Modern Monetary Theory (MMT): The Clockwork Orange of Economics
(June 10, 2020) – In a Wall Street Journal editorial published May 8, 2020 titled, “A Trillion Here, a Trillion There,” the newspaper’s editorial board, in response to a dramatic upward revision of the fiscal 2020 federal deficit by the Congressional Budget Office due to passage of the 2020 CARES Act, states;
- “It’s impolite to say that any of this matters, since we are all apparently supposed to be converts to Modern Monetary Theory. This is the view that governments can spend whatever they like because the Federal Reserve can monetize it without economic harm.”[i]
What is Modern Monetary Theory, and why has it suddenly become one of the latest buzzwords being bandied about in Washington, D.C.?
Modern Monetary Theory: Definition
According to Wikipedia, Modern Monetary Theory is defined as:
- “A heterodox macroeconomic theory that describes currency as a public monopoly for a government and unemployment as the evidence that a currency monopolist is restricting the supply of the financial assets needed to pay taxes and satisfy savings desire.”
In case you were wondering, “heterodox” is defined as “not conforming with accepted or orthodox standards or beliefs.” Investopedia defines Modern Monetary Theory as:
- “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…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.”
In other words, MMT says countries with advanced economies can:
- Print and borrow money in their own currency.
- Can’t go broke.
- Don’t need to worry about budget deficits when inflation is restrained.
In brief, MMT suggests countries that issue their own currencies can never “run out of money” the way people or businesses can.
Modern Monetary Theory: Deficits
Under conventional economic thinking, a government that spends more than it collects has two choices: borrow money or collect taxes. Modern Monetary Theory, however, is more accommodating when it come to deficit spending, especially among politicians whose wish lists include guaranteeing everyone a job, fixing infrastructure, free college tuition and ensuring everyone has access to free health care. The progressive wing of the Democratic Party certainly comes to mind. However, the U.S. has run surpluses in only 12 of the last 77 years, and the Republican Party recently cut taxes and raised military spending, adding more than $1 trillion to the national deficit.
The standard economic GDP model suggests the government levies taxes and then uses them to pay for what it can. To support budget deficits, it borrows money by issuing bonds that investors can buy. But such borrowing has a big downside. Budget deficits increase demand for loans, because the government needs loans on top of all the loans that private individuals and businesses are demanding. And just as a surge in demand for Super Bowl tickets should increase the going price of those tickets, a surge in demand for loans makes loans more expensive, i.e., the average interest rate charged goes up. But the higher interest rate applies to both private companies and individuals. And that could lead to fewer families taking out mortgages, fewer students taking student loans, fewer businesses taking out loans to build new factories, and just generally slower economic growth. In economic terms, this is called “crowding out.”[ii]
If things get really bad and the government is struggling to cover its interest payments, it has a few options, none of which mainstream economists typically like: financial repression (using regulation to force down interest rates); paying for the interest by printing more money (which risks hyperinflation); and defaulting on the debt and saying that lenders just won’t get all their money back (which makes interest rates permanently higher in the future, because investors demand to be compensated for the risk that they won’t be paid back).
MMT advocates dispute this type of thinking on two levels. First, they adopt an older view, known as the endogenous money theory, that rejects the idea that there’s a supply of loanable funds out there that private businesses and governments compete over. Instead, they believe that loans by banks themselves create money in accordance with market demands for money, meaning there isn’t a firm trade-off between loaning to governments and loaning to businesses of a kind that forces interest rates to rise when governments borrow too much.
Second, MMT believers argue that government should never have to default so long as it’s sovereign in its currency: that is, so long as it issues and controls the kind of money it taxes and spends. The US government, for instance, can’t go bankrupt because that would mean it ran out of dollars to pay creditors; but it can’t run out of dollars, because it is the only agency allowed to create dollars. It would be like a video game running out of points to give players.[iii]
MMT incorporates an approach to analyzing deficits that implies government deficits are often necessary to boost savings in the private sector. In other words, when the government is in debt, that means another segment of the economy is running a surplus. For example, when the US is running up substantial trade deficits, and the domestic US economy is overwhelmed with debt, the government must run deficits if it wants to help the private sector recover.[iv]
Modern Monetary Theory: Taxing and Spending
When it comes to the mechanics of how governments tax and spend, MMT suggests that taxes and bonds do not directly pay for government spending. Instead, the government creates money whenever it spends. So why, then, under MMT, does the government tax? Two reasons: First, taxation gets people in the country to use the government-issued currency. Because they must pay income taxes in dollars, Americans have a reason to earn dollars, spend dollars, and otherwise use dollars as opposed to, say, bitcoins or euros. Second, taxes are one tool governments can use to control inflation. When governments tax, they remove money from the economy, which keeps people from bidding up prices.[v]
And why does the government issue bonds? According to MMT, government-issued bonds aren’t necessary. The US government could, instead of issuing a dollar in Treasury bonds for every dollar in deficit spending, just create the money directly without issuing bonds. Modern Monetary Theory argues that the purpose of these bond issuances is to prevent interest rates in the private economy from falling too low. When the government spends, that adds more money to private bank accounts and increases the amount of reserves in the banking system. The reserves earn a very low interest rate, pushing down interest rates overall. If the Fed wants higher interest rates, it will sell Treasury bonds to banks. Those Treasury bonds earn higher interest than the reserves, pushing overall interest rates higher.[vi]
Modern Monetary Theory: Inflation
MMT’s rhetoric about governments always being able to print more money conjures images of post-WW I German citizens pushing wheelbarrows full of worthless German marks to pay for a loaf of bread. The MMT reply to this is simple; raise taxes. Taxes are sometimes necessary to stave off inflation, and preventing inflation can require cutting back on deficit spending by hiking taxes. But the lower inflation caused by higher taxes is not an effect of “lowering the deficit”; the lower deficit is just an artifact of the choice to raise taxes to fight inflation.[vii]
Like most strands of economics, MMT thinks that inflation can result when aggregate demand exceeds the stuff available for purchase. If there are a lot of dollars out there trying to purchase goods, and not enough real stuff to purchase, that stuff becomes more expensive — so, inflation. Taxes, however, have the effect of reducing aggregate demand. For example, eliminating all taxes while spending 50% of GDP on government operations would spur a massive increase in aggregate demand, and thus dangerous inflation. So, according to MMT, raising taxes dampens inflation.[viii]
Jay Powell, Chairman of the Federal Reserve, describes Modern Monetary Theory as “just wrong.”[ix] BlackRock Chief Executive Larry Fink says MMT is “garbage.”[x] Conversely, Senator Elizabeth Warren’s says MMT is a way to, “rethink our (economic) system in a way that is genuinely about investments that pay off over time.”[xi]
Some Modern Monetary Theory advocates argue that MMT isn’t all that different from standard economics. The main difference, they contend, is that MMT swaps the roles of fiscal and Monetary Policy.[xii] Under standard macroeconomics, ensuring that the economy is at full employment and that prices are stable are the responsibilities of the monetary policy — the Federal Reserve — which can achieve both goals by manipulating interest rates. If the Fed declares a zero percent interest rate, then fiscal authorities (Congress and the president) can come in to boost aggregate demand and get the economy moving. In MMT, the fiscal authority, whoever it is, oversees both. Interest rates should always be 0 percent — in part because MMT argues that the use of government-issued bonds that bear interest is a mostly pointless practice. Instead of raising interest rates to fight inflation, you raise taxes.
Interestingly, the first MMT textbook, the 600-page “Macroeconomics” for college students, sold out of its initial print run two months after its London launch party. Publisher Macmillan didn’t specify how many copies it printed but says more are on the way. “I knew there was pent-up demand,” said Bill Mitchell, one of the book’s authors and an economist at the University of Newcastle, Australia.[xiii]
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