The Rise of Modern Monetary Theory
A particular theory of money is on the rise in the United States. It goes by the name of “Modern Monetary Theory”, or MMT for short. It rises hand in hand with the shining star of the young Congresswoman Alexandria Ocasio-Cortez, who was elected as a democrat Representative for New York last year. She found in MMT an economic theory that justifies higher government deficits to finance programs such as a “Green New Deal” and Job Guarantee. It is also endorsed by presidential candidate Bernie Sanders. His former economic advisor is Stephanie Kelton, one of the leading theorists in the field of MMT.
What is Modern Monetary Theory?
The theory begins with the observation that the government requires payment of taxes in its own currency. This creates demand for the currency, because eventually we all need to pay tax. Intrinsically worthless paper is given value because we need it to pay the tax bill. The state has a monopoly on the issuance of this money. What this implies is that the government does not need taxes to fund its expenses. It can just print the money. Taxation is not a source of funding, it is a tool to manage aggregate demand in the economy. The reason why people are still taxed is to fight inflation. If inflation runs too high, the government can just increase taxes and take the money out of circulation. This can also be done by issuing bonds.
The government does not need taxes to fund its expenses, it can just print the money.
Bottom line here is that the government practically takes over monetary policy. It has a printing press to fund expenses. If inflation is too high, the tax rate is increased to reduce it. This inflation rate is at the same time the limit for government spending. Inflation is not suddenly not a problem anymore. According to Kelton, it is an indication of overspending. Deficits, however, are not viewed as a problem. As such, the government can just let the debt burden grow as long as inflation is under control. After all, it can always print its own currency to pay off the debt. This is really the core of MMT: a government that can print its own money can never go broke.
Employer of last resort
The observation that the government cannot go bankrupt paves the way for higher budget deficits. A major idea of MMT in this respect is that the economy can reach full employment by means of a labour pool. The government guarantees the unemployed in this pool a job at a fixed rate of 15$ per hour. If the pool grows, the government budget deficit grows. If the pool shrinks, the deficit is reduced. This is an automatic stabilizer in the economy. The idea is that people willing to work can always do so since the government pays them. They move back and forth from the pool to the private sector. This is the foundation for a Job Guarantee Scheme.
"The government becomes the “employer of last resort".
In Modern Monetary Theory, deficits are not a problem as long as inflation is kept in check. Therefore, the government can guarantee full employment. In effect, the government becomes the “employer of last resort”. Not only jobs can be guaranteed. Pretty much every idea that needs money can be financed in this way. The Green New Deal, as advocated by Ocasio-Cortez, requires massive deficit spending to finance renewable energy. Other ideas that are liable to this source of finance are free universities and free Medicare for all. The government is only limited by things that are in fact for sale and an arbitrary level of inflation it deems too high.
MMT and financial markets
How would financial markets respond if Modern Monetary Theorists were in charge of the government? Mainstream economists argue that interest rates would rise. The government would not really care about investors anymore, it will just print the money if needed. A steady loss of confidence in the currency is likely to result, with inflation and higher risk premia as a consequence. This is not the MMT view. The MMT people argue that it is, in fact, the other way around: as the governments spends more, the amount of money in the economy increases. Result? Interest rates drop. Rather than crowding out investment, a crowding-in effect occurs. Investments are stimulated and economic growth increases because of higher government spending in this view.
A crowding-in effect occurs.
Critiques on MMT
MMT as outlined above looks like paradise on earth: full employment is guaranteed, the debt burden does not really matter anymore, free college and Medicare for all and the climate problem is solved in the process. So, what’s wrong with this theory? MMT is a heterodox approach and it won’t come as a surprise that many conventional economists are not too fond of it. The chairman of the Federal Reserve, for example, said: “The idea that deficits do not matter for countries that can borrow in their own currency is just wrong”. He is supported by prominent economist Larry Summers, who argues that MMT policy is to blame for hyperinflation in Latin America. This fear is shared by top investor Warren Buffet: “We don’t need to get into danger zones, and we don’t know precisely where they are”.
This critique of MMT rests on the belief that politicians cannot be trusted with a printing press. The temptation to pay for politically popular projects by issuing freshly printed money is just too big. Politicians cannot resist the temptation, even when inflation is already high. Common economic wisdom holds that central bank should therefore operate independently from the government. This principle is known as central bank independence. However, this is exactly what MMT’ers want to abolish. It stands in the way of the government truly issuing its own currency fully by itself. If only the politicians were in charge of the central bank, all economic problems could be printed away. Now we get to the core of central banking: printing money does not solve problems, except for severe liquidity shortages. To put politicians like Sanders and Ocasio-Cortez in charge of a printing press is a recipe for economic disaster. This belief is not only shared by more conservative economists, but also by Keynesians like Paul Krugman. The crux of the matter lies in the faith MMT proponents place in politicians. Can we trust them with a printing press?
Printing money does not solve problems.
Modern Monetary Theory is gaining popularity in the United States, where politicians like Sanders and Ocasio-Cortez use it as the academic foundation for programs like the “New Green Deal” and a job guarantee program. However, their theory seems to be old wine in new bottles. Mainstream economists argue that inflation will occur if politicians are free to spend. Nevertheless, MMT continues to rise. Let’s keep an eye on the markets should either of the two democrats be nominated as Presidential candidate. Economists disagree about the effects of MMT on financial markets. Because in the end, the market is always right, isn’t it?