What Is Modern Monetary Theory?
Modern Monetary Theory (MMT) is an unorthodox macroeconomic theory that diverges from mainstream economic thought in several ways. It is based on the premise that countries with total control over their currency can finance spending by creating money at will, unconstrained by budget deficits and national debt. Federal spending by these monetarily sovereign countries is only limited by inflation and the availability of “real resources,” which are described as natural resources, labor, and capital.
Modern Monetary Theory has been thrust onto the political landscape by progressives such as Bernie Sanders and Alexandria Ocasio-Cortez, who see it as a pathway to financing programs such as Medicare for All, Universal Basic Income, and the Green New Deal.
Basic Tenets of Modern Monetary Theory
Modern Monetary Theory provides alternate and sometimes opposite views on government spending, taxation, and monetary policy when compared to mainstream macroeconomic theory. Under MMT, the government’s role in the economy is to promote full employment and a stable economy that fully utilizes natural resources.
The basic tenets of MMT include:
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Monetary Sovereignty:
To be monetarily sovereign, a country must be the sole issuer of a fiat currency that is unburdened by pegs to another currency and is the only currency allowed to circulate in the country. To be considered monetarily sovereign, a country must have total control of its monetary policy. Examples of monetarily sovereign nations include the US, the UK, and Japan.
Countries that are not monetarily sovereign include:- all EU countries (multiple issuers),
- countries with government debt denominated in another currency, such as dollar bonds,
- countries whose monetary policy is dictated by the IMF to qualify for economic assistance, making austerity programs a prerequisite for loans.
- countries with fixed exchange rates (pegs) to other currencies, and
- countries whose currencies are heavily influenced by commodity prices.
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Debts and Deficits:
One basic tenet of MMT is its view on government debt. Debt is often described as “money the government puts into the economy that it hasn’t taxed back.” Under this theory, government deficits allow people to save more by increasing the money supply.
MMT and traditional economic theory agree that deficit spending stimulates the economy, but MMT asserts that monetarily sovereign countries can handle a higher debt load than is generally supposed. Japan is often used as an illustration of this, though it isn’t directly using MMT. -
Government Spending
According to MMT, monetarily sovereign countries do not have to borrow from the private sector to spend. They simply print the money they need by selling bonds to the central bank, which does not charge the government interest or expect repayment. -
Taxes and Revenue
MMT views taxes and bonds as monetary policy tools, not a means of generating revenue. Taxes are used to regulate the economy and drain money from the economy to fight inflation. Taxes are also seen as a tool for redistributing wealth.
Bonds are used to set overnight interest rates and drain excess bank reserves, as well as perform their traditional role as safe-haven assets. Any revenue received would be incidental. -
Inflation Control
MMT shifts the burden of controlling inflation from monetary policy to fiscal policy, via spending and taxation. It agrees with the consensus view that the major way to bring down inflation is by cutting government spending and raising taxes, thereby reducing the money supply.
Controlling inflation under Modern Monetary Theory is made more difficult with its emphasis on funding social programs such as guaranteed employment, universal healthcare and a Universal Basic Income. - Jobs Guarantees According to MMT, the government should guarantee full employment by operating as an employer of last resort. This entails offering jobs at a living wage, thereby setting a wage floor for private sector jobs. Ideally, this program would include job training and apprenticeships that would allow workers to easily transition to jobs in the private sector when the economy expands.
History of Modern Monetary Theory
Modern Monetary Theory as we know it was first formulated by Warren Mosler in his 1993 book “Soft Currency Economics”, but it traces its roots to economic theories first espoused in the early 20th century. Early influences on Mosler’s work were Georg Friedrich Knapp’s 1905 work “The State Theory of Money,” which introduced chartalism, Alfred Mitchell-Innes’ 1913 publication on the credit theory of money, and Abba Lerner’s work on Keynesian economics.
Mosler was joined by L. Randall Wray, Bill Mitchell, and Stephanie Kelton in developing and publicizing the theory. Kelton, in particular, has become the public face of MMT in recent years. Their work was referred to as “Neo-Chartalism” before Mitchell coined the phrase Modern Monetary Theory.
The ideas behind Modern Monetary Theory received a boost in 2005 when then-Fed Chairman Alan Greenspan remarked before Congress “I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.”
MMT was proposed in 2008 as a way to help the economy recover from the Global Financial Crisis, but it wasn’t until Bernie Sanders’ 2016 presidential campaign that the theory received mainstream attention. Alexandria Ocasio-Cortez first championed MMT as a way to fund the Green New Deal during her Congressional campaign, bringing the idea into the spotlight.
Most recently, MMT proponents have pointed to the success of the government’s heavy spending and emergency payments to citizens as proof that MMT works.
Criticisms
Modern Monetary Theory faces several important criticisms. The most common point is that the massive spending MMT espouses would lead to hyperinflation, currency devaluation, and a loss of confidence in the dollar.
Paul Krugman, a prominent critic of MMT, once noted “Do the math, and it becomes clear that any attempt to extract too much from seigniorage – more than a few percent of GDP, probably – leads to an infinite spiral of inflation. In effect, the currency is destroyed.”
Another danger critics point to is the assumption that any government would have the political will to cut spending and raise taxes to rein in inflation. Critics also contend that the theory leans on the exorbitant privilege that the US dollar has as the world’s reserve currency.
Another concern is that, aside from the brief COVID crisis, there is no empirical evidence that MMT would work in the real world. Supporters of MMT point to Japan as a model, citing its ability to provide a high standard of living under higher debt loads than the US. However, beyond small fits and starts, Japan has shied away from adopting the concept. The Bank of Japan and the Japanese government both vehemently deny that they would even think of employing MMT.
While Modern Monetary Theory has gained attention and adherents, much needs to be addressed before it can gain widespread acceptance.
