Modern Monetary Theory and inflation – Anwar Shaikh’s critique

9780199390632Last week I posted several times on Modern Monetary Theory (MMT), a set of ideas which seems to have plenty of support, or at least generates plenty of debate, judging by its presence on the internet.

MMT is an offshoot of post-Keynesianism. The policies which flow from its main theses suggest that a wise and benevolent state can ‘print’ money, within certain limits, to achieve full employment and moderate inflation.

Some MMTers also support an Employer of Last Resort (ELR) function for the state too. In other words, the state should provide a job at a set wage for all those who want one, so that full employment can be sustained even when economic growth slows or the economy goes into recession. The ELR policy was supported by Hyman Minsky whose ideas have also influenced MMT. He saw it as a more productive alternative to forms of welfare which pay people while they are inactive in terms of formal employment.

MMTers support ‘functional’ government finance, so that aiming for a balanced government budget should not be the rule, rather fiscal policy should support the goals of full employment and moderate inflation.

If the economy is underperforming, MMT might put this down to inadequate aggregate demand, so that by allowing the budget deficit to increase, this can be mitigated or even prevented.

If the economy is overheating, with rising inflation, MMT puts this down to excess demand, so that a smaller deficit or a surplus (with tax revenue greater than public spending), will solve this problem by withdrawing money from circulation.

The ELR policy is also meant to stabilize inflation with cost-push causes, since MMT, in line with much post-Keynesian theory, argues that firms set prices as a mark-up on costs, which include wages. If the state can fix the ELR wage, this should act as an anchor for private sector wages, and from there the price level and overall inflation, to the extent that it is driven by cost-push factors.

MMT does not deny that inflation can be created by excess demand, but this can apparently be managed via fiscal and monetary policy.

For MMT, interest rates should generally be set at a low level and kept there, to avoid any ‘crowding-out’ effect of the budget deficit on private investment.

Anwar Shaikh, an economist whose work falls largely within the Classical tradition, although he also draws on some Keynesian ideas, has set out his own theory of modern money and inflation in his book Capitalism. In doing so, he offers a critique of MMT.

Shaikh argues that there are a number of problems with MMT and its associated policies.

Firstly, it ignores the effects of profitability on growth, employment and inflation.

Secondly, it assumes away class conflict between capital and labour, so that workers are passive in their behaviour.

Thirdly, the labour supply is not fixed, so that labour is not the main constraint on growth. A tighter labour market can lead to rising labour force participation, or higher labour-saving productivity, while governments can relax immigration controls.

Fourthly, it assumes mark-up pricing by firms, so that imperfect competition is the norm. Firms therefore have a degree of monopoly power in the marketplace. Shaikh argues that his theory of ‘real competition’ is more in tune with the reality: individual firms set prices, but do not determine them.

Fifthly, it ignores Marx’s theory of the reserve army of labour, which in the long run tends to keep wage rises in check and a lid on inflation. The ELR would be a threat to the business sector, as it would undermine wage discipline.

Some sort of cooperation between employers and unions in the wage bargaining process would be needed to manage this. The success of such a pact would depend on political and institutional factors.

Finally, as already mentioned, MMT sees a wise and benevolent state as able to determine output, employment, interest rates, inflation and wages. History shows that there are definite limits to what I prefer to term the state’s power to influence rather than control the economy.

Shaikh offers an alternative theory of modern money and inflation in his book, and plenty of empirical evidence to support it.

Under modern capitalism, money is backed by the state: it is fiat money and can be issued potentially without limit. This removes the government budget constraint. MMT suggests that this can be exploited to run budget deficits which help to sustain full employment, apparently without cost. Sovereign states with their own currency can therefore never become insolvent.

History has shown that the supply of money, when it is expanded beyond certain limits, can generate rising inflation. MMT does not deny this.

For Shaikh, inflation under modern fiat money is determined by aggregate demand and supply. It responds positively to net injections of purchasing power into the economy (pp), negatively to net profitability (rr), which is the profit rate minus the interest rate, and positively to supply resistance (s), which is the investment share in profit.

pp acts on the demand side. It can rise due to greater net private, public or foreign spending. If the real supply of output does not increase due to rising pp, then by definition inflation must rise.

If pp rises (say due to a larger budget deficit or current account surplus) while the rate of profit is falling, the supply-response of the economy will tend to be weaker and the economy will be more inflation-prone.

rr, net profitability, has a negative relationship with inflation. If the net profit rate rises, this will tend to weaken inflationary pressures.

s represents the ‘growth utilization rate’ for the economy as a whole. The theoretical maximum rate of growth is equal to the profit rate. This maximum occurs when all the realized profit is re-invested in expanded production. The closer the amount of investment is to profitability, the ‘tighter’ the economy and the more bottlenecks firms will experience. A higher level of s, as the growth rate approaches the theoretical maximum, will therefore tend to lead to higher inflation.

Historically, hyperinflation has occurred in the presence of massive injections of purchasing power (pp) alongside a collapse in the supply of output, so that demand rises rapidly even though supply is falling.

Stagflation occurs when the economy experiences rising unemployment and weak or falling output alongside rising inflation. It  can occur when the profit rate is falling faster than the growth rate, so that the economy becomes tighter on the supply-side, and pp rises, say due to a government budget deficit which boosts aggregate demand.

This mechanism offers an explanation for the breakdown of the Phillips’ Curve and the Keynesian social democratic consensus in the 1970s in many rich countries. The presence of stagflation ushered in the policy turn towards neoliberalism and, for a while, monetarism.

MMT, and post-Keynesianism more generally, emphasise inadequate demand as the more common constraint on growth and employment, and inadequate supply as a possibility but less common, in both the short and the long run.

Shaikh’s classical theory emphasises the limits imposed by the rate of profit, on both the demand and supply sides. It tries to incorporate Keynesian theories of effective demand, but also theories of supply-response limited by profitability and the growth utilization rate.

Thus if a government were to follow MMT ideas and expand the money supply to fund a budget deficit during a recession in order to boost demand and reduce unemployment, stagflation could result if the rate of profit is falling and fails to recover.

Having said that, if the government expands the money supply to run a deficit and spends the money on projects which raise the productivity of the economy, such as necessary infrastructure, then profits could rise, at least over the longer term. The outcomes would depend on the effects on aggregate demand and supply over the short and longer runs. Demand would rise in the short run and supply in the longer run if the projects were productive.

The long term effects of government policies on output, employment and inflation are therefore limited by their effects on profitability. For Shaikh, the latter is the driving force of capitalist expansion, providing both the incentive and the resources to expand output and increase productivity.

On this reading, economic policies based on MMT do have potential, but their limits depend on the longer term effects on profitability, and on the resultant dynamic interactions of aggregate demand and supply. Demand-pull and supply-response factors are thus key to Shaikh’s model of modern money and inflation, in contrast to the predominance of demand-side limits in post-Keynesianism and MMT.

6 thoughts on “Modern Monetary Theory and inflation – Anwar Shaikh’s critique

  1. “MMT is an offshoot of post-Keynesianism. The policies which flow from its main theses suggest that a wise and benevolent state can ‘print’ money…”. Actually Keynes himself in the early 1930s advocated escaping the 1930s recession by printing money. See 5th para of his letter to Roosevelt.

  2. How MMT got inflation wrong
    Comment on Nick Johnson on ‘Modern Monetary Theory and inflation – Anwar Shaikh’s critique’

    Nick Johnson compares Anwar Shaikh’s approach with the MMT approach. Scientifically, this is a futile exercise, just as comparing Superman with Spiderman because both are NONENTITIES.

    MMT is an offshoot of Post Keynesianism. Anwar Shaikh works largely within the Classical/Marxian tradition. However, the main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/formally inconsistent, and all got profit wrong. With the pluralism of provable false theories both orthodox and heterodox economics sits squarely at the proto-scientific level.

    Clearly, when the pivotal concept profit is not properly understood the rest of the analytical superstructure falls apart and the whole is scientifically worthless. What the representative economist has to understand is that nothing less than a paradigm shift is required, that is, a move from obsolete Walrasian microfoundations and false Keynesian/Marxian macrofoundations to entirely new macrofoundations.#1

    In order to go back to the basics, the pure consumption economy is for a start defined by three macro axioms (Yw = WL, O = RL, C = PX), two conditions (X = O, C = Yw) and two definitions (profit/loss Qm ≡ C – Yw, saving/dissaving Sm ≡ Yw – C).#2

    It always holds Qm + Sm = 0 or Qm = -Sm, in other words, the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the PROFIT LAW. This law refutes the familiar profit theories. Note in particular that profit has nothing to do with capital or productivity or greed or power.

    Money is needed by the business sector to pay the workers who receive the wage income Yw per period. The workers spend C per period. Given the two conditions, the market clearing price is derived for a start as P = W/R. So, the price P is determined by the wage rate W, which has to be fixed as a numéraire, and the productivity R. From this follows the average stock of transaction money as M = kYw, with k determined by the payment pattern. In other words, the quantity of money M is determined by the AUTONOMOUS transactions of the household and business sector and created out of nothing by the central bank. The economy never runs out of money.

    The transaction formula reads M = (k/rhoE) PO, with the ratio rhoE defined as C/Yw, and this yields the commonplace correlation between quantity of money M and price P for a given employment/output level, except for the fact that M is the DEPENDENT variable.

    The market clearing price is given in the general case with the price formula P = (rhoE)*(W/R).#3 An expenditure ratio rhoE greater than 1 indicates credit expansion = dissaving, a ratio rhoE less than 1 indicates credit contraction = saving. In the initial period rhoE = 1, i.e. the household sector’s budget is balanced. The ratio rhoE establishes the link between the product market and the money/capital market.

    See part 2

  3. Part 2

    Now we have: deficit spending, i.e. rhoE greater 1, yields a price hike. If deficit spending is repeated period after period the price remains on the elevated level but there is NO inflation. No matter how long the household sector’s debt increases, there is NO accelerated price increase.

    The price formula makes it clear that inflation only occurs if the wage rate W increases in successive periods faster than productivity R. This can happen at ANY employment level. It is NOT a precondition that employment is close to the capacity limit. This is merely a false interpretation of the Phillips curve.

    MMT claims that inflation/deflation can be managed via fiscal and monetary policy. This policy advice has no sound theoretical foundation.#4

    The current deflationary trend is caused by the fact that (worldwide) wages lag behind productivity growth. To turn this trend around it does not matter much what happens on the money/bond/stock markets, what matters is that governments/central banks engineer a coordinated world wide increase of the average wage rate.

    Policy guidance of both MMT and Anwar Shaikh is ineffective/misleading because for both approaches the macrofoundations and the concept of profit are ill-defined and methodologically forever unacceptable.

    Egmont Kakarot-Handtke

    #1 First Lecture in New Economic Thinking

    #2 For the detailed description see ‘How the intelligent non-economist can refute every economist hands down’

    #3 Wikimedia Price formula

    #4 For the comprehensive overview and the point-by-point refutation of MMT see cross-references

  4. Pingback: Top ten posts of 2017 | The Political Economy of Development

  5. “Stagflation” does not offer “an explanation for the breakdown of the Phillips’ Curve and the Keynesian social democratic consensus in the 1970s in many rich countries.”

    The turn away from Keynesianism was the initiated by the reactionary forces of the corporate ruling class beginning with the Powell Memo (

    It hit its peek with the Regan Revolution against Keynseianism and regulation, and again With Bill Clinton’s Neoliberal orientation of the Democratic Party.

  6. I think Post-Keynesianism is just another middle-class management or stabilization of capitalism. Namely, they want just enough class struggle to stabilize the capitalist mode of production. But if it goes beyond said (so-called “Just”) class struggle, they support capital against labour. It is like a Goldilocks vision of class struggle. This is why “inflation moral panics” (which is I think economist code-word for “class struggle”) are so widely invoked.

    I think if we look at the more responsible business press (e.g. Bloomberg), they are starting to listen to MMT, because neoclassicals are increasingly useless at devising economic policies that can sustain the legitimacy of the capitalist mode of production. Each class revolt scares the (“liberal”) ruling-class leading them to listen to ever more heterodox, but still pro-capitalist thinkers, in an effort to find some policy reformism that can possibly satisfy growing popular “revolution of rising expectations”.

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