Modern Monetary Theory

Modern Monetary Theory (MMT) is a controversial macroeconomic theory of recent vintage. It was invented by former hedge-fund manager, Warren Mosler (b. 1949), who first published the idea in his 2010 book, The 7 Deadly Innocent Frauds of Economic Policy.

In a nutshell, MMT says that modern national governments which are fully in control of their own currencies should view the creation of money and its injection into the economy to stimulate growth as a purely political decision that need not be constrained by economic considerations.

More specifically, Mosler argues that governments should “print money” (which is of course done today at the press of a button) without any backing in the form of government bonds or other debt instruments sold on the market.

According to the conventional understanding of the way the money supply works, if indulged in on a large scale such “free money” should have a whole suite of catastrophic consequences, from distorting the marketplace in favor of government-supported firms, which would drive their competitors out of business, to hyperinflation, leading to collapse of the currency.

With respect to market distortions, MMT’s supporters typically view them as a feature, not a bug. That is to say, they are for the most part socialists who believe government officials by rights ought to be in charge of economic decision-making anyway, and not the market.

A number of socialist and progressive economists have given their public support to MMT, notably Stephanie Kelton, author of The Deficit Myth (2020). Kelton was an advisor to Bernie Sanders during his 2016 and 2020 campaigns for the Democratic Party’s presidential nomination.

The theory is of course not entirely new (nothing is). Rather, it draws on earlier ideas of John Maynard Keynes, Joan Robinson, Nicholas Kaldor, Michał Kalecki, Piero Sraffa, Abba P. Lerner, and Hyman P. Minsky, among others—socialists or progressives, all.

The unexpected influence the theory has had is undoubtedly due to the 2008 financial crisis and the loss of confidence in the capitalist system that has flowed from it—events perhaps best exemplified by the cult-like following of the French socialist author, Thomas Piketty.

On the other hand, not all progressive economists support MMT. For example, Paul Krugman finds fault with the theory for a technical reason.

Krugman has pointed out that what MMT recommends—the creation of money unlinked to the issuance of debt, such as the sale of government bonds—is technically a form of seignorage, which is the net difference between the face value of money and its cost of production.

Since in the digital age the cost of production of money is effectively zero, the seignorage attached to money creation today is for all practical purposes +100%.

So, what is wrong with that?

Krugman writes:

Do the math, and it becomes clear that any attempt to extract too much from seigniorage—more than a few percent of GDP, probably—leads to an infinite upward spiral in inflation. In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.

As far as the threat of hyperinflation is concerned, MMT proponents observe that the government can always raise taxes further down the line.

That is of course true. However, the problem with this idea is that the whole point of raising taxes would be to put the brake on economic activity. After all, it is the curtailment of activity that causes the rate of inflation to fall.

In effect, MMT recommends giving inflation free rein until it begins to run out of control and then applying the brakes at the last minute to save the currency by throwing the economy into recession.

But notice that throwing the economy into recession defeats the whole purpose of MMT! Given that the main selling point of MMT was supposed to be its ability to bring about maximum productivity and provide full employment, this built-in necessity to create a recession to avoid hyperinflation would seem to be more than just a minor defect in the theory that might be fixed by a tweak or two here and there.

Remember that this necessity was created by injecting “free money” into the economy in the first place. But it is not such highly artificial “stimulation” that is the secret to economic productivity and growth. Rather, it is low taxes, reasonable regulation, and, above all, a sense of security and predictability (confidence).

Any artificial stimuli such as those recommended by MMT are likely to fail, sooner rather than later. When they do, they inevitably lead to long-term economic outcomes that are worse than they would have been if the measures had not been taken.