Modern Monetary Theory and the return of magical thinking
The Modern Monetary Theory is back in fashion again. How worried should we be?
Why is Modern Monetary Theory back in the spotlight?
The leader of the Green Party, Zack Polanski – whose more assertive, charismatic and left-populist tenure has seen the party dramatically surge in the polls to within a few points of both Labour and the Conservatives – speaks about economics and fiscal constraints in a way that’s ominously familiar to observers of the Modern Monetary Theory (MMT) debate.
Last month, Polanski told The New Statesman that “the fiscal rule we need to have is to make sure that inflation doesn’t go higher than the skills and resources that we have in our economy”. In a TV interview, he told Laura Kuenssberg that higher taxes on the wealthy will not be needed under his gigantic public spending plans since “this isn’t about creating public investment, we can do that anyway, we don’t need to tax the wealthy to do that”.
He further argued that loans from the Bank of England are “money we owe to ourselves, it’s not borrowing or a debt in any real sense”. In other words, all classic MMT stuff.
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What is Modern Monetary Theory?
MMT is a broad and loose term for a group of economists and adherents, rather than a precise set of policy prescriptions. But essentially MMT is a set of ideas that came to prominence in the 2010s – and popularised by Stephanie Kelton’s book The Deficit Myth – which rest on the assertion that, for a currency-issuing government such as the UK’s, debt is not a significant constraint, at least compared with inflation; that macroeconomic policy can and should be managed through fiscal rather than monetary policy; and that it doesn’t matter if the two are blurred.
In orthodox economics, the idea of printing money to solve a nation’s problems is near-universally seen as a very bad one. In contrast, MMT proposes that nations that issue their own “fiat” currencies can freely create and spend their own money, and that this need not devalue the currency, create inflation or lead to economic meltdown.
What else does it say?
That governments should use their fiscal budgets to “manage demand and maintain full employment”, says The Economist – that is, tasks now assigned to monetary policy, set by central banks. It also holds that the main constraint on government spending is not the harsh realities of the bond market, but the availability of underused resources, such as jobless workers. Raising spending when the economy is already at capacity can lead to rapid inflation, thus the purpose of taxes is to keep inflation in check. “Spending is the accelerator, taxation the brakes. Fiscal deficits are irrelevant as long as unemployment is low and prices are stable.”
Thus, in the MMT worldview, the established idea that high public debt is a drag on economies, and a burden on future generations, is turned on its head. Proponents argue that, on the contrary, private citizens and businesses tend to do better in countries running high levels of government (or fiscal) debt. Taken to its logical extreme, MMT allows high spending without taxes or borrowing – a truly radical idea sometimes derided as the Magic Money Tree.
Why has Modern Monetary Theory been taken seriously?
Because utopianism is seductive and contagious. Although MMT has been widely attacked by mainstream economists (including well-known left-leaning economists, such as Paul Krugman), its attractions are obvious in terms of funding ambitious spendthrift political programmes – especially given the low-growth environment since the great financial crisis.
Many economists (not just left-wingers) think that a too-conservative, “austerity” approach to deficits has led to needlessly contractionary policies, especially during recessions (for example, in the UK in the early 2010s). At the very least, MMT offers a useful critique of the too-simplistic analogies between government budgets and household finances that dominate public discourse.
And proponents would argue that MMT aligns with empirical observations that have embarrassed orthodox macroeconomics. For example, Japan has sustained very high public debt levels for decades without triggering inflation or a bond-market revolt.
But it is wrong?
Yes. At its heart, MMT stems from “a question that young children often ask”, says Christopher Snowdon in The Spectator. If there are so many poor people in the world, why can’t we print lots of money and give it to them? The answer is that we can. As Alan Greenspan once put it, “there’s nothing to prevent the federal government creating as much money as it wants”.
The trouble is that printing money won’t increase the number of goods and services. It will only make them more expensive thanks to inflation. As the Bank of England ex-chief economist Andy Haldane expressed it, Modern Monetary Theory is not modern (it is a descendent of discredited ideas from the early 20th century), not monetary (it’s a political project) and not a theory (more wishful thinking).
What should investors do?
Not worry too much for now. Most analysts thought that, on the left, the post-Covid inflation spike had killed off MMT for good. On the right, the final nail in the coffin was – ironically enough – the supposedly pro-growth Truss-Kwarteng mini-Budget of 2022, which demonstrated that excessive borrowing can indeed cause financial distress for a country without an international reserve currency.
But investors might want to remain alert for further signs among the leadership of political parties of MMT-style thinking. British politics is in a time of extraordinary flux and the years ahead may well produce unlikely coalitions that would have seemed absurd even a few years ago. In 2017, Jeremy Corbyn’s Labour party won 40% of the popular vote with his plan for “People’s QE” – a first cousin to MMT that proposed printing money to fund direct government investment. MMT is a form of populist thinking that has the potential to be very popular indeed.
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