Modern Monetary Theory (MMT) - Everything you need to know

Modern Monetary Theory (MMT) is currently having a moment and has been characterized as the “big new left economic idea.”[1] It became a very appealing notion to those in the progressive economic and political fields as observed in the 2019 United States Presidential candidate debates.[2]  This  was evidenced by Rep. Alexandria Ocasio-Cortez (D-NY) who suggested that MMT certainly needed to be a part of the larger conversation, and former 2020 candidates such as Sens. Bernie Sanders and Kirsten Gillibrand who embrace domestic policy elements of MMT such as its job guarantee.[3] Arguably, MMT became so appealing as liberal presidential candidates could validate financing of their progressive agendas through government deficits which did not have to be ‘paid off.’[4] It is no wonder that it has become such a ‘trendy’ political-economic perspective, however, inescapably it has it also produced a wave of denunciations.[5] Among those who openly criticised the theory is former Treasury Secretary Larry Summers, former IMF chief economist Kenneth Rogoff, Fed Chair Jerome Powell, and Bill Gates. This paper critically examines the key elements of MMT that has enabled it to rise to prominence and centred itself as a major topic of debate among high-profile economists and Democrats; namely due to its conceptualization of money, its interpretation of funding government programs, its principle policy goals and subsequently its political impact. We find that the theory is more nuanced than what many of its critics seem to perceive it to be, perhaps providing a very real space for its operational implementation given the current political and economic climate. 

Context

MMT is considered as a heterodox branch of economics, driven from the post-Keynesian framework, as it draws upon the seminal works of scholars such as Innes, Knapp, Keynes, Lerner, Minsky, and Godley.[6] Also, bearing resemblance to older schools such as Functional Finance and Chartalism, it has become a dynamic economic amalgamation to conceptualise the present-day relationship between economics and government.[7] The contributions from Mosler, a successful hedge fund founder during the 1970s have also enhanced the theories economic credibility.[8] Despite MMTs historical roots, it is largely considered as a contemporary framework in so much as economists William Mitchell, Martin Watts and L. Randall Wray who produced the textbook Macroeconomics claim that the theory grew following the 2008 Global Financial Crisis and the “cult of austerity” which accompanied it.[9]

In a purely definitional sense, according to scholar Wray, MMT is an analytical tool to examine the fiscal and monetary policy of national governments that utilize a sovereign currency.[10] Thus, in order for a national currency to qualify as ‘sovereign’ it must meet the following four requirements; a) The national government decides how the currency is denominated; b) The national government enforces obligations (taxes, fines etc.); c) the national government produces the currency according to how it desires this to be denominated and will accept it as payment for the obligations it enforces on the population; and d) if the national government chooses to issue further obligations, they are also denominated in the designated currency, and again payable in that currency.[11]

OEDC countries no longer back their currencies by the gold standard and therefore are not constrained by fixed exchange rates. Thus, countries like New Zealand, Australia, Britain and the USA whose governments issue their own currency cannot run out of money, as put simply by Mitchell “there is no default risk on government debt.”[12] In that sense, it rejects Adam Smith’s household budget analogy and rather posits that unlike a firm or household, a government has the authority to print money and tax its population. Following this, a national government with a sovereign currency with the ability to avoid foreign debts can always afford to purchase anything.

The Origins & Value of Money to MMT

The origins and nature of money have been a historically contested notion. For MMTers, Farley Grubb’s (a leading expert on America’s colonial currency) account of money is the accurate historical perspective.[13] He posits that colonial America (1607-1776) under the control of Great Britain, faced a persistent problem of a lack of money. The legal tender of Great Britain was both gold and silver coins or the bimetallic system, however, such coins were rarely circulated within the colonies and American colonial governments were prohibited from coining their own.[14] Thus, to finance American colonial projects, specific colonies such as Virginia or North Carolina produced their own money of account, enforced obligations in that money of account, issued currency in that money of account, spent the currency, collected obligations in that currency and then ultimately burned the obligations revenue.[15] This chartalist account of money is anchored in post-Keynesian and subsequently MMTs understanding of money’s origins and value.

The term “Chartalism” was coined by Knapp, in his publication State Theory of Money, that was translated into English in 1924.[16] He was opposed to the orthodox “Metalist” approach which perceives money to be a medium of exchange, in which historically derived its value through its connection to precious metals.[17] Rather, he propagated the heterodox “Chartalist” approach, in which money was understood as a state-backed unit, a “creature of law” which acquired its value from the state accepting it as payment for settling debts. This Chartalist approach was further re-affirmed by Keynes, who argued that “Chartalism begins when the State designates the objective standard which shall correspond to the money-of-account.”[18] This understanding was hypothesized after reading Innes’ account that examined how the early monetary units were predominantly based on grain weight units – illustrating a record-keeping form of foodstuffs.[19]

In that sense, the MMT perspective of the value of money as argued by Wray follows Knapp, by positing that the state is only required to accept its fiat money for payments made to the state.[20] Those payments being fines, interest, fees but of most importance taxes. More broadly, for MMT proponents, the acceptance of paper money for state payments is the exclusive reason for money’s development, its value and thus purchasing power to that money. However, Tcherneva, points out that the exact value prescribed to the currency is dependent upon how difficult it is to acquire that money necessary for state payments.[21] As the state holds the monopoly over issuing the currency, it establishes the rate of currency exchange. Therefore, the state is responsible for the currencies value by setting “unilaterally the terms of exchange that it will offer to those seeking its currency.” [22] Although this practical chartalism concept is a largely valid economic doctrine at present, post-Keynesians (and potentially institutionalists) and MMT proponents disagree as to the specific degree in which this concept of chartalism is evident in today’s financial system.[23]

Paying for Government Spending

Under the MMT framework, financing government programs can be done so in three forms, which Mitchell et al., have reduced to the following equation: G + iB = T + ΔB + ΔM.[24] Whereby G represents government spending, iB is interest payments on debts, T stands for tax revenue, ΔB is borrowing and selling new government bonds, and ΔM represents the new money created. Firstly, and perhaps the most politically unpopular tool is direct taxation (T).[25] So, MMT advocates would argue it is best to simply spend now and tax later. Kelton advances this further by noting that governments don’t need to tax to spend, they merely need to pass laws which “articulate spending”.[26] She suggests that government spending financed by tax revenues places wealthy Americans at the centre of fiscal policy-making, which leads to an unhealthy outcome. Moreover, Mosler notes that in application, to finance the US Medicare-for-all issue, it is not necessary for the government to levy taxes to finance universal health care. The millions of private insurance redundancies produced by those in the health care administration roles when this program is implemented will cause immense deflation.[27] He states that if anything, to counter this, the government should provide tax cuts or increase expenditure to “pay for” the policy.[28] Mosler’s perspective is not universally accepted among MMT theorists.

Those who are still sceptical about this tax tactic may suggest why does MMT not simply eliminate taxes altogether? Proponents would contend that taxes are still necessary but instead of their conventional usage, they are effective drainage systems and thus control monetary demand, reduce potential inflation and redistribute income, as previously mentioned.[29] 

The second and third proposed method to finance a new government program can be discussed in tandem. In that sense, a government can borrow the funds to pay for it (ΔB) and subsequently ‘print’ money for re-payments.  In theory, we can consider the government and the Central Banking (CB) system as a singular unit, any CB, for the most part, is constitutionally an arm of the government. Therefore, a country issuing its own sovereign currency (as mentioned prior a prerequisite for MMT) when that government generates “debt” with the CB as a result of deficit spending, this is merely an accounting convention. Such a government can spend by “debiting its account at the CB”. In that sense, a national government does not face budget constraints nor cannot run out of money, as it issues its own money (and in turn net creates money) so it has the capacity to pay any debt if this is its own.[30]

In practice, this resembles Kelton’s Say’s Law of Deficits presented in a September 2018 interview.[31] She states that political projects such as infrastructure and medical care could be funded without considering current budget constraints nor laws. She claimed that the shared understanding in Washington was that to pay for nice things one takes money from the wealthy on whom this money seems to grow. However, she does not support this notion. Rather, Washington merely needs to establish authorization to spend, in turn, resulting in a deficit.[32] As Skousen refutes, this method simply postpones the pain incurred by paying immediately with taxation, as the government is required to still pay back the bondholders and with its interest (iB).[33] Mosler who adds the Wall Street element argues that in fact this poses as a unique opportunity for the financial sector; Wall Street hedge fund speculators, rent-seekers, and enterprises to profit and trade on financing sovereign debt.[34]

Principle Policy Goals: Price Stability & Full Employment

For MMT proponents, fiscal policy should ultimately seek a full employment market in both the private and public sectors and ensure that the price of goods and services remains at an affordable level compared to income.[35] As Mitchell et al., argue the key macroeconomic policy goal is not economic growth, nor enhancing freedoms, nor inflation targeting but rather job guarantees for the entire adult population (who desires one) based upon the right to work at a living/fixed wage (approximately US$15 per hour).[36] They perceive inflation targeting to result in persistent levels of high unemployment purely to stabilise prices. Instead, they suggest that national governments should implement an employment buffer policy grounded in the aim of ensuring the full employment of labour and resources for those unemployed and desiring work. The policy would work through the means that when private sector demand for labour decreases, the national government would increase its job guarantees (JG).[37] Conversely, when private sector demand for labour decreases, the National government would reduce job opportunities. This buffer employment ratio (BER) is defined as: BER = JGE/E, whereby JGE represents national government job guaranteed employment and E is the total number of those employed within the economy. Therefore, BER increases when the job guarantee opportunities rise and declines with the job guarantee opportunities fall.[38] Neo-classical economists would argue that this macroeconomic policy aim is inflationary in nature as when labour markets are tight, employees have the capacity to demand a greater share of the profits created.[39] As Marx would affirm, a portion of unemployed persons or a “reserve army of the unemployed” will keep labour cheap.

So how does the BER control inflation? MMT proponents would reject the previous claim and argue that overarchingly, that to manage inflation, BER requires the continual adjustment of fiscal and monetary policy, whereby to reduce demand in the inflating private sector, the policy is able to transfer labour to the public sector. It suggests that by offering a JG program with a set living wage it implements a cap on wages and provides employees with an option to reject private-sector work that may be exploitative and unconscionable in nature.[40] Mitchell et al., posit that this will ultimately reduce inflationary pressures that occur because of wage-price conflicts.  In summation, BER counteracts the ‘booms and busts’ of the private sector, stabilises the economy, and ensures that workers have an income regardless of the capitalist system.[41]

MMT proponents are consciously aware of critics such as Skousen who are understandably concerned about potential runaway inflation. Studies have demonstrated that once inflation begins it is unlikely that it will cease before causing a recession.[42] So how might MMT handle creeping inflation that may leave a country struggling in hyperinflation? Put simply, MMT won’t lead to hyperinflation because this concern is taken seriously and thus continual adjustment of fiscal policy is ensured to prevent this.[43] However, Mitchell et al., acknowledge that a government that excessively spends without appropriate oversight may very well lead to increasing inflation rates. Utilizing infamous hyperinflation cases of a) the Weimar Republic and b) Zimbabwe, they illustrate that rather than this being caused by excessive fiscal deficits this is instead due to the increasing aggregate supply constraints.[44] The case of Germany during the early 1920s was faced with a serious inflation problem, according to Mitchell et al., this was the result of the overzealous demands enforced by the Treaty of Versailles that could not be re-paid from the Weimar Republic’s domestic taxation nor exports. Moreover, Zimbabwe’s economic decline can be accounted for by its state mismanagement of commercial farms in which Mugabe’s regime turned ownership over to rebel groups who lacked experience in such industries.[45]

The Political Impact of MMT

The very real dilemmas currently emerging are providing case studies for how national governments can utilize MMT-style fiscal policy effectively to solve such.  At present, perhaps the most pressing global issue is the unfolding Covid-19 global pandemic. If left unchecked within the US, the disease is on a trajectory towards overwhelming their healthcare system, particularly as the countries death toll surpassed 100,000 as of 28 May 2020.[46] MMT could provide a way in which US policymakers can justify implementing universal health care legislation that typically is refuted under the pretext that the federal government simply does not have the funds for it.

Yet, MMTs meteoric rise and application should not only be considered within the confines of the US. It seems to have infiltrated the discourse of other national governments with sovereign currencies. Even less pressing issues, Bill argues, such as the current infrastructure building boom in Australia presents an intriguing dilemma best solved by MMT.[47] He posits that several large and predominantly public sector projects are at present in progress, however, Australia has reported a limited supply of construction materials including cement, concrete and hard rock which in turn drastically increases costs. In other words, a real resource constraint is present. This shortage of real resources is detrimental to essential infrastructure development and has implications for the speed in which the public sector can provide the population with goods.[48] We can observe resource shortages but also note that 15% (we suspect this has risen recently) of the countries labour market is being unused with close to a million people classified as unemployed.[49] This infrastructure bottleneck suggests to be the result of spending constraints, thus, greater deficits are required. He calls for BER or JG policies that will help to ameliorate this particular dilemma.

On analysis, this paper argues that given the current political, social and economic climate this heterodox style of economics may be a solution for real-world issues that simply are not being solved by orthodox economics. This will require radical shifts in the culture of banking and dominant perspectives in politics but if so, MMTs primary operational recommendations may prove helpful for a variety of issues including; America’s 13.3% unemployment rate or Australia’s real resource infrastructure constraints.[50] With global headlines noting “No choice but to MMT,” “To MMT or not to MMT?,” and “Turning the economic tide: could a radical monetary theory fix Australia’s woes?” this ‘radical’ shift in thinking may not be an overly optimistic claim.

[1] Dylan Mathews, “Modern Monetary Theory, explained,” VOX, April 16, 2019, https://www.vox.com/future-perfect/2019/4/16/18251646/modern-monetary-theory-new-moment-explained

[2] Mathews, “Modern Monetary Theory, explained.”

[3] Ibid.

[4] Gordon Brady, “Modern Monetary Theory: Some Additional Dimensions,” Atlantic Economic Journal 48, (2020): 2, https://link-springer-com.ezproxy1.library.usyd.edu.au/article/10.1007/s11293-020-09654-6#citeas

[5] Mathews, “Modern Monetary Theory, explained.”

[6] L. Randall Wray, “Alternative paths to modern money theory,” Real-Word Economics Review, no. 89, (2019): 6, http://www.paecon.net/PAEReview/issue89/Wray89.pdf

[7] Neil Hart, “Macroeconomic Policy and Abba Lerner’s System of Functional Finance,” Economic Papers 30, no. 2 (2011): 208, https://onlinelibrary-wiley-com.ezproxy1.library.usyd.edu.au/doi/pdfdirect/10.1111/j.1759-3441.2011.00117.x

[8] Brady, “Modern Monetary Theory: Some Additional Dimensions,” 2.

[9] Mark Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” Atlantic Economic Journal 48, (2020): 12, https://link-springer-com.ezproxy1.library.usyd.edu.au/content/pdf/10.1007/s11293-020-09651-9.pdf

[10] Wray, “Alternative paths to modern money theory,” 6.

[11] Ibid.

[12] Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” 12.

[13] Wray, “Alternative paths to modern money theory,” 10.

[14] Sharon Murphy, “Early American Colonists Had a Cash Problem. Here’s How They Solved It,” TIME, last modified February 27, 2017, https://time.com/4675303/money-colonial-america-currency-history/

[15] Wray, “Alternative paths to modern money theory,” 10.

[16] James Juniper, Timothy Sharpe, and Martin Watts, “Modern monetary theory: contributions and critics,” Journal of Post Keynesian Economics 37, no. 2 (2015): 281, https://www.tandfonline.com/doi/pdf/10.2753/PKE0160-3477370205.2015.11082991?needAccess=true

[17] L. Randall Wray, “From the State Theory of Modern Money Theory: An Alternative to Economic Orthodoxy,” Working Paper 792, Levy Economics Institute of Bard College, Annandale-on-Hudson, NY (2014), 4, http://www.levyinstitute.org/pubs/wp_792.pdf

[18] John Maynard Keynes, “Economic Possibilities for our Grandchildren,” In Essays in Persuasion (New York: Harcourt Brace, 1932), 11, ProQuest Ebrary.

[19] Wray, “Alternative paths to modern money theory,” 10.

[20] Wray, “From the State Theory of Modern Money Theory: An Alternative to Economic Orthodoxy,” 4.

[21] Pavlina Tcherneva, “Chartalism and Tax-Driven Approach to Money,” In Handbook of Alternative Monetary Economics, ed. P Arestis and M Sawyer (Northampton, MA: Edward Elgar, 2006), 80, ProQuest Ebrary.

[22] Tcherneva, “Chartalism and Tax-Driven Approach to Money,” 80.  

[23] Juniper, Sharpe, and Watts, “Modern monetary theory: contributions and critics,” 286.

[24] Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” 14.

[25] Ibid.

[26] Brady, “Modern Monetary Theory: Some Additional Dimensions,” 2.

[27] Mathews, “Modern Monetary Theory, explained.”

[28] Ibid.  

[29] Wray, “Alternative paths to modern money theory,” 10.

[30] Ibid.

[31] Brady, “Modern Monetary Theory: Some Additional Dimensions,” 6.

[32] Ibid.

[33] Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” 14.

[34] Brady, “Modern Monetary Theory: Some Additional Dimensions,” 6.

[35] Rebecca Rojer, “The World According to Modern Monetary Theory,” The New Inquiry, April 11, 2014, https://thenewinquiry.com/the-world-according-to-modern-monetary-theory/

[36] Mathews, “Modern Monetary Theory, explained.”

[37] Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” 13.

[38] Ibid.

[39] Rojer, “The World According to Modern Monetary Theory.”

[40] Rojer, “The World According to Modern Monetary Theory.”  

[41] Ibid.

[42]Josh Bivens, Andrew Fieldhouse, and Heidi Shierholz, “From free-fall to stagnation,” February 14, 2013, https://www.epi.org/publication/bp355-five-years-after-start-of-great-recession/

[43] Rojer, “The World According to Modern Monetary Theory.”

[44] Skousen, “There’s Much Ruin in a Nation: An Analysis of Modern Monetary Theory,” 17.

[45] Ibid.

[46] Martin Anderson, “Early Evidence on Social Distancing in Response to COVID-19 in the United States,” SSRN, last modified April 6, 2020, https://ssrn.com/abstract=3569368 

[47] Bill Mitchell, “Real Resource constraints and fiscal policy design,” last modified June 21, 2018, http://bilbo.economicoutlook.net/blog/?p=39578

[48] Mitchell, “Real Resource constraints and fiscal policy design.”

[49] Ibid.

[50] U.S. Department of Labor, “The Employment Situation,” Bureau of Labor Statistics, last modified June 5, 2020, https://www.bls.gov/news.release/pdf/empsit.pdf