Author: Luis Alonso Cabezas Villagarcia – Junior Researcher
Abstract: Modern Monetary Theory (MMT) is a novel and controversial monetary theory that reverses the mainstream conceptions about governments’ spending, borrowing, and taxation mechanisms. In sum, it proposes that governments are not constrained by their budgets when it comes to spending and are much freer to run deficits without adverse consequences, like inflation, than what mainstream economic theories establish. Stephanie Kelton’s book The Deficit Myth explains the theory in six main points which will be used as a basis for the essay. Moreover, real-world evidence presented by MMT economists, as well as objections by critics, will be discussed. Finally, the prospects of the MMT will be presented, bringing special attention to normative issues and policy implications.
Introduction: What is Modern Monetary Theory?
As its name suggests, Modern Monetary Theory (MMT) is a novel theory of monetary policy that aims to describe the functioning of fiat currencies since the fall of the Bretton Woods system in 1971. According to the MMT, fiat money, unlike the gold standard, places governments in a position to freely engage in the type of monetary policies that they wish without needing to worry about their budget deficits. In fact, by being the sole entity that can create currency, and by not having it pegged to the value of any other currency or metal, the state can never run out of money and can just print more to pay its obligations. Note that this is exclusive of governments with monetary sovereignty like the United States, Japan and Canada, and not of subnational entities like American states and countries that have given up their monetary sovereignty, like Panama, El Salvador, and the individual members of the Eurozone.
MMT is a theory that has been influenced by many 20th century economists like John Maynard Keynes, Abba Lerner, Hyman Minsky, and Wynne Godley. It was synthesized into a coherent theory by the works of Warren Mosler, and later by the contributions of Bill Mitchell, Stephanie Kelton, and Randall Wray. From this group of scholars, Kelton is perhaps the most famous, having appeared in different conferences explaining the MMT and having published a book in 2020 titled The Deficit Myth, which explains the MMT in a clear and simple language for non-scholars. The book aims to provide evidence against the six most widespread myths about American monetary and fiscal policy, believed not only by the general public but also by policymakers and even scholars.
Myth 1: governments should budget like a household
Governments with monetary sovereignty, according to Kelton, should not budget like a household because they are currency issuers, not users. This means that they can never run out of currency to pay their debts because they can just print more when needed. This situation is different from personal finances: regular people need to control their expenses because they can always run out of money. This intuition reverses the traditional TABS model proposed by mainstream economists: Taxing And Borrowing before Spending. It is substituted by a STAB model, in which the spending comes first.
Even though taxes are not directly useful for financing anything, taxation does serve a purpose: the government creates demand for its own currency by pushing people into working to pay the government back. Besides, taxation also controls inflation as it reduces demand for goods and services, reduces inequality, and helps prevent certain harmful behaviors, like smoking.
Myth 2: deficits are evidence of overspending
Deficits are not evidence of overspending because they do not have any negative effect on the economy. A real indicator of overspending, says Kelton, is inflation, as it would be the natural result of having “too much money chasing too few goods”. MMT economists believe, against the monetarist theory, that full employment can be reached, the only real constraint in the economy being inflation. However, in the United States stimulus packages have never been enough to reach full employment – this because after the 2008 stimulus packages inflation did not skyrocket.
Myth 3: the national debt puts a burden on everyone
According to Kelton, national debt is not real debt, as it is not a liability to be paid by taxpayer money. It is just an accounting identity that shows the amount of “yellow dollars”, i.e., government treasuries – possessed either by private nationals or by foreigners – produced and stored at the Federal Reserve. This is different from the situation of an entity that runs debt on a currency that it cannot produce.
Myth 4: government deficits crowd out private investment
According to this myth, governments run deficits by borrowing from a limited pool of savings. This, in turn, raises interest rates and reduces investments by the private sector, leading to slower economic growth. However, Kelton argues that government fiscal deficits imply a surplus in the non-government part of the economy, enlarging the savings of the private sector. On the contrary, government surpluses, like the one achieved by the Clinton administration in the US between 1998 and 2001, reduced savings, as the money to achieve a balanced budget has to be taxed away from the private sector.
If the government were to borrow from the private sector to run a deficit, i.e., by issuing treasuries (yellow dollars), it still would not eat up savings, as the government supplies both the treasuries and the money to acquire them.
The crowding out story does hold in governments without monetary sovereignty, like Greece and Italy, which during the Euro crisis had to borrow money from financial markets, with a risk of non-payment so high that interest rates skyrocketed.
Myth 5: The trade deficit means that the United States is losing
The trade deficit in and of itself is not something positive or negative. A trade deficit means a surplus of goods flowing into a country. However, according to the author, in the United States, free trade agreements and increased trade with China and developing countries have caused delocalization, making millions of people lose their jobs and fueling Donald Trump’s anti-trade rhetoric.
The trade deficit is important for non-monetarily sovereign countries and for developing ones, as the latter are usually heavily reliant on imports and must pay for them in foreign currency like the US dollar. In sum, much of the American trade deficit arises from foreign countries building up their dollar reserves. This puts some of them in a particularly disadvantageous situation, staying at the mercy of the United States. For example, interest rate hikes by the Federal Reserve lead to increasing borrowing costs in a foreign currency and reduced investment, spiking economic crises. The United States could, in theory, use its monetary power not only to promote full employment but to allow developing countries to prosper.
Myth 6: Entitlement programs like Social Security and Medicare are financially unsustainable.
In the United States, entitlement programs are federally funded, which means that the payments are provided by the federal government. As stated before by the author, unlike individual states, the federal government can never run out of money to pay for entitlement programs; to be able to pay, it just needs the political will to do so. Kelton tries to prove this by explaining how SMI (Supplementary Medical Insurance) is handled. The SMI is subject to a legal commitment by the federal government to always pay full benefits, a commitment that is not present for the other parts of the Medicare and Social Security programs. Thus the only real limit to welfare spending would not regard financial sustainability, but real economic capacity to handle the growth in demand (of doctors, nurses, and hospital equipment) created by these programs, the threshold being full employment.
Evidence of MMT:
For the MMT, the state of the government budget (surplus, deficit, or balance) is irrelevant. This entails, in theory, that monetary sovereignty allows for a policy of full employment. Before Keynes had written his General Theory, setting the basis for the MMT, in the United States the Roosevelt administration tackled unemployment aggressively through programs like the Civilian Conservation Corps, the Works Progress Administration, and the Tennessee Valley Authority, which managed to reduce unemployment from its peak 25% in 1933 to 14%. Although unequal in its implementation, with black Americans receiving mixed support (a “raw deal”) through the perpetuation of segregation, the New Deal is usually perceived positively in retrospect by Americans, and it is proof of the ability of the federal government to spend directly to tackle unemployment.
Another important piece of evidence in favor of the MMT is the huge stimulus packages implemented by the Obama administration after the 2008 financial crisis. The Fed carried out Quantitative Easing to pump up bank reserves, and this, unlike the mainstream narrative, did not increase inflation, while it reduced unemployment from almost 11% to just below 5%. Moreover, as not only the US but also central banks elsewhere became preoccupied by deficit spending and austerity became the norm, more and more economists by 2013 were recognizing that austerity was actually a hindrance for economic recovery. Anti-austerity rhetoric has even reached top officials at the IMF, an institution previously known for promoting structural reforms and balanced budgets. Besides, until the COVID pandemic interest rates were kept to almost zero and inflation had not skyrocketed, confirming the MMT narrative of unused economic capacity.
Regarding the COVID stimulus packages, in the United States and in Europe central banks engaged not only in Quantitative Easing, which in practice merely swapped bonds for bank reserves, but also in money-financed budget deficits, getting close to the well-known metaphor of “helicopter money” (meaning readily spendable cash) getting straight into people’s pockets. Although inflation was paramount, especially during the 2021-2022 era, world supply disruptions, like the war in Ukraine and the following Western sanctions, played a big role in the rise of inflation.
Maybe the most emblematic and cherished example of applied MMT is the case of the job guarantee implemented in Argentina in the early 2000s. From 2002-2005, the program Jefes y jefas de hogar (“Male and female heads of households”; from now on Jefes) provided a compensation of 150 pesos (a little less than 40 dollars at the time) a month to the head of a household for their employment in community service programs. These were, for example, infrastructure projects, setting up community kitchens, taking care of the environment and improving local agriculture. Although short-lived, the program managed to greatly reduce the rate of indigency and was very well received by the participants, with over 90% satisfaction of those involved. The limited impact on the rate of unemployment was very likely because only the heads of households could participate. Moreover, and as anticipated by the MMT, the job guarantee acted as a de facto minimum wage. In the Jefes program, 93% of those who managed to get employed in the private sector after participating in the program received a compensation above the 150 pesos mark. In addition, the program did not have any significant effect on inflation and increased GDP by 2.49% through the augmented aggregate demand.
On a side note, in 2023 the Colombian scholar Miguel Alfonso Montoya Olarte published an article for the journal Lecturas de Economía applying the MMT to the monetary operations of the Colombian treasury and central bank for the period 2007-2018. In the 1990s, the Colombian government established rigid limits for the central government’s public deficit and debt, as well as the independence of the central bank, which prohibits it from directly funding the government. However, in practice there were no limits for treasury operations, like bond-selling and monetary operations aimed at maintaining a given level of liquidity and an established short-term interest rate. Regardless of the normative restrictions on the treasury to be funded by the central bank, the bank indirectly funds the treasury when it acts to increase the liquidity of the economy by the acquisition of treasury securities by the private sector. This exact situation applies to the American Federal Reserve, and this process is not inflationary in and of itself. Besides, the paper shows a statistically significant correlation between monetary operations and collected taxes, as well as between monetary operations and the amount of total deposits, further proving that governments do not need taxes to fund themselves but create the reserves from which they tax the private sector. In addition, the study shows no correlation between interest rates and surpluses/deficits run by the Colombian treasury.
Critiques to the MMT economists:
Maybe the most known arguments against the MMT are the examples of Weimar Germany, Zimbabwe and Venezuela, countries known to have massively printed currency and who suffered severe hyperinflation. The arguments are dismissed by MMT economists as hyperinflation not being caused directly by money creation, but by other series of factors like these countries having a debt owed in a foreign currency, a reduced production output, insufficient adjustment of taxes to reduce aggregate demand, and continued deficit spending.
Warren Coats of the libertarian CATO Institute argues that a government that seeks full employment is taking away resources (labor and natural resources) from the private sector to the public sector, and this result is desirable only as long as the economic outcomes of such employment are better than those produced by the market, which he believes to be unlikely. Moreover, Coats claims that inflating away government debt, if it were to just print more money to pay for it, is de facto a default, which, of course, can severely alter the stability of financial markets. In sum, mixing the treasury with the Fed, which is what MMT economists propose in practice, is undesirable from his perspective.
From a Marxist point of view, Michael Robert argues that the MMT places too much emphasis on money in and of itself without criticizing the mode of production that exists behind economic processes, i.e., class struggle under capitalism. The Marxist theory of value and prices, unlike the Chartalist theory followed by the MMT, sees the “socially necessary time of labor” as the sole creator of value and prices, and not the State. Moreover, Robert puts into question whether, after reaching a hypothetical full employment, governments under the MMT would be able to “tame” the private sector to fine-tune it for the appropriate production processes and prices. In sum, money is a social relation for Marxists, while for the MMT it is just an instrument. Robert ran a small regression to show that government spending and unemployment have a direct relationship; governments with more public expenditure have higher levels of unemployment. Robert points out that massive unemployment is not due to a lack of government spending, but due to a lack of private investment, which is both what Marx and Keynes believed. He also criticizes the MMT as being an American-centered theory, in which the dollar can be printed at will as it serves as the world reserve currency, but one that does not work for the developing world.
Even proponents of more government spending have raised alternative policy prescriptions to the MMT, like a Universal Basic Income (UBI). UBI has been proposed by more libertarian economic thinkers like Milton Friedman, and it entails a monthly stipend paid to everyone for just existing. UBI lays at the antipodes of the MMT: such an income would have to be paid by raising taxes which, as we know, is ludicrous for the MMT as it strongly asserts that “taxes don’t pay for anything”. UBI would be a more market-based approach to welfare, as the government would not have any say in how that money is spent, supposedly making UBI more economically efficient than a job guarantee, while at the same time being less inflationary. Unlike the MMT, UBI tends to be endorsed by people of both the left and the right, and it stands as a means to protect people from the phenomenon of automation.
Conclusion: building an economy for the people?
Maybe the most important aspect of the MMT is its normative dimension. In Chapter 7 of The Deficit Myth, Kelton talks about “the deficits that matter” in the United States, which refer to real economic deficiencies like a lack of infrastructure, good paying jobs, good education, and affordable housing and healthcare. The most famous policy prescription by the MMT economists is that of a job guarantee, in the likes of FDR’s New Deal or Argentina’s Jefes program, but on a massive scale. After all, for MMT economists there is no reason to pretend that there is a “natural” rate of unemployment. On the contrary, unemployment has severe consequences for economic development and political stability. Moreover, the community service and infrastructure projects promoted under the job guarantee would service the needs of the community and generate positive economic results for all. This is the reason why the MMT is so appealing to many leftist activists and pundits: it proposes a practical solution to many problems existing both in developing and developed countries.
MMT represents a hope for many people that wish for a better world against the prescriptions of mainstream economic theory. Tax cuts, deregulation and privatization have failed to trickle down from the wealthiest individuals, and alternatives to the market-based way of thought are emerging. Even though mainstream economists and MMT economists have managed to converge in the last years, after the severe crises that disrupted the financial world, the debate is still open, and more research will be needed to prove the utility of MMT and whether it does not risk creating hyperinflation.
Information Content | ||
1 | Confirmed | Confirmed by other independent sources; logical in itself; coherent with other information on the topic |
2 | Presumably true | Not confirmed; logical in itself; coherent with other information on the topic |
3 | Maybe true | Not confirmed; reasonably logical in itself; coherent with some other information on the topic |
4 | Uncertain | Not confirmed; possible but not logical in itself; no other information on the topic |
5 | Improbable | Not confirmed; not logical in itself; contradicts with other information on the topic |
6 | Not able to be evaluated | No basis to evaluate the validity of the information |
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