What is Modern Monetary Theory (MMT)? [My Two Cents]
A Pocket Guide To Modern Monetary Theory and Why It Matters
In a few words, MMT is founded on the understanding that as long as a government is printing and managing its own money and doesn’t have debt issued in the currency of another country (more on this later), the country won’t ever have to worry about running out of money. It can just print more. MMT’ers asserts that the focus should not be on the deficit, but rather on managing inflation. If inflation can be kept in check, the government can engage in whatever spending it wants. This is MMT’s diagnosis.
Armed with this understanding – that if we eliminate the conventional debt concerns, then we unlock a whole pool of underutilized money, MMTers ask:
- What should the government be financing that it’s currently not because of debt concerns?
This is the question guiding MMT’s key proposal
Why is this important? Because if MMT’ers are right, then we’re artificially constraining our growth and limiting our ability to do good. If they’re wrong, either in their diagnosis or in their proposals, inflation could skyrocket.
The Diagnosis In A Few More Words…
Imagine national debt in terms of credit cards. Credit card debt is debt in a currency that you do not control. You can’t just print more dollars, euros, or yen to pay off the debt. If you don’t make your payments, you’ll default, ruin your credit, and struggle to get loans in the future. It works like this for some governments, but not for all of them.
If a government has debt in its own sovereign currency, then it can’t “default.” It made the money in the first place. If it needs to pay off debt, it can just print more money.
A Brief Macro Economic Lesson
Fixed v. Floating Exchange Rate
With a Fixed Exchange Rate, a Central Bank will manipulate the supply and demand of the national currency to keep it closely tied to the price of dollars. For example, Angola might peg the kwanza to the value of the dollar. In this case, the Central Bank of Angola would purchase and hold large reserves of dollars. If the kwanza began to drop in value compared with the pegged currency (i.e. the dollar), Angola would flood the market with dollars by buying back kwanzas. This would drive up the price of kwanzas in comparison to the dollar.
No currency’s value is solely determined by fixed or floating rates. The kwanza is vulnerable to the impact of supply and demand and the U.S. Fed intentionally manipulates rates to adjust the value of the dollar. Fixed v. Floating simply refers to the primary means in which a currency’s value is determined.
Why? Because the free-market is the house and the house always wins…
What does this mean for America?
The U.S. benefits from having the dollar serve as the global reserve currency because it allows the U.S. to only ever need to accrue debt in dollars. Everyone wants dollars so everyone is happy to have America pay back the debt in dollars.
Issuing debt in one’s own currency (like the U.S.) presents a whole class of great benefits. Enjoying those points your credit card company offers? Well so does America. America can rack up charges on their credit card while also having a money printing press at home. Time to pay the bill? Just print more! In fact, unlike in the above example, inflation actually makes existing debt cheaper for America.
However, MMT’ers do understand that while debt in ones’ own currency can easily be paid off, it’s not without consequence. MMT’ers understand that the risk for America is not defaulting. It’s hyperinflation.
If a country accrues debt in a foreign currency, it is vulnerable to default because debt becomes more expensive if its native currency loses value in comparison to the foreign currency.
If a country accrues debt in its own currency, there is no real risk of default since the country can just print more money. The only danger is that it will create inflation.
Modern Monetary Theory (MMT)
Now we can get to the good stuff. I’m going to try to present this as fact-based as possible. I appreciate making my own opinions and I assume you do too. The opinions will be in the next article.
MMT points out that everyone today is essentially an MMT’er. Governments spend and spend without any tax raises or concern over funding those expenditures. MMT defines this reality by pointing out that given today’s economic reality, we only need to offset spending to control inflation. We don’t need to balance the budget.
And if this is true, and modern Central Banks absolutely do believe this, then we should disregard the old financial policies built upon the importance of a balanced budget (i.e. Treasury bonds and monetary policy). We should open up the federal pocketbook.
The Bedrock of MMT Belief
This belief is rooted in the understanding that one major consequence of monetary policy is unemployment. If you remember from Part 1, contractionary monetary policy makes it harder for companies to access capital. Thus, they end up laying off employees and decreasing their expansionary operations.
MMT believes that since the government is creating unemployment, it has an obligation to solve unemployment.
Since Fiscal Policy includes government spending, MMT’ers believe that the government can kill two birds with one stone. It can print money to stimulate the economy AND use that money to finance bills that solve social problems such as unemployment.
Don’t Fear The Deficit
Come on baby, don’t fear the deficit
Baby take my hand, don’t fear the deficit
We’ll be able to fly, don’t fear the deficit
So MMT asks, why don’t we accept this reality and put some of that money towards public-good expenditures? We spend trillions of dollars buying corporate debt, but we’re not willing to spend money on healthcare and a guaranteed jobs bill?
MMT’ers would argue that because unemployment is a consequence of federal monetary policy, employment should also be a guaranteed policy.
So MMT’ers say, “let’s stop doing all this debt financing.” In fact, we don’t need to finance the debt. Let’s (as the U.S. Government) stop selling debt on the open market. Let’s get rid of Treasury Bonds. Since we don’t actually care about financing government spending, let’s stop pretending we do.
MMT’ers believe that we should pretty much abolish Monetary Policy and set interest rates to 0%. Instead, we should use Fiscal Policy to manage inflation AND put people to work. A trillion dollars spent on a guaranteed jobs bill will accomplish the same thing as lowering interest rates, with the added bonus of putting people to work and helping facilitate economic wealth.
And since we don’t have to worry about America (or other countries) “defaulting” on its debt, provided that they only have debt in dollars (which we do), then the deficit is only bad when it causes inflation.
The government can spend as much as it wants as long as it keeps inflation under control. Inflation hasn’t increased in years even with massive government expenditures. So let’s put those massive government expenditures to some good.
MMT Economic Beliefs
MMT bases its ideas on several key economic understandings. If you want to save time, you can just read these conclusions here. For a deeper explanation, continue below.
- MMT Tenant #1: Money is Endogenous. The U.S. government will never default.
- MMT Tenant #2: The government must run a deficit if it wants the private sector to run a surplus.
- MMT Tenant #3: The government must offset spending, not fund spending. It can offset it with tax increases and with government spending in targeted areas. The government can pay for everything it wants (technically). Its only constraint is inflation.
- MMT Tenant #4: Monetary policy should maintain a 0% interest rate. The government should guarantee a job to everyone who wants one.
- MMT Tenant #5: The Government can only cause inflation if it spends when the economy is at full capacity. When the economy is under capacity, government spending is crucial for a quick recovery. This is true for unemployment since unemployment means the economy is under capacity.
- MMT Tenant #6: We worry too much about inflation and deficits. As long as we’re being smart about how we spend money and how we offset inflation, we’ll be fine.
- MMT Tenant #7: Raising taxes on the rich raises money, but it’s a poor strategy to offset spending. Thus, to offset spending and prevent inflation, taxes must be raised on the actual people spending large percentages of their income: the middle and lower class.
1) Endogenous Money
So the idea that the U.S. won’t be able to pay off its debt is absurd. It could pay it off tomorrow by just buying assets from the public and crediting the accounts of those banks (remember Expansionary Monetary Policy?). Deficit Crisis solved. There is zero chance that the U.S. defaults on its debt.
MMT Tenant #1: Money is Endogenous. The U.S. government will never default.
2) Sectoral Balances
Imagine that I am transacting with you and only you. If I had a deficit (spent more than I made) you would — by default — have a surplus (since you’d be receiving my excess money without any way of creating a deficit for yourself).
But it’s unsustainable for the private sector to always operate in a deficit. Because, unlike the government, the private sector can default. And if it’s spending more than it makes year after year after year, it will default, and it did. In 2008 we saw the bubble pop.
MMT Tenant #2: The government must run a deficit if it wants the private sector to run a surplus.
3) Offset Spending
So when the government decides to spend money, it needs to make sure that it’s offsetting that spending somehow. It can offset it by raising taxes to remove money from circulation. It can also issue bonds to accomplish the same thing. It can also build economic value to meet the greater cash supply. For example, it could improve infrastructure so that production will increase to meet the increased money supply. It could create jobs with the money as well. In other words, MMT’ers hold that governments should spend, but they must spend wisely to keep inflation under control.
MMT Tenant #3: The government must offset spending, not fund spending. It can offset it with tax increases and with government spending in targeted areas. The government can pay for everything it wants (technically). Its only constraint is inflation.
4) Fiscal Policy NOT Monetary Policy
MMT’ers believe that Fiscal Policy, not Monetary Policy, is the best way of managing inflation. They see an outdated, archaic system and question why we need to still play by these (largely ignored) laws. Why influence interest rates when we could just keep interest rates at 0% and manage inflation through taxes and government spending?
This is especially true since they see that Monetary Policy hurts people since it creates unemployment. The government should spend more to guarantee jobs to its citizens which will, in turn, spur economic growth.
MMT Tenant #4: Monetary policy should maintain a 0% interest rate. The government should guarantee a job for everyone.
5) Meeting Capacity
MMT’ers point out that we can see the economy in relation to its total capacity: i.e. how many people are employed and is all the demand for goods being met? If the economy is under capacity, government spending will not cause inflation. Under capacity is synonymous with deflation. So at that point, government spending is just counteracting deflation. Only when an economy is at full capacity (total employment) can the government spending create inflation. This isn’t a new view; Keynes saw this too. But MMT’ers have returned to this principal.
MMT Tenant #5: The government can only cause inflation if it spends when the economy is at full capacity. When the economy is under capacity, government spending is crucial for a quick recovery. This is true for unemployment since unemployment means the economy is under capacity.
6) The Green New Deal
The reality is that the only problem we’ve really encountered in the last 40 years in developed countries is deflation, not inflation. We’ve cut taxes, lowered rates, spent enormous amounts of money, and we still haven’t spurred inflation.
America’s inflation rate since 1930
And she’s expecting that the Green New Deal will encourage more economic progress which will further protect against inflation.
MMT Tenant #6: We worry too much about inflation and about deficits. As long as we’re being smart about how we spend money and how we offset inflation, we’ll be fine.
7) Taxing the middle and lower class
To see an inflationary benefit, taxes must target the middle and lower class. This is where I see some of the logic in AOC’s Green New Deal breaking down.
MMT Tenant #7: Raising taxes on the rich raises money, but it’s a poor way of offsetting spending. Thus, to offset spending and prevent inflation, taxes must be raised on the actual people spending large percentages of their income: the middle and lower class.
MMT is basically saying that we’ve been living in a contradiction for a long time. We’ve pretended like the deficit matters but our actions show that we don’t actually care. So we should accept that the only constraint the government has on its spending is inflation. We should do away with federal debt since there never was any need to finance anything anyways. Let’s focus only on controlling inflation.
And you know what? Inflation hasn’t been a problem for a long time— even when the economy was exploding (like during the last ten years). So let’s keep spending money in smart ways so that the economy grows and we can control inflation through taxation if we need to.
There’s also a reason that the biggest advocates for MMT are also the biggest advocates for government spending. MMT is the narrative that not only permits, but condones enormous government spending. The motive driving this narrative, regardless of whether the narrative is accurate or not, is that there are problems that can be solved by increased government spending in the right areas.
This article is less about asserting whether MMT is right or wrong and more about understanding what MMT proposes and what it says about our economy. Part 3 will look at the potential consequences of MMT: for America, for our global economy, for Bitcoin. It will explore whether MMT’s principals are founded on an accurate understanding of the financial system and it will analyze to what end MMT might be taking us.
I love getting questions or suggestions, so comment away! I do my best to respond to all thoughtful comments.
I received no compensation for this article.