Modern Monetary Theory: The Next Paradigm or Utter Nonsense?
Updated: Sep 10
The advancing economic theory stressing the irrelevance of national deficits is facing a wave of denunciations. But MMT is more nuanced than its caricatures.
Martin Tekeli Brogaard
Modern Monetary Theory (MMT) has become a controversial phrase in economics during the past year. Some of the world’s foremost economists – including Harvard’s Kenneth Rogoff and Nobel Laureate Paul Krugman – lampoon MMT as a quixotic project pleading us to disregard government debt and “just print more money”. Still, the movement’s staunchest supporters remain enthusiastic about its implications for public finance. Should we take them seriously?
In essence, MMT makes the observation that a sovereign entity, like the US government, is not constrained by tax revenue when conducting government spending and can run a budget deficit perpetually without consequences. After all, any accumulated debt in countries with monetary independence can be dealt with by simply issuing more currency. Policy makers should be less concerned than they are today about the national deficit, insist MMT devotees, and instead focus on maintaining full employment whilst staving off inflation, a legitimate threat to economic stability.
Critically, the national budget does not function like a household personally saddled with debt that must be ‘paid off’. In countries like the US, Japan, the UK, and Canada which issue their own fiat currencies, the state has a monopoly on the supply of money. In other words, the money the state owes is money it has created in the first place. A government which prints and borrows in its own currency will never default since it can always produce new money to pay its creditors. This is by no means controversial, even amongst mainstream economists.
The difference lies in how governments choose to deploy their monopoly power. MMT proposes that if economic resources are left idle (think unemployed workers during a recession), there is nothing preventing the US or UK governments from activating them by injecting newly created money into the economy. In fact, a refusal to utilise spare capacity during busts based on a doctrine of balanced budgets could be viewed as fiscally irresponsible. Japan’s debt-to-GDP ratio has recently passed 250%, yet its ten-year government bond yield has stayed close to zero whilst inflation remains stable. Amassing ever-more debt has not been inimical to growth. American progressives like Alexandria Ocasio-Cortez and Bernie Sanders have also expressed sympathy for MMT as a vehicle to realise green investments. Nevertheless, most economists deem it to be a wishy-washy renaissance of Keynesianism with sparse mathematical formalisation.
‘The Deficit Myth’
Our political discourse has conditioned us to worry about deficits as the pavement to economic calamity. MMT considers this misguided. The classic tale reads that the government pays for its proposals with tax revenue and collects the remaining funds by issuing treasuries for investors to buy up. But such borrowing, the tale goes, has a downside: the government’s heightened demand for loans begets a relative scarcity of funds, raising the price of borrowing (the interest rate) and putting sand in the wheels of private investment.
For countries like the US and UK, this story is a far cry from the truth. The financing for fiscal stimulus throughout the pandemic has come predominantly from newly created cash issued by the Federal Reserve. The result was the shortest recession recorded in US history. Policies like the British furlough scheme are no different. As Stephanie Kelton – an outspoken MMT founder, economist and author of The Deficit Myth – puts it, “When the government spends more than it taxes away from us, it makes a financial contribution to some other part of the economy […] Every deficit is good for someone.”
Viewed from this perspective, policy makers should not be asking themselves ‘how to pay’ for ambitious proposals like a $1trn infrastructure bill, but how to resource them: “Paying the bills to expand Medicare to include dental, vision, and hearing is easy,” affirms Kelton, “The challenge is to make sure we have enough dentists, optometrists, and audiologists to treat everyone who needs care.” Put generally, if countries like the US or UK have the real resources to lift their economies out of a recession, then there is theoretically nothing stopping them.
But what about inflation?
Textbook economics teaches us that excessive money printing reduces the currency’s value, fueling inflation or possibly hyperinflation. MMT’ers worry a great deal about inflation; in fact, the theory views it as the main constraint holding back governments from extravagant spending. To understand why, we should rely on a more sophisticated appreciation of what drives inflation. The well-known proportionality between the money supply and the price level, captured by the canonical ‘Quantity Theory of Money’, is not a universal law but a product of a distinct mechanism.
Inflation arises because producers cannot keep up with surging demand, or costs, due to a lack of real resources and instead opt to raise prices. Every economy, therefore, has a constraint – a ‘speed limit’ – above which it cannot absorb any more spending without affecting the price level. Spending when the economy is at full employment could kickstart a dangerous inflation spiral, a threat which MMT supporters are acutely aware of.
The primary purpose of taxes, then, is to keep inflation in check. According to MMT, fiscal deficits are irrelevant as long as unemployment is low and prices are stable. Spending is the accelerator, taxation the brakes. To circumvent runaway inflation, spending must be targeted meticulously at industries with sufficient spare capacity. The extent to which policy makers can execute this effectively is questionable but not unthinkable.
A description, not a prescription
Counterarguments to MMT are abundant – and many of them astute. What incentives does the possibility of reckless money printing generate for politicians once introduced in the political arena? Shouldn’t taxes serve other purposes than smoothing away business cycles? And what happened to central bank independence?
These are all relevant concerns. However, critics ought to acknowledge that MMT is far more positive than it is normative. The theory does not endorse misrepresentative statements like “deficits don’t matter” or “just print more money”. MMT is merely a description of how a currency works within a society. It is not a prescription for policies per se. Asking if MMT ‘works’ is like asking if particle physics works; it is nonsensical.
Like other modes of inquiry, economics is a complex science about which we continue to make new discoveries. Most economists did not anticipate the financial crisis fourteen years ago, nor did they foresee nominal interest rates going negative. As usual, there is still much we don’t know. For science – and the world – we should welcome the insights MMT can offer with equal sympathy and scrutiny.