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Economic Theory in the Time of Coronavirus

State and local officials say there's an easy way out of the coronavirus-induced economic crisis: Just create more money.

(PXHere / CC0 Public Domain)

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They knew their letter would fall on deaf ears in Washington, D.C. But those weren’t the only ears they hoped to reach.

Around a hundred local elected officials from around the country signed the letter in April, demanding federal budget aid for state and local governments, which face steep revenue declines due to the COVID-19 pandemic. They called it the “Local Bailout for the Many.”

One estimate puts the cumulative state and local government revenue shortfall at at least $650 billion through fiscal year 2022.

To pay for covering that shortfall, rather than suggesting a tax on billionaires or cutting costs elsewhere, the letter demands to make use of the Federal Reserve’s power to issue currency.

State and local governments don’t issue currency, so they can’t just spend money without taxing or borrowing it first. But the federal government — which has the power to literally print money — can never run out. This difference is at the heart of Modern Monetary Theory, a small but growing branch of economics that is gaining popularity.

You don’t have to “believe in” Modern Monetary Theory to understand that the federal government cannot run out of money. The Federal Reserve’s power to print money has been on unprecedented display during the pandemic: In March, it began to buy trillions of dollars of U.S. government bonds in an attempt to stabilize financial markets. Then, after the CARES Act authorized $2.2 trillion in spending, the Federal Reserve started making payments on behalf of the federal government. In neither case did the Federal Reserve have to borrow those dollars from anyone or dig them out of a secret vault before spending them.

That’s why policymakers, like Chicago 33rd Ward Alderman Rossana Rodriguez Sanchez, drafted the April letter. The signers of the letter were asking for the Fed to use its power to cover looming state and local government revenue shortfalls. By creating money.

“Economics is a thing that requires a little bit of time and attention to understand some of this stuff. I think people get a little intimidated by it, and rightly so,” says Rodriguez Sanchez. “We’re up against a ruthless, horrible system that offers very little space to have these conversations.”

Stephanie Kelton has been having those conversations for more than two decades. Her New York Times bestseller, “The Deficit Myth,” is another reason Modern Monetary Theory is reaching new audiences right now — including Ice Cube.

Kelton is currently a senior fellow at the Schwartz Center for Economic Policy Analysis and a professor of economics and public policy at Stony Brook University. She also served as chief economist for the U.S. Senate Budget Committee (Democratic staff) in 2015 and as a senior economic adviser to Bernie Sanders’ 2016 and 2020 presidential campaigns.

Lately, Kelton is finding herself spending an occasional weekend on Zoom calls with mayors and local officials. While state and local governments generally aren’t issuing currency anytime soon, those officials may end up in Congress some day and are definitely a key constituency to at least some existing members of Congress.

“They want to go in well-armed with a clearer understanding of what the limits are and better able to defend their own progressive agenda against the drum beat of ‘how are you going to pay for that?’” says Kelton, in an interview with Next City.

As Kelton tells in her book, even the famously progressive Senator Sanders was not familiar with Modern Monetary Theory when he first called her into service for the U.S. Senate Budget Committee. Her time with the committee and later with Sanders’ campaigns helped crystalize the framework of her book, which is actually built around defusing six myths about federal budget deficits.

The most pervasive myth is that people should think of the federal government budget like a household budget — that deficits represent irresponsible and dangerous over-spending, living beyond one’s means, and even moral failure for leaving the debt for future generations to pay off. It’s a popular analogy on the campaign trail or on cable news.

Modern Monetary Theory says that the household analogy is a fair metaphor for state and local governments. Like households and businesses, state and local governments are currency users, not currency issuers. But if you are the one issuing currency, you don’t borrow it from somebody else before you spend it; you just spend it.

Printing money to pay for a ton of new spending might sound alarming, but Modern Monetary Theory argues that if a government issues its own currency and it only borrows in denominations of that currency, it can never run out of money. A country like Greece defaulted on debt because it gave up the power to issue its own currency as part of joining the European Union. Countries like Venezuela or Argentina default because even though they issue their own currency, they borrow in foreign currency denominations, so they can still run out of foreign currency to pay their debts. If you issue a currency and only borrow in amounts denominated in that currency, you can always print more money to make your debt payments.

That wasn’t always the case. Modern Monetary Theory is so named and it’s considered so outside mainstream economics is because the reality it describes has only really existed since 1971. As Kelton explains in her book, that is the year President Richard Nixon ended the “gold standard” — the ability to convert dollars into gold held by the Federal Reserve. It was initially temporary, but became permanent in 1973. There are some economists and ideologues who want to go back to the gold standard, but there is broad economic consensus that the U.S. will never go back to doing that.

The gold standard limited the amount of money that the Federal Reserve could print — unless it wanted to lower the value of the dollar, the only way it could suddenly print trillions more dollars would be if it somehow got its hands on the equivalent amount of gold. As of 1971, we were no longer living in that world.

“Modern Monetary Theory is grounded in institutionally accurate operational realities,” says Kelton. “That’s part of what I think upsets so many people about the book. Economists in a way are not supposed to be divulging the inner workings of money and the economy.”

That doesn’t mean there is no reason for currency-issuing governments to tax or borrow. Modern Monetary Theory just says taxes and government debt serve different purposes than financing the ability of currency-issuing governments to spend — such as helping to manage inflation or discourage harmful activities like carbon emissions.

Kelton’s book outlines how Modern Monetary Theory provides a framework that supports proposals, like a Federal Jobs Guarantee, which have broader roots in the civil rights movement.

Critics of Modern Monetary Theory charge that printing too much money will lead to catastrophic inflation, because there would be “too much money chasing too few goods” — the phrase credited to conservative economist Milton Friedman.

As Kelton explains in her book, Modern Monetary Theory doesn’t disagree with that assessment; it just says instead of worrying first about having too much money, worry first about making sure the economy can produce enough of the right mix of goods and services to meet demand. It becomes in part a question of urban and regional planning — what transportation infrastructure, zoning, building codes or other local policy factors need tweaking to ensure public and private investment aligns with the best possible information about what people today or in the future will need or want to buy with the money they have?

But there’s still a long way to go before state and local officials can have the freedom to focus on those discussions instead of being overly preoccupied with the question of “how do we pay for that?”

That’s where the April letter came in. Even knowing it would fall on mostly deaf ears in Washington, Rodriguez Sanchez felt it was also an opportunity to educate more colleagues in state and local government across the country about the nature of federal spending.

“I think it was important to put the message out there, it’s important for people to know that power exists within the Federal Reserve and we should be demanding that,” says Rodriguez Sanchez. “It’s about how little we know about how the government works and what are the resources that should be at our disposal. We’re not taught these things, nobody knows this. So whenever we hit a crisis like the one we’re in right now it just feels like we are absolutely on our own, and that shouldn’t be the case.”

This article is part of The Bottom Line, a series exploring scalable solutions for problems related to affordability, inclusive economic growth and access to capital. Click here to subscribe to our Bottom Line newsletter.

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Oscar is Next City's senior economic justice correspondent. He previously served as Next City’s editor from 2018-2019, and was a Next City Equitable Cities Fellow from 2015-2016. Since 2011, Oscar has covered community development finance, community banking, impact investing, economic development, housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha and Fast Company.

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Tags: covid-19federal reservemodern monetary theory

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