This article is a transcript of an interview was conducted by The Hub, a project of the Centre for Civic Engagement and Hub Canada Media. Listen to the interview here.
SEAN SPEER: Welcome to Hub Dialogues. I’m your host, Sean Speer, editor-at-large at The Hub. I’m honored to be joined by Chris Ragan, the founding director of the Max Bell School of Public Policy at McGill University. Chris is the author of one of the most widely used introductory economics textbooks in Canada. He’s a brilliant macroeconomist who has published dozens of books and articles and advises governments on a range of topics including public finance, carbon taxes, and monetary policy. I’m grateful to be able to speak with him about fiscal and monetary policy in general, and the growing salience of Modern Monetary Theory in particular.
Chris, let’s start by contextualizing our conversation with how we’ve tended to think about fiscal and monetary policy over the past quarter-century or longer. Broadly speaking, how would you describe the conventional wisdom with respect to deficits and debt on one hand, and the interrelationship between fiscal and monetary policy, on the other hand?
CHRIS RAGAN: The conventional view is that fiscal policy is really about two things. One is that you come up with a way to raise the revenues you need to finance all the spending that you do. And there’s a huge amount that goes into that. There’s a huge amount that goes into what you decide public spending will be on and what it won’t be on, and there’s a huge amount that goes into how we figure out how we want to raise the tax revenue required for that. That’s one big bundle of things.
The second big bundle of things with fiscal policy is the extent to which you want to use Keynesian-style fiscal stimulus when you are confronted with a weakening economy or a slumping economy. And I think there has existed for many years a fair amount of agreement that fiscal stimulus is a potentially very important tool. You probably don’t want to respond to every bump and wiggle in the economy, but you can certainly respond with well-designed fiscal stimulus packages to big shocks, like we saw in the 2008-2009 financial crisis. That’s a very good example. So, to me, that’s all fiscal policy. And notice, nowhere in there did I mention the central bank, nor did I mention inflation. Part of this conventional wisdom has been the division of duties.
All of those things that I just talked about were kind of left to fiscal policy, and the corollary is that the central bank would focus its attention on stabilizing the economy. So there, they overlap with the Keynesian fiscal stimulus, but they would be really keeping their eye on inflation. And they would be directing their very limited number of policy instruments, which is really the central bank’s balance sheet, to controlling inflation. And we can talk a little bit more about what is involved in the control of inflation. But really, there has been this division of duties with taxes and spending and deficits on one side—deficits or surpluses, I should say—and with monetary policy and inflation on the other side.
The one final thing I will say in that is that, in this conventional thinking, there has been the belief in what is sometimes referred to as monetary dominance: the idea that if the fiscal authorities end up spending a lot or cutting their spending or adjusting their taxes, it, of course has an effect on the aggregate economy. It may, in fact, have an effect on the amount of aggregate demand or deficient demand in the economy, and that may have implications for inflation, but if the central bank is doing its job, then it can sort of counteract some of the negative inflationary aspects that come from that fiscal policy. So the fiscal authority wouldn’t have to worry about that. Securing the knowledge at the central bank sort of had that covered. So, that is my long-winded way of characterizing that division of duties between fiscal and monetary policy.
SEAN SPEER: How much is the renewed interest in deficit spending driven by a basic political economy challenge? Let me put this proposition to you. On one hand, the public seems to want more government spending, but, on the other hand, it doesn’t seem prepared to fully pay for it. An empirical way to make this point may be that public spending as a share of GDP is up, but revenue as a share to GDP is generally flat. Is that a sign that Canadians and others in advanced economies want big government on the cheap? If so, are deficits an imperfect way to solve for this dissonance in our political preferences?
CHRIS RAGAN: Okay, I would say there were two questions there. So, one invites a little bit of history, and the other is about our current belief in getting something for nothing. Just to start with where you ended, I actually think there is a lot behind what you just said; I think there’s a belief that you can get a bunch of a government on the cheap. “Why raise taxes, if you can just put it on the credit card?” But I’ll come back to that.
I want to start by talking a little bit about the history. I won’t go back that far; I’ll go back to the mid 1990s. When the federal Canadian government had a 68 percent debt-to-GDP ratio, the aggregate provincial debt-to-GDP ratio was about 22 percent. So, the combined federal-provincial debt ratio was about 90 percent of GDP. This is when we thought as a country that we had hit the “debt wall,” and some bad things happened in financial markets.
I think there was a general belief that maybe Canada wouldn’t be able to pay back its debt, or at least there were some questions raised about the extent to which that would be possible. Both provincially and federally, we embarked on a pretty serious fiscal consolidation over the next few years. And even though for 15 years, there were many people from the 1980s and early 1990s that had talked about the dangers of high government debt, the rubber didn’t really hit the road on this issue until the early- to mid-1990s, and then we embarked on this fiscal consolidation.
So of course, under Paul Martin—who was the finance minister at the time—and Jean Chrétien—who was prime minister, we brought very large fiscal deficits into pretty substantial fiscal surpluses in a fairly short amount of time; pretty quickly the debt-to-GDP ratio was falling. And as you know, by the time we got to 2008, just before the financial crisis, our federal debt to GDP ratio was just about 30 percent—plus or minus a very small amount. That was quite a change.
And what was interesting politically, before the financial crisis happened, is that we had come to the point in this country where even the NDP in the mid 2000s were agreeing that high public debt really is a problem, we really should be very careful about budget deficits, and we should actually be balancing the budgets. The political convergence on that point was actually quite shocking. One can argue whether it was good or bad, but it was quite surprising.
Then the financial crisis happened, and it took a while, but—Stephen Harper was prime minister and Jim Flaherty was the finance minister—it took a while for them to believe that there would be a recession, and it took a while for them to really believe that we needed some sort of Keynesian fiscal stimulus. But the G20 countries got together in the fall of 2008, and they all agreed to go back home to their national capitals and to embark on a sizable two-year fiscal stimulus package. We did, other countries in the G20 did, and I think it was a very good thing that we did. I mean, given the nature of the financial crisis, given the nature of the collapse in aggregate demand and the massive uncertainty, I think a big fiscal stimulus—and over those two years that amounted to something like five or six percent of GDP—the fiscal stimulus was relatively well-designed, and I think it was well motivated. And at that point, of course, there wasn’t a huge amount of political opposition to that fiscal stimulus.
So now, what had just two years or a year before been a unanimous political view that we should be balancing budgets had become a view that a fiscal deficit was okay. But of course, the deficits lasted only for a few years; the debt-to-GDP ratio increased and then sort of came back down again. And by the time we got to just before the pandemic, our debt-to-GDP ratio federally was again back down to something like 30 or 31 percent. It was pretty low. I mean, maybe I’m off by a percentage point, but nothing serious. And then, of course, we were confronted by the pandemic. The pandemic is not only a huge shock, but it’s a very, very different economic shock than we experienced in the financial crisis of 2008-9.
And so, what we embarked on was massive deficit spending, but not stimulus spending. And I think that’s a really important distinction: The federal government—Justin Trudeau has been saying now for the last two years that “We have your back.” What he meant by that, or my fiscal interpretation of what he meant by that, was, “We will make sure that the financial relief is there for you, for households for small businesses, even for some large businesses, while your income has basically disappeared because of the requirement that people stay at home and isolate safely, and you know while your income generating ability has disappeared, we will provide the financial relief.”
That has not been stimulus spending in the usual way; it’s not designed to increase aggregate demand, it’s really designed to allow you to pay your mortgage and to buy groceries, etc. And of course, those last two years, our deficits have gone literally off the charts, off most charts, and that’s been true in most advanced countries. Though, if Omicron is the last wave, then the budget deficits will eventually get back down to something closer to zero; the debt-to-GDP ratio will come on down, and you saw in the Fiscal Update that there is a path—hopefully it will happen—that has that debt-to-GDP ratio coming back down slowly. It’ll be a long time before it gets back to the low-30s, but it will get back to the low-40s within several years.
So, we’re now in this situation where I think for very, very good reasons, we had very large budget deficits over the past couple of years; there was some relief spending that I think needed to be done, and the government deserves credit for designing those packages. But, and the “but” here comes to your second point, is this: Are we now in this situation where we think that we can just spend on lots of things and not actually pay for them? We’re so used to, like in the last 18 to 22 months, we’re so used to putting things on the charge card, that I actually think there is this growing belief that maybe we can just keep spending, and we don’t have to raise current taxes to pay for it. And in a world of very low interest rates, it is true that you can put things on the, you know, you can borrow to finance those expenditures, and you are putting the cost onto the future, but you’re putting a low cost onto the future, because those interest rates are so small.
And one of my concerns is that the current finance minister and the current federal government are not talking enough about the future and to what extent should we be rethinking government spending priorities—to what extent should we be hastening the decline in the debt-to-GDP ratio. Because there will be another recession of some sort. There will be either another financial crisis or another pandemic or another something that we can’t even imagine. There will be a need to lower that debt-to-GDP ratio so that there is fiscal room for the government can respond to the next event, whenever and whatever it is.
But I think my criticism here is that the government is not really thinking enough or talking enough about the need to rethink fiscal priorities; the need to think about possible tax increases; the possibilities of what might happen if interest rates rise. All of that is just not being talked about, in my estimation.
SEAN SPEER: Well, thank you for that comprehensive answer, Chris, from recent fiscal history to a discussion of the future, which is a good segue to my next question.
You outlined concerns that the government isn’t thinking about how to close the gap between its spending ambitions and the revenue it collects. But there are some who would argue that they don’t need to, which brings us to the conversation that I want to have with you about Modern Monetary Theory. Maybe just to start definitionally, where did it come from? And in the fairest possible terms, what’s the general proposition behind Modern Monetary Theory?
CHRISTOPHER RAGAN: So those questions sound simple, but they’re not quite so simple. Let me address the first one. Where does it come from? I think some of the ideas about MMT have actually been around for a long time. But it’s the last 10 or 12 years that we have seen a couple of things happen. We have seen the big financial crisis in 2008-2009 and we’ve seen the pandemic that we’re living in right now. The policy responses to both of those crises had, number one, large amounts of government spending—much larger in the pandemic than in the financial crisis, but a large increase in government spending in both cases. And in both cases, central banks that increase their balance sheets, they increase their amount of large asset purchases through printing of money. So, quantitative easing. Now, that didn’t happen in Canada in 2008, but it's happening in Canada, during the pandemic, right now. And it happened in the United States and in the Bank of England, and in the European Central Bank, both in the financial crisis and now.
So, I think this confluence of these two things: We’ve got big economic shocks, we’ve got the central bank printing a lot of money and using that freshly printed money to buy government and other bonds. And at the same time, we’ve got government spending a huge amount of money on the fiscal side, and I think that has brought— it’s come together, and people have said, they’ve kind of dusted off these old ideas that, “Oh, well, maybe we can just print money to finance the government’s budget deficits. And maybe that’s not so bad and let’s wrap that all up, and we’ll call that Modern Monetary Theory.” Okay, so I think that’s where it has come from, or at least why it’s been dusted off in the last few years.
What is it at its heart? Well, this is actually tough. I mean, I, last year, I was teaching in the MPP program at Max Bell, and I teach in the macro class, and I wanted to teach a section on monetary policy in theory, but I also wanted to cover off MMT. So, it forced me to go away and read a bunch of literature on MMT. And I was shocked at how hard it was to figure out what it was. Because there are times when you kind of think, “Well, hold on, there’s nothing new here.” And then there are other times when you think, “Well, I’m not sure if there’s anything at all here.” And then there are times when you read something and you think, “Well, I think this is just wrong.”
And so, here’s the way I would describe MMT. I think MMT is a belief that if you are a government that has your own central bank, that can create its own currency, then you don’t have to worry so much about running budget deficits and all of the constraints that ordinarily we would think of as being associated with budget deficits, because you can effectively get your central bank to purchase your bonds, and you own the central bank, so you can get your central bank to print the money required to buy your bonds.
Now, that was always true. Any government that had a central bank could always do that. But the MMT people think, or they seem to think if it’s my interpretation here, that you not only can do that, but you should do that, and you shouldn’t require your central bank to worry too much about inflation; you should worry about inflation through adjusting your spending and your taxation. So, it’s really a way to subsume the central bank into the fiscal authority.
And if you go back to our first question, that sort of division of duties between fiscal policy and monetary policy, my interpretation of MMT is that they have completely stuck these two things together by subsuming the central bank into the fiscal authority, so that the central bank would no longer be operationally independent; it would no longer be focused on inflation. In fact, it would no longer be in the headlines at all, because the fiscal authority would be basically taking charge of the central bank. And you could do that, you absolutely could do that. The question is whether you want to do that. I think this is technically possible. I think the fundamental question is, is this a good way to run policy?
SEAN SPEER: Isn’t it the case, Chris, that we collectively, not just Canada, but dozens of jurisdictions around the world, established an independent monetary policy authority precisely because the evidence over decades was that politics couldn’t be trusted with managing the question of inflation? So, in effect, wouldn’t this be a reversion to the politicization of inflation management?
CHRIS RAGAN: So, I agree with everything that you just said, and I think that is a correct reading of the 1950s, 1960s, and 1970s. I think there was a growing recognition that countries with less independent central banks tended to have higher inflation, and they tended to have higher inflation because the politics got into the mix. And, you know, the government would basically encourage the central bank to goose the economy before an election, so to speak, and you’d end up with higher inflation as a result. And so, there was a worldwide movement toward more independent central banks, taking the politics out of it to the extent possible. And there was a growing recognition as well, Sean, that central banks couldn’t do everything: that inflation was fundamentally a monetary phenomenon in a sustained way, that bumps and wiggles in inflation may be caused by all kinds of things. But if you really wanted to understand what the long-run effects of monetary policy were, they ended up being largely on inflation.
So, once you’ve concluded that monetary policy can’t control a lot of things, but it does seem to have a systematic and sustained influence on inflation, then, I’d like to say it’s a kind of a hop, skip, and a jump to saying, “Well, we should have central banks focus on inflation.” It just took us 50 years to really get to that recognition. We’re slow learners, I guess. But there has been this absolute recognition that there are benefits to having operationally independent central banks, focused on inflation. Canada was the second country to embark on inflation targeting—after New Zealand in 1991—and for 30 years, we have been targeting inflation. Inflation has been low and stable and relatively predictable, and therefore the costs associated with high inflation haven’t been there.
So, I think you’re quite right. I think the MMTers who want to subsume the central bank into the fiscal authority are effectively saying, “We don’t like an independent central bank; we don’t want the central bank to focus on inflation. Also, we don’t like the constraints on a government that are put on in private capital markets about whether people will buy our bonds or not. Why don’t we just have the central bank buy the government bonds?” And so, I think there really is a stated preference for a policy framework which, for many good reasons, we don’t use currently. I think MMTers really want to go back to a very different world, and I would argue that it’s not a good world to be in.
SEAN SPEER: Your answer reminds me of our excellent Dialogue from late last year in which you joined me to talk about the pending decision on renewal the Bank of Canada’s inflation target. Listeners will recall that you made the case then that the Bank of Canada ought to be focused like a laser on its inflation target and not take on other policy responsibilities with respect to inequality, or climate change, or any number of issues that were being discussed in the context of renewing the mandate.
What you just outlined, it seems to me, implies that the central banks are facing pressure on both sides. On one hand, there are those who want to add a host of non-inflation issues to their respective mandates. And on the other hand, you have MMTers, who, in effect, want to strip them of their core mandate and hand it to the fiscal policy authorities. Do you want to maybe just outline your thoughts on what I think you’ve described as a two-front war facing central banks in advanced economies?
CHRIS RAGAN: Yeah, I think that’s exactly right. I’ve been thinking about writing this up, and I guess maybe I should do that one of these days. But I actually do think that central banks are currently finding themselves in a two-front war. The MMTers are effectively saying, “Let’s take away the central bank’s independence, and let’s take away its mandate on inflation.” So, those are people who wish to basically strip the central bank of power. And on the other side, there are people who seem to believe that the central bank is capable of not only controlling inflation, but doing much more. And so, let’s have them deal with reducing income inequality and let’s have them address climate change. Let’s have them possibly help on the front of Indigenous reconciliation, and maybe there’s some other things we could have the central bank do as well.
It’s really quite ironic because the MMTers either don’t believe the central bank should have the power that it does, or maybe it just doesn’t think maybe it is trusted with the power. But the other people want to get the central bank to do much more than they’re currently doing. They’re not trying to get them to switch from inflation to something else; they’re trying to get them to do inflation and a few other things. And so, maybe as long as that two-front war is going on, maybe the outcome of that two-front war is that we just kind of stay with the status quo. And we go, “Okay, well, let’s just leave the central banks to target inflation, and maybe that’s what we’ll do.” And that would be, in my view, a good outcome, because I do think central banks have been successful in dealing with inflation. And I don’t think you want to combine the central bank with the fiscal authority, because effectively you’re giving up a policy instrument, which I think is a bad idea.
But at the same time, I also think there are serious limitations on what central banks can do, and I think it would be a big, big mistake to expand their mandate to climate change or income inequality or other things. So, that maybe just makes me sound like an old conservative guy, and maybe I’m just an old conservative guy, but I think that central banks should actually stick to their knitting. And they’ve actually, I think, shown that they can stick to their knitting, and they can do very well.
Now, some people might say, “But, but we haven’t had great economic outcomes. We’ve had a financial crisis; we’ve had a pandemic.” And I would say, “Well, that may be true that we have not had all the great economic outcomes we’d had like, but I don’t think most of that can be laid at the door of monetary policy.” I think monetary policy has done quite a good job in Canada and in other countries in keeping inflation low and stable. And I happen to share the view based on lots of evidence and theory over many years in many countries, that that is all central banks are actually able to do. I don’t ask that much of my central bank, and I’m happy when all they do is deliver low and stable inflation.
SEAN SPEER: Well, let’s just wrap up Chris with a couple of final questions that speak to the motivations behind of Modern Monetary Theory and its likely influence.
I mean, at some level, it seems to me, these are people whose preferences are for a more ambitious role for government that would necessitate higher levels of spending, but who seem to be making the political economy assumption that the higher levels of taxation necessary to carry out their programme is politically unpalatable. And so MMT has become something of an alternative to the higher rates of taxation that would be required.
But what if a politician or political party made a straightforward argument that spending and taxes should rise as a share of GDP in the name of fully funding an expansion of the welfare state or some other public purpose? Is that okay? Are there empirical limits on the optimal size of government?
CHRIS RAGAN: This is a fabulous question, Sean, and it’s not the easy one. This is the 64-gazillion dollar question. It’s how big do you want government to be? And I think you can have a very healthy, very interesting debate and disagreement about how big government should be.
There’s no right answer to this. So, if you look at the scale of government in the Scandinavian countries, it is larger as a share of the economy than it is in sort of Western European countries. And in Western European countries, it’s higher than it is in Canada, which in turn is higher than it is in the United States. I mean, that’s there is quite a range; a range of something like 15 percentage points of GDP between the big government countries and the smaller government countries.
You could have a discussion about whether one of those is better than the other, but they’re different. They’re different people who, through democratic processes, have chosen different things. It’s not necessarily better that Scandinavians have decided to have a more generous social safety net, and Americans have decided to have a less generous social safety. I mean, I might have that view, but other people could have a completely legitimate disagreement with that.
However, while you see larger government spending in the Scandinavian countries, you also typically see more taxation. Scandinavian countries aren’t just spending a lot but not paying for it. And to me, that’s the key point: If you want to be a country that has a generous set of social programs, that’s fine. But I would say you need to pay for it. And if you want to be a country that has a much less generous set of social programs, and you have less government spending as a result, that’s fine too. Then presumably you have lower taxes to pay.
What I think is the dangerous combination here is to say, “Let’s have really generous social programs, and let’s not pay for it with taxes, and then we’ll put it on the charge card. We’ll just borrow, and we will run deficits, and that will accumulate into the government debt.” And then one day, you might just wake up, and you’re like Greece in 2011. Or even like Italy today. There are problems with high government debt. I think there are also problems, by the way, with high government spending and high taxation. But those you tend to experience as they’re in place.
So, if governments are going to spend 50 percent of GDP, and then they’re going to have to raise that through taxation, they are then going to start to have really high marginal tax rates. You’ll start to encounter problems gradually as you’re adjusting those policies. But if you’re spending 50 percent of GDP, but you’re only taxing 40 percent of GDP, and so, you’re borrowing 10 percent of GDP and then that accumulates up to debt, the problem is, at some point rather quickly, financial markets may simply decide that they don’t believe that you have a realistic mechanism for paying this stuff back. And then nobody wants to buy your debt anymore. And that’s roughly what happened to Greece in 2011, and I think you want to make sure you avoid that situation.
So, to me, you can have the debate, all you want about—it’s a great debate—about what the government should be in and what the government shouldn’t be in. But I would then say, wherever you land on that debate, make sure that you also have to design a tax system that with some sort of trade off probably between efficiency and equity, you’ve raised enough revenue to actually finance that level of spending, and then you don’t have to worry about having undue accumulation of government debt.
I actually think there are really two very different debates. One is how big do you want your government to be? And there’s no right answer to that, or you can have a juicy debate about it. And then the second one is, okay, then how much do we want to pay for government with taxation versus debt? And I would say, “Look, if you’re doing a bunch of government spending you think is good, and the people think it’s good, then collect the money from taxes from the people.” It’s not rocket science.
SEAN SPEER: Well, final question. You may not be a rocket scientist, but I’m going to ask you to be a bit of a prognosticator. We’re early in 2022. What’s your sense about the political fecundity of MMT? Are we going to see countries or governments explicitly commit themselves to MMT? Or will this remain a mostly kind of intellectual fad in certain progressive circles?
CHRIS RAGAN: Okay, I’m going to give you my prediction, but it’s also my hope. But I’m going to hope that this issue gets talked about enough that people come to the view that it’s just not a good way to think about your fiscal and monetary policy. And, you know, a recognition that there are good reasons why we have gotten to the place where we are today, where there’s this division of duties between monetary and fiscal policy. So that’s my prediction; it’s also my hope.
But I think we’ll probably talk about it for a little while longer. But I’m comforted, I guess, by the observation that when this does come up, and the people whom I read in various places, whether it’s newspapers or online sources, I don’t come across very many voices that think MMT is a good idea.
To me that is comforting that there’s enough intellectual capital out there right now—which policymakers are listening to—that suggests that MMT is not a good way to organize your thinking, that monetary policy should keep to what it was doing before, and that the kind of constraints that apply to fiscal policy are real and you have to pay attention to them. Again, that’s just the old conservative guy thinking life is going to continue on the way it has been, but that’s my prediction, and it’s my hope.
SEAN SPEER: Well, thank you, Professor Ragan. This has been a masterclass in unpacking a complex yet highly important topic. I think this conversation no doubt will contribute to that intellectual environment in which we’re grappling with these questions of fiscal policy, monetary policy, and Modern Monetary Theory. Thanks so much for joining us today at Hub Dialogues.
CHRIS RAGAN: Thank you for having me, Sean.
About the interviewee
Chris Ragan is an Associate Professor and the founding Director of McGill University’s Max Bell School of Public Policy.
Ragan was the Chair of Canada’s Ecofiscal Commission, which launched in November 2014 with a 5-year horizon to identify policy options to improve environmental and economic performance in Canada. He was also a member of the federal finance minister’s Advisory Council on Economic Growth, which operated from early 2016 to mid 2019. During 2010-12 he was the President of the Ottawa Economics Association. From 2010-13, Ragan held the David Dodge Chair in Monetary Policy at the C.D. Howe Institute, and for many years was a member of the Institute’s Monetary Policy Council. In 2009-10, Ragan served as the Clifford Clark Visiting Economist at Finance Canada; in 2004-05 he served as Special Advisor to the Governor of the Bank of Canada.
Chris Ragan’s published research focuses mostly on the conduct of macroeconomic policy. His 2004 book, co-edited with William Watson, is called Is the Debt War Over? In 2007 he published A Canadian Priorities Agenda, co-edited with Jeremy Leonard and France St-Hilaire from the Institute for Research on Public Policy. The Ecofiscal Commission’s The Way Forward (2015) was awarded the prestigious Doug Purvis Memorial Prize for the best work in Canadian economic policy.
Ragan is an enthusiastic teacher and public communicator. In 2007 he was awarded the Noel Fieldhouse teaching prize at McGill. He is the author of Economics (formerly co-authored with Richard Lipsey), which after sixteen editions is still the most widely used introductory economics textbook in Canada. Ragan also writes frequent columns for newspapers, most often in The Globe and Mail. He teaches in several MBA and Executive MBA programs, including at McGill, EDHEC in France, and in special courses offered by McKinsey & Company. He gives dozens of public speeches every year.
Ragan received his B.A. (Honours) in economics in 1984 from the University of Victoria and his M.A. in economics from Queen’s University in 1985. He then moved to Cambridge, Massachusetts where he completed his Ph.D. in economics at M.I.T. in 1989.
