Paul Krugman – The Conscience of a Neo–Liberal

By

Scott Fullwiler

(Reprinted with the Permission of the Author)

(Editor’s Note: This is a long and difficult piece, originally published at Yves Smith’s Naked Capitalism site, and has an academic style. But, nevertheless, if you want to understand more about what the Modern Monetary Theory (MMT) school of economics has to offer, it is well worth your investment of time. It is the definitive critique of Paul Krugman’s two recent blog posts on MMT, in my view.

In addition, in the process of criticizing Paul’s views, Scott Fullwiler illuminates a lot of the deep thinking and knowledge developed by those following the MMT approach over many years, now. If you read this, you can see just how far off-base Paul Krugman is in his attempt to de-construct MMT, and you can also see how much work Paul has to do to really understand what his colleague economists using the MMT approach have developed.)

The old saying that bad press is better than no press is definitely true in this case. Without the advent of the blogosphere, our work would likely never even be noticed by the likes of Paul Krugman, so the fact that he’s writing about us (here and here) this weekend at least means we’re doing better than that, even if his assessment of us is far less than glowing. At the same time, and particularly given that Krugman is so widely read, it’s imperative to at the very least set the record straight on where MMT and Krugman differ. I should note before I start that others have done very good critiques already that overlap mine in several places (see here, here, here, and here).

Krugman makes three incorrect assumptions about what MMT policy proposals actually are while also demonstrating a lack of understanding of our modern monetary system (as is generally verified by volumes of empirical research on the monetary system by both MMT’ers and non-MMTer’s). These are the following:

Assumption A: The size of the monetary base directly (or indirectly, for that matter) affects inflation if we’re not in a “liquidity trap”

Assumption B: MMT’s preferred fiscal policy approach or strategy—Abba Lerner’s functional finance—is Non-Ricardian

Assumption C: Bond markets alone set interest rates on the national debt of a sovereign currency issuer operating under flexible exchange rates

Assumptions A and C are central to the Neo-Liberal macroeconomic model. Assumption B is a common misconception about MMT and a common perception of Neo-Liberals about the nature and macroeconomic effects of fiscal policy (i.e., Neo-Liberals often believe that activist fiscal policy is Non-Ricardian).

While MMT’ers argue that all three assumptions are false, one does not need to necessarily agree. The point is that to critique MMT on the basis of assumptions that are inconsistent with MMT is to actually not a critique MMT at all. It is a straw man.

I explain these assumptions and how they relate to Krugman’s two posts as I go through the text of both, written below in italics. Krugman begins,

Right now, deficits don’t matter — a point borne out by all the evidence. But there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency.

Of course, Krugman grants in his follow-up (below) that MMT’ers don’t say this at all, perhaps due to the many responses to this post pointing out his error, as this is simply a straw man that makes Assumption B—more on this below.

I wish I could agree with that view — and it’s not a fight I especially want, since the clear and present policy danger is from the deficit peacocks of the right. But for the record, it’s just not right.

Again, MMT’ers don’t say it is, either.

The key thing to remember is that current conditions — lots of excess capacity in the economy, and a liquidity trap in which short-term government debt carries a roughly zero interest rate — won’t always prevail. As long as those conditions DO prevail, it doesn’t matter how much the Fed increases the monetary base, and it therefore doesn’t matter how much of the deficit is monetized. But this too shall pass, and when it does, things will be very different.

Krugman here is using the basic Economics 101 view of a liquidity trap, where interest rates and spending are unresponsive to continued increases in the monetary base. Paul Davidson has explained numerous times that this mainstream conception of a liquidity trap is not at all what Keynes was after, though I won’t go into that specifically here.

The MMT point here, instead, is that changes in the monetary base NEVER matter per se, at least not in terms of causing anything. Recall what the monetary base is—the outstanding quantity of currency (physical “money” held by the households and businesses, or in bank vaults) and reserve balances held by banks in reserve accounts at the Fed.

Increases in currency are portfolio shifts, generally out of deposits or savings accounts. These are not controlled by the Fed—the Fed enables banks to trade reserve balances for currency as banks anticipate their customers’ withdrawals. There is no such thing in the real world as the Fed dropping currency from a helicopter—that would be an increase in private sector income, not a shift in their wealth from savings accounts to physical currency (see here for more on this point). At any rate, the key point is that an increase in currency is a trade made by banks of currency for reserve balances. This occurs in response to the private sector’s desired currency holdings out of existing wealth and relative to existing income, and to the extent they are related to an increased desire to spend, the latter is certainly not caused by the fact that the Fed accommodates the desired portfolio shift.

Regarding reserve balances, the Economics 101 story is that banks use excess reserve balances to create loans. The reality is that a loan is created when a credit worthy borrower desires a loan at a bank’s stated interest rate (that is set consistent with the bank’s anticipated costs of liabilities and the anticipated credit risk of the borrower), and this loan creates a deposit for the borrower. No prior reserve balances necessary. If the bank is short its required reserves after creating the loan/deposit, it will borrow reserve balances in the wholesale markets; in the aggregate, the Fed will ensure sufficient reserve balances to meet requirements are available at its target rate, since that’s what it means to set a target rate. Should the borrower withdraw the deposit (as when a household takes out a mortgage and immediately uses the proceeds from the loan to buy a house), if the bank is short reserve balances to settle this payment it will automatically receive an overdraft to its reserve account and that it will clear by the end of business; again, the Fed ensures that sufficient aggregate balances are circulating that the target rate is achieved. For any individual bank, what matters is the cost of the liabilities the bank anticipates it will ultimately be left with as an offset to the newly created loan along with the capital charge associated with the loan. For this, it is the Fed’s target rate that can matter, but never the aggregate quantity of reserve balances circulating.

As an aside, it should be obvious that this all works exactly the same if a bank purchases, say, a bond from the private sector. The bank simply acquires the asset and credits the seller’s account with deposits. If this raises reserve requirements, then the bank acquires them in wholesale markets if necessary. If the seller banks at a different bank, then the bank may need to borrow in wholesale markets to cover an overdraft as it settles the bond purchase with the seller’s bank.

As with currency, an increase in reserve balances will occur in response to economic activity as reserve requirements increase after a loan has created a deposit (assuming the deposit ultimately remains a deposit and isn’t converted into a money market account or time deposit). More reserve balances don’t help banks make more loans; in the aggregate this will only reduce the overnight rate below the Fed’s target unless the Fed pays interest on reserve balances at its target rate as it has since late 2008.

This has been understood for decades by many heterodox economists operating under various titles such as MMT, neo-Chartalist, endogenous money, horizontalists, and Circuitistes. Particularly since 2008, an increasing number of mainstream monetary economists have started to figure this out, though it has yet to make its way to any of the undergraduate or graduate textbooks.

Returning to the main issue, Krugman here has invoked Assumption A—that the monetary base would matter if the economy wasn’t in a liquidity trap. The MMT response, as I’ve explained here, is that the size of the monetary base never matters per se. The currency component of the monetary base is entirely set in response to economic conditions, whereas reserve balances do not help banks “do” anything they couldn’t otherwise. Indeed, banks in Canada “do” exactly what banks in the US “do” even though the banking system in Canada has operated with 0 reserve balances for many years already.

So suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are once again imperfect substitutes;

Again, Krugman’s Assumption A is false.

Further, his assertion that the monetary base and T-bills eventually will be “imperfect substitutes” demonstrates his lack of understanding of monetary operations. The reason why reserve balances and T-bills are substitutes right now is because they both earn the same return—reserve balances earn the target rate, that is. (Note that the currency components of the monetary base earns nothing, and thus is not now and will not be, in the case of any positive rate on T-bills, a substitute for the latter.) If the Fed someday in the future does raise its target rate, the question is whether or not it will continue to pay interest on reserve balances at its target rate. If so, then reserve balances and T-bills will be substitutes, at least for banks (since non-banks don’t have reserve accounts and thus can’t hold reserve balances). If not, then the Fed will be forced to drain all the excess reserve balances not consistent with achieving its target rate by selling its own assets, reverse repos, or issuing its own time deposits.
True, reserve balances and T-Bills will no longer be substitutes, but “why” this is so, and “how” the Fed will respond to this, are far more important than asserting that this will occur. That is, whether or not reserve balances and T-bills are substitutes is entirely dependent on how the Fed chooses to achieve its target rate. Note further that if the Fed chooses to simply pay interest on the excess reserve balances at its target rate, leaving this part of the monetary base at its current size even when the economy leaves the so-called liquidity trap, this will not matter since banks can’t do anything with reserve balances besides settle payments and meet reserve requirements, and the Fed always supplies enough reserve balances in the aggregate to do these things anyway.

also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation.

Remember this point, since it’s key to Krugman’s Assumption B below.

The last time we were in that situation, the monetary base was around $800 billion.

As above, Krugman’s Assumption A is wrong and demonstrates a lack of understanding of monetary operations. Whether the monetary base is $800 billion and the national debt held by private investors is $9 trillion, or the two are reversed, such that it is the monetary base that is $9 trilllion, is of no consequence. It’s merely a choice of monetary policymakers about how to achieve the target rate. In the former case, the Fed has set the target rate above the rate it pays on reserve balances and has drained all excess reserve balances not consistent with its positive interest rate target; in the latter case, the Fed has kept the target rate and the rate paid on reserve balances equal such that T-bills and reserve balances are “perfect substitutes” still for banks.

Suppose, now, that we were to find ourselves back in that situation with the government still running deficits of more than $1 trillion a year, say around $100 billion a month.

Here we see, for the first time, Krugman’s Assumption B: Functional Finance is Non-Ricardian. To define terms, “functional finance” refers to a fiscal policy strategy that uses deficits to manage the macroeconomy (for purposes here, the precise mechanisms by which this is done are not important; there’s a lot of MMT research on that point for those that are interested). The core point is that it is not the size of the deficit that matters, but rather the effects of the deficit. As such, MMT’ers only support large deficits to the extent that they do not push the economy beyond full capacity utilization and thereby create demand-pull inflation. Consequently, Krugman’s assumption here that the government is running $100 billion deficits/month must also assume that this deficit is consistent with full capacity utilization, and no more utilization than that, otherwise it is a larger deficit than any MMT’er would ever support.

Ricardian fiscal policy is a Neo-Liberal economics term that refers to a policy strategy that brings the path of the government’s primary budget balance (the total deficit less interest on the national debt) in line with the government’s so-called inter-temporal budget constraint. Where this is not the case, the path of the government’s primary budget balance ultimately brings rising inflation—even hyperinflation—or default to avoid this outcome due to exponential increases in debt service. This is referred to as Non-Ricardian fiscal policy. All sorts of fiscal policy strategies can be Non-Ricardian—running large, fixed deficits regardless of the state of the economy; maintaining a primary deficit at its current size even as debt service rises exponentially; and so forth.

MMT’ers generally don’t have much use for the inter-temporal budget constraint (as I explain here—largely because it requires Assumption C to be true; MMT’ers reject Assumption C for a sovereign currency issuer under flexible exchange rates, as I also explain below). Nonetheless, and interestingly, Wynne Godley and Marc Lavoie demonstrate that a functional finance-consistent fiscal policy strategy is in fact Ricardian. This is true regardless how large the interest rate on the national debt becomes relative to the growth rate of the national debt since an increase in debt service that pushes the economy beyond full capacity utilization and thereby raises inflation is necessarily—in order to remain consistent with the functional finance strategy—offset by a decline in the primary deficit (see pages 12-23).

It’s important to clarify that while functional finance is Ricardian, it is not so “on purpose”; that is, the policy strategy is to sustain full capacity utilization—no more and no less stimulus than necessary to reach this point (again, MMT’ers have little use for the inter-temporal budget constraint given the latter’s reliance on Assumption C). That the functional finance strategy is in fact Ricardian is a side effect—and, again, a very interesting one at that—not something that is pursued directly.

And now suppose that for whatever reason, we’re suddenly faced with a strike of bond buyers — nobody is willing to buy U.S. debt except at exorbitant rates.

This is Assumption C: Interest rates on the national debt are set by “market forces.” Krugman tries to push this heroic assumption without anyone noticing by inserting “for whatever reason” into the sentence, as if somehow he can just wave his hands and make it so. Indeed, “whatever reason” is the crux of the matter, and in this two-word phrase he has assumed MMT’s vast literature on the monetary system away in order to make his argument against MMT. It’s like proving theory X is wrong by simply assuming all of the supporting evidence for theory X—for “whatever reason”—is wrong.

There is probably nothing more central to MMT than the idea that the government does not need its own money, since a currency-issuing government is by definition the source of its own money. Taxes, in the MMT framework, have the effect of giving the government’s money value, and also serve the purpose of managing aggregate demand. But since it does not need its own money, it also does not need the bond holders, wherever and whoever they are (and the last time I checked, China’s government created yuan, not US dollars).

Of course, governments—particularly when they are operating on an outdated understanding of the monetary system—can and do impose constraints upon themselves. In the US case, laws previously written by Congress forbid the Fed from providing direct overdrafts to the Treasury. As such, if the Treasury wants to spend and its balances are dwindling, it must either tax or issue bonds to do so. Unfortunately, this self-imposed political constraint is the starting and ending point for Krugman and most others, even as it has little to no economic significance according to MMT.

MMT’s approach to this self-imposed political constraint is more general. A currency issuer under flexible exchange rates that allows itself to receive overdrafts in its central bank account will see the interest rate on its debt equal to the central bank’s target rate at the very lowest. This is because the central bank cannot achieve its target rate in this case unless it pays interest on the reserve balances created by the government’s spending net of balances drained by taxes, and these central bank outlays will reduce the profits it turns over to the treasury (a de facto interest payment by the treasury). This is what I like to refer to as the strong form of MMT regarding interest on the national debt. If the treasury instead decides to issue short-term bills, or is required to by self-imposed constraints, these will arbitrage against the central bank’s target rate; if it issues longer-term bonds, these will mostly arbitrage against the current and expected Fed targets. I call this the semi-strong form, and explained it in more detail here and here. Randy Wray does, too, here. Losing access in the semi-strong form is a non-starter—the arbitrage opportunity grows stronger as the non-govt sector can borrow at a lower rate, and there are primary dealers and thousands of hedge funds that would love to take advantage of that trade.

In neither of these cases should interest rates on the national debt be considered to be set by “market forces” (aside from what Warren Mosler likes to call “technicals”). Further, the self-imposed political constraint is not a constraint of any economic significance—if one is given the choice between an overdraft at the central bank’s target and issuing debt at roughly the central bank’s target, does it really matter if the overdraft option is then withdrawn? MMT’ers say “no.”

Failing the strong and semi-strong forms of interest on the national debt—which I would argue would be exceedingly rare, though the probability is probably not 0—a final option would be for the central bank to purchase the government’s debt in order to keep interest rates on the debt from rising. I call this the weak form of MMT regarding interest rates on the national debt. Marshall Auerback and Rob Parenteau explained this option in more detail here. Here again, access to the bond markets isn’t the issue.

The overall point here is that the interest rate on the national debt for a currency issuing government under flexible exchange rates always is, or at the very worst always can be, a monetary policy variable. Concerns about “bond market vigilantes” are misplaced, as they could apply only to non-currency issuers (e.g., Greece, California) or fixed exchange rate regimes. Assumption C is false.

Finally, note that Krugman’s Assumption C here is related to his Assumption B, since, as explained above, neo-liberal economics holds that a government running a Non-Ricardian fiscal policy strategy can lose access to the bond markets (explained in more detail here). . But, again, functional finance is Ricardian, so even if Assumption C were correct, the fact that that Assumption B is wrong makes it unlikely that Assumption C would be relevant at any rate.

So then what? The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations;

This is Assumption C again, though this time with the Fed’s intervention to keep rates from rising, as in the weak form described above.

either way, the government would in effect be financing itself through creation of base money.

Before Krugman again invokes Assumption A below, note that the Fed actually cannot do this and achieve a positive interest rate target unless it pays interest on the large quantity of excess reserve balances left circulating (Krugman’s “base money,” since, as above, these Fed operations aren’t about currency). In other words, an understanding of monetary operations reveals that the only way this can happen is if the Fed makes reserve balances and T-bills perfect substitutes, which was the scenario under which Krugman argued above that the size of the monetary base doesn’t matter.

So? Well, the first month’s financing would increase the monetary base by around 12 percent. And in my hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s not crucial) roughly in proportion to the increase in monetary base. And rising prices would, to a first approximation, raise the deficit in proportion.

This is Assumption A, as the rising monetary base is believed to increase the price level directly.

Recall, though, that the monetary base (actually, reserve balances, since that’s what’s increasing here) in this case is a perfect substitute for T-bills, since the Fed cannot engage in these operations to purchase the government’s debt without paying interest on the reserve balances at its target rate. The alternative would be for the Fed to be unable to achieve a positive target rate. Again, Krugman’s own view is that the size of the monetary base doesn’t matter when it and T-bills are perfect substitutes—his mistake was that his lack of understanding of monetary operations led him to believe this would only happen when the economy was in a so-called liquidity trap.

More importantly is the fact that a deficit that results in the non-government sector holding government securities is not less stimulative than where the non-government sector does not hold securities. To some degree at least, this should be obvious given that the latter operationally requires that T-bills and reserve balances be perfect substitutes. Note that any government spending results in recipients having more income and increased deposits in their bank accounts, while their banks have greater reserve balances. Taxation does the opposite, reducing income and reducing deposits.

A bond sale does neither of these. It is simply a drain of reserve balances (in the case of a bank purchasing the security) or deposits (in the case of a sale to a non-bank such as a primary dealer) and reserve balances (of the dealer’s bank) in exchange for the security. And the new owners of the security, or security holders in the aggregate, don’t suddenly have less spending power. Treasuries are the most liquid of financial assets and can be sold at any moment should the holders for whatever reason prefer deposits, and dealers that would purchase these from current holders generally finance their purchases by borrowing in repurchase agreement markets—that is, this process can result in the creation of additional deposits. Indeed, unlike deposits created by government spending, Treasuries can and do enable additional credit creation via repurchase agreements, often several times the market value of the security itself.

Similarly, if banks are holding Treasuries instead of reserve balances, as explained above, they don’t somehow have less ability to create additional loans/deposits. And given that the Fed would have to pay interest at the target rate on reserve balances in order to purchase government securities, the banking system would be indifferent between holding T-bills and interest earning reserve balances.

The issue is not whether a given deficit is offset by interest earning reserve balance or securities, since this choice does not create more or less inflation (aside from potential interest rate differentials if longer-term bonds are issued—and in that case the bonds can in fact be more inflationary than not issuing securities), but rather whether the deficit itself—which is raising nominal incomes—and the accompanying debt service—given the Fed’s interest rate target—is pushing the economy beyond full capacity utilization and thus potentially resulting in demand-pull inflation. If this occurs in a functional finance policy world, the appropriate response according to MMT is to reduce the primary deficit. Assumption B is wrong.

So we’re talking about a monetary base that rises 12 percent a month, or about 400 percent a year. Does this mean 400 percent inflation? No, it means more —.

All three assumptions are required to get this result:

The monetary base will only grow as fast as Krugman is implying if the Fed has set interest rates that high; the Fed could slow the growth by simply reducing its interest rate target. Assumption C is wrong.

It doesn’t matter how fast the monetary base grows, per se; what matters is the deficit itself relative to full capacity utilization. Assumption A is wrong.

MMT would argue that the primary deficit should be reduced if the combination of the existing primary deficit and the interest rate on the debt is creating demand-pull inflation. Assumption B is wrong.

. . . because people would find ways to avoid holding green pieces of paper, raising prices still further

Apparently Krugman believes that Fed security purchases raise the quantity of “green pieces of paper.” They don’t. They increase the quantity of reserve balances while reducing the outstanding quantity of Treasuries. And we’ve already established that the Fed can’t do this unless T-bills and reserve balances are substitutes, while it is the interest paid on reserve balances that ensures banks will hold the reserve balances at the Fed’s target rate. Assumption A is wrong.

I could go on, but you get the point: once we’re no longer in a liquidity trap,

Assumption A is wrong.

running large deficits without access to bond markets

Assumptions B and C are wrong.

. . . is a recipe for very high inflation, perhaps even hyperinflation.

Assumptions A and B are wrong.

And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base.

Assumption A is wrong. Yet again, what has to happen when the Fed buys Treasuries is that in order to achieve a positive interest rate target reserve balances must earn the target rate. This is sufficient to ensure someone will “hold the additional base.”

Whether this scenario is inflationary is based on (1) the primary deficit, (2) the interest payments on the national debt set by the Fed, and (3) the size of these two combined relative to the non-government sector’s net savings desired at full employment real GDP. If so, then one or both of these can be reduced.

At this point I have to say that I DON’T EXPECT THIS TO HAPPEN — America is a very long way from losing access to bond markets,

Assumption C is wrong.

. . . and in any case we’re still in liquidity trap territory and likely to stay there for a while.

Assumption A is wrong. Krugman’s own straw-man scenario unwittingly makes T-bills and reserve balances substitutes.

But the idea that deficits can never matter,

Deficits can matter for MMT because Assumption B is wrong.

that our possession of an independent national currency makes the whole issue go away,

It makes the issue of “involuntary default” go away, while the interest on the national debt is or at least can be a monetary policy variable. Assumption C is wrong. The resulting size of the monetary base doesn’t matter either, since Assumption A is wrong.

is something I just don’t understand.

Clearly it is difficult for a Neo-Liberal to understand MMT.

Krugman’s follow-up 24 hours later continued with:

I think one way to clarify my difference with, say, Jamie Galbraith is this: imagine that at some future date, say in 2017, we’re more or less at full employment and have a federal deficit equal to 6 percent of GDP.

Just to be clear, the assumption here must be that the six percent deficit is consistent with being at or near full capacity utilization and no additional demand-pull inflation. If not, then Krugman is making Assumption B, which is wrong.

Does it matter whether the United States can still sell bonds on international markets?

Why would it need to? And if it wanted to, why wouldn’t it be able to at roughly the Fed’s target rate? This is Assumption C again, and it is wrong.

As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary.

Yes.

The perceived future solvency of the government is not an issue.

I don’t really know what “perceived future solvency” means. There are a lot of people, like, say, Bill Gross of PIMCO, who currently perceive that there are problems with the government’s future solvency. Has that mattered in any economically significant way for the prevailing interest rate on the national debt? No. And even if it did, there’s still the weak form of interest on the national debt available as a policy option.

What MMT’ers say is this: How could a government that issues its own currency face involuntary default? This is obviously not to suggest that deficits can’t be inflationary—though this would be imposing Assumption B, which for purposes here is obviously wrong—or that governments cannot impose default on themselves (see here and here).

I disagree. A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary.

If it’s overly expansionary, then MMT would be against it and would argue in favor of a smaller primary deficit. Assumption B is wrong. Using tighter monetary policy instead will only “work” if the higher overnight rate reduces credit creation more than it raises government debt service; consequently, this could potentially require a larger reduction in the primary deficit than not altering monetary policy at all.

But if the U.S. government has lost access to the bond market

“Losing access” to the bond market for a sovereign currency issuer is a non-starter. The closest approximation would be for the central bank to set the interest rate too high or, in the weak form scenario, is purchasing the government’s bonds at too high a rate, such that interest on the national debt is rising so fast that inflation is rising. Assumption C is wrong.

But if this happens, then a primary surplus will be necessary to avoid inflation according to functional finance approach. Assumption B is wrong.

. . . the Fed can’t pursue a tight-money policy —

The Fed can raise the rate it pays on reserve balances—recall that for Krugman’s scenario to work, the Fed must pay interest at its target rate. True, this may not actually “tighten,” since it will raise interest on the national debt that much faster, and thus raise aggregate demand absent a reduction in the primary deficit. But interest rates certainly are still under the Fed’s control even if the transmission mechanism is not as the textbooks suggest.

In any event, fiscal policymakers can reduce the primary deficit if a reduction in aggregate demand is desired. Assumption B is wrong.

. . . on the contrary, it has to increase the monetary base fast enough to finance the revenue hole.

Assumption C is wrong—debt service will only grow that fast if the Fed sets an interest rate target that high.

Assumption B is wrong—the primary deficit can be (and under a functional finance strategy, should be) reduced if it is large enough that demand-pull inflation is occurring.

And so a deficit that would be manageable with capital-market access becomes disastrous without.

Assumptions A, B, and C are wrong.

Now, this has NOTHING TO DO WITH OUR CURRENT SITUATION:

It has nothing to do with our situation now or in the future, or the situation of any other currency issuer now or in the future, as I’ve explained. It can only ever be otherwise if all three of Krugman’s assumption are true. But they are all false.

. . . the rapid growth in monetary base since 2007 has taken place because the Fed is trying to rescue the economy, not because it’s trying to finance the government —

True. Not that it matters, though, since, yet again, Assumption A is wrong.

. . . and that base growth can and will be reversed as soon as the economy gets anywhere close to full employment. (Actually, the big danger is that it will be reversed too soon.)

One last push for Assumption A, this time in reverse. That’s wrong, too. If a larger monetary base doesn’t matter, then it doesn’t need to be wound down, either.

So at the moment this is just an intellectual exercise. Still, it’s a point that needed making.

If only to demonstrate, for anyone who still remains unconvinced, that Krugman doesn’t understand MMT and, perhaps even more, doesn’t understand the basics of how the monetary system actually works.

To conclude by way of reiterating the main point here, one need not agree with MMT that the three assumptions Krugman makes are incorrect. The overarching problem is that Krugman has simply assumed the Neo-Liberal macroeconomic model is correct, and the MMT view is incorrect. This is far different from actually demonstrating that MMT is incorrect, which Krugman has yet to even attempt.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

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