What Is Modern Monetary Theory?
Modern monetary theory (MMT) is a heterodox macroeconomic supposition that asserts that monetarily sovereign countries—such as the U.S., U.K., Japan, and Canada, which spend, tax, and borrow in a fiat currency that they fully control—are not operationally constrained by revenues when it comes to federal government spending.
Put simply, modern monetary theory decrees that such governments do not rely on taxes or borrowing for spending since they can print as much money as they need and are the monopoly issuers of the currency. Since their budgets aren’t like a regular household’s, their policies should not be shaped by fears of a rising national debt.
Several other differences also exist between mainstream monetary theory and modern monetary theory, the most important being the sequence of events that emerges from loans and deposits, and from government spending and taxes.
Key Takeaways
- Modern monetary theory (MMT) challenges conventional beliefs about how the government interacts with the economy, the nature of money, the use of taxes, and the significance of budget deficits.
- These beliefs, critics 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 such progressive legislation as universal healthcare and other public programs for which governments claim to not have enough money to fund.
Investopedia / Julie Bang
Core Principles of Modern Monetary Theory (MMT)
The central idea of modern monetary theory (MMT) is that governments with a fiat currency system under their control 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.
Some say such spending would be fiscally irresponsible, as the debt would balloon and inflation would skyrocket. But according to MMT:
- Large government debt isn’t the precursor to collapse that we have been led to believe it is;
- Countries like the U.S. can sustain much greater deficits without cause for concern; and
- 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 debt is simply money that 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 modern monetary 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.
Government Money Creation
According to modern monetary theory, the only limit that the government has when it comes to spending is the availability of real resources, like workers and construction supplies. 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.
“[W]hat happens if you were to go to your local IRS office to pay your taxes with actual cash?” wrote MMT pioneer and American economist 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, they’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, they’d take that hard-earned cash you just forked over and throw it in a shredder.”
Modern monetary theory says that a government doesn’t need to sell bonds to borrow money, since that is the 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 governments 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 to help the government control inflation in the economy.
Origins of MMT
Modern monetary theory was developed by Mosler and bears similarities to 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 instead made $100 million in profits.
Mosler, who has a 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 Federal Reserve 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.
A Shift in Paradigm
Modern Money Theory also involves a paradigm shift from two-body problem-solving to three-body problem-solving.
While the classic economics paradigm is characterized as a two-body problem (where taxes equals money in and spending equals money out), MMT turns the tax and spending factors into a three-body problem.
It takes into account the fact that sovereign governments can legally print their own money. Thus, spending (or printing new money) is legal and no longer a problem, as long as spending new money into the economy keeps the following three economic indicators healthy:
- Employment-unemployment
- Inflation
- Continued investment in domestic factories and production.
Criticism of MMT
Modern monetary theory 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 ideologues, but Krugman has been strongly opposed to the theory. In an op-ed in The New York Times 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, the 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.
How Does MMT Differ from Mainstream Theories of Money and Banking?
Modern monetary theory is a falsifiable empirical monetary theory that sets out to explain the real world, whereas mainstream economic theory sets out from model assumptions and then moves to the real world. Critics, however, have argued that MMT is not a true theory because there is no mathematical model associated with it. MMT is essentially a balance sheet approach to macroeconomics that sees government spending accomplished through money creation, and not through raising taxes. Another major difference is that mainstream theory posits that deposits create loans, whereby MMT suggests that loans are what create deposits.
What Does MMT Say About Government Debt?
Modern monetary theory argues that the government can never run out of money because it can always create more of it. As a result, sovereign governments that control their own money (unlike EU members, for instance) can never default on their own debt since they can always create enough new money to cover the existing and future obligations.
How Does MMT Deal With Inflation from Money Creation?
Modern monetary theory proponents argue that high inflation rates should not occur unless there is full employment in the economy. But, if the government spends too much, the excess demand will also cause inflation. In either case, MMT suggests that inflation can be curtailed by reducing government spending and raising taxes.
The Bottom Line
Modern Monetary Theory is a macroeconomic model positing that countries that issue their own currencies, such as the U.S., are not constrained in their spending. Proponents of MMT argue that such countries can't default on the securities they issue, as they can simply print or issue more currency. MMT is used in debates over whether the government should increase spending, particular for progressive policies, such as universal healthcare.
