Continuing this critique of Modern Monetary Theory, I now come to the standard explanation of the MMTers as to why inflation will not break out when the Government prints money – they refer to the excess capacity in the economy. According to the theory, if an economy is suffering unemployment, then there is not enough demand to fully use the resources. Printing money is a costless way to increase demand, get the unemployed into work and increase wealth. Inflation will be a risk only if there is no excess capacity, no underutilized resources in the economy.

To the MMTer, this is a beguiling theory – to be free of the constraint of having to raise taxes or borrow money to finance Government expenditure. They recommend simply printing the money and use it to increase production by filling in that missing aggregate demand. Sadly, this is a fantasy. By the way, does Stephanie Kelton really think she has hit upon a new insight that no one else in the last 2,000 years ever thought of or tried before?

The familiar representation of gross national income based on the expenditure side of the circular flow, a beloved model of Keynesians everywhere, is:

Y = C + I + G + (X-M)

Y is national income, C is consumption expenditure, I is investment, G is government expenditure and (X-M) is exports net of imports. What a discovery: if G is increased then Y is increased, all else being equal. Consider an example: the Government sees an unemployed old white man and decides to get him working. The Government’s printing press pushes out some money and the man agrees in return for that new money to dig a hole in the ground, and then fill it in again. According to the above statement of income, that transaction just increased the gross national product of the country. So why not lets get all the unemployed out digging even bigger holes in the ground and filling them in again and increase wealth even further? Or break windows and then fix them? This is where the Keynesian view of the world, to which MMT is joined at the hip, breaks down badly. We know that the country’s wealth has not increased by the hole digging and filling trick. Wealth increases when production increases, provided the product is something that is valued by other people. The value added over the cost of production is the growth. The best way to see if you are adding value check your profit. Profitable businesses are adding value. Loss making businesses are detracting value and will eventually go out of business.

Of course, no MMTer that I have met seriously proposes hiring the unemployed to dig a hole and fill it in again. (I know that Paul Krugman said in 2011 on CNN that an impending alien invasion would be one way to get out of the last economic slump in 18 months. Krugman has been a source of amusement to me for years.) But what the MMTers say is that the underutilized resources can be used for projects, often large green projects or railways, roads, nation-building stuff.

What resources are needed to build a road? Land, ballast, gravel, bitumen, steel, engineers, surveyors, labourers, paint, wire and it all has to be brought on site, mixed together, built in the correct way and so on. The land, labour, raw materials and technical know-how is substantial. While there may be some underutilized resources in the economy, particularly unskilled labour, are all these inputs underutilized? How would the MMTer avoid bidding for resources that are not underutilized? If resources already in use are bid for, then the more that money printing machine needs to go to work and the quicker the inflation comes at you: slowly at first then in a rush. Just like it is when you go bankrupt.

Belief that there is a costless way to us underutilized resources to increase wealth is a fantasy.

Earlier parts of this critique series are available here and here.