What Is Modern Monetary Theory (MMT)?

What Is Modern Monetary Theory?

Modern Monetary Theory (MMT) decrees that governments that issue their currency do not need to rely on taxes or borrowing for spending since they can print as much money as they need. Using MMT, these countries and policies should not be shaped by fears of rising national debt.

Traditional monetary theories rely on two ideas: taxes equal money in, and spending equals money out. MMT also accounts for the fact that sovereign governments can legally print money to maintain employment levels, inflation, and domestic investment.

History of MMT

Modern Monetary Theory was developed by Warren Mosler, who wrote The 7 Deadly Innocent Frauds of Economic Policy, and it bears similarities to older schools of thought like functional finance and chartalism. Mosler argued that paying taxes is like taking cash directly to the IRS, which disposed of taxpayer money in a shredder.

Mosler constructed his concepts in the 1970s, when he worked as a Wall Street trader. He eventually used his ideas to place some smart bets at the hedge fund he founded. In the early 1990s, when investors feared Italy would default, Mosler understood this wasn’t a possibility. His firm and clients became the largest holders of Italian lira-denominated bonds outside Italy. Italy did not default, and instead made $100 million in profits.

Mosler holds a B.A. in Economics from the University of Connecticut and was largely ignored by the academic world when he tried to communicate his theories. In 1993, he published a seminal essay called “Soft Currency Economics” and found others like Australian economist Bill Mitchell, who agreed with him.

Taxes and Debt

According to MMT, governments with a fiat currency system under their control can and should print as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken. MMT theorists explain that debt is money the government added to the economy and doesn’t tax back.

Taxes create an ongoing demand for currency and are a tool to take money out of an economy that is getting overheated. This goes against the conventional idea that taxes are primarily meant to provide the government with money for building infrastructure or funding social welfare programs.

Modern Monetary Theory says that a government doesn’t need to sell bonds to borrow money, since that is the money it can create on its own. The government sells bonds to drain excess reserves and hit its overnight interest rate target. Thus, the existence of bonds, which Mosler calls “savings accounts at the Fed,” is not a requirement for the government but a policy choice.

Support

According to modern monetary theory, the only limit the government has when it comes to spending is the availability of real resources, like workers and construction supplies. When government spending is too great for the resources available, inflation can surge if decision-makers are not careful.

Economists and critics argue that spending would be fiscally irresponsible, as the debt would balloon and inflation would skyrocket. According to MMT, large government debt doesn't predict collapse, countries like the U.S. can sustain much greater deficits without cause for concern, and a small deficit or surplus can be harmful and cause a recession, since deficit spending helps build people’s savings. MMT claims unemployment results from governments spending too little while collecting taxes.

While supporters of MMT acknowledge that inflation is theoretically a possible outcome from such spending, they say it is unlikely and can be fought with policy decisions in the future if required. They often cite the example of Japan, which has much higher public debt than the U.S. Support for MMT grew with the rise of the internet, where economists explained the theory on popular personal and group blogs. Political leaders like Alexandria Ocasio-Cortez, Bernie Sanders, and economist Stephanie Kelton have espoused Moser's ideas.

Criticism

American economist Thomas Palley has said MMT's appeal lies in it being a “policy polemic for depressed times.” He has criticized the suggestion that central bank interest rates be maintained at zero, and said MMT does not account for political complications arising from vested interests.

Nobel Prize-winning economist Paul Krugman has opposed the theory. In an op-ed in The New York Times in 2011, he warned the U.S. would see hyperinflation if MMT were practiced and investors refused to buy U.S. bonds. “Do the math, and it becomes clear that any attempt to extract too much from seigniorage—more than a few percent of GDP, probably—leads to an infinite upward spiral in inflation,” he wrote, “In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.”

Michael R. Strain, the resident scholar at the American Enterprise Institute, has argued that MMT’s proposal that taxes can be used to reduce inflation is also flawed. “Raising taxes would only make a downturn worse, increasing unemployment and further slowing the economy,” he said in a Bloomberg column.

The Bottom Line

Modern Monetary Theory is a macroeconomic model positing that countries that issue their currencies, such as the U.S., are not constrained in spending. Proponents of MMT argue that such countries can't default on the securities they issue, as they can print or issue more currency.