What is Modern Monetary Theory? How does it challenge how we think about money, government spending, federal deficit and debt, taxes and bonds, unemployment, and monetary policy?
Modern Monetary Theory (MMT) stems from an alternative story of money. Rather than evolving from barter economies, MMT holds the view that money originated from authority figures in a society issuing a currency to motivate desired activities.
This alternate story has significant implications for governments in countries that have sovereignty over the currency it issues. Spending does not face financial constraints, taxes and bonds do not fund government budgets, federal deficits and debt are not problematic, and the lines between fiscal and monetary policy blur completely.
We were fortunate to be joined on the Becoming Denizen podcast by Andres Bernal, leading MMT proponent and former advisor to AOC, to help us understand the essential topic.
Key concepts to understand:
- Fiat currency: a currency that is not tied to a commodity and designated as legal tender by an issuing authority such as a government
- Monetary sovereignty: A spectrum of sovereignty over a national currency whereby countries can have maximum capacity to spend (according to MMT) when they 1) are the sole issuers of a currency that it also taxes, 2) that the currency is floating and non convertible, i.e. not pegged to another currency or a commodity, 3) and that the country does not hold debt in a foreign denominated currency
- Currency issues vs. currency users: currency issues are the federal governments who issue a domestic currency. Currency users are anyone who uses it (consumers, businesses, etc.)
Two different origin stories of money:
Medium of Exchange / The Barter Story:
- First we had barter economies, then moved to some form of currency to facilitate exchange.
- Some commodity had to be agreed upon for it to make sense, e.g. metal for a coin.
- Issue is there’s little anthropological evidence for it
Genesis from some authority figure issuing it:
- First some society comes about, with some kind of authority >> that preceded markets
- Society’s governance structure or authority system issues debt to direct economic activity or some sort of social task going
- Authority can ask for some fraction of it to come back in form of taxes or fines >> this is essential as it drives demand for the currency, makes it valuable to begin with because you need it to pay the authority
- Once that process underway people could use the same currency to clear debts amongst each other
- Evidence for this predates writing
What is MMT?
- A framework for understanding the way money works in an economy, which yields an expanded policy space from the traditional view of money
- Applies to monetarily sovereign governments
- States that since monetarily sovereign countries can never run out of their own currency >> Federal governments with have no financial constraints to annual budget, can spend without needing to first collect money in form of taxes or issuing debt (bonds)
- Federal spending is constrained by the resources available to employ (labor, land, technology, etc.) not money, so governments should spend until the run up against full utilization of those resources, at which point you’d get inflation
- May also have political constraints, e.g. some countries have a debt ceiling in place
- Unemployment indication that there is excess capacity in an economy, according to MMT government should spend to reach full employment
- Jobs guarantee is an important policy component MMT for many its advocates
- Serves as an automatic stabilizer in downturns by putting money in pockets of laid off workers and mitigating recessions
- Many proponents of MMT also advocate for permanently zero or near zero overnight interest rates
- Monetarily sovereign governments will never default on debt because of a lack of funds
- Spending precedes taxation therefore, federal spending is not funded by taxes and bonds
- Taxes serve several other purposes: drive demand for the currency (see alternate story of money above); enable government to address market failures (e.g. taxes to internalize externalities); tools to realize social objectives beyond market failures (e.g. wealth tax); one potential mechanism for controlling inflation out of several
- Purpose of bonds is a tool for monetary policy, enables central bank to reduce bank reserves , mechanism for interest rate management
- Contrary to popular belief, deficits are not a bad thing, just an indication of a surplus in the non-governmental sector. Concept known as sectoral balances ie: One sector’s red ink must be another’s black ink
- Places employment and inflation in the scope of fiscal policy, contrary to traditional views of that being largely confined to monetary policy.
- MMT rejects monetarist view that there’s a tradeoff between unemployment and inflation
- Not reliant on economic growth for creating jobs
- Inflation or price instability is a matter of resources and productive capacity and thus depends on where the inflation is in the economy and what exactly is affecting cost increases
- Inflation solutions may require *more* spending to increase resilience or infrastructure eg: 1) quality mass public transit like high speed trains reduces need for driving which reduces demand on gas. 2) Better port infrastructure reduces likelihood of shipping bottlenecks 3) more renewable energy reduces energy costs.
- Inflation may also require varieties of price controls, antitrust law, taxes, or financial regulation to manage demand
The Deficit Myth NYT Best-seller by MMT advocate Stephanie Kelton, debunked the following myths:
- The Federal government should budget like a household (no, bc issues currency it spends)
- Deficits are evidence of overspending (no, inflation is)
- National debt: we’re on the hook for it (national debt poses no financial burden whatsoever)
- Government deficits crowd out private investments, making us poorer (fiscal deficits increase wealth and collective savings)
- Trade deficit means America is losing (trade deficit is just our stuff surplus)
- Entitlement programs like Social Security and Medicare are not sustainable, can’t afford them. Can always pay them, what matters is economy’s long run capacity to produce the goods and services people need
Criticisms of MMT (delineated and addressed in “Seven Replies to the Critiques of Modern Monetary Theory”):
- No theory in MMT, if there is, there’s nothing new. No mathematical model so it’s not a theory.
- Job guaranteed program is not workable
- MMT has a narrow view of the monetary system
- MMT policies will lead to economic and political instability
- MMT policies lead to financial instability and slow economic growth
- MMT is unrealistic, disruptive, and leads to incorrect framing of economic problems
- MMT mostly applies to the US and can’t be applied to open and / or developing countries
MMT’s lineage in economic thought // Chartalism:
- Chartalism is a theory of money that argues it originated with the state not as a medium of exchange evolving from a barter economy
- Can find these ideas in writings of Adam Smith, Karl Marx, William Stanley Jevons
- Germain economist George Friedrich Knapp invented the term charlatism in State Theory of Money, published in 1905
- Alfred Mitchell-Innes in 1914, In Credit Theory of Money - “Whenever a tax is imposed, each taxpayer becomes responsible for the redemption of a small part of the debt which the government has contracted by its issues of money, whether coins, certificates, notes, drafts on the treasury, or by whatever name this money is called. He has to acquire his portion of the debt from some holder of a coin or certificate or other form of government money, and present it to the Treasury in liquidation of his legal debt. He has to redeem or cancel that portion of the debt ... The redemption of government debt by taxation is the basic law of coinage and of any issue of government 'money' in whatever form.”
- Economists such as Randall Wray, Stephanie Kelton and Bill Mitchel revitalized ideas of Chartalism. MMT originally called Neo-Chartalism then Modern Money Theory, then Modern Monetary Theory stuck