MMT's Godfather Says the US Government Is Spending Like a Drunken Sailor

efficacy of interest rates in the current inflationary environment. So if you think back to the twenty twenty period, the idea that we had all these supply disruptions, lots of snarls in transportation and logistics, what are interest rate hikes really going to do in that context? Right? Yeah, And some people even argue that higher interest rates are detrimental for that kind of inflation, because you make it harder

for people to build out capacity. Yeah, but what's happening more recently, and I think you're hearing more talk of this is the idea that higher interest rates in and of themselves can contribute to the inflationary impulse through the interest income channel.

be inflationary. But then there is this sort of like there is the more are read upon view that you mentioned, which is that higher rates can constrain investment and contribute to less housing and that has an inflationary impulse in a time of housing shortage. That seems to be a little less controversial. The connection is clear, but I think regardless, like I think, Okay, here we are in July twenty

twenty four. Inflation has come down a lot. There's still many stories that could be told a lot about the last four years, and I don't think there are any really economists who have like nailed this cycle with some theory or whatever that it's like, Yep, they explained how it's all going to work. There are many this period.

Whatever we've experienced over the last four years will be debated and argued about, and what role did higher rates have and bringing down inflation or why the will be debated by economists for like one hundred years.

come to be known as modern monetary theory. So Warren, thank you so much for coming on outlaws.

me and myself and my partner Cliff Viner. Back in the nineteen eighties, we always used to muse about how the best indicator of what M two growth would be is live or because the interest rate itself determines the money like growth as it was measured back then. You know, there's been there's been institutional changes since, but this was back in the eighties, and so the idea that, you know, the interest rate itself was instrumental in how the price

level moves over time. I'll notice I'm going to avoid using the word inflation rate. I may say inflation indicators from time to time, but that is the whole word, and term has gotten so confused by the way it's been used. You know, if tomatoes go up, that's tomato inflation or something, right, instead of just the price of tomatoes going up. That I it's not informative the way I like it to be, So excuse me for not using that word. Maybe you know as much as you

all do. Yeah, So the interest rate itself has had this effect on a price level, you know, for a long time that I've observed. Okay, nineteen eighty that's forty five years, right. Something interesting happened in this cycle compared to prior cycles. Now in prior cycle is like in

two thousand and eight. I was saying back then that the rate cuts, the BERNANKI rate cuts were probably not going to do much for the economy, if anything, because cutting the rates from five and a half to zero or whatever it was a time removed something like four hundred billion dollars a year of interest income from the economy, lowered the deficit by four hundred billion from what it otherwise would have been. And all that income and those net financial assets were no longer being added. So I

was looking at a very sluggish recovery. I didn't see the stimulus packages being large enough to cause a particular boom. It was plenty large enough for decent growth, but not any kind of a runaway inflationary boom or anything like that. And I can recall being at the FED at a meeting, private meeting with a guy named Dave Wilcox who was talking about quantitative easy and how he didn't think would be inflationary. I said, yeah, I'm not so much worried

about not being inflationary. But with the FED buying all these securities, okay, they were buying securities that had higher yields, they were paying for them with reserves, adding reserves, which is fine. It was changing the duration of the government holdings. But it went from you know, the Fed was now earning the high interest rates and the market was earning those zero percent or whatever they were paying on reserves.

At the time, it was very low. And I said, you know, they're effectively taking ninety billion dollars a year of interest in come out of the economy. That might have been half a percent one percent of GDP at the time. I thought, for that reason, quantitative easing would probably slow down the economy at that point in time. And you know, that's kind of what happened.

seemed to play that. And I don't know if it's just confirmation by some hypart, but it looked at me like that's what happened, and we did have this sluggish economy, and that was partially the reason that the depth SIT wasn't large enough, partially because the interest Now I'm categorically against using a positive interest rate policy to increase DEPSIT spending to support an economy because it's so obscenely regressive.

When they raise rates, you know, the only thing they do is pay interest to people who already have money in proportion. I'mers, they already have, okay, and you increase depths A spending that way.

GDP held by the public. Yeah, so a one percent increase in rates two and a half years ago ultimately increased interest payments by a full one percent of GDP, three times the impact of the prior cycle. So here I am saying, look, if I thought this had an impact before, now it's really has an impact. Okay, Now it's three times larger than before. This is going to

be far different than anybody can imagine. And raising rates this time around is going to have a strong supporting effect on aggregate demand, you know, keeping unemployment down, you know, total employment growing, that type of thing. And at the time they increase the rate, the Fed was ranged with criticism for engaging in policy that was going to cause unemployment to go up to fight inflation. Remember that, Yeah, of course. Well, and I'm going no, they've got it backwards.

This is going to bring unemployment down, This is going to bring total employment up. This is going to cause strong positive GDP growth, not a recession. Every forecast was for recession for what years, right, they were just ignoring this fiscal impact of this increase in depth at spending. Now, the only thing I could rationalize why where they get where they're getting this from is that they must have had in their deep in their model somewhere, a zero

propensity to spend interest income. Right, no matter how high you raise rais, no matter how much interest you pay, there, nobody's going to spend a dime of it, and so you don't have to worry about it. And that's why they look at the primary deficit when they talk about emerging markets. They don't even count the interest income expense, right, That's all I could come up with this to why they would ignore that.

basically never happened to me before. However, I wouldn't necessarily say that because I was earning, you know, two to five percent on my savings that I went out and bought a bunch of additional things, and of course a lot of that was offset by the increased cost of living, increased price level for not using the term inflation. So how do you see that aspect of it playing out? People are earning more income, but does that actually translate into more demand?

You're wrong, We're going into recession. The interest rate effects on you know, borrow wars is going to dominate, and that's going to take down the economy. And the answer is you can only look at the data and see what happens. We can both come up with a narrative of what we think the propensities to consume a ount of interest income, but we're not going to know until

after it happens. And I looked at in prior cycles, the data was telling me that it's not zero, that there's a substantial amount that directly or indirectly does get spent.

But that's all it is. It's a view looking at the macro data, looking at what GDP did versus what it was expected to do, looking at how the rate cuts help the economy or didn't help the economy, you know, based on what their models expected, right, and the same way those rate cuts didn't help the economy as expected back in two thousand and nine, Ish is telling me it was that four hundred billion a year of you know, income that was cut out was having a dampening effect

on spending. Goes back to under Bush in two thousand, two thousand and one, when we hit that recession, they dropped interest rates to one percent and nothing happened. It didn't help. And I was actually in a meeting with Andy Carr Andrew Card, who was chief of staff at the White House in two thousand and two February March.

And I'd gotten that meeting because in my car company, two of the people on the board of directors were ex engineers, one General Motors, one for a New Card personally, he was an engineer at GM, and when I talked to him about the interest income than the same way I'm talking about it to you. They said, you got to talk to Andy and set up this meeting. You know, I went to the White House. Meeting was in the West wing, and the first thing I did was just what I said to you, and what look in the

economy itself when when they lowered interest rates. Okay, it helped borrowers, but it hurts savers. You know, into the penny for every dollar saved, there's a dollar borrowed in the economy. Banks have loans and deposits and their equal or somebody made an arithmetic mistake, you know, I assets and liabilities, and so you know, when you lower rates,

you're just shifting income from one eneity to another. And the only way that can have an effect is that if there are differences in the propensities to spend interesting income of those two. But at the macro level, because of the public debt, when you lower rates, you're cutting the size of the depths that you're cutting total interest

income in the economy. I said, I think that effect dominates, and looking at what happened in the last year in two thousand and two, you know, I wouldn't expect Race to do anything. And Carter looks at it. He goes, He says, yeah, why would anybody think that's going to work? And he says and he goes, oh, look what does work? Then I explained fiscal side, where when you spend more than the tax that is a direct ad of income

and financial assets. And when you increase deficit spending proactively, any economist who pays to be right it's going to revise his forecast upward for the economy. And he says, well, how much do we need? I said, well, I think it's probably seven hundred billion annually back then, which was maybe about five percent of GDP. He says, well, we don't have much time doing it, and he said, oh, you better get started. It was got a nice note

back from it was very nice. A week later, the President was asked about the deficit and he said, look, I don't look at numbers on a piece of paper. I look at jobs which came right out of our meeting. And after that. I don't know if you remember those days, but they passed every tax cut you could imagine, including retroactive tax something we never had before. People were getting tax refunds from taxes from previous years. And they passed

every spending bill. They could get through Congress trying to get this deficit off to save the economy, and that included prescription drugs for medicare. So I'll take personal responsibility, even though that wasn't disgusting meeting or you know, for good government, spending all that money on prescription drugs definitely got up to two hundred billion by the third quarter, which was about my reign target number, you know, seven hundred million for the year. The economy turned around, and

it didn't cost him the election. So you know, I've been on this for a while, so it's all been from a narrative and then watching the data.

And he says, well, if you deficit spend for the job guarantee, the deficit could get so large that if the FED tried to raise you know, if we get inflation, the FED won't be able to use interest rates as a tool because the interest in you know, expense will be so high that that itself would cause inflation. Now, he was using that as an argument against the job guarantee and he made my argument and I said to him, yeah, I agree with you, I said, but I think we're

already there for all practical purposes. And the debts GP was lower than but you know, it was at least neutral, that that interest rates were a tool. And he disagreed with me, and that's fine, And I said, in any case, you know, I support, as you know, at permanent zero rate, in which case it's moot. You know, you could spend for job guarantee without worrying about whether rate raising rates is going to do anything. And now, because you're not going to do it, you're going to just leave him

at zero. But the point was he that was his new Keynesian the position out of the new Keynesian model, and it was a standard Nukenesian position yours, you know, not that long ago. You remember them all talking about anti deficit talk and how the interest payments are, you know, are unsustainable and all this stuff. By unsustainable, they always mean inflation shared, right, you know, say it in their first phrase. But that's if you drill down on them,

that's what they get to. But in the last couple of years, when I asked them again two years ago. It's like, no, I don't think we're at that level. I still think that FED can raise rates to fight inflation. I said, okay, you know, we'll see. So this is this is in the new Canesian model. You know, it's just arithmetic that at some point the deficit gets high enough, the public deck gets high enough so that when you raise rates and pay more interest, you do call the

interest itself cause inflation. Now, let's look at how high the deficit spending is. CBO's latest number shows seven percent of GDP, right, yeah, and I think that's just treasury. I don't think that includes FEDERI mints. So maybe it's seven and a half or something. Okay, Now, have we ever had anything anywhere near a seven percent budget deficit during an expansion? With the unemployment it's like four percent,

you know, kind of record low levels. No, the only time we've gotten anywhere near this highest countercyclically when you have a collapse and then tax revenues fall off and transfer payments kicking kick in because unemployment's high. You know.

Then we got to eight or nine percent in two thousand and nine, and we got to I don't know what the number was of COVID maybe fifteen percent, but normally, if you look at eight the budget DEFs, it was down to something like one percent of GDP, and that was low enough to allow the high price of oil and the other catalysts to trigger, you know, a major collapse in the financial sector, not a seven percent deps. Seven percent is like drunken sale or level of government spending.

And out of that four percent is the interest expense. It's over one point two trillion, I think annually. We just passed one hundred billion for the month.

bit of a bump in the numbers. Right the Fed Atlanta is down to one point seven percent GDP, growth's still not a reception or anything, and everybody's now looking for this collapse and FED rate cuts and everything else. And I'm sitting here, going, how can this be with a seven percent pro cyclical budget depicit? It doesn't It seems like an absurd assumption that we could have any kind of substantial weakness or really any kind of a

sustained weakness in the price level. So but you know, for the last few weeks, maybe a month's, a couple of months. You know, it's certainly been plenty of indicators around the edges that things a week in and it may turn out, you know, I'm completely wrong, we have a total economic collapse with a seven percent deficit, and I can I'm seventy five this year. You'll never hear from me again, right, Well, see what happens.

and price pressures. Now, the other interesting thing is this one hundred billion a month only translates into about a three and a half percent of the Treasury debt as interest payment, whereas FED fundraise five and a half five and three a's, which means and T bills are somewhere around there five and a quarter five and three a's, which means that as rollovers continue, as time goes by,

the depthit expands, that number is going up. Okay, even if they just leave rates alone, it will get to five three a's, you know, asseptotically, but it'll get there. And so that we're getting more and more of this, and the CBO's deficit forecasts are showing deficits higher than six percent. Put it to the future like this is like going to be interesting. That to me is at

least six seven percent nominal growth. And if you think, you know, price level is going to be I don't know what you want to use PCE or something two and a half. That's that's four and a half real, Right, that's a pretty strong number. More likely you will get two to three reel and the rest will be you know, price level changes just one of the channels where the interest rate normally are. Over time, I've just noticed over fifty years they're changing the price level. The rate of

inflation gravitates towards the Fed's policy rate. Over time they converge, and so with the five and a half percent rate, five and three's rate, you'll see CPI gravitating towards that interest rate, you know, towards that number five five and

a half. Not in day one, you can go once without it, but over a longer periods of time, and you can think of that something like a stock split, you know, or a stock dividend where if you just pay all more shares you're getting, you know, all is equal to the value of this of an individual share goes down by that amount. Right, So if you have a two for one stock split, the price of the stock

falls in half. If you're paying out five and a half percent a year on the public debt, which is the net financial assets in the economy called the net money supply in the economy, you're expanding it at five and a half percent a year through a payment of interest. There's nothing on the supply side, it's just a distribution. Then. I've just observed that over time price level gravitates upward by about that amount, and there's you know, plus or minus.

So those are my expectations going forward. And if you notice CPI has leveled off at about three, you know, a quarter percent or something. It went up with COVID, it came down and then sort of leveled off. It's been going sideways here and that's about at the interest rate. You know, the effective rate on treasuries last year was about three and a half whatever it was. So to me, that's not a coincidence. It's not a surprise. It doesn't

have to happen. It could have been different, you know, But it's kind of like the midpoint of my expectations as to what's going to happen with the price level. Now. PCE is a different thing, right, that includes substitution. If the price of stake goes up until people eat chicken instead but spend the same amount, you know, then there hasn't been any increase in the PCE.

or down price. You know, all the time. That's constantly changing relative value in the act of all kinds of things. You know, there's no way about that. And we have course of taxation, right and the tax structure affects prices and affects things. So if we have right now major tax credits for solar for example, I think I get a forty percent tax credit for installing solar, So I'm

putting solar panels in the USVII. The electricity is forty five cents to kill one, so it's pretty easy calculation, you know, so that I want to put in without that tax inteative from the government. So I figure it's probably not just me. So I talk to people at accounting firms, major accounting firms. Are you seeing tax time people doing this? They go, oh, yeah, We've got our own partnerships and structures where you can put money in

and participate in this solar tax credit. You know. So who knows how large is open end tax credits getting and what it's affecting. So, yes, governments spending, but government fiscal policy is entirely distributional between tax liabilities and spending. It's pushing and pulling, you know, everything everywhere. It's it's it's a major determined it's it's a it's a large part of the command economy, and it's a command economy,

you know, to the extent that it's there. If the government decides it wants jet planes, it's going to get jet planes right right through the tax structure to the spending structure. The pre market would not be producing jet planes without the government ordering. Right. It's everything caters to these you know, forces of government that are just on us all the time. So it's not that I'm in favor of them, but I'm just recognizing them and what they do.

point two trillion of income has been taken away. But you know, looking at the numbers I'm looking at, that's going to have a massive deflationary bias to it. It's going to be taking away all that income and all those next financial assets from the economy. It's going to be a staggering like creation of fiscal space. Let's say, I don't know how you want to put it, but just a major deflationary event. And that's not even under consideration.

That's it would be considered a major inflationary event. Right.

That's why I look at all the people that have looked at Japan with there's zero rates and forecasts like hyperinflation or the end went through one sixty big deal, Right, The inflation rates are lower than ours and it didn't go up and they kept zero race the whole time, but they're so forecasting hyperinflation, so they've got this bias that the low rates are going to a rate cut like that would be inflationary when it's the opposite.

In recent years, Japan has seemed like the rest of the world, if for a substantial inflationary impulse, still low by international standards, but the side the stock of the national debt in Japan is very high, as we all know. And now they actually for the first time and forever, have actually seen inflation again, not that high, but again historically by Japanese standards. Is there a pump mix right now for Japan? Is there a risk that I don't

know about hyper inflation? Kind of seems unrealistic that actually, if they follow conventional macro thinking and could hold rates up or move rates up to fight this inflation, that some of these disaster scenarios might actually emerge with the size of the.

they're there, so we have the data. But yeah, okay, does that answer your question?

can pay interest expens if they need to. And so we're seeing you know, three it's not this quarter, but we've seen you know, three and four percent GDP numbers. Now first and second quarter seems to be a little bit weak. I don't know if there's something in the seasonals that aren't quite fully sorted out, but and might prove me wrong, but I think, you know, the first quarter was one point four right due to inventory selling off inventories because they believe the economy wasn't going to

be strong, so they didn't replace their inventories. Now they have to replace them. We'll see what happens in the second quarter. But anyway, so that's a narrative you had, but the data hasn't. It hasn't played out because the income of their clients has been high enough to buy their output at a price that they like, you know, that they're comfortable with. They've had good pricing power and covers these added expenses from the interest expenses and interest

related expenses that you were talking about. But like it, so if you're spending enough, is throwing enough gasoline on the fire. Yeah, you're it's going to burn.

But in there's consumer credit, there's cars. We know that housing has slowed down. It does. Housing has slowed down substantially. It does seem like there are many parts of the US economy.

I have my own cars, you know. I had the Mosler Empty nine hundred, which I would run on track days. I never ran it real races. I used professional drivers, you know, but in amateur racing I would drive it, and I would drive our consotly ers. I used to say, these cars can win races even with me driving.

the economy is not a monolith. So you have these interest rate sensitive portions of the economy like housing, yes, that that are affected by rate rises, and then you have pockets that are more insensitive and maybe we don't have the balance of those two things exactly right, or maybe traditional economics hasn't done a good job of taking like those individual portions of the economy and netting them out into a cohesive picture of the actual effect of interest rates on them.

booming economy, that's never happened. It's got to be tax credits of some sort of you know, working out there. So the composition is going to follow the money. And if the money's going to those you know, earning interest, then that's where the composition is going to go. And you'll see more high end purchases, You'll see more things that sort that group of people. There'll be you know, all kinds of investments in that direction, and that's what

we're seeing. So again, it's about following the money, and the government policy directs to a large extent, where the money goes. And right now we've got over a trillion dollars a year going to interesting, which is more than defense and more than Social security and everything else.

real busy. The only time he had was an hour in the steamroom at the Racket Club in Chicago, so I went out and met him there. So we're sitting in our towels in the steamroom going through softcurt see economics, and he then gave me a list of his economists that he thought would be a good place for me to go. And our Laugher was on that list, and his guys were like Paul McCracken and Samuelson. I mean,

these were not anybody on my rollodecks. And I contacted a few of them, and Laugher agreed to do it in exchange for twenty five thousand dollars would help me write this thing, and he assigned Mark McNairy. So I got to know Art a little bit, and because we talked quite a bit on these things, and it turns out he's an ex university a Chicago professor, and he knew all this stuff. He knew learner and functional finance, and you know, long before I met any of the

academic and you know, he agreed with it. He signed Tom Nugent to cover me because he was always looking to do business. I went to a little conference where he was and he got up to talk and he said, I'm going to give the talk on money, and I'm going to tell the money story. He says, And Tom and Warren and he points to us disagree with me, he said, and they're right, and I'm wrong, but this is the way I tell it. And he went and told the story about how banks take in deposits and

make loans, you know, completely backwards. And then hesus a talk and look at him, like what was that. He says, well, you know I told everybody you were right and I was wrong. He said, like, what do you want? It's like, okay, So I don't know what's going on with our laugher. But he did say the the problem with the laughter curve was it only worked at the very extremes. So

he was very like, you know, reasonable about everything. You know, he's a very easy guy to talk to, and you know self deprecating in many ways, and you know, you know, yeah, it worked out well. Mark was very good and he wrote and I edited, He wrote and I edited. Did it. We came up with the soft currency economics thing, and it didn't help. I thought having Laughter's name on it and whatnot might give it more attention, more media attention.

But I don't think it made any difference. But you know, they say you have to kiss a lot of frogs, and that was just one of those, one of those times.

And the other part that does seem intuitive to me right now is this idea of a tiered economy where people who do have a lot of financial assets and are earning a lot of income on those financial assets do spend on certain things like, as Warren mentioned, luxury items like a lot of that makes intuitive sense.

And then I also think that while it's certainly true probably that the propensity to spend interest income is not zero, it is probably somewhat low, given that we're talking about people who already have a lot of money and income, Whereas the propensity to spend among people who are paying high interest rates, either through car payments or credit card payments, et cetera, is probably much higher and therefore impaired by

higher rates. So while I certainly get the theory and I think there's probably something to it, I still like would need more a little bit more convincing that the distributional effect of this change in spending is on net inflationary. But it's interesting ideas.

I can't remember the exact number, but like thirty trillion dollars or something like that, and people earn income on those treasuries, but each individual person is probably not holding a pure treasury portfolio, as you say, like personal wealth will be comprised of real estate, which is affected by higher interest rates, stocks which also go up and down

depending on interest rates. And so yeah, it seems like there's there's a sort of like net or sorry, there's a compositional complexity there that we still need to work out.

it'll be interesting to see how they react. Go to discord dot gg slash out Lots and if.