Better Economic Predictions Could be Made if More Economists Read Wynne Godley's Writings

This morning, as I was going through my hard disk seeking information on some unrelated subjects, I came across a paper by the late Wynne Godley (1926 – 2010), one of the originators of Modern Money Theory (MMT). His distinguished career included the Economic Section of HM Treasury from 1956 to 1970, and as director of the Department of Applied Economics at the University of Cambridge. I had saved the paper, entitled Strategic Prospects and Policies For the U.S. Economy (2002) and was particularly impressed with its predictions that extended to (yes!) 2007. Godly was careful to explain that his scenarios were not necessarly accurate predictions, but it is clear that, barring unforeseen events, he believed that the U.S. economy would follow one of the paths he had laid out.

In light of the fact that he wrote this article in 2002, he seems to have been unusually prescient. His theory was based on the behavior of the three factors determining the money supply of the U.S.: The government’s net cash flow (+ or -), the private sector’s net cash flow (+ or -), and the current account (balance of trade) (+ or -). These three numbers always sum to zero.

Assuming that the current account is unlikely to change significally in the short run (around -$700 billion/year), the government and private sectors must make up for that shortfall. If the government is in balance or surplus, the private sector must bear the brunt of the negative current account. Funds normally available for consumption, savings, and investment will decline by some $700 billion, which would lead to a recession. Thus, to make up that loss, either the government must make up the difference by printing money, or the private sector must borrow the money from banks. If the economy does not grow, the cost of servicing the debt to banks will eventually exceed the ability of debtors to pay and a large number of debts will become bad. Lending will decline, which is the recipe for a recession. It goes without saying that if the government runs a surplus, it will take even more money out of the private sector. That is why the government sector usually creates more money by spending than it destroys by taxing. It's called a deficit, a term that is a misnomer, since the government, unlike a family, can create money and spend it without having to be concerned with creditors.

For a little more background, Godley’s paper,  Seven Unsustainable Processes is informative but rather technical. The download is slow, so be patient.