* Update – It’s come to my attention that some of the statements in this piece might be somewhat misplaced. Many different economists have contacted me over the last few months to point out that MMT was not, in fact, the first group of economists to predict the Euro crisis (although that should not detract from the fact that they did in fact predict the crisis). I should also be clear that Wynne Godley was not an MMTer and I should not have implied as much. Additionally, there are a number of economists who predicted that the Euro would not work and did so well before the MMT economists. This list has been updated to account for this. Sorry for the exaggeration.
- Wynne Godley – 1992. http://www.lrb.co.uk/v14/n19/wynne-godley/maastricht-and-all-that
- Martin Feldstein – 1992 http://www.nber.org/feldstein/economistmf.pdf
- Barry Eichengreen – 1994 http://www.princeton.edu/~ies/IES_Studies/S76.pdf
- Thomas Palley – 1996 http://www.thomaspalley.com/docs/articles/international_markets/european_monetary_union.pdf
Being right matters. This isn’t emphasized quite enough in the finance world and in economics in general. Too often, bad theory has led to bad predictions which has helped contribute to bad policy. While MMT remains a heterodox economic school that has been largely shunned by mainstream economists, the modern proponents have an awfully good track record in predicting highly complex economic events.
In the last few years, the Euro crisis has proven a remarkably complex and persistent event. And no school of thought so succinctly predicted the precise cause and effect, as the MMT school did. These predictions were not vague or general in any manner. In reading the research from MMTers at the time of the Euro’s inception, their predictions are almost eerily prescient. They broke down an entire monetary system and described exactly why its construction would lead to financial crisis if the union did not evolve.
In 1992 Wynne Godley described the inherent flaw in the Euro:
“If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market in competition with businesses, and this may prove excessively expensive or even impossible, particularly under conditions of extreme emergency….The danger then, is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.”
In his must read book “Understanding Modern Money” Randall Wray described (in 1998) the same dynamic that led to the crisis in the EMU:
“Under the EMU, monetary policy is supposed to be divorced from fiscal policy, with a great degree of monetary policy independencein order to focus on the primary objective of price stability. Fiscal policy, in turn will be tightly constrained by criteria which dictate maximum deficit to GDP and debt to deficit ratios. Most importantly, as Goodhart recognizes, this will be the world’s first modern experiment on a wide scale that would attempt to break the link between a government and its currency.
…As currently designed, the EMU will have a central bank (the ECB) but it will not have any fiscal branch. This would be much like a US which operated with a Fed, but with only individual state treasuries. It will be as if each EMU member country were to attempt to operate fiscal policy in a foreign currency; deficit spending will require borrowing in that foreign currency according to the dictates of private markets.”
In 2002, Stephanie Kelton (then Stephanie Bell) was even more specific in describing the funding crisis that would inevitably ensue in the region:
“Countries that wish to compete for benchmark status, or to improve the terms on which they borrow, will have an incentive to reduce fiscal deficits or strive for budget surpluses. In countries where this becomes the overriding policy objective, we should not be surprised to find relatively little attention paid to the stabilization of output and employment.In contrast, countries that attempt to eschew the principles of “sound” finance may find that they are unable to run large, counter-cyclical deficits, as lenders refuse to provide sufficient credit on desirable terms. Until something is done to enable member states to avert these financial constraints (e.g. political union and the establishment of a federal (EU) budget or the establishment of a new lending institution, designed to aid member states in pursuing a broad set of policy objectives), the prospects for stabilization in the Eurozone appear grim.” (emphasis added)
In 2001 Warren Mosler described the liquidity crisis that the Euro would lead to:
“Water freezes at 0 degrees C. But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify. Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place. All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.
A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning. History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested. The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system. Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.”
In a recent article, Paul Krugman referred to some of his predictions as “big stuff”. What the MMT school has accomplished through its understanding and prescience of the European union is not merely “big stuff” – it is nothing short of remarkable. This was not merely saying that the Euro was flawed for this reason or that and that the construct of a united Europe was misguided (a prediction made by many at the time of the Euro’s inception due mainly to political biases). The MMT economists approached the formation of the Euro from a purely operational aspect and predicted with near perfection, exactly why it was flawed and exactly why it would not work as is currently constructed.
Some economists say MMT focuses too much on reality by focusing on the actual operational aspects of the banking system and the monetary system. But as we have seen time and time again, having a poor understanding of the monetary system is not only detrimental to your portfolio, but detrimental to the millions of citizens who are now being subjected to the ignorance of the economists who influence these monetary constructs.
* Corrected date error in Godley citation.
** I should also be clear that Godley was not an MMTer and was the first post-Keynesian making the Euro comments.