How Ben Bernanke refuted Doug Henwood on MMT

by Jehu

In my last post, I explained some of Doug Henwood’s major objections to modern money theory, as expressed in his essay, Modern Monetary Theory Isn’t Helping. The biggest of these objections, that MMT carries the profound risk of hyperinflation, can probably be captured by this passage from his essay:

That brings us to the next problem: inflation. When the printing presses run freely, it’s not only reactionaries who think that runs the risk of spiraling prices. As I was researching this piece, many people to whom I described MMT, from Democrats to Marxists, brought it up as a worry. MMTers are coy about the topic — they never say how much is too much, and they profess great confidence in their ability to control it. In a paper criticizing MMT, the left-Keynesian economist Thomas Palley says he’s heard a “leading” MMTer say inflation less than 40 percent is “costless.” That’s nearly three times the modern US record of just under 15 percent in 1980, which was widely regarded, and not just by bondholders, as a crisis. Since wages typically lag behind price changes, inflations can lead to real declines in living standards.

Hyperinflation can impoverish a country in a matter of months, says Henwood. And it can set in motion a chain of political events that lead to a Reagan, or worse, a Hitler:

Though it might scandalize some liberals to say so, it’s dangerous to be sanguine about inflation. People find it destabilizing and it feeds a hunger for order. The rise in inflation through the 1970s that climaxed in that 15 percent record helped grease the way for Reagan. The extreme inflation of Weimar Germany in the 1920s contributed to the rise of Hitler. As a British diplomat stationed at the embassy in Berlin wrote to his bosses at home during the hyperinflation: “The population is ripe to accept any system of firmness or for any man who appears to know what he wants and issues commands in a loud, bold voice.”

Oddly enough, one of the most important policy makers in the last two decades, former Federal Reserve Chairman Ben Bernanke, agrees with Henwood on the inflationary impact of MMT-style dollar printing. Bernanke however viewed this impact positively because he believed the U.S. economy faced the more pressing risk of deflation. To address this danger, Bernanke argued Washington should be prepared to use its ability to create unlimited fiat dollars on a computer terminal and force the tokens into circulation in much the way MMT describes.

In a deflationary crisis Washington could depreciate the value represented by a single dollar to whatever extent necessary by a series of measures involving purchases of both domestic and foreign bonds. These purchases could be undertaken in cooperation with a fiscal stimulus program — including a so-called ‘helicopter drop’ of cash on households and a huge tax cut.

Surprisingly, Bernanke argued in his presentation that none of what he was suggesting was breaking any new ground. The interventions he proposed in 2002 to rapidly depreciate the purchasing power of the dollar had already been implemented by Washington during the last huge outbreak of deflation in the Great Depression:

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt’s devaluation.

Modern money theory isn’t a new idea by any mean; it was how FDR implemented the New Deal response to the Great Depression.