What is Modern Monetary Theory?

Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that says monetarily sovereign countries like the U.S., U.K., Japan and Canada are not operationally constrained by revenues when it comes to federal government spending. In other words, such governments do not need taxes or borrowing for spending since they can print as much as they need and are the monopoly issuers of the currency.

MMT challenges conventional beliefs about the way the government interacts with the economy, the nature of money, the use of taxes and the importance of budget deficits. These beliefs, supporters say, are a hangover from the gold standard era and are no longer accurate, useful or necessary.

MMT is used in policy debates to argue for more progressive legislation like universal healthcare and other expensive public programs for which governments claim to not have enough money for.

Core Principles

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 public debt 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 is too great with respect to the resources available, 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 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 taxpayer, 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 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, serves as a senior economic adviser to Sanders.

Worldwide Google search interest in the term peaked in March 2019. Deutsche Bank in a September 2019 report on global debt wrote that "helicopter money/MMT-type policies" and "fiscal expansion" are what is needed in Europe. This was after ECB Chief Mario Draghi said the central bank's Governing Council should look at untested ideas like MMT, but maintained that it's a government decision and "typically a fiscal task."

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 were 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.