’ analysis of Latin American countries undertaking macroeconomic populism is questionable.

Who wins? 

In conclusion, L Randall Wray's 'Congressional Testimony: Re-examining the Economic Costs of Debts' boasts as the more convincing case at it promotes Modern Monetary Theory through disproving criticism of the model's dismissal of the government budget deficit. However, Wray's 'Congressional Testimony' appeal would have improved if Wray took external factors, like a foreign direct investment, into account in his analysis of the endogeneity of the budget deficit. While Edwards' 'Modern Monetary Theory: Cautionary Tales From Latin America' provided empirical evidence of his arguments, his analysis of Latin American economies employing macroeconomic populism was not MMT at its fullest, hence distorting validity. 'Cautionary Tales' would have been a compelling case if Edwards studied actually MMT in practice.

References

- Edwards, S. (2019). Modern Monetary Theory: Cautionary Tales From Latin America . Stanford: Hoover Institution.
- Wray, L. R. (2019). CONGRESSIONAL TESTIMONY: Reexamining the Economic Costs of Debt. 210 Cannon House Office Building: House Budget Committee.