What is Modern Monetary Theory? Here's a Primer on the Biden Administration's New Progressiv
Modern Monetary Theory (MMT) is the macroeconomic theory being used to justify the levels of spending that would be required to support the policy programs of Elizabeth Warren, Bernie Sanders, and the Green New Deal, and it lies in stark contrast to traditional understanding of monetary economics. Nevertheless, it’s all the rage among those who see a new dawn for increased government spending, even as the national debt reaches the highest levels it’s ever been.
MMT isn’t really a new set of strategies, but rather a new way of interpreting how the economy works, particularly with regard to monetary policy and government spending. While MMT is generally regarded as a misinterpretation of both the goals and outcomes of monetary and fiscal policy, panned by everyone from Paul Krugman to Larry Summers, it has increasing appeal among ambitious progressives.
What is the Premise of MMT, and How is it Different from Traditional Monetary Theory?
MMT challenges the traditional view that governments must pay for their spending through taxation and debt insurance, instead positing that in a "fiat currency" condition, governments can pay for their spending merely by printing more money, with taxes a tool to limit resulting inflation by keeping the money supply constant.
While traditional approaches to monetary policy prioritize the maintenance of a stable currency and stable interest rates to incentivize investment in the economy (supply-side economics), thus challenging government spending to conform in a non-disruptive way to the economy (like a budget paid for through an equivalent amount of taxes), advocates of MMT argue that maximizing government spending should be at the top of the priority. To them, monetary concepts like interest rates and the value of currency can be effectively manipulated to accommodate more spending, and taxes are a mere tool for managing future inflation.
To say it a bit more succinctly, in a traditional reading of our economy, massive spending is seen as a problem because it risks destabilizing the otherwise stable forces that power growth in our economy. Under MMT, however, spending is reinterpreted as the foremost tool for growing the economy, with those other forces ancillary to make that spending possible.
Because even this simplified explanation is still complicated, let’s compare the traditional approach to money with the approach suggested by MMT in a more step-by-step fashion.
In a traditional reading of our economy, the roles of monetary policy and fiscal policy are separate and distinct.
Traditional Monetary Policy:
Traditional monetary policy, which is set by the Federal Reserve, prioritizes maintaining a stable dollar and stable borrowing and investing opportunities through the gradual manipulation of interest rates.
The stability of the dollar and interest rates helps protect the government by giving people the confidence to lend the government money at low relative interest rates.
The stability of the dollar and interest rates helps propel the private sector by setting rates at appropriate levels to drive liquidity into the marketplace, which in turn helps drive full employment.
The stability of the dollar and interest rates helps protect American citizens by ensuring their nest eggs won’t disappear due to inflation or runaway rates, regardless of where they are invested.
Traditional Fiscal Policy:
Fiscal policy, by contrast, is managed by the Congress and the US Treasury, and prioritizes balancing the amount the government spends with the amount that is taken in via taxes, much like balancing a checkbook.
When the government spends more than it takes in, fiscal policy also involves the borrowing necessary to sustain the deficit spending. Because the currency is stable, such borrowing can happen at low rates.
The traditional treatment of these forces preserves stability in the currency and for investors, protecting the next eggs of American citizens. It also challenges Congress to spend within its means. Both offer challenges to progressives, who would like the government to spend more and more easily, and who frequently view the growing nest eggs of American citizens as the primary source of relative inequality.
While traditional approaches to monetary and fiscal policy are designed to protect the stability of Americans’ nest eggs and investments against inflation and volatility by squeezing government spending to be as consistent as possible with government revenues, those who subscribe to MMT invert that pyramid, believing they can effectively manipulate tools like inflation and taxation to accommodate any amount of spending they like.
So How Does it Really Work?
A radical theory, MMT challenges the traditional view that governments must pay for their spending through taxation and debt insurance, instead positing that governments can pay for their spending merely by printing more money. Predictably the brainchild of those looking for a way to justify greater spending, MMT has many radical elements:
Modern Monetary Theory views spending not as an expenditure to be weighed and limited against government revenues like a checkbook, but as something limitless that is a nation’s foremost tool for achieving full employment. Its protection becomes the primary goal of monetary policy.
In turn, Modern Monetary Theory views taxes not as a front-end tool to fund the government, as traditional theory suggests, but as a back-end tool to curb inflation that may result from exorbitant government spending.
In its implementation, Modern Monetary Theory integrates fiscal policy and monetary policy to create a new pathway to pay for higher levels of government spending by drawing down the bank accounts of American citizens through inflation and taxation, rather than paying for that spending through foreign borrowing.
MMT reimagines both the Fed and the Treasury by integrating their missions to facilitate any amount of government spending as a first priority, using the tools of the Federal Reserve as a way to accommodate that spending.
MMT’s Combined Monetary and Fiscal Policy:
The obligations of the Federal Reserve and the Treasury will both be re-imagined to protect and promote high levels of government spending through the printing of as much money as is needed to sustain spending.
Government spending is used to fund programs that support full employment of the citizenry.
The increased levels of money in circulation will lead to inflation, hyer-inflation, and rising interest rates.
Inflation, in turn, shrinks people’s savings, in effect sapping those savings to pay for the original spending.
High levels of taxation will be deployed to reduce the money supply to draw down inflation.
The theory posits that the US can spend as much as it wants to by eternally printing more money to pay for that spending. While the printing of money will drive runaway inflation, MMT posits that inflation can be managed through taxation to reduce the money supply.
Why is MMT so Risky?
For traditional Americans, the greatest risk of traditional monetary and fiscal policy is that the interest payments on America’s national debt will gradually eat into our ability to provide public services from our federal coffers. Because the currency is stable, however, nest eggs are protected and the scale of those debt payments is limited by the fact that at least the country is able to borrow at low rates.
The greatest risk of Modern Monetary Theory for American citizens is that runway inflation will decimate the value of your nest egg. Or, alternatively, that the ever-higher taxes needed to curb that inflation will eat into your nest egg just the same.
There is no such thing as a free lunch. In both cases Americans will pay for the costs of government spending. The difference is who will pay for it. Under the traditional approach, government spending will be necessarily limited as interest payments on our debt comprise an ever-greater share of how much the government spends. This will influence government spending, but it shouldn’t much impact the nest eggs of individual American citizens.
MMT, by contrast, protects the spending as its foremost priority, using monetary tools creatively to slowly sap money from the citizens by reducing the value of their investments, first through the subtle reductions of inflation, and later through the heavy hand of taxes as a tool to combat that inflation. The MMT approach is designed to shrink the wealth gap by sapping the wealth Americans already hold through inflation and transfer that wealth to an ever-increasing pot of government expenditures that they can direct in whatever direction they choose. Under the traditional use of monetary policy, Americans will continue to grow an ever-greater share of the national wealth. Under MMT, that share will shrink, while the government’s share will be protected and grow in perpetuity.
There is one additional difference, as neither traditional monetary approaches nor the MMT approach ultimately will shrink the amount America borrows. Because traditional monetary theory prioritizes keeping the currency stable, America should be able to continue to borrow for low rates. Under MMT, by contrast, wild oscillations in the currency will by consequence cause other countries to lend us money only at ever increasing rates. The result will be an ever-greater debt burden we will all shoulder for generations.
Venezuela and Zimbabwe are examples of countries that tested the limits of exorbitant spending funded by printing money. Predictably, in both cases each country experienced runway inflation that indeed sapped the wealth of its citizens. When private wealth became worthless, so too did the value of their tax revenues, which in turn killed the spending plans. The resulting bread lines and destitution are testament to the inevitable failure of this approach.