An analysis of Modern Monetary Theory

By Professor Arthur S. Guarino

Modern Monetary Theory (MMT) has caused quite an uproar among economists in the United States. Proponents of MMT hold that it is a viable method to spur economic growth, create jobs, and combat inflation. They feel that it does not need to concern itself with federal budget deficits and that the Federal Reserve Bank is not a useful tool with dealing with the money supply or stimulating the macroeconomy. But economists arguing against MMT feel that this idea does not take into consideration the risk of too much money in circulation that would actually make inflation a far worse problem. While both sides have viable arguments, the real question is whether MMT can make the transition from untested economic theory to a viable economic alternative.

How MMT Works

MMT states that major economic entities, such as the United States, Japan, and the United Kingdom really are not restrained by tax revenues when spending is needed. Governments that print their own money or not confined by dollarization, may print as much money as they need and do not have to concern themselves with taxes or go into debt for purposes of spending. These governments have a monopoly on issuing currency, especially their own.

MMT holds that governments with a fiat currency have the freedom and flexibility to print as much money as needed to create jobs or stimulate their macroeconomies. These governments can print money without any concerns of overextending themselves with too much debt or becoming insolvent. MMT holds that budget deficits by the central government are actually needed to create jobs and get the nation’s economy out of a recession, or worse, a depression. MMT feels that federal budget deficits should not be regarded as harmful to the macroeconomy nor that budget surpluses are beneficial. Surpluses and deficits are actually accounting identities with no moral or qualitative value nor use. Government’s role is to either print money to stimulate the economy by creating jobs or take money out of circulation by levying taxes. Budget deficits could be seen as a method of stimulating the nation’s economy and become a private sector surplus. Professor Stephanie Kelton of the State University of New York at Binghamton, a former economic advisor to Bernie Sanders and major proponent of MMT, feels that “federal deficits are private sector surpluses.”

For MMT, the U.S. Treasury Department literally has free reign to spend money without any limitations since it can print all that it needs to. MMT proponents feel that since the Treasury Department has this unlimited power to print money, it can never default on its debts nor seek permission to issue new, increasing amounts of financial obligations such as Treasury bills, notes or bonds. When the Treasury Department spends money, according to MMT, there is a positive effect on the economic growth of the United States since it is increasing the amount of funds in circulation going to the private sector. MMT claims this will not only expand the American economy but cause productivity increases. As productivity increases over time, fiscal deficits will be absorbed by economic growth.

MMT also holds that a central government printing its own money does need to issue bonds to borrow financial capital for such things as infrastructure projects or keeping their operations going. Government can just print as much money as needed. MMT also holds that unemployment results from a central government not spending enough to stimulate job growth and collecting taxes instead. MMT proponents feel that government should provide transition jobs for those looking for work when they cannot find employment in the private sector. Some proponents of MMT feel that a guarantee of jobs is needed to provide temporary employment in order to regulate the economy and stimulate it when necessary even if this results in a federal budget deficit. Professor Keltonhas stated that, “Unemployment is evidence that the deficit is too small.” When full employment is attained, any further government spending is inflationary and then budget tightening or balancing or possibly a surplus is justified. Even if this means raising taxes.

History of MMT

MMT goes back to the 1940’s when Abba Lerner came up with the idea of “functional finance” in which fiscal policy would be the key needed to stabilize a nation’s macroeconomy. Lerner’s paper in 1943, entitled “Functional Finance and the Federal Debt”, put forth the idea that the Keynesian economics model advocated having a government budget deficit in order to achieve full employment to stimulate the macroeconomy. Under functional finance, fiscal policy would use taxation to combat inflation by lowering spending by the general populace. A contributor to MMT was Warren Mosler in his essay, “Soft Currency Economics” which gained the notice and support of Australian economist Bill Mitchell.

Other contributors to MMT are Professor Randall Wray who argued that finance had a functional purpose for the general public and not achieve a balance between spending by government and revenues it collected from the citizenry. The focal point of public economic policy was that monetary and fiscal policy needed to reach full employment along with price stability. Wray also felt that involuntary default by government would not occur as long as it continued promising in accepting its own currency in payment.

Perhaps the most recent famous proponent of MMT is Professor Keltonwhose paper, “Can Taxes and Bonds Finance Government Spending?” is regarded as a classic in the field. Professor Kelton is concerned with the operational realities of the current monetary system. Professor Kelton feels that government spending actually creates reserve balances while taxes and the sale of bonds obliterate them. She also states that spending by the federal government is created by reserve balances. Professor Kelton’s ideas were picked up Senator Bernie Sanders in his run for president in 2016.

Positives of MMT

Some individuals have stated that MMT has serious positive elements that policymakers in the Treasury Department and the Federal Reserve Bank should embrace.

First, MMT espouses the idea of full employment. When a nation is in a recession or economic slowdown and jobs are lost due to corporate layoffs, MMT encourages that government temporarily hire workers until things start to improve. Even if this means operating at a severe budget deficit, this is necessary so that people are working and could possibly be a better fix than unemployment insurance. In order to pay for these working individuals, as MMT states, the government would just have to print more money. When the macroeconomy stars to improve and corporations start hiring again, these individuals would return to the private sector.

Second, inflation is a necessary part of a growing and robust economy. Even if it means that more money is in circulation than normal, it can be controlled by having some tax increases in order to lessen the flow of cash. MMT feels that deflation is just as dangerous as too much inflation. MMT proponents even argue that deflation is perhaps more dangerous since it creates more problems for borrowers who must repay their debts by trying to sell products with decreased prices.

Third, MMT can pay for programs such as the Green New Deal (GND). MMT would allow money to pay for programs such as the GND without having to cut funding for other programs such as Medicare or the Environmental Protection Agency (EPA). Proponents of MMT feel that programs such as the GND would not only help save the environment but also create new jobs, fund new technology, and pay for research and development without raising taxes or imposing fees.

Negatives of MMT

MMT has its critics who feel that this theory does more harm than good.

First, there is the threat of high inflation. MMT allows for the central government to print more money without any accountability. The problem is the potential for runaway inflation if too much money is put into circulation. This will cause prices for food, gasoline, and college tuition, to name a few, to skyrocket and money becoming worthless. While MMT advocates full employment, the problem is that workers would have a government-sponsored job at a salary that cannot afford food, gasoline, or college tuition. This will cause economic panic and severe disruption among the general populace.

Second, the financial markets could go into a panic mode with the printing of more money than is possibly needed. The markets would respond by raising rates that could exceed the economy’s rate of growth. This would cause lending rates to increase substantially to the point where borrowers, whether in businesses or households, would not be able to afford short and long-term loans and ultimately cause an economic crisis. Higher interest rates would ultimately stop economic growth and unnecessarily prolong any recessions.

Third, MMT espouses raising taxes in order to control inflation. That is, when policymakers recognize that inflation is rearing its ugly head, then taxes must increase to combat it. But the problem is that firms and households would be hit with a double whammy of higher prices due to inflation and rising taxes. Firms and households would be under a double burden that many may not be able to bear. This could also cause an economic recession that would be unnecessary and prolonged.

Fourth, despite the key idea of MMT, budget deficits do matter. They matter because in the long run they add to the national debt and the interest on that obligation must be paid for. With the national debt increasing as it is, the interest to pay for it means taking money away from other programs that could fund such programs as the GND. Allowing the federal budget deficit to increase will have long-term financial consequences despite what the proponents for MMT may think or advocate.

Can MMT work?

While proponents of MMT have good intentions of making sure everyone has a job or that programs such as the GND can work, it is how these goals are achieved that need further and careful deliberation. Money is a commodity that adheres to the rules of supply and demand. The difficult task of having a proper balance of money is a goal that has policymakers and economists scratching their heads. MMT is a theory that has not really been put into practice. But doing so may have unforeseen consequences.