What Is Modern Monetary Theory?

Modern monetary theory (MMT) is a school of economic thought that essentially posits that governments can run large budget deficits without much concern because they can always print more money to make up the difference. The theory also argues that deficits only become a problem when they cause inflation, at which point governments should raise taxes.^[1]

American economist Warren Mosler is credited with developing MMT in 1993.^[2] The theory got more of a following during the 2016 U.S. presidential campaign when it was one of the cornerstones of Democrat candidate Bernie Sanders' economic platform. It then gained increasing popularity after it was embraced by several other prominent U.S. "progressive" politicians.^[1]

Government Deficits Equate To Public Wealth

MMT proponents believe that conventional thinking about government deficits—equating them to a household or a business that spends more than it takes in, which is bad—is simply wrongheaded. Rather, when a government runs a deficit, it's actually injecting money into the economy, not pushing other borrowers out in a grab for a limited supply of money, as conventional economic thinking holds.^[1]

Government deficits "help people" because they provide a surplus to the private economy, says Stephanie Kelton, a professor of public policy and economics at Stony Brook University in New York who was senior economic advisor to the Sanders campaign in 2016 and was previously chief economist for the Democrats on the U.S. Senate Budget Committee. "Their red ink becomes our black ink," she says.^[1] Government debt, therefore, becomes a public asset, not a liability.

Put another way, "private debt is debt, but government debt is financial wealth to the private sector," Yeva Nersisyan and L. Randall Wray wrote in a working paper for the Levy Economics Institute of Bard College.^[3]

Moreover, because governments can print as much money as they need, they "can never run out of money" or default on their debt, nor do they have to borrow or raise taxes before they spend it, according to Kelton.^[1]

MMT And The Coronavirus Response

That part of the theory's premise has taken on new legitimacy in 2020. This is because, to many observers, the U.S. government and the Federal Reserve are creating money "out of thin air" in order to spend trillions of dollars in coronavirus relief for households, businesses, state and local governments, and myriad other institutions without a plan to pay for it. Rather, the U.S. Treasury is selling vast amounts of government bonds, most of which are being purchased by the Fed, and all without any harm to the U.S. economy or American taxpayers, MMT advocates believe.^[4]

As of early May 2020, the Fed's balance sheet—its portfolio of Treasury bonds, mortgage-backed securities and other assets—has increased to US$6.7 trillion, up from US$3.7 trillion since September 2019. By way of comparison, in response to the 2008 global financial crisis, the Fed's balance sheet rose from less than US$1 trillion in September 2008 to more than US$4.5 trillion in late 2014.^[5]

Inflation And Employment

MMT advocates don't necessarily believe that government deficits don't matter. They do, but only if they get so large that they create inflation, at which point the government should raise taxes. However, the U.S. inflation rate has fairly consistently run below the Fed's 2% target since the 2008 crisis, which would indicate that more than 10 years of deficit spending have not ignited inflation.^[6]

MMT advocates also point to the example of Japan that governments can run huge deficits for decades without creating inflation. Japan's current debt-to-GDP ratio is about 240%, yet both inflation and government bond yields are around zero.^[1]

The theory argues that deficits can be "too small" because they mean that the government isn't injecting enough money into the economy, which creates unemployment and is thus "destructive." A balanced economy is one with low inflation and full employment.^[1]

MMT doesn't work in countries such as those in the eurozone, where individual governments don't issue their own currency. Rather, the European Central Bank does, while each government is responsible for setting its own budgets and fiscal policies.^[7]

Criticisms of MMT

MMT critics argue that the theory is both too simplistic and misleading.^[7] For example, they say the government can't simply create money "out of thin air" because ultimately real income and output are necessary to give the currency credibility that, when lost, creates inflation and leads investors to back away from buying government debt.^[7]

They also point out that there are examples in which high government deficits have caused inflation, such as in the 1970s, when the U.S. government ran large budget deficits. Likewise, many developing countries have overspent and borrowed to the point where they created runaway inflation. Critics also take issue with MMT's cure for inflation by raising taxes, noting that isn't always politically practical, nor does it guarantee that it will bring in enough money.^[7]

In addition, MMT has enabled "progressive" politicians in the U.S. such as Sanders and Rep. Alexandria Ocasio-Cortez, D-N.Y., to dismiss concerns about the cost of their proposed programs, such as Medicare for All and the Green New Deal, which have been derided by critics as too expensive and unrealistic.^[8]

While MMT is generally considered to be a left-wing ideology, it does have some similarities to more mainstream economic thought. For example, conservative economist Milton Friedman believed that the growth in the money supply can create inflation if it outpaces economic growth. The ideas of John Maynard Keynes, which have influenced political and economic thought for the past century, argued that governments should spend heavily on public projects in order to create jobs and boost economic growth.^[8]

Summary

Modern monetary theory is an economics idea that argues that government deficits by themselves are not harmful; rather, they create wealth for the private sector and boost employment. Advocates believe government deficits are not the same as household or business debt, because governments can print as much money as they need and can take forever to pay it back. MMT does, however, warn that too much deficit spending can create inflation, which they say can be battled by raising taxes.