If you have ever taken a macroeconomics lesson, you have probably been taught that printing too much money is inflationary. It has been a widely established fact of the macroeconomy for time immemorial. Economists are always keen to remind the public of this fact whenever issues of government spending and taxation arise.
However, the Modern Monetary Theory (MMT) says otherwise, making the argument for fiscally sovereign countries (those that control their own money supply) to not worry about increasing deficits as they can always print money to pay them back.
So what is Modern Monetary Theory?
The most crucial element of MMT is to reduce the separation between central banks and government treasuries.
Since the Bundesbank was first made independent in 1951, central banks across the developed world have slowly gained operational independence to achieve targets set by the government. Some central banks set their own goals too but across major developed economies these are typically similar to government set-targets. Broadly, inflation, growth and employment are the key indicators for central banks with something around a 2% inflation target typically set.
MMT favours an approach where the central bank and government are much more intertwined, with the central bank using direct monetary financing to fund the government’s deficit. The government can then use this unlimited money supply (or ‘Magic Money Tree’, according to its critics) to spend on whatever it chooses.
Much of the literature surrounding MMT comes from the left of the political spectrum and often proposes using this new money supply to fund investment projects, universal healthcare, free higher education and job guarantees.
What are MMT’s origins?
MMT is based on a ‘Chartalist Theory of Money’ that suggests that fiat money was first created by governments to control economic activity by ensuring the demand for money through taxation (i.e. everyone needs fiat money because you have to pay your taxes with it).
As governments are sovereign, under a Chartal theory of money, governments have total control of the currency. On the other hand, critics are keen to point out that money only became Chartal in the 1970s, for the previous hundreds of years, demand for money had been linked to physical commodities.
MMT’s approach to Inflation
MMT advocates accept that inflation exists and poses a problem to economic growth.
However, MMT suggests that inflation can be prevented using taxation.
For MMT economists, the primary role of taxation is to remove money from the economy to limit demand-pull inflation (when demand is higher than supply) rather than as a means to fund government spending.
A problem though is that taxation is both a) set by the elected government and b) deeply unpopular.
MMT relies on governments to be efficient with taxation and be able to rapidly increase or reduce taxation based on quarterly economic data. This is where we can find a blocker.
Governments and politicians are not known for acting with speed, issues are debated, considered and analysed to the maximum before legislation is enacted or policy is changed. Most western democracies are unlikely to be able to act with the speed needed to keep up.
It’s also important to note that taxes are unpopular with large swathes of the population. Governments are unlikely to raise taxes near election periods or at times of when they are low in the polls, they are unlikely to be able to make consistently difficult decisions that MMT requires.
Another important tenet of MMT is a job guarantee. MMT accepts that automatic stabilisers (features of tax and welfare spending that dampen fluctuations in real GDP) are crucial to maintaining economic stability. Government deficits rise during recessions as tax receipts fall and welfare spending rises while the opposite occurs during growth periods. MMT replaces these spending stabilisers with a job guarantee. Under the new spending model of MMT, governments would achieve full employment by providing a job for everybody that wants one. The government would set a minimum wage paid by the guaranteed job and the idea is that in times of economic boom, the private sector would attract workers with higher wages and in times of recession there would be a failsafe floor to prevent unemployment.
MMT in action
MMT gained traction throughout the 2010s and was beginning to hit a peak as the pandemic struck.
The pandemic ended up providing a perfect opportunity for a ‘trial of sorts’ for MMT as crisis policy led to mass government spending with little concern for deficits and with central banks providing accommodative monetary policy.
Ardent MMT proponents maintain that Covid-19 spending was not true MMT policy as there was no analysis of its potential inflationary outcomes and inflation stabilisers were not built in. Nonetheless it was a good trial of the principle of MMT.
Most MMT research has been focused on the United States, a common practice in economics as it is the world’s largest economy. In the US, the national debt rose by roughly $6 trillion in 2020 and 2021, the largest spending increase on record. Much of this was financed by central bank dollars and ranged from welfare programmes to infrastructure spending and direct stimulus checks.
Arguably, US monetary and fiscal policy have never been closer than in recent times as there was a coordinated response to support the economy. MMT’s predictions were largely both truthful and successful, after a big initial hit in Spring 2020, the US economy then bounced back, aided largely by strong consumer spending throughout the rest of 2020 and 2021. Financial markets surged with record M&A and venture capital funding and it looked like the US was primed for a re-run of the Roaring Twenties. Unfortunately, this was not to be, as inflation fears worsened in Winter 2021/22.
Inflation is now a significant risk with several major economies teetering on the edge of recession. Interest rates are being increased at the fastest rates in 40 years and central banks are now in crisis mode.
MMT advocates vigorously defend their policy trial run as a success, yet there have been some troubles. Stephanie Kelton, the public face of MMT, has blamed the current rates of inflation on both external supply shocks (not related to money-printing) and a lack of inflationary stabilisers built into crisis spending policy.
While the US Covid-19 spending packages presented an initial victory for MMT, its effects are clearly still playing out- perhaps more negatively than was hoped. MMT provides some vital lessons on the viability of a monetary financing approach and perhaps how it could be used for big investment spending in the future.
To conclude...
As a theory- MMT is strong, in practice though it has problems.
Without proper modelling and research, it’s unlikely to dissuade decades of orthodox economic thought but it certainly provides interesting food for thought.
For further reading, you could read The Deficit Myth by Stephanie Kelton as a great introduction to the arguments behind MMT. On the other hand, The Critics of Modern Money Theory Are Right by Thomas Palley provides the opposing view.
