What is Modern Monetary Theory (MMT)?
Modern Monetary Theory (MMT) has recently been a hot topic in economics. Analyzing its ideas became more pressing during the COVID-19 pandemic as the debate of whether governments should be increasing debt to support economies. Money Monetary Theory is an economic theory that says governments that create and control their own fiat currency can do so without limits. This heterodox framework provides that sovereign governments shouldn’t fear incurring large debt to grow their economies because they simply can’t run out of money.
Modern Monetary Theory stresses the creation of more money to help meet a country’s economic needs, like expanding access to health care, improving infrastructure, and boosting government-funded projects. As appealing as the extra money may sound, critics believe this move could increase inflation and make national debt unsustainable.
As policymakers and members of academia debate whether MMT can help grow an economy to its full capacity, it’s helpful to know how the theory works as a layperson. Read on as we delve into the intricacies of MMT.
What Is Modern Monetary Theory?
Modern Monetary Theory is an economic theory largely associated with the investment fund manager Warren Mosler. In his book The 7 Deadly Innocent Frauds of Economic Policy, authored in 2010, Mosler suggests that governments that control their fiat currency can never go bankrupt or run out of money. The main idea is that governments can print as much money as they possibly need to spend since they can’t suffer insolvency.
The thinking behind this theory is that national debt and government deficits are not as material as we think they are. Rather than rely on tax revenue or external borrowing to fund government spending, MMT proponents believe that a government can create more money. This is a huge contradiction from how economists view government funding and spending.
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How Modern Monetary Theory Works
While MMT has been around for many years, it has only become mainstream over the past few years as lawmakers like Rep. Alexandria Ocasio-Cortez try to popularize the concept. The idea of this concept is that a sovereign nation can borrow its own fiat currency and print more money when it needs to clear its outstanding debt. Modern Monetary Theory challenges the notion that governments are supposed to pay for spending with taxes. It holds that taxes should control inflation in periods of rising prices instead of funding any government spending initiatives. In this sense, MMT may be seen as an extension of quantitative easing, where government central banks buy long-term securities to increase the supply of money in an economy.
Governments like the U.S., Canada, U.K., and Japan that use their own fiat currencies aren’t limited by their tax revenues when it comes to government spending. These governments can constantly run a budget deficit since they can always print more money to fill the shortfall. As sovereign issuers of currency, governments are endowed with the ability to borrow from their nation’s central bank. The central bank can credit the government’s account for unlimited money without charging any interest on it or demanding repayment. In 2020, for instance, central banks in the U.S. and Canada purchased a large share of bonds compared to previous years, which prompted observers to attest that both governments were practicing MMT.
While some proponents argue that disappropriate government spending is fiscally irresponsible because the national debt would blow up as inflation skyrockets, MMT provides a rather different view. According to MMT:
- Large government debt isn’t a prerequisite for economic collapse as we’ve always believed.
- Countries like the U.S. can stomach larger budget deficits without any cause for alarm.
- A small surplus or deficit may be very harmful and cause recession because deficit spending contributes to boosting people’s savings.
Modern Monetary Theory proponents explain that debt is money a government pumps into an economy but doesn’t tax back. They also hold that the average budget for a government and household are two incomparable aspects.
The History of Modern Monetary Theory
Modern Monetary Theory holds a long and winding history deeply rooted in ideas like functional finance and chartalism. Functional finance is the idea that a government should direct its spending to meet objectives like achieving full employment or controlling the business cycle. Chartalism is the idea that money originates with activities like spending and taxation instead of coming out organically from markets.
Ex-Wall Street trader Warren Mosler helped publicize the tenets behind MMT in the early 90s after connecting with non-mainstream economists like Bill Mitchell and L. Randall Wray. The group came together to synthesize their viewpoints regarding the theory, and they’d later be considered the founding fathers.
In his essay “Soft Currency Economics,” Mosler argued that the validity of the current view about the federal budget deficit and debt would be challenged immensely. He pointed out that once governments realize that deficits present no financial risk, spending programs will need reevaluation based on their economic benefits and weighed against their economic costs.
Modern Monetary Theory started to gain traction in the following decades. Republican presidents like George W. Bush were huge deficit-spenders, while Democrats like Bill Clinton and Barack Obama fought over every spending package. The contradicting patterns came to an end with Donald Trump, who, even before the COVID-19 pandemic struck, was already pushing the national deficit and debt to new heights, reaching nearly $1 trillion in 2019. At this point, new-generation proponents of MMT started making their case. Rep. Alexandria Ocasio-Cortez supported MMT as a way of paying for Medicare and the Green New Deal.
Stephanie Kelton, who authored The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, also delved into the topic. She is now considered the de facto face of modern-day MMT proponents. She also served as an economic adviser to Sen. Bernie Sanders in his presidential campaign and has also advised the Biden administration.
More recently, Kelton highlighted that President Biden could go all out on his infrastructure package and not pay for it conventionally. She urged Biden to go beyond traditional ideas on fiscal responsibility and identify what exactly the economy needs for support. She also didn’t express much concern about the rising inflation.
Modern Monetary Theory vs. Traditional Economics
When it comes to application, economics around MMT differ from traditional economics. More specifically, MMT defies the idea that it’s inherently bad to print more money to fund government spending. On the other hand, the traditional economic theory sees printing money as an inappropriate way of managing fiscal policy because such actions could devalue the local currency or cause inflation to soar.
Key Concepts of Traditional Economics Theory
Here are the key tenets of traditional economics theory:
- When an economy is struggling, its government can boost it through monetary and fiscal stimulus, or what’s known as quantitative easing.
- Governments control inflation and stabilize currency values through interest rate policy.
- Interest rate policy may be used to increase spending during recessions by encouraging borrowing at lower rates.
- Taxes and debt are the main ways through which government spending is funded.
- Unlimited government debt and spending could destabilize an economy.
Key Concepts of Modern Monetary Theory
Here are the key tenets of MMT:
- Sovereign governments that control their fiat currency have no cap on their spending because they can always print more money.
- A country that implements MMT can’t go insolvent or bankrupt unless by its political choice.
- Unlimited government spending boosts economic growth and reduces unemployment.
- Taxes help control inflation but are not a government’s primary source of funding.
- A government that incurs national debt can simply print more money to meet the debt obligations without fearing inflation, deflation, or its currency losing value.
Modern Monetary Theory also stipulates that governments don’t need to source funding by selling bonds because they can print money. In this case, bonds inherently become optional instead of a requirement for maintaining government cash flows. For instance, rather than issue $1 in Treasury bonds for every $1 deficit in spending, the U.S. government could just create the money directly.
Critics have also maintained that MMT isn’t a true theory because it isn’t a product of any mathematical model. The theory is considered a balance-sheet approach that sees government spending achieved by printing more money rather than by raising taxes.
Potential Benefits of Modern Monetary Theory
While some economic circles view MMT as a radical theory, the idea behind it is quite simple. If governments that control their fiat currency can print more money, they have unlimited resources to bolster economic growth. In this theory, spending deficits don’t disappear but may continue to grow.
For taxpayers, MMT may be beneficial because it may translate to fewer tax hikes to meet a government’s funding initiatives. Similar to spending deficits, taxes wouldn’t just vanish. However, there’d be less concern about the government rolling out new tax measures to manage its own debt or spending.
Flaws of Modern Monetary Theory
Modern Monetary Theory’s vocal supporters and outsiders who hold more traditional economic beliefs view MMT as an idealistic solution to ever-rising economic problems. As the theory gains popularity, critics have not held back their skepticism and sentiments. In fact, the general consensus among top critics like Federal Reserve Chair Jerome Powell and former Chief Economist and Director of Research at the IMF Kenneth Rogoff is that MMT poses a huge risk to national economies.
Critics and skeptics of the MMT raise these arguments:
- Unlimited spending doesn’t solve all economic problems. While MMT gives governments leeway to print money as needed, the action itself isn’t a catch-all solution to solving economic problems like rising inflation and unemployment. If resources are scarce or an economy isn’t running on full employment, a government will need to rely on taxation to control inflation.
- Too much debt is a problem. There may easily be less attention to the national deficit when an economy is in the midst of a boom cycle. However, this may manifest into a huge financial problem for a government when its economy enters recession, and printing more money isn’t the ultimate solution. A huge deficit could compromise lending and interest rates, therefore triggering inflation.
- Rising inflation. However, MMT proponents argue that the theory doesn’t cause inflation. In support of their arguments, they point out that the financial crisis, which resulted in huge government spending, didn’t cause inflation. However, rising deficits are often accompanied by soaring interest rates, and rising inflation could tip over to hyperinflation. This implies there is a rapid, out-of-control price increase and a sharp devaluation of the currency. Both aspects combined may lead to an economic crisis or collapse.
To further cement the concern about inflation, critics draw their reference to countries like Zimbabwe and Venezuela as examples of how things can go wrong. While both countries didn’t subscribe to MMT, they attempted to get through their economic troubles by printing more currency. The end result, in both cases, was grave hyperinflation and a deep financial crisis.
For or Against Modern Monetary Theory?
Modern Monetary Theory proponents believe that countries with sovereignty over their currency should spend freely because they can never run out of money. This is because these countries issue their own currency and their debt is denominated in that currency. Even so, MMT isn’t a solution to all economic problems, and arguments around high budget deficits and the risk of rising inflation expose the theory’s potential flaws. Since the COVID-19 pandemic, elements of MMT are making their way into many economies. The MMT debate isn’t about to cool off, and the intensity will only increase with time.