The Policy Implications of Modern Monetary Theory

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In contemporary economics, one of the most contested topics is the debate surrounding Modern Monetary Theory (MMT). This article will explain Modern Monetary Theory, outline the current debate surrounding the theory’s merits, and examine its policy implications if implemented.

Simply put, Modern Monetary Theory is the idea that a government that issues its own currency cannot go bankrupt, meaning government deficits might not matter as much as conventional economics suggests. The consensus among economists was that large government deficits have a negative impact on the economy by increasing the demand for loanable funds, thereby increasing rates, which slows down the economy by crowding out investment from individuals and businesses. MMT proponents argue that this view of deficits is flawed, arguing instead that money supply is endogenous, meaning governments and businesses do not compete for a supply of loanable funds – which would mean deficits do not have the negative consequences many economists believed. Extending this idea, MMT supporters assert that if a government is the sole issuer of a fiat currency, then that government cannot default because it is the sole sovereign monetary authority. Therefore, MMT would allow governments to enact fiscal policies targeting social spending, full employment, or whatever other goals it desires without any financial constraint. 

To put it in simpler terms, some MMT proponents have explained MMT by comparing it to the board game monopoly. They argue that in the same way the banker cannot go bankrupt in Mmonopoly because it controls the money supply and it can always issue new money, governments cannot go bankrupt or default because it controls the money supply and can always issue new money. Indeed, this analogy may be an apt comparison, as the actual money creation process is not dissimilar from the issuance of money in Mmonopoly. In a famous interview, Ben Bernake, the Chairman of the Federal Reserve during the 2008 financial crisis, described the process of creating billions of dollars of liquidity to help stabilize financial institutions during the crisis. As Bernake explains, the billions of dollars given to those banks were is not taxpayer money, new money wais simply created by marking up the bank’s accounts with the FED. This understanding of how the money supply operates, is key to understanding how MMT would work in practice. Again, the key idea under MMT is that a government with sovereign control of its currency can never default (by missing a payment) because it can always issue new money, meaning the real constraint on government spending is inflationary pressures, not arbitrarily acceptable deficit levels.

In recent years, MMT has become more mainstream both in economics literature and amongst progressive politicians and activists around the world, with progressive American politicians like Rep. Alexandria Ocasio-Cortez citing MMT as a mechanism for financing progressive reforms. This increased awareness of MMT has also led to widespread debate amongst economists about its merits. The leading criticisms of MMT suggest that implementing MMT would lead to inflation, currency depreciation, and that deficits that would crowd out investment. Economists like Larry Summers argue that uncontrolled government spending under MMT could lead to inflation or even hyperinflation, leading to a collapse of exchange rates. Further, many economists are standing by their view of large government deficits increasing interest rates, a fact which they argue will hurt the economy.

Arguably, Summers and other economists are being slightly unfair to what MMT is actually proposing. MMT does is not saying that governments can just print as much money as they want to finance spending projects;, and saying that is what MMT is advocating for is advnancing a strawman argument. Leading MMT proponents like Bill Mitchell, one of the leading voices behind MMT’s growing popularity, acknowledge the inflationary constraint on spending , and acknowledge that implementing MMT may lead to some inflation, but make it clear they are not arguing for unlimited spending. 

Based on the data Modern Monetary Theory has empirical standing. For example, the United States was in had $28.43 trillion USD ofin debt at the end of 2021, with a debt-to-GDP ratio of 127%. As this deficit has grown since the turn of the century, American interest rates have remained consistently low. This suggests that the conventional economic thinking about large government deficits raising interest rates by crowding out investment may be flawed. The existence of such a large deficit without any correlated change in interest rates bodes well for Modern Monetary Theory’s central tenet that deficits do not matter. It is worth noting that the United States is in a unique monetary policy position as the world’s default currency of exchange and abecause of its hegemonic geopolitical might. Despite this, the lessons learned from the U.S. case should be largely applicable to any other country that exercises control over its currency including Canada, but excluding all countries on the Euro.

Though there is still considerable ongoing debate surrounding the merits of Modern Monetary Theory, potential implications for economic policy are massive. If a government adopted MMT principles, it could theoretically dramatically increase spending without increasing taxation. Progressive politicians the world over are often faced with the legitimate question of how to finance the ambitious reforms they support. As MMT ideas become more mainstream, these politicians will increasingly be able to justify their ideas. If implemented, MMT would allow governments to spend more liberally on welfare, infrastructure, health care, housing, education, and countless other projects without conventional budgetary constraints. Additionally, MMT could transform the role of central banks in an economy, affording governments the opportunity to rethink their mandates and give central banks more monetary tools to manage the economy.

That being said, Modern Monetary Theory is still a controversial topic within economics, suggesting governments should exercise patience and allow the debate to become more settled before fully embracing MMT monetary and fiscal policy. The MMT assertion that government deficits do not matter as much as conventional economic thinking dictatesd seems to have some merit, though the question of how much deficits matter remains unanswered. Clearly, in the absence of deficit constraints, the primary restraint on government spending under MMT would be an inflationary constraint. Therefore, before adopting MMT, more research is needed on how much governments can spend while keeping inflation manageable. In short, despite being a new and controversial topic within economics, MMT appears to have promise regarding how governments should think about deficit spending and has the potential to enable bold spending projects that could help improve peoples’ lives. Thus, Modern Monetary Theory deserves more attention and research focus to see if it is a panacea for the world’s problems or whether there is really no such thing as a free lunch.