Modern Monetary Theory
Written for RealTimeCEO
As our leaders look to repair our economies after the COVID-19 crash, a wild new way of economic thinking has surged to prominence: modern monetary theory, or MMT for short. MMT’s supposedly radical ideas for money creation and government spending have caused fear and confusion. ‘It’s dangerous,’ we hear. ‘We’ll end up like Zimbabwe!’ we’re told. Debt crises, financial ruin — or, perhaps, the chance for a better future. All this angst is intriguing. So, let’s take a closer look at MMT.
(I) The Path to MMT
The rise of MMT started after the global financial crash in 2008. As Netflix’s film The Big Short shows, bad financial modelling, systemic malpractice, and underestimating risk caused a collapse of the banking system. Blatant and severe problems in the financial sector grew unchecked, and eventually, the whole thing exploded. Remarkably, almost nobody saw the crash coming. Alan Greenspan, former Fed Chair and ‘greatest central banker in the history of the world,’¹ was dismayed. He said the ‘whole intellectual edifice’ underpinning our financial markets had collapsed. Unable to understand its own flaws, contemporary economic and financial modelling lost its credibility during the crisis: the crash bankrupted it, alongside Bear Stearns and Lehman Brothers.²
After the GFC, we needed a new way to think about economics. We were desperate for a new paradigm that avoided the fatal flaws of the old ways of thinking. Over the last decade, people worldwide have laboured hard to meet this demand, and several of their ideas have become prominent. Some of them are quackish, others are underwhelming, but a few have promise.
Modern monetary theory has been the most successful and the most controversial of these ideas. Until recently it was an academic obscurity, but now it has gone mainstream. Politicians like Bernie Sanders and Alexandria Ocasio-Cortez have adopted MMT-inspired policies. Leading theorist Stephanie Kelton’s recent book, The Deficit Myth, has also been widely acclaimed. These figures are all highly visible in the media, where they regularly make surprising calls for policy change. They say we need a ‘universal job guarantee’ and a ‘Green New Deal’, both financed by — what? — printing money. That’s right. Printing money.
(II) What is MMT?
At the moment, there is no consensus on MMT. Depending on our source, MMTers are either charlatans or savants; they are profoundly pragmatic or dangerously utopian. Some say Kelton’s work is ‘on a par with the genius of DaVinci and Copernicus’. Others simply tell us MMT is ‘dead wrong’. And a poll of leading economists like Angus Deaton and Daron Acemoglu suggests the academy is overwhelmingly against it.³ There is some potent opposition to MMT, then. But if we read what MMTers themselves have to say, it’s hard to see why it inspires these extreme responses.
According to economist James K. Galbraith, MMT is just ‘a description of how a modern credit economy actually works’.⁴ While its arguments might be surprising, they aren’t illogical. In essence, the theory tells us that governments with their own currency don’t need money reserves or tax revenues before they can spend. After all, the government is always the source of money in the economy. Logically, taxation can’t occur before money creation. Instead, the government has to create money ex nihilo — ‘from nothing’ — and spend it into existence before receiving their tax revenue. The whole monetary system doesn’t make sense otherwise.
‘From nothing?’, you say. Yes: from nothing. MMT says money only exists because the government creates it from nothing. ‘How does this work?’ you ask. Well, it’s pretty simple. First, the state uses its power to impose taxes on its people. Then, it demands payment of these taxes in the currency it issues. Workers and producers then find that they need government currency, and they get it from a combination of government spending and private lending. Once they have the money, they pay taxes on a portion of their output, and they keep the rest. The government gets its tax, and the workers use the remaining money for investment, consumption, etc.⁵
All this leads us to a new take on government deficits. As taxes are never equal to 100% of output, the government initially falls into a budget deficit. They can’t tax away dollars that they haven’t spent first. The government, then, can only achieve a budget surplus if the private sector is in deficit. To run a surplus, the government has to reduce money creation, pull existing money out of the system by raising taxes, or seek loans from the private sector.⁶ Accordingly, the government doesn’t need to finance their deficits through borrowing. For them, reasonable, perpetual deficits are a sign of a healthy economy. Budget surpluses, on the other hand, impede economic growth by draining resources away from private investment. Worse still, surpluses frequently precipitate periods of crisis, as the private sector engages in risky lending to finance the government.⁷
If all this is true, it has some important implications for government policy. MMTers tell us that countries who:
a) hold a sovereign currency (in MMT-speak, a fiat currency that isn’t convertible into something the government can run out of, like gold or foreign currency), and
b) who borrow only in that currency⁸
can and should issue money to create ‘a full employment economy.’⁹ According to MMT, a government can spend money into existence to bring the economy to its productive capacity. It also says that countries using a sovereign currency can’t default on their obligations. As Galbraith tells us, countries like Australia and the USA are ‘not Greece, and cannot become Venezuela and Zimbabwe’. Incidentally, Warren Buffet and Alan Greenspan agree:¹⁰ a country with a sovereign currency can always finance its deficits by creating currency. We can’t run out of our own money.
(III) The Case Against MMT
For those weaned on monetarism — practically everyone reading this article, myself included — this sounds like pure anathema. Isn’t ‘inflation always and everywhere a monetary phenomenon’?¹¹ Won’t printing money to fund our deficits lead us to ruin, Argentinian style? Mainstream economists — none of whom foresaw the GFC in 2008, by the way — seem to think so.
For Harvard economist Kenneth Rogoff, these ideas on deficits are ‘just nuts’. In his view, this ‘modern monetary nonsense’ forgets that the ‘printing press is not a panacea’, as its use can lead to problems with debt repayment and currency demand. Nobel Laureate Paul Krugman tells us he doesn’t ‘understand [MMT’s] arguments at all’. Elsewhere, he expresses ‘mild concern’ over the MMT position ‘that because we have a printing press deficits don’t matter’. Lastly, for Larry Summers — Yanis Varoufakis’ very own ‘Prince of Darkness’ — MMT is ‘voodoo economics’ and a ‘recipe for disaster’. It offers ‘the proverbial free lunch’, he says, ‘the ability of the government to spend more without imposing any burden on anyone.’
The fearsome free lunch, people: be afraid.
Economists hate free lunches. We know this. We all agree that a free lunch is the worst kind of lunch. Today, no serious economist argues for policies that try to give people something for nothing. History tells us this is usually disastrous. We know that printing money to finance expenditure will cause inflation. Government’s credibility will decline. The costs of borrowing will increase, and the currency’s value will fall.¹² We know there is nothing desirable about printing endless piles of money — ‘keystroking’ it into existence with computers, as MMTers say. And we know that countries around the world have ruined themselves by pursuing this strategy.
(IV) The Case for MMT
It is lucky, then, that MMT proposes nothing of the kind. Stephanie Kelton is at pains to reassure us: ‘MMT is not a free lunch’, she says throughout her Deficit Myth. Galbraith also tells us he knows of no MMT advocate so naïve as to say that ‘deficits don’t matter’. Along with the MMT community at large, Kelton and Galbraith understand that governments looking to spend must be sensitive to our economy’s real resource constraints.
Proponents of MMT don’t advocate for unlimited money printing. Instead, they argue that the government can spend money until all the economy’s real resources are used in productive activities. The economy has real constraints, a point Kelton makes at least seven times in her book. She also emphasises that ’failing to identify — and respect — those limits could bring great harm’ to our economy’ in the form of inflation.¹³ Like all economists, MMTers say governments can spend money to push the economy to its productive limit. Unlike others though, they also say governments should do this. That it’s their responsibility to spend until we hit full employment.
(V) Insight
As we have seen, MMT purports to offer a compelling solution to our economic problems. But do its arguments stack up? And will it work?
When I think about the viability of MMT, I have to remind myself of a few facts. Since my birth in 1994, our society has lived through the rupture of the dot-com bubble in 2000. Next, we saw the global financial system collapse in 2008. Then, the Eurozone crisis persisted through the 2010s. Now, we’re in a recession caused by the COVID-19 lockdowns in 2020. Over this period of crises, interest rates and capital investment measured as a share of GDP have fallen to historic lows in many countries, taking economic growth down with it.¹⁴ Over my life, economies worldwide have become more ineffective, partly because of our way of thinking about economics. We need to change. Maybe, MMT is the winning idea.
In truth, I’m hesitant to endorse MMT fully. To me, it seems that MMT offers the same story as always, albeit with some minor adjustments. It gives us some great ideas on money’s origins and the way governments work. And it drives a stake through the heart of austerity politics. But the fact remains: the government can only print money to finance expenditure up to a point. If the spending doesn’t increase real productivity, expansion beyond this limit will cause inflation. Once they reach this resource constraint, the government can only spend more money through — you guessed it — taxing the private sector. If they don’t increase taxes, the government will find themselves competing against the private sector, and prices will rise.
In the absence of tax hikes, I am sceptical that MMT-based expenditure could finance projects like a Green New Deal without inflation. After all, high-skill workers generally have jobs doing other essential activities. And I am puzzled by their ‘job guarantee’ idea. Of course, their vision of full employment is attractive. But I wonder about the real value of the projects the workers would complete. Its design and administration must be thoughtful, or it could end up like the universal employment programs in the USSR, where ‘they pretend to pay us, and we pretend to work’. In short, there is a fear that governments will fail to use the theory correctly. MMTers may inadvertently prove their critics right if they aren’t careful.
Despite these reservations, overall, I am open to MMT. At the moment, inflation isn’t a risk. Interest rates are low, and our economic resources are underutilised. And our intellectual paradigm hasn’t ensured economic stability for nearly twenty years. Perhaps, then, our governments should pay attention to MMT. After all, the ideas that provoke us usually tell us something important. Maybe it’s time to listen.
Recommended Reading
An excellent introduction to MMT is James K. Galbraith’s article, ‘Modern monetary realism’. Stephanie Kelton’s The Deficit Myth is a highly accessible book-length introduction to the topic. L. Randall Wray offers a more comprehensive account in his Modern Money Theory. Thoughtful criticism of MMT from a left-wing perspective can be found in Doug Henwood’s article, ‘Modern Monetary Theory Isn’t Helping’. For a critical ‘free-market’ perspective, see Peter Smith’s article, ‘Unmasking Modern Monetary Theory’.
Endnotes
1 Phil Gramm is responsible for these words. See: https://www.economist.com/united-states/2000/01/06/almighty-alan-greenspan
2 See https://oversight.house.gov/sites/democrats.oversight.house.gov/files/migrated/20081023100438.pdf
3 Respectively, these remarks belong to David Cay Johnston and Robert P. Murphy. For the poll on leading economists, see http://www.igmchicago.org/surveys/modern-monetary-theory/
4 See https://www.japantimes.co.jp/opinion/2019/03/18/commentary/world-commentary/modern-monetary-realism/
5 For MMTers, then, money is an expression of state power — a means of forcing debt upon people through tax obligations. According to L. Randall Wray, it is correct to say that ‘all money is debt’. (Wray, 2015, p. 58).
6 Note that private sector money creation also occurs ex nihilo. When a customer takes out a bank loan, the customer sells a financial security to the bank — their promise to pay — and the bank creates an account for them, without drawing money from elsewhere. The bank makes with the expectation that the debtor will generate sufficient returns with the sale of their financial security. On this point, see chapter three of Wray’s Modern Money Theory, and Prof. Richard Werner’s intriguing paper, ‘Can banks individually create money out of nothing? — The theories and the empirical evidence’. Available https://www.sciencedirect.com/science/article/pii/S1057521914001070
7 See chapter three of Kelton’s Deficit Myth.
8 If they hold debt in another currency, then government expenditure in the home currency will depreciate the exchange rate, increasing the debt burden and the likelihood of default. For this reason, MMT advocates advise against holding debts denominated in foreign currencies. Their theory, then, is not universally applicable.
9 Kelton, 2020, p. 38.
10 Kelton, 2020, pp. 147–148. See also https://www.youtube.com/watch?v=Q2om5yvXgLE
11 Milton Friedman’s words, quoted by Stephanie Kelton on p.161 of The Deficit Myth.
12 Wray tells us that hyperinflation typically requires additional circumstances beyond the printing of money. If increased government expenditure is accompanied by: a collapse in productive capacity, sociopolitical upheaval, the existence of onerous debt obligations denominated in foreign currencies and an inability to raise taxation for political reasons, or a weakening of the government’s power to collect tax, the real resource constraint narrows and inflation will increase.
13 Kelton, 2020, p. 70.
14 According to World Bank Data, US GDP has grown by less than 3% for all but one year since 2006, while countries like Germany and Australia have done little better. See https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=US-DE-AU
