Longtime followers of this blog (and its associated InFi podcast) know that I am no friend of Modern Monetary Theory (MMT). My chief complaint is that their ostensibly unorthodox ways of viewing government finance are incredibly misleading, at least in the hands of some of their most popular gurus. In today’s post I’ll give yet another example, this one coming from a tweet by Stephanie Kelton (and endorsed by Warren Mosler himself).
Specifically, Kelton and Mosler argue that because the Congressional Budget Office (CBO) isn’t forecasting a sharp inflation problem for the US economy, its rising debt must not be a problem after all. As I’ll explain, this argument is incredibly slippery, though perhaps Kelton and Mosler mean it in earnest.
Below I reproduce a screenshot of the Twitter exchange, which started with Kelton, whom I retweeted, and then Mosler responded to me:
Before proceeding to my critique, let’s first be clear on what Kelton/Mosler are arguing in the above. After reproducing the CBO’s assessment of the Big Beautiful Bill (BBB), in which CBO argued that (consumer price) inflation would “increase by a small amount through 2030,” Kelton claims that in the absence of a long-term inflation problem, there can likewise be no debt problem for the government.
To understand why, we need to review the central thesis of MMT, at least in the hands of Kelton, who is arguably its most important popularizer at the moment. Specifically, as the recent MMT documentary (which starred Kelton) says in its title, it is never a problem for the US government to come up with money. Unlike a household or even a giant corporation, the US authorities are currency issuers, or “monetary sovereigns” (in the MMT phrase), who have the power to create new dollars at will. In this respect, Kelton claims, it is nonsensical to ask, “How we will pay for a proposed government program?” This would be like asking, how will the officials award a football team more points if they score a touchdown?
Having said that, Kelton and other MMTers are quick to reassure skeptics that there are limits to government’s powers, even a government armed with a printing press. If the feds spend too much money, outstripped the economy’s real resource capacity, then the result will be rapidly rising prices. (Inflation is often characterized as “too much money chasing too few goods.”)
Now that I’ve summarized Kelton’s view about government spending and inflation, her tweet above makes more sense: She is arguing that the conservatives (and even progressives) wringing their hands over the mushrooming debt showcased in CBO forecasts, are completely missing the point. Since the CBO is not forecasting a rapid rise in consumer price inflation, it must mean that the US economy can accommodate the government spending that is already baked into current law. And since there’s no problem mechanically with the feds coming up with the dollars needed to pay the rising interest expense on the federal debt, all of this fretting is a useless distraction.
There are two major problems with Kelton’s “what me worry?” attitude. First, look again at the tweets above. The CBO actually wasn’t saying there was no long term inflation problem; it was merely saying inflation wouldn’t rise much over the next five years.
However, even though the specific evidence she retweeted didn’t support Kelton’s claim, in fairness we can admit that in general, even the CBO’s Long Term Budget Outlook documents don’t assume unreasonable inflation projections. But this isn’t reassuring, because the CBO wouldn’t be allowed to build in a debt/inflation crisis cascade.
The function of the CBO is to act as a non-partisan scorekeeper, to give legislators and the public a sense of the fiscal impact of proposed bills. Although the term “non-partisan” is often a bad joke, I can personally attest that the CBO actually is fairly neutral in this regard. Once you understand the ground rules they are given, the CBO analysts actually do as good a job as could be expected to “keep politics out of it.”
Now economists have vastly different theories about the interaction of a rising debt burden and how the Federal Reserve might respond, and furthermore what the impact of such a response will be on CPI inflation in the decades ahead. Because of this huge gulf between different schools of economic thought, it would bias the analysis if the CBO were to build in specific mechanisms that showed, say, a debt-to-GDP ratio of 120 percent suddenly triggering a panic in the bond markets which then led to massive rounds of quantitative easing by the Fed. Some economists might welcome this type of forecasting, but others would understandably recoil at the “fearmongering” and “attempts to hijack fiscal policy.”
So instead of building in controversial feedback cycles of debt, interest rates, and inflation, instead the CBO tries to neutrally show what happens under business as usual. And the answer is, the federal debt grows like this:
But as far as (consumer price) inflation, CBO assumes the Fed will get its preferred metric (of the PCE price index) back to its desired target (of 2 percent) by 2035 and and keep it there, as far as the eye can see:
Now I don’t fault the CBO for proceeding in this way. However, I personally think it is ludicrous to suggest that if the federal debt grows to 150 percent of GDP by mid-century, and if, at that time, it is projecting to exceed 200 percent in another 20 years, that the bond markets would remain calm. (We recently saw Moody’s downgrade Treasury debt a notch.)
In closing, let me alert the reader to the fact that Kelton herself did not appreciate the surge in CPI inflation that was coming in the wake of the Covid lockdowns and aggressive central bank action. In July 2021 she appeared on Bloombergand dismissed inflation concerns saying it was “transitory” and due to supply-chain bottlenecks. Yet at that point, year-over-year CPI inflation was “only” 5.3 percent. After Kelton’s pooh-poohed inflation fears, it continued to rise, peaking at 9 percent in June 2022 (almost a year later).
For its part, the CBO long-term outlook as of February 2021 didn’t forecast the surge in CPI inflation either. Here is the relevant table:
As this table shows, back in February 2021 CBO forecasted that CPI inflation for the year 2022 would be 2.2 percent, and for 2023 would be 2.3 percent. In reality, the actual levels of inflation (calculated as the annual change in the 4th quarter average, as the CBO table indicates) were 7.1 percent and 3.2 percent.
In short, if the CBO is off by five percentage points for what next year’s inflation rate will be, should we really be reassured that they’re forecasting the Fed to hit its targets smoothly in 30 years?
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