Modern Monetary Theory (MMT) is a heterodox macroeconomic theory that, for countries with complete control over their own fiat currency, government spending cannot be thought of like a household budget. Instead of thinking of taxes as income and government spending as expenses in a checkbook, MMT proponents say that fiscal policy is merely a representation of how much money the government is putting into the economy or taking out. In this way, MMT sees fiscal policy in a similar way to how we now think of monetary policy.
This means that any government spending can be paid for by the creation of money, with the purpose of taxes being to limit inflation, by controlling the money supply. This means that spending shouldn't be determined by deficit levels, but by whether or not spending is keeping the economy at full employment and at a reasonable level of inflation. This would turn government fiscal policy into the tool that would fulfill the Federal Reserve's dual mandate, in place of the Fed's role in fulfilling it.
The central idea of MMT is that governments with a fiat currency system can and should print (or create with a few keystrokes in today's digital age) as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.
Traditional thinking says such spending would be fiscally irresponsible as the debt would balloon and inflation would skyrocket.
But according to MMT, a large government debt isn't the precursor to collapse we have been led to believe it is, countries like the U.S. can sustain much greater deficits without cause for concern, and in fact a small deficit or surplus can be extremely harmful and cause a recession since deficit spending is what builds people's savings.
MMT theorists explain that the national debt is simply money the government put into the economy and didn't tax back. They also argue that comparing a government's budgets to that of an average household is a mistake.
While supporters of the theory acknowledge that inflation is theoretically a possible outcome from such spending, they say it is highly unlikely and can be fought with policy decisions in the future if required. They often cite the example of Japan, which has much higher debt-to-GDP ratio than the U.S.
According to MMT, the only limit the government has when it comes to spending is the availability of real resources, like workers, construction supplies etc. When government spending, meaning the amount of money introduced into the economy, is too great with respect to the resources available, that's when inflation can surge if decision makers are not careful.
Taxes create an ongoing demand for currency and are a tool to take money out of an economy that is getting overheated, says MMT. This goes against the conventional idea that taxes are primarily meant to provide the government with money to spend to build infrastructure, fund social welfare programs etc.
"What happens if you were to go to your local IRS office to pay your taxes with actual cash?," wrote MMT pioneer Warren Mosler in his book "The 7 Deadly Innocent Frauds of Economic Policy." "First, you would hand over your pile of currency to the person on duty as payment. Next, he’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the tax payer, left the room, he’d take that hard-earned cash you just forked over and throw it in a shredder."
MMT says that a government doesn't need to sell bonds to borrow money, since that is money it can create on its own. The government sells bonds to drain excess reserves and hit its overnight interest rate target. Thus the existence of bonds, which Mosler calls "savings accounts at the Fed," is not a requirement for the government but a policy choice.
Unemployment is the result of a government spending too little while collecting taxes, according to MMT. It says those looking for work and unable to find a job in the private sector should be given minimum-wage, transition jobs funded by the government and managed by the local community. This labor would act as a buffer stock in order to help the government control inflation in the economy.
Origins of MMT
MMT was developed by American economist Warren Mosler and bears similarities to the older schools of thought like Functional Finance and Chartalism. Mosler first began thinking about some of the concepts that form the theory in the 1970s when he worked as a Wall Street trader. He eventually used his ideas to place some smart bets at the hedge fund he founded.
In the early 1990s when investors were afraid Italy would default, Mosler understood this wasn't a possibility. His firm and his clients became the largest holders of Italian lira denominated bonds outside of Italy. Italy did not default and they made $100 million in profits.
Mosler, who has B.A. in Economics from the University of Connecticut, was largely ignored by the academic world when he tried to communicate his theories. In 1993, he published a seminal essay called "Soft Currency Economics" and shared it on a Post-Keynesian listserv, which is where he found others, like Australian economist Bill Mitchell, who agreed with him.
Support for MMT grew in large part thanks to the internet, where economists explained the theory on popular personal and group blogs, the idea of a trillion dollar coin was widely discussed and supporters shared a clip of former Fed Chairman Alan Greenspan saying pay-as-you-go benefits aren't insecure because "there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody."
Political leaders like Alexandria Ocasio-Cortez and Bernie Sanders have espoused MMT, and economist Stephanie Kelton, who first came across Mosler's ideas on the listserv and is now arguably the face of the theory, served as chief economic adviser to Sanders during his 2016 presidential campaign.
Google search interest in the term peaked in April 2019 and has been rising again amid the coronavirus pandemic.
Criticism of MMT
MMT has been called naive and irresponsible by critics. American economist Thomas Palley has said its appeal lies in it being a "policy polemic for depressed times." He has criticized various elements of the theory, like the suggestion that central bank interest rates be maintained at zero, and said it provides no guidance to countries like Mexico and Brazil and does not take into account political complications arising from vested interests.
Nobel Prize-winning economist Paul Krugman's views on U.S. debt are similar to many MMT theorists, but Krugman has been strongly opposed to the theory. In a New York Times op-ed in 2011, he warned the U.S. would see hyperinflation if it was put into practice and investors refused to buy U.S. bonds.
"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 upward spiral in inflation." He wrote, "In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds."
Michael R. Strain, resident scholar at the American Enterprise Institute, has argued that MMT's proposal that taxes can be used to reduce inflation is also flawed. "Raising taxes would only make a downturn worse, increasing unemployment and further slowing the economy," he said in a Bloomberg column.