MMT/ELR: A Mix of Old and Unsubstantiated New Ideas

Randy Wray and Mat Forstater, two leading contributors to the MMT School, have replied to my recent blog on the MMT controversy. Their replies warrant a brief response.

I agree that it does not matter very much who first identified the euro’s potential for failure. Along with other Keynesians, MMT-ers were early to identify the euro’s structural flaw – namely, its conversion of the financial status of national government into provincial government status via removal of government’s power to access money creation through a government controlled central bank. In many ways Warren Mosler (1995) is the godfather of interest in this issue.

I also fully agree that neither Bayoumi and Eichengreen (1994) nor Martin Feldstein (1997) predicted the problem. They argued the euro was not an optimum currency area (OCA), while Feldstein argued it would also fall apart, amidst political turmoil, for that reason. This is an argument every member of the economics profession was familiar with. However, the entire mainstream profession failed to foresee the economic mechanism whereby the euro has been slowly disintegrating - bond market driven higher interest rates and bond market imposed limits on expansionary fiscal policy which governments are powerless to do anything about because of absence of a central bank willing to intervene on their behalf.

There are two big takeaways from all of this. First, it was heterodox economists, as a group, rather than mainstream economists who identified the flaw. Second, nothing new is added to Keynesian theory as old Keynesians always recognized stripping away central bank backing of bonds exposes government to financial fragility. In principle, the same analytical argument applies to currency boards, the gold standard, and fixed exchange rates.

As for the mainstream profession, it still seems blind to this as evidenced by its talk of the euro lacking a “lender of last resort”. A lender of last resort provides financing to private banks when financial panic causes financing to dry up. The euro has a lender of last resort in the form of the European Central Bank (ECB) and it has been performing that function. What the euro lacks is a government banker in the form of a central bank that helps finance government deficits and manage government’s interest rate burden. Almost all European governments can still access financial markets (i.e. they have not been subject to financial panic) but they are slowly drowning because of the lack of a government banker (Palley 2011a, 2011b).

The profession’s refusal to talk in such terms reflects a deep intellectual bias against money financed fiscal policy. That bias stems from flawed beliefs in the neutrality of money; the inefficacy of fiscal policy; and a political economy hostile to government. These beliefs have moderated somewhat during the economic crisis but they have characterized the profession for most of the past thirty-five years, and those beliefs are now deeply ingrained among mainstream economists.

Seen in that light, the principal contribution of MMT is to push the case for money financed counter-cyclical fiscal policy. However, that is a policy contribution rather than a theoretical contribution, and it is also a policy that other Keynesians can easily agree with given their theories. The notion of Modern Monetary Theory therefore seems over-blown, as is any claim to be new.

Mat Forstater has criticized me for saying that MMT ignores sector bottlenecks. He is right. My comment was too indiscriminate. An employer of last resort (ELR) will create jobs for unemployed workers regardless of the type of unemployment. It does not matter why a person was laid-off: all can apply for ELR jobs.

My comment on sector bottlenecks was intended to be about inflation. Proponents of ELR seem to claim it is non-inflationary because it hires off the bottom. However, in a multi-sector economy job creation in one sector via ELR will have spillovers in other sectors, which could be inflationary if those other sectors are at full employment (Palley, 2001).

Unfortunately, Wray’s response is spoiled by insinuations that I do not care about the unemployed. That is the type of rhetoric that has poisoned the well of intellectual exchange between MMT-ers and other Keynesians. I do care about the unemployed; strongly support money financed fiscal policy at this time; and was one of the earliest advocates for having the ECB monetize existing European government debt and help finance current government deficits (Palley, 2010a, 2010b). However, I stop short of advocating full fiscal union with transfers between countries because that is not politically feasible, and instead advocate an ECB-backed financing union (Palley, 2011c).

All of this indicates there is much agreement. However, there are important unresolved theoretical issues. These include the determination of interest rates and interest rate policy; whether bond financed budget deficits should be permanently abandoned in favor of pure money financed deficits; the inflation consequences of alternative financing arrangements and the real consequences of alternative inflation outcomes; exchange rate and open economy implications; and how ELR would affect the real economy, not just in times of mass unemployment but also in better times and over the longer run.

Exploring these issues will require papers rather than brief notes. That offers an opportunity for intellectual exchange, but there must be room for disagreement. Exchange cannot take place when one side adopts an “if you’re not completely with us, you’re against us” mentality.


Bayoumi, T., and Eichengreen, B., “One Money or Many? Analyzing the Prospects for Monetary Unification in Various Parts of the World,” Princeton Studies in International Finance, No.76, September 1994.

Feldstein, M., “EMU and International Conflict”, Foreign Affairs, Vol. 76 (6) (November/December 1997).

Palley, T.I., “Government as employer of last resort: Can it work? Industrial Relations Research Association, 53rd Annual Proceedings, 2001, 269 – 274.

Palley, T.I., “Euroland is being crucified upon its own cross of gold,” FT Economists’ Forum, February 10, 2010a.

Palley, T.I., “Europe’s debt crisis and Keynes’ green cheese solution,” FT Economists’ Forum, May 23, 2010b.

Palley, T.I., “Monetary union stability: The need for a government banker and the case for a European Public Finance Authority,” Working Paper 2, Macroeconomic Policy Institute, Dusseldorf, Germany, February 2011c.

Palley, T.I., “Euro bonds are not enough: Eurozone countries need a government banker,” FT Economists’ Forum, August 31, 2011a.

Palley, T.I., “The euro lacks a government banker, not a lender of last resort,” FT Economists’ Forum, December 9, 2011b.

Mosler, W., “Soft Currency Economics,” West Palm Beach, Florida: Finance III, September 1995.

by Thomas I. Palley

One Response to “MMT/ELR: A Mix of Old and Unsubstantiated New Ideas”

  1. Employer of Last Resort? « occasional links & commentary Says:

    [...] hunt I’m referring to is the current spat between Thomas Palley and Randall Wray over Modern Monetary Theory, especially the idea of the government as Employer of [...]

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