MMT: what is modern monetary theory and will it work?
“Modern monetary theory” – or MMT – is all the rage among progressive thinkers, especially in the United States. What is it? And does it stand up to scrutiny? Stuart Watkins reports.
This article was first published in MoneyWeek magazine issue no 940 on 28 March 2019. To make sure you don't miss out in future, and get to read all our articles as soon as they're published, sign up to MoneyWeek here and get your first six issues free.
Back in 2015-2016, the Labour Party rounded up a panel of experts to advise it on economic policies that could lead the way out of austerity without indulging in profligacy. As a result, Labour adopted a "fiscal credibility rule", based on the work of academics Jonathan Portes and Simon Wren-Lewis. This meant committing to balancing day-to-day expenditure with revenue from taxes, to borrowing only to invest for the long term, and to reducing debt over a five-year period. Sounds sensible. But for proponents of “modern monetary theory” (MMT), this is exactly the same kind of wrong-headed thinking that led to austerity in the first place.
As Portes explains in Prospect magazine, MMT has become popular on the left, both in the UK and abroad. (Wags say that it stands for "magic money tree", giving a flavour of what it's all about and its appeal for the left.) There are supporters of the idea close to the Labour leadership. One of MMT's leading theorists is an adviser to US presidential candidate Bernie Sanders. One of the Democrats' rising stars, Alexandria Ocasio-Cortez, has expressed an interest and suggested it might help fund her ambitious spending plans.
The governor of the US Federal Reserve, Jerome Powell, weighed in on the debate last year. His assessment was that MMT is "just wrong", but the fact that he felt obliged to address the idea at all is a sign in itself of MMT's rapid rise to prominence. So what does MMT say, exactly?
That is far from straightforward to answer. For one side of the debate, which includes many mainstream economic experts, what MMT says is pretty straightforward, but is also, in the words of various protagonists, "crazy", "nonsense", "disastrous", "garbage", "voodoo economics", or just plain "wrong". On the other side there is a small number of academics (backed by an internet mob of fanatic adherents) who have worked on the theory for years. They say their critics just haven't understood the ideas at all, or have misrepresented them. From there, the debate descends into hot-tempered accusations of bad faith and idiocy, if you're lucky, or down a rabbit hole of specialist jargon that will leave you short of air if you're not.Let's embrace some caricatures to begin with. As Doug Henwood explains in Jacobin magazine, "while adherents strenuously profess that MMT is subtler and more complex than this, its main selling point is that governments need not tax or borrow in order to spend they can just create money out of thin air. A few computer keystrokes and everyone gets health insurance, student debt disappears, and we can save the climate too, without all that messy class conflict". This is a caricature, as Henwood admits, but "not an outlandish one".
Central to MMT is the fact that it is governments that designate the one official currency for a country by accepting only that currency for the payment of taxes. And "monetarily sovereign" governments ie, those that issue their own currency, such as the US and Britain, as opposed to those that don't, such as Greece, which uses the euro can print as much of that money as they like. They do not need to tax or borrow they can just issue more money. Monetarily sovereign governments do not, it is obvious from this analysis, face constraints on their ability to create money and spend it.
Rather, the danger is that if they do too much of that then they will spark inflation. The government, then, should not worry about how it raises money or about balancing budgets, but should keep an eye on inflation instead and clamp down on it if it looks like it might be getting out of hand. As Henwood says, the idea is that governments should be trusted to print and spend as much money as they see fit, on projects of their own choosing, and then cause a recession by, say, raising taxes, if things start to get a bit too hot.
What could possibly go wrong?
It might be hard to believe that the same people currently fumbling over Brexit, or rumbling over whether to fund the building of a massive wall on the border to keep out immigrants, could be trusted with such decisions. Or indeed whether the holiest philosopher-kings and technocratic experts could reasonably be expected to have access to sufficient knowledge, or to act on it in a timely enough manner, for this to possibly work, or whether we would be happy for them to flirt with hyperinflation and societal collapse in the name of trying out some progressive new theories.
Indeed, it's so hard to believe that this is what is being proposed that we must turn from the caricatures to the words of the prophets themselves. Three prominent MMT academics Scott Fullwiler, Rohan Grey and Nathan Tankus recently wrote a rejoinder to anti-MMT diatribes for the Financial Times's Alphaville blog. The proposal, they say, is to "design a macroeconomic policy framework for a Green New Deal with price stability [that] is radically different from current" practice. A budget constraint would be replaced by an inflation constraint, but taxes are not the only way to restrain inflation, they say.
For MMTers, inflation is not just caused by excess demand, or printing too much money, but by a range of factors including businesses raising profit margins or passing on costs, or financial interests speculating on asset price rises. Tools to "manage the power of big business and ensure their pricing policies are consistent with public purpose" would therefore be needed. New price indices would be created to keep an eye on inflationary pressures. Administrative agencies responsible for regulating business pricing power should be constructed, who would work with other agencies to tighten financial and credit regulations to reduce bank lending, market finance, speculation and fraud.
Detailed analysis from a range of industry experts would assess the potential inflationary effect of new spending proposals, the academics continue, and then determine "how underutilised our present resources are". Businesses deemed too large or dirty "must be shrunk one way or another". At the same time, the government would offer everyone who wanted one a job and focus on "increasing the quality of jobs and ensuring our economy generates prosperity for everyone".
An MMT-informed budgetary agency would produce detailed reports of how specific spending or lending proposals would increase demand and which sectors or regions would be most affected, and would monitor inflationary pressures closely to determine the appropriate policy response. It goes on. But if this already sounds to you like an unnerving Soviet-era five-year plan, then you're not alone it sounded just like that to some FT readers who commented on the piece too.
"Problem solved" the hubris of economists
It's almost as if economists have learnt absolutely nothing from the great financial crisis of 2008, as economist Noah Smith points out on Bloomberg. In the years leading up to that crisis, leading economists "displayed a startling amount of complacency, bordering on hubris". For them, the big problem of macroeconomics how to prevent serious depressions had been "solved". The Federal Reserve and other central banks around the world had learnt how to judicially fine-tune the economy by raising and lowering interest rates to smooth out the bumps in the cycle. People trapped in such thinking put too much faith in their simplified models and so could not see the crisis coming, or even believe that one was possible.
The MMTers are making the same mistake. As its leading thinkers often complain on their blogs and Twitter feeds, they've put a lot of time into thinking all this stuff up, writing the papers, creating the models. Those models tell them that we can be intensely relaxed about such old-fashioned notions as the need to balance budgets and be wary of deficits. And when people raise their eyebrows at such notions, the MMTers react with scorn.
This is hubris, says Smith. No theory can hope to perfectly model complex economies. And those who would embark on an experiment in the name of progress armed only with that model should be aware that they are gambling with the wealth and stability of nations. When a possible outcome looks very like hyperinflation ie, a dangerous collapse of trust in one of society's most important social institutions, namely, money caution would seem to be called for.
Something a bit like this experiment actually took place during the financial crisis itself, of course. The seriousness of that crisis made extraordinary monetary experiments such as QE (quantitative easing: buying bonds with newly created money) and negative interest rates necessary or forgivable, at least in some people's eyes.
But in this case it was always understood that these were to be temporary measures that would be reversed, even if that ended up taking somewhat longer than anyone envisioned (the reversal has at least begun, as interest rates creep up and central banks begin quantitative tightening, ie, withdrawing money from supply by selling bonds).
MMT wants to repeat the experiment on a grander scale, but this time to throw caution to the wind. That would surely affect investors' expectations about the future direction of inflation and hurt confidence in the currency. History is full of warnings about what happens when governments pursue such a course. As Nathan Lewis puts it in Forbes, "currency traders know that he who panics first panics best; to even talk about this sort of thing is dangerous".
Not modern, not money, not a theory
Even the very name of MMT is a complete misnomer, says Charles Gave of Gavekal Research. First, MMT is not modern financing government spending by printing money is as old as paper money itself. Second, MMT is not about money. The classical economists understood that money has three functions as a means of payment, unit of account and store of value.
MMT proponents focus only on the means of payment, which can be, and often is, organised by the state. But the value of money is and has always been determined by myriads of transactions taking place between individuals. This aspect of money is a common good and cannot be controlled by the government.
Finally, neither is MMT much of a theory. It boils down to a belief that state technocrats can manage "aggregate demand" by guaranteeing jobs for all that the solution to all our economic problems is to pay people to work with money that didn't exist a week ago. "It is amazing that no one ever thought of this before."