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With U.S. government deficits increasing again and big spending plans coming from potential Democratic candidates for president, we thought it would be prudent to have a conversation with Stephanie Kelton. She's a proponent of Modern Monetary Theory (MMT), the economic rational cited by rising political stars like Rep. Alexandria Ocasio-Cortez D-N.Y.
Kelton currently works as a professor of public policy and economics at Stony Brook University. Previously, she served as chief economist for the Democrats on the U.S. Senate Budget Committee and was a senior economic advisor to Bernie Sanders' 2016 presidential campaign.
Below is the Q&A with Kelton, edited for time and clarity. She was being interviewed for a CNBC Digital video.
Jordan Malter, CNBC: You wrote an article in The New York Times. It was titled, "How we think about the deficit is mostly wrong." What's the conventional thinking and why is it wrong?
Stephanie Kelton: So the conventional thinking about budget deficits, I think, tends to be that people look at a deficit and they think that it's evidence of overspending. They think it's evidence the government is mismanaging its books. That it's done something wrong. [But] evidence of overspending is inflation.
So what is the budget deficit? I like to do this by using an example. I think it helps people. If you think of the government deficit as the difference between what the government spends into the economy and what it taxes back out, then imagine a government that spends $100 into the U.S. economy but it only taxes $90 back out. We label that a government deficit and we record that on the government's books. But what we forget to do, is pay attention to the fact that there's now $10 somewhere in the economy that wouldn't have been there otherwise, that is put there by the government's deficit. In other words, their deficits become our surpluses. So when we talk about the government having all this red ink, we have to remind ourselves that their red ink becomes our black ink, and their deficits are our surpluses.
Malter: So, do deficits and aggregate debt matter at all? At some point can a country have too much debt?
Kelton: So the deficit definitely matters. It's just that it matters in ways that we're not normally taught to understand. Normally, I think people tend to hear deficit and think it's something that we should strive to eliminate, that we shouldn't be running budget deficits. That they're evidence of fiscal irresponsibility. And the truth is the deficit can be too big. Evidence of a deficit that's too big would be inflation.
But the deficit can also be too small. It can be too small to support demand in the economy and evidence of a deficit that is too small is unemployment. So, deficits can be too big, but they can also be too small. And the right level of the deficit is the one that gets you a balanced overall economy. The one that allows you to achieve high levels of employment and low inflation.
Malter: Where does growth play into this? You're saying high unemployment means that the deficit might be too small. Is low growth also a sign of the deficit being too small?
Kelton: Well, it depends because you've got to balance the potential benefits from higher growth against the risks of higher inflation. And so you may see a slow-growing economy that has close to full employment and inflation at about 2 percent. The question is then: Should you expand fiscal policy? Should you run bigger budget deficits in order to boost growth? So what is the objective? What is the proper policy goal? I think the right policy goal is to maintain a balanced economy where you're at full employment and you're guarding against an acceleration in inflation risk.
Economists tend to understand that the kinds of things that you can do to boost longer-term growth are investments in things like education, infrastructure, R&D. Those are the sorts of things that tend to accelerate productivity growth so that longer-term real GDP growth can be higher. So there are ways in which the government can make investments today — that increase deficits today — that produce higher growth tomorrow and build in the extra capacity to absorb those higher deficits.
Malter: I want to talk a little bit more about the policy proposals a little bit later but before that, Modern Monetary Theory — MMT — can you explain that?
Kelton: MMT starts with a really simple observation and that is that the U.S. dollar is a simple public monopoly. In other words, the United States currency comes from the United States government. It can't come from anywhere else. And therefore, it can never run out of money. It cannot face a solvency problem, bills coming due that it can't afford to pay. It never has to worry about finding the money in order to be able to spend. It doesn't need to go and raise taxes or borrow money before it is able to spend.
So what that means is that the federal government is nothing like a household. In order for households or private businesses to be able to spend, they've got to come up with the money, right? And the federal government doesn't have to behave like a household. In fact, it becomes really destructive for the economy if the government tries to behave like a household. You and I are using the U.S. dollar. States and municipalities — the state of Kansas or Detroit — they're also using the U.S. dollar. Private businesses are using the dollar. The federal government of the United States is issuing our currency, and so we have a very different relationship to the currency. That means that in order to spend, the government doesn't have to do what a household or a private business has to do: find the money. The government can simply spend the money into the economy and when it does, the rest of us end up receiving that spending as part of our income.
Malter: How much is too much? The CBO estimates that if things remain unchanged, the debt will be 152 percent of GDP in 2048. That will be the highest in the nation's history. Is that too much?
Kelton: Let's remember what the national debt is. The national debt is nothing more than a historical record of all of the dollars that the government spent into the economy and didn't tax back that are currently being held in the form of safe U.S. Treasurys. That's what the national debt is. So the question about whether the debt is too big or too small (or whether it might get too big at some point in the future) is really a question about whether that's too many safe assets for people to hold 10, 20, 50 years from now.
If you think about what happened after World War II, when the U.S. national debt went in excess of 100 percent, close to 125 percent of GDP. If we were talking about it the way we talk about it today as burdening future generations as posing a grave national security risk, we would have to scratch our heads and say, wait a minute. Do we think that our grandparents burdened the next generation with all of those bonds that were sold during World War II to win the war, build the strongest middle class, produce the longest period of peacetime prosperity, the golden age of capitalism, all of that followed in the wake of fighting World War II, increasing deficits, massively increasing the size of the national debt. And of course the next generation inherits those bonds. They don't become burdens to the next generation. They become their assets.
So it's impossible really to put a number, nobody can. How much debt is too much debt? If you look at Japan today you see a country where the debt-to-GDP ratio is something like 240 percent. Well above, orders of magnitude above, where the U.S. is today or even where the U.S. is forecast to be in the future. And so, the question is how is Japan able to sustain a debt of that size? Wouldn't it have an inflation problem? Wouldn't it lead to rising interest rates? Wouldn't this be destructive in some way? And the answer to all of those questions, as Japan has demonstrated now for years is simply: No. Japan's debt is close to 240 percent of GDP — almost a quadrillion, that's a very big number, yen. Long-term interest rates are very close to zero, there's no inflation problem. And so despite the size of the debt there are no negative consequences as a result and I think Japan teaches us a really important lesson.
Really, the only potential risk with the national debt increasing over time is inflation and to the extent that you don't believe the U.S. has a long-term inflation problem you shouldn't believe that the U.S. is facing a long-term debt problem.
Malter: Isn't it a valid concern that printing more money to pay for spending, especially when we're not in a recession, will result in inflation and destroy the spending power of regular people.
Kelton: If Congress got together and wrote a budget and decided they were going to put trillions of additional dollars into something like infrastructure investment, noting that our national infrastructure is approaching kind of Third World standards, and they said let's put several trillion dollars in and not offset any of that new spending. They just said, "Let's spend $3 trillion more into the U.S. economy." Would that be problematic? The answer is almost certainly yes, because we have an economy that has approached full employment (I don't believe we're there).
But the question is always: How much capacity does the economy have to absorb any new spending without prices beginning to rise?
So look, the Republicans passed the tax cuts and we now know that that added about $1.9 trillion to deficits over the next 10 years. There were people at the time who said, "The U.S. economy cannot take $1.9 trillion in fiscal stimulus. We're at full employment, if we do this it's going to create all kinds of problems. Interest rates will spike, inflation will accelerate, growth will slow." None of those things happened and the answer to the question why is because the economy had the capacity to absorb it.
Malter: From my understanding, one way to fight inflation (if we do get to that point of inflation) under MMT, is to raise taxes. So my question there is: Isn't it the wrong time to raise taxes when people are having trouble paying for basic goods? And is that even politically feasible? It seems like it would be easier to have the Fed raise rates or something like that?
Kelton: So the best defense against inflation is a good offense, and what MMT does is to try to be I think kind of hypersensitive to the risks of inflation. I don't see any other macro school of thought pay as careful attention as we do to the inflation risk question. And so what we would say is: Look, if you are Congress and if you are considering a new spending bill, instead of thinking about the ways in which that new spending will add to the deficit or add to the debt, you should be thinking about the ways in which that new spending has the risk of accelerating inflation. And then avoid doing that.
So instead of going to the Congressional Budget Office and saying, "Would you take a look at this piece of legislation and give us feedback? We'd like to know what this bill will do to the debt and the deficit over time." Instead, go to the Congressional Budget Office or other government agencies and say, "We're considering passing this trillion-dollar investment in infrastructure. This is our bill would you look at it? And we plan to do this spending over the course of the next five years. Tell us if that would create problems in the real economy. Evaluate the inflation risk and come back to us and give us some feedback." And if that feedback comes back and they say five years is too fast, we don't have enough slack in the U.S. economy you should spread it over seven or 10, that's the kind of responsible budgeting that I think that I would like to see Congress begin to move toward.
So there is always the risk of inflation with any additional spending once you get close to full employment. Not just from government, but if the rest of the world increase their appetite suddenly for the goods and services that we produce here in the U.S. and we're already at full employment, then foreign demand carries inflation risk. If consumers got very optimistic, if we had a housing bubble and people were leveraging up using the equity in their homes to finance new spending, that spending would carry inflation risk. So there's always the risk of inflation if you spend too much. What MMT tries to do is to maintain the level of spending in the aggregate at the level that is just compatible with full employment and price stability.
The question about what to do if inflation becomes a problem is a different one. And I think the first thing you have to do is say: "What is driving the inflation? What's the source of the inflationary pressure?" Because to think that the inflation that is going to be become important at some future date is likely to be the result of an overheating economy of too much aggregate spending is really hard to believe.
I mean, the U.S. economy hasn't experienced what we might call Demand-Pull Inflation for almost a century. The types of inflation episodes that have been important in the U.S. have almost always come on the cost side, what we call Cost-Push Inflation. They come about because of things like oil price shocks. You might see increases in headline inflation rates because the housing component or health care. Energy is the more likely. These tend to be the more important drivers of inflation.
And so when you think about how to fight inflation, I think the first question is to understand what the source of the inflationary pressure is and then to move forward with a policy tool that you think is going to help you get at that inflation. If you've got inflation resulting from energy price increases it's probably not going to do much to have the Fed raise interest rates or even to have Congress raise taxes. You've got to do something else that's going to work.
I reject the idea that MMT is about using taxes to fight inflation. That's a mischaracterization of pretty much everything we've written, but people say it all the time.
Malter: From your perspective what is it OK to spend on versus what do you think is sort of a waste of deficit spending?
Kelton: So it's a great thing to think about: How close are we to having an economy that is already using its resources so fully that if the government were to try to come in, or if any additional spending were to happen, that we would see an acceleration of inflation to levels that we find intolerable.
So are there things the government could safely spend money on today even though we may have an economy that's very close to approaching full employment? And I think the answer is yes, because there are things the government can spend money on today that actually create more room in the economy to produce more, so that we can absorb that additional spending. The kinds of investments that would allow you to do that would be things like infrastructure investment, like R&D. Things that lead to breakthroughs, technological innovation that allow the economy to be more productive, that raise productivity. Education is another good example.
Malter: There's a lot of chatter about debt and deficits but I feel like there's not a lot of action. So in some ways haven't politicians already taken your advice and they've just kept cutting taxes and kept spending?
Kelton: I think that in a sense the Republican tax cuts have given us a really good lesson in MMT. The risks are always on the inflation side. And so again many economists were warning that the tax cuts would be risky and irresponsible and have all kinds of negative effects, according to traditional modeling and traditional approaches. And now the evidence is in, and once again we have engaged in deficit spending without any of the fallout the textbooks and the conventional narratives have warned about, so I think it's a pretty good lesson in MMT.
Malter: With regard to our president, he has coined himself "The King of Debt" before and you mentioned how personal debt and business debt is very different for government debt. So is it OK to be the "King of Debt" when you're the president of the United States?
Kelton: At some point [Trump] said, you know after initially worrying about the national debt as a candidate, he talked about the need to possibly renegotiate the debt, negotiate with our creditors and there was a lot of backlash against those comments. And I think he had a really important conversation with someone and then he changed his narrative. He came out and he said, "Let me tell you, you don't have to negotiate with your creditors OK? I hate to tell you but we print the money OK? I hate to tell you there's never going to be a default." So, I think the king of debt figured out that there's a difference between taking on debt to finance casinos and real estate in your personal capacity or in your capacity as a business, and taking on and selling Treasurys and having a national debt and being able to afford to make every payment on time in perpetuity.
Malter: What was it like advising Bernie Sanders back in the 2016 election?
Kelton: Well he knew what he wanted to do. He already had an agenda laid out before the two of us even met for the first time. He had a 12-point agenda that became sort of the bedrock for his presidential run. And so I was useful to him where I could be, but the big policy ideas had taken shape really before I got involved.
Malter: Are you working with any of the 2020 candidates on the Democratic side currently.
Malter: And you'll just leave it at that?
Kelton: I better, because if they don't go public then I don't go public.
Malter: If not Bernie in 2020 who do you think is in a position to sort of make the best stand with regard to some of these big Democratic proposals?
Kelton: I just look at the field, you know, the people who have entered so far, and I see Democrats kind of swinging for the fences. I think you're seeing more ambitious policy proposals this time than, you know, you would have seen probably if the way hadn't been paved for this kind of thing in 2016. So there are a lot of people: Sen. Booker's got a big proposal for doing something called "baby bonds." Sen. Harris is talking about very big tax cuts for the middle class. Sen. Warren's talking about a green new deal. Sen. Sanders has talked about a job guarantee. So there's just all kinds of big stuff out there and I think there's just going to potentially be a lot of excitement in the Democratic Party around some of these big ideas.