Readers are probably aware that there is quite a lot of discussion of Modern Monetary Theory (MMT) and the potential for fiscal experimentation batting around at the moment. Others have weighed in on this already, and I have little to add.
It is striking, however, that most of the push-back — where there is push-back — is not focused on trying to discredit the idea that we should engage in fiscal experimentation. Indeed, the notion that we should engage in fiscal experimentation seems to be, if not mainstream, at the very least part of the discussion.
Yet, vulgar strawman-style arguments against MMT aside, no one seriously disputes the fact that if too much fiscal expansion is undertaken the economy will eventually hit a hard inflation barrier, past which any increase in spending will generate inflation rather than real output expansion. Interestingly, no one seems to have tried to come up with a new framework for estimating where this inflation barrier might be and whether it is too risky to overshoot it.
So, I’ve decided to fill that gap. Linked below is a paper where I use a new capacity utilisation-based framework to provide hard, yet optimistic numbers of how far we might push the economy in the spirit of fiscal experimentation.
I find that we could probably safely increase the current US fiscal deficit by around 5% of GDP structurally — that is, from the current level of around 3.8% of GDP to around 8.8%. This would give rise to annual real GDP growth of around 6% and a once-off shot of inflation that would drive the annual growth in CPI to around 4.9%. As I say in the paper, this would then lower the private debt-to-GDP ratio from around 200% of GDP to around 190% in the first year and this decline would continue every year that the new 5% rate of inflation was maintained.
I argue that, based on a new framework I’ve developed for measuring the likelihood of sustained, runaway inflation that I call the Worker Bargaining Index (WBI), it is highly unlikely that a sustained inflation will result.
That said, after undertaking such an experiment, we would be wise to watch whether sustained, overly high nominal wage growth results and if so take action. Given the current institutional arrangement, tight monetary policy would probably be the best response but it would also be possible to tighten the fiscal stance.
So long as nominal wage growth merely kept pace with the new 4.9% rate of inflation and did not greatly outstrip it, the economy will certainly be safe from a wage-price spiral. We probably want to see some real wage growth, however. At the very least we should want to see real wage growth keeping pace with productivity growth. And given the redistribution from labour to capital in the past few decades, we may want to even see real wages outpace productivity growth, for a few years at least.
It should only be if there is clear evidence that wage growth is getting out of control that we should consider slamming on the brakes. If we start to see wage and inflation growth feed upon each other that should be our signal to act.
Here is a link to the paper: