Difference Between New Keynesian Economics and Modern Monetary Theory

Peter Cooper (heteconomist) has a post today on One of the Fundamental Differences Between Modern Monetary Theory and New Keynesian Economics.  That got me thinking and I'd like to simplify what he said.

New Keynesian Economics (NKE) is the current standard for Democrats in the United States and (neo)liberals around the world.  See the Evolution of Selected Economic Schools.  It was developed around 1980 as a response to difficulties that the U.S. and other economies were facing after decades of experience with Keynesian economics as the predominant paradigm.  Specifically, inflation had become a problem.

At root is the issue of limitations on the power of government with regard to macroeconomic policy.  Households, businesses, and small countries have a limited amount of power to create their own money and mobilize workers to solve problems.  Large and powerful nations, such as the United States since World War II, have a much greater capacity to do this.  Even so, there are limits.  Creating too much money can cause inflation.  Too much direct management of the nation's economy can restrict individual freedom, resulting in personal incentives that differ dramatically from governmental incentives.  This is generally recognized as the problem with Communism.

The main difference between NKE and Modern Monetary Theory (MMT) is on the limits of government power to control the economy..  NKE relies upon classical concepts of economics in which governments are small and weak, not much different from businesses.  In this line of thinking, governments should generally balance their budgets.  Only when unemployment is exceptionally high should governments run deficits to stimulate the economy.  Other tools, such as manipulation of government interest rates and regulation are deemed appropriate for managing the economy during more normal times.

MMT, on the other hand, claims that the NKE limit of government spending is needlessly restrictive for large and prosperous nations, while tinkering with government interest rates (monetary policy) is generally ineffective.  Governments can and should do more to achieve societal goals.  Inflation can be addressed more directly when it becomes a serious problem. 

In essence, NKE economists feel that MMT will fail for the same reasons Communism failed -- too much government control of the economy cannot work.  MMT economists feel that NKE will fail for the same reasons classical capitalism failed -- free markets by themselves do not address many societal failures.

Compounding this basic philosophical difference, NKE and neoclassical (mainstream Republican) economists frequently employ an almost religious taboo against discussing the appropriate boundaries of government involvement in the economy.  Their economic preferences are accorded the status of natural laws.  Understandably, this infuriates MMT economists and is a major problem with economic discourse.  Just as religious dogma has been used historically to support the status quo, economic dogma is used to support the status quo.

For a good example of how the NKE / neoclassical dogma is wrong and counterproductive, please see The Socrates Show, with guest Pete Peterson.