Modern Monetary Theory Explained: The Macroeconomic Theory

Modern monetary theory (or modern money theory) is a macroeconomic proposition suggesting it’s possible to unshackle government budgets from mainstream economic constraints.

MMT theorists believe public debt is different from debt held in the private sector. This is because governments can fund their deficit spending by printing more of their own fiat currencies, a luxury not afforded to individual firms and consumers. This enables them to spend without concern for paying back their creditors since they are, in effect, lending to themselves.

As such, MMT proponents believe governments can increase spending on social welfare programs like universal health care, federal job guarantees, and climate action initiatives. Tamer versions of MMT—like quantitative easing—are already in effect throughout many countries as well.

Modern monetary theory descends from the Keynesian school of economic thought, albeit with a much broader scope in mind. It gained traction in the decades after the United States went off the gold standard and embraced a fiat currency. Other nations followed suit.

This led economists like Bill Mitchell, L. Randall Wray, and Warren Mosler to posit governments could spend as much of their own currencies as they wanted. In the 2010s and 2020s, the theory became even more mainstream. Economist Stephanie Kelton’s book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy is an exposition of the theory for laypeople and was a bestseller upon its release in 2020.

In the aftermaths of both the 2008 financial crisis and COVID-19 pandemic, federal governments throughout the world injected vast amounts of fiscal stimulus into their respective economies. The initial positive effects seemed to indicate MMT’s validity. Still, more critical economists—like Paul Krugman and Larry Summers—speculated implementing MMT’s principles would lead to rampant inflation. While the 2008 stimulus did not correlate to such a rise in price levels, the COVID-related stimulus did.

Modern monetary theory, or MMT, might sound complex at first, but it’s simple to grasp. Here are several key tenets of the framework:

1. 1. Budget deficits are not innately bad. MMT advocates believe government balance sheets are different from the assets and liabilities in the average person’s bank account. This is because governments can print more currency to pay off their own debts. As an example, the Federal Reserve could, in theory, forgive all US government debt minus any debt foreign creditors are holding.
2. 2. Fiat currency is potentially limitless. MMT proponents insist you can increase the money supply to meet social needs in most developed economies. In their view, this will generate increased economic activity by fostering GDP (gross domestic product) growth and a higher standard of living.
3. 3. Interest rates should remain low. MMT proponents believe the Fed should set interest rates at zero to encourage positive economic growth. They also insist government bonds are an unnecessary and outmoded way to fund and sustain government debt levels. Critics push back on pursuing this type of monetary policy for fear of hyperinflation.
4. 4. More social welfare programs are possible. If the principles of MMT are attainable in practice, greater social welfare is possible. In the US, politicians like Alexandria Ocasio-Cortez and Bernie Sanders insist modern monetary theory lays the groundwork for policies like Medicare for All, the Green New Deal, and full employment.
5. 5. Printing money can solve fiscal problems. MMT theorists believe central banks can work with legislators to set fiscal policies capable of helping the common man. In the United States, Congress could disregard concerns about government deficits (or the national debt in a broader sense) to stimulate the economy during downturns and avoid major recessions.
6. 6. Taxation can reduce inflation. MMT advocates address their critics’ concerns about limitless money creation by saying taxation can tamp down inflation when it gets out of control. Just as the government can stimulate the economy or fund programs, it can also pull money out of the system to encourage price stability. Since the government can pay for all its expenditures through money creation, tax revenues become secondary to any government funding.

The central belief of MMT is government borrowing should not involve any constraints. When it comes to government debt, the issuer and debtor are one and the same. As a result, central banks can work in tandem with legislative and executive bodies to increase the money supply without fear of reprisal.

This economic theory has as many detractors as it does proponents. Opposers often criticize the following aspects of MMT:

1. 1. Disincentivization to invest: Since MMT proponents suggest setting interest rates to zero and inflating currency levels, critics insist no one would have an incentive to invest. People would have no ability to seek returns on their stock or bond investments since rates would always remain artificially low.
2. 2. Inflation risk: MMT critics assert advocates are naive about the potential of inflation. They point to the fate of Weimar Germany as one cautionary tale. Proponents of the theory point to countries with high debt levels yet sustainable currencies (like Japan) as a counterpoint.
3. 3. Potential of upward wealth transfer: While MMT might benefit the working and middle classes in the short term, it’s at least possible Wall Street investment banks might stand to gain the most in the long term. Whenever the Federal Reserve creates new money, it primarily circulates within this sector of the economy.

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