Short Read

Modern Monetary Theory: Miracle Solution or Recipe for Disaster

Modern Monetary Theory, or MMT, is a growing macroeconomic theory amongst members of the Democratic Party in the USA, such as Bernie Sanders and Alexandria Ocasio-Cortez. As MMT begins to rear its head in other nation’s political discussion, it is important to understand whether it is truly a miracle solution or an ideological fantasy.  

Despite the name, MMT rejects the common consensus that interest rates should guide economies. The theory suggests that monetary policy is ineffective because banks make loans based on the demand for borrowing rather than deposits. MMTers, therefore, believe that fiscal policy must be used instead to manage economic demand.  

MMT essentially proposes that economies should never have to worry about the accretion of debt denominated in their currency when undertaking government spending because central banks can always create more money “with a keystroke”. Furthermore, MMT claims that any inflationary fears that might arise from this process can be subdued by using higher taxation and bond issuance as reducers of aggregate demand. Simply put, large and persisting fiscal deficits are only dangerous if they cause inflation, but since inflation can be easily managed, economies can always be kept at full employment without any trade-offs. 

If this sounds too good to be true, that is because it is. The economically correct elements of MMT are not new, and those which are new are unfortunately invalid. 

MMT’s response to spare economic capacity or a slowdown in growth is to inject money through government spending. This approach is not new; it predates even Keynesian Economics. However, the size of this fiscal injection is where MMT finds its “originality”. For example, the Green New Deal would spend between 52 and 93 trillion dollars in the next 10 years to achieve full economic employment. However, as Thomas Palley put it “MMT over-simplifies the challenges of attaining non-inflationary full employment”. 

A spending plan like this would undeniably create inflationary pressures; meaning MMT conforming governments would issue vast amounts of bonds to redirect consumption to savings. However, due to the aforementioned inflationary fears, the debt would only be appealing to domestic economic agents if it had rates of return which were high enough to overcome the expected price increase. Consequently, central banks would have to print more money to finance the sizable repayments on these bonds, resulting in yet another inflationary injection to the economy. This process would continue cycling until prices inevitably spiraled out of control. 

MMT also fails to recognise that debt obtains its value from the expectation of repayment. Countries like Japan or the USA can run large fiscal deficits and carry high debt to GDP ratios because investors believe the coupons on these liabilities will be paid. However, if said country were perceived as unstable or radical by international and domestic investors, which is feasible if its central bank was printing money at the rate MMT suggests, then the bonds could be considered too risky. As a result, very little spending would be redirected to these bonds, rendering them useless as a means of “inflation control”. 

Lastly, MMT could have major unintended consequences on society as a whole. The guaranteed government job and national living wage that come with the MMT package would lead to a “crowding out” effect on labour markets. If the government could always hire any worker at a living wage, the private sector would struggle to compete and would almost certainly shrink. If this policy continued for a prolonged period, the state could become much larger than the private sector. As the government began to produce a greater proportion of goods and services and hire a greater proportion of the work force, the country would begin to resemble a centralized command economy, even if this was not the initial intention. 

MMT is not the panacea it pretends to be. It fails to acknowledge basic economic principles, so it is unsurprising that it has been subject to such criticism. Larry Summers, former treasurer to Bill Clinton, called the theory “fallacious at multiple levels.” A 2019 survey on leading economists by the University of Chicago resulted in a unanimous rejection of the assertions attributed to Modern Monetary Theory. In reality, it is unlikely that MMT’s emergence is a genuine attempt to develop a new economic theory. Its blatant flaws suggest that the theory is nothing more than a political attempt to capture voters by selling them unrealistic fantasies in radical social times. 

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