Definition:

A heterodox macroeconomic theory that describes currency as a public monopoly, and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. [REF]

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Deconstruction:

If you’re at all interested in finance, or politics, you’ve probably heard Modern Monetary Theory, or MMT, mentioned recently.  The formal economics definition above is not exactly enlightening, as it’s filled with typical academia jargon.

However, MMT is an important topic to understand, since policy changes in this direction could influence every American in the near future. 

Modern Monetary Theory was initially postulated by hedge fund manager Warren Mosler in the late 1990’s via an online forum.  Recently, the movement has been taken up by many prominent economists, including Stephanie Kelton, who was an economic advisor on Bernie Sanders 2016 presidential campaign. 

There is no shortage of political bantering tied to MMT.  So much so, that it’s hard to separate the data, theories, conjecture, and outright lies.  In this regard, it’s unfortunately similar to many other societal topics which have become completely politicized and bipolar recently.  The information to follow is intended to present a factual and unbiased exploration of this unique economic philosophy.

Essentially, Modern Monetary Theory suggests that sovereign governments with their own fiat currency can create as much money as desired to fund programs deemed beneficial to the country.  The amount of total government debt doesn’t matter, because more currency can be issued to service interest payments, and avoid default.  Only once true full employment is achieved will inflation become a concern, at which time legislation can be used to levy taxes, thereby controlling the amount of excess money in the system.

Imagine the federal government being able to spend money at will, without needing to raise taxes to offset the growing debts.  What politician, or general citizen, wouldn’t sign up for this scheme.  That’s the siren’s call of Modern Monetary Theory.  Unencumbered expenditures.

It’s fairly obvious that for an individual household, or even at the Fortune 500 corporate level, racking up ever increasing debt with no regard for fiscal austerity will end in catastrophe.  However, the U.S. Government has one trait that an individual or company does not.  The ability to create more of its sovereign currency at any time.

The main reason people have trouble grasping the Modern Monetary Theory concept is because they think the government has a balance sheet that must be managed, like pretty much any other business entity.  Income is received in the form of tax revenues.  Programs are funded based on the available cash reserves.  Money works its way into the economic, spurring consumption and growth.  Rise and repeat.

However, what if the government simply spends first, then monitors how their stimulative policies impact the economy before levying taxes.  We actually tried a hybrid version of this technique in recent years, as President Trump’s 2017 Tax Cuts & Jobs Act was essentially MMT light; slashing taxes for both corporations and individuals under the presumption of future economic expansion benefits.  The jury is still out as to whether the GDP growth generated from these lower levies will offset the near-term losses in tax revenue.  MMTers say it doesn’t matter.  

Modern Monetary Theory could change the push-pull dynamics between the tax manipulating tendencies of Republicans, and desired social programs of Democrats, which has existed in American politics for decades.  However, if some unforeseen aspect of this new methodology is flawed, then short-term economic windfall could lead to crippling long-term societal consequences.

Standard Keynesian economic theory surmises that as government debts increase, interest rates for all loans rise, thus restricting corporate investment.  If the situation gets too bad, the administration must artificially manipulate rates downward, keep borrowing to cover interest payment which risks generating hyperinflation, or, in the worst-case scenario, completely default on their obligations. 

None of these options are ideal, which is why most countries throughout recent history have tried to avoid becoming overburdened with debt in the first place.  Apparently, Germany’s Weimar Republic in 1923, Hungary after World War II, and Argentina about once a decade recently, missed the memo.

In reality, Modern Monetary Theory does not differ markedly from the key principles of mainstream economics.  The primary discrepancy is with regards to how government debts affect private lending, and overall interest rates.  Rather than envisioning treasury bonds as competition for corporate loans, MMTers think of federal deficits as a transfer of wealth to the private sector.  Growing government obligations are therefore a tool for spurring the economy, not a financial burden.

In fact, MMT claims that the government doesn’t even need to issue bonds equal to the money it creates, though these offerings can be useful for manipulating interest rates if desired.

This scheme sounds great so far.  And there’s one question every American citizen is asking.  If the U.S. Government can create money at will, then why don’t we get rid of these pesky income taxes.  Biweekly payroll checks would be a lot fatter, and mid-April a lot more relaxing each year, in this scenario.

Unfortunately, MMT’s creators aren’t magicians, though some advocates do try playing one on TV.

Taxes serve two functions in MMT land.  One is to promote citizens use of their home country’s currency.  If you have to pay taxes in U.S. dollars, you’re more likely to buy groceries, fill up the gas tank, and tip the babysitter in dollars.  Makes sense.

The second reason for taxes is the key, and most debated, tenant of Modern Monetary Theory.  Taxes are used to control price appreciation, and hence avoid the dreaded hyperinflation.  Inflation is the key economic parameter that drives MMT decision making and policy adjustments.

In its simplest form, inflation occurs when demand for a good or service is higher than supply, thereby pushing up the price people are willing to pay.  Think toilet paper at the beginning of the COVID-19 outbreak, or buying tickets from a scalper at a sold-out concert.  This mechanism is one of the few mechanisms all economists can agree on.

While fine in theory, aligning required congressional legislation with real-time economic observations might present a few challenges.  The federal government is historically poor at monitoring the actual rise in prices felt by the average consumer.  Also, what will the appetite be for increasing taxes when inflation does appear, as this phenomenon is often associated with generally poor economic conditions.

In the middle of a recession, with unemployment rising, and inflation spiking, as was the case in the United States in 1975, no sane politician would vote to levy more taxes.  There was already rioting in the streets on account of gas prices tripling; taking extra money from every American’s paycheck at this time would not have been well received.

The final element of the interest rates, inflation, unemployment triumvirate balance is jobs.  Modern Monetary Theory offers a simple solution here.  Just have the government guarantee every citizen a job at a nominal wage.  This keeps unemployment, and wage growth down, thereby simultaneously stimulating the economy, while curbing one of the key drivers of inflation.

With employment guaranteed, legislators are free to implement any economic measures needed to control inflation, should it happen to arise.  MMTers highlight issues like breaking up corporate monopolies, stopping executive fraud, and tightening financial regulations; tools which can be more readily used as needed to control the economy if employment is ensured.  This may sound like a pipe dream, but there’s some logic to it.

Currently, the U.S. Federal Reserve has two mandates.  Maintaining price stability, and getting the economy to full employment.  The MMT contingent argues that the Fed should just set their baseline lending rate at zero, then allow the Legislative branch to monitor these two economic factors, using the wide array of fiscal policy measures available to them. 

In traditional monetary policy, when inflation occurs, the government raises interest rates, stifling corporate investment, and resulting in job loss.  Your classic recession cycle.

MMTer’s argue this approach, with the Federal Reserve in control, targets an unnecessarily high level of unemployment based on the Philips Curve.  This philosophy is half a century old, and has been essentially invalidated by actual economic observations in recent years.

However, with the job guarantee, laid off workers from the private sector simply move into public employment, maintaining at least a menial level of income.  Somewhat counterintuitively, guaranteeing everyone a job actually keeps salaries down, since employers can pull from the cheaper civic labor pool, rather than being forced to raise wages due to competition.  A key element of this balance is setting the guaranteed wage at the appropriate level.

These federally entitled jobs would be in the services sector, supported by the national funding, but executed at the local level to ensure they serve the community’s needs.  FDR’s New Deal work programs of the 1930’s were similar to this approach, though not as widely sweeping as proposed in Modern Monetary Theory.  Ideally, all citizens remain skilled, supported, and engaged, while the baseline standard for private sector employment is raised.

Most importantly, guaranteed jobs create an automatic, self-correcting feedback loop based on changing economic conditions, so constant legislative action is not required.  The budget deficit simply grows in a recession, and shrinks in an expansion, depending on the number of people participating in these public employment programs.  

There is a contradiction between the humanitarian cause of providing work for everyone, and the actual result of promoting stable prices by limiting wage increases.  However, in recent years, the distinction between welfare and economic support has become pretty blurred anyways.

The Modern Monetary Theory is not without its detractors, and has been the brunt of numerous jokes.  Most notably are the alternative acronym, “Magic Money Tree”, along with various versions of “The printing press goes brrr!” meme typically used to prod the Federal Reserve.  In reality, government officials can just hit a few buttons on a keyboard these days to create more currency, since all the money at the U.S. Treasury, and the key national banks it deals with, is virtual.

As we have seen repeatedly in recent years, neither political party seems very interested in balancing the annual U.S. Government budget, or reducing the ballooning federal debt.  Raising taxes, and cutting welfare programs, is not the way to get reelected, regardless of your political affiliation.

There is no doubt that the COVID-19 pandemic, and the resulting massive coordinated fiscal and monetary stimulus, has reinvigorated these discussions.  It’s hard to argue with those who point out that despite nearly infinite printing from the Federal Reserve: QE1, QE2, QE3, QE4ever . . . meaningful inflation has not materialized in the United States over the past decade.

Some form of universal basic income is likely inevitable in America in the near future.  We just need to be careful what we wish for.  Modern Monetary Theory relies on politicians stepping up when needed to pass legislation that ends government payments, and takes money from citizens through tax increases, if inflation materializes.  Partisanship aside, it’s hard to come up with a scenario where current leaders will show such restraint, discretion, and cooperation. 

One thing is for sure in the future, regardless of who’s in charge.  We’re in for more acronyms coming out of the government, though how clever, or effective, these policies will be is anyone’s guess.  The economic future of the United States, and the world, will be interesting to monitor is coming years.

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Details:

• Background on the history and key players who developed MMT. [REF]

• Summary of Stephanie Kelton’s justification for Modern Monetary Theory. [REF]

• Detailed VOX article about the history and tenants of Modern Monetary Theory. [REF]

• History of the Phillips Curve, and it’s recent diversions in the actual economy. [REF]

• Potential for broader adoption of MMT by the U.S. Government moving forward. [REF]