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Modern Monetary Theory : Principles, Origin & Criticism

Last Updated : 09 Jan, 2024
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What is Modern Monetary Theory?

According to the alternative macroeconomic theory known as modern monetary theory (MMT), nations like the United States, the United Kingdom, Japan, and Canada that have complete control over their fiat currency are free to spend, tax, and borrow in that currency without facing revenue restrictions. This means that revenue is not a constraint on federal government spending. Modern Monetary Theory says that these kinds of governments don’t need taxes or loans to pay for their spending because they have the power to print as much money as they want and are the only ones who can do so. Fears of a growing national debt shouldn’t affect their decisions because their budgets aren’t like those of regular households.

Geeky Takeaways:

  • Modern monetary theory (MMT) questions traditional assumptions concerning government-economy relations, money, taxation, and budget deficits.
  • Critics argue these gold standard-era assumptions are inaccurate, useless, and unnecessary.
  • MMT is used in policy arguments to support progressive legislation like universal healthcare and other public programmes that governments say they can’t pay.

Core Principles of Modern Monetary Theory (MMT)

The central idea of modern monetary theory is that governments with authority over a fiat currency system can and should print (or create with a few keystrokes in today’s digital age) as much money as they need to spend because they cannot go bankrupt or be insolvent unless a political decision is taken to do so. Some argue that such spending would be fiscally imprudent, causing the national debt to inflate and inflation to spike. However, according to MMT,

1. Large Government Debt Doesn’t Cause Collapse: Large government debt is not the precursor to collapse that we have been led to believe; countries such as the United States can sustain much larger deficits without concern; and a small deficit or surplus can be extremely harmful and cause a recession because deficit spending is what builds people’s savings.

2. Debt Is Money Invested in the Economy Without Taxing it: According to MMT theorists, debt is essentially money that the government placed into the economy but did not tax. They further contend that comparing government finances to those of average households is incorrect.

While defenders of modern monetary theory admit that inflation is potentially a possible outcome of such spending, they argue that it is extremely uncommon and can be dealt with with future policy decisions if necessary. They frequently use Japan as an example, which has a significantly bigger national debt than the United States.

Government Money Creation

1. MMT and Government Expenditure Limits: Modern monetary theory proposes that the government’s expenditure is entirely limited by the accessibility of tangible resources, such as labour, construction materials, and so forth. Inflation may rise if decision-makers fail to take precaution when government spending rapidly exceeds the available resources.

2. Taxation in MMT: According to MMT, taxes generate a continuous demand for currency and serve as a mechanism to withdraw funds from an inflated economy. This contradicts the conventional wisdom that the primary purpose of taxes is to generate revenue for the government to spend on infrastructure development, social welfare programmes, and other initiatives.

3. Government Bond Sales in MMT: A government does not need to sell bonds in order for borrowing money, since it can create that money internally, according to modern monetary theory. To exhaust excess reserves and achieve its target overnight interest rate, the government sells bonds. Therefore, the presence of bonds, which Mosler refers to as “Federal Savings Accounts,” is a matter of policy preference and not a mandatory government requirement.

4. Government Debt: According to MMT, governments incurring debts while undercollecting taxes contribute to unemployment. Individuals who are unemployed and unable to secure employment in the private sector should be provided with transition positions paying a minimum wage, which would be publicly funded and administered by the local community. This labour force would function as a buffer to assist the government in managing inflation within the economy.

Origins of MMT

1. Origins of Modern Monetary Theory (MMT): Mosler came up with modern monetary theory, which is related to school of thought from the past, such as functional finance and chartalism. Mosler first thought about some of the ideas that make up the theory when he was a trader on Wall Street in the 1970s. He used his ideas to make some smart bets at the hedge fund he started in the end. Investors were scared that Italy would not pay its debts in the early 1990s, but Mosler knew that this wasn’t likely to happen. It was his company and its clients who held the most Italian lira-denominated bonds outside of Italy. Italy did not go bankrupt; instead, they made $100 million. 

2. Challenges in Academic Reception of MMT: Mosler, who has a B.A. in economics from the University of Connecticut, had a hard time getting his ideas across to people in academia. He wrote an important article in 1993 called “Soft Currency Economics” and shared it on a post-Keynesian listserv, where he met people who agreed with him, such as the Australian economist Bill Mitchell.

3. MMT’s Rise in Popularity through the Internet: Many people became interested in MMT because of the internet. Economists wrote about it on popular personal and group blogs, the idea of a trillion-dollar coin was talked about a lot, and supporters shared a video of Alan Greenspan, the former chairman of the Federal Reserve, saying that pay-as-you-go benefits are safe because “there’s nothing stopping the federal government from creating as much money as it wants and paying it to somebody. Bernie Sanders and Alexandria Ocasio-Cortez are two politicians who support MMT. During Sanders’ 2016 presidential campaign, Stephanie Kelton was his top economic adviser. It was Kelton who first heard about Mosler’s ideas on a listserv and is now considered the face of the theory.

Criticism of MMT

1. Naivety and Irresponsibility: Some critics say that MMT is often seen as naive and reckless, especially when it comes to the policies it suggests. Some economists, like Thomas Palley, think it’s a “policy polemic for depressed times” and wonder how useful it would be.

2. Central Bank Interest Rates: Some people, like Palley, don’t agree with MMT’s idea that central bank interest rates should stay at zero. Some say that this way of thinking might not work well as advice, especially for nations with different economies, like Mexico and Brazil.

3. Political Complications and Vested Interests: MMT has been criticised for not taking into account special interests and the problems they cause in politics. Some people disagree with MMT policies saying that they might not be easily put into place because of the way politics work and the power of certain groups.

4. Concerns About Hyperinflation: Paul Krugman, the Nobel Prize-winning economist, is worried about hyperinflation if MMT policies are put into place. Krugman says that relying too much on seigniorage, especially if you can’t sell government bonds, could cause inflation to go up and up forever, which could destroy the currency.

5. Taxes Don’t Work to Lower Inflation: People who disagree with MMT’s idea that taxes can lower inflation include Michael R. Strain from the American Enterprise Institute. Strain says that raising taxes to fight inflation could make economic downturns worse by making unemployment rise and the economy move more slowly.

6. Lack of Practical Advice for Certain Countries: Some critics say that MMT might not offer useful advice for certain countries because its ideas might not fit with their unique political and economic situations. Concerns have been made about how well and how often it can be used in different global economic settings.

MMT has gotten a lot of notice for questioning traditional economic thinking. These criticisms show how sceptical and worried economists are about its practicality and what might happen if it is used.

How does MMT Deal with Inflation from Money Creation?

People who believe in modern monetary theory say that inflation rates shouldn’t be high unless the economy is fully employed. But if the government spends too much, inflation will happen because of the extra demand. In either case, MMT says that cutting government spending and increasing taxes can slow down inflation.

Frequently Asked Questions (FAQs)

1. What does Modern Monetary Theory (MMT) stand for?


Modern Monetary Theory is an economic theory that questions traditional ideas about how much the government should spend. It stresses the importance of fiat currency and downplays worries about budget deficits.

2. What is the main idea behind MMT?


MMT says that a government that prints its own money can pay for any amount of spending on public services and products without having to borrow money or rely on taxes.

3. What does MMT think about bills and deficits?


MMT says that debts are not always bad and can be good for getting the economy going. It also says that government debt is basically money that people in the private sector own and that it can be handled without the risk of failure.

4. How does MMT deal with worries about inflation?


MMT recognises the risk of inflation and suggests using taxes to control it by lowering the amount of extra money in circulation.

5. Does MMT say that the government should spend as much as it wants?


MMT doesn’t support spending as much as you want, but it does stress that the government’s fiscal policy should be based on real resources, not arbitrary financial limits.

6. What does MMT think the role of central banks should be?


MMT sees central banks as means of controlling interest rates, but it also says that they are not limited by worries about the budget and can make money to meet public needs.

7. What part does the government play in MMT when the economy is bad?


MMT says that the government can deal with layoffs during economic downturns through fiscal policy, which can include directly creating jobs.

8. What does MMT say about the criticisms of hyperinflation?


People who support MMT say that inflation can be controlled by using smart fiscal and monetary strategies, like changing tax rates.

9. Does MMT say that we should not pay any taxes at all?


No, MMT acknowledges that taxes create demand for the currency and suggests using them to control inflation and share income more fairly.

10. What does MMT have to do with other ways of thinking about money?


MMT is related to older economic ideas like functional finance and chartalism in some ways, but it also offers new ways of looking at fiscal and monetary policy.

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