Night School: Modern Monetary Theory

Why, you might ask, is Clean Yield writing about an arcane economic theory in the midst of a pandemic and economic implosion? We were already planning to write about it due to its emergence as part of the progressive agenda to pay for Medicare for All and the Green New Deal. Now, with the Federal Reserve injecting trillions of dollars into the economy via asset purchases and the federal government spending trillions more to prop up the economy, it’s more important than ever to consider alternatives to conventional economic theory.  

On the off chance that you have been reading about anything other than the coronavirus pandemic, you may have seen mention of Modern Monetary Theory (MMT), an unorthodox economic theory that has gained traction in progressive circles.  MMT has had only a handful of academic proponents over the past two decades. Few of us had heard of it until prominent political progressives—notably Alexandria Ocasio-Cortez—embraced it as a proposed means to pay for the vast spending required by the Green New Deal and Medicare for All.

The essence of MMT is that a government that borrows in its own currency can never have too much debt. The government spends to implement its policies, then simply prints enough money to pay for them. This is enticing, especially now that the U.S. government has the most debt relative to the size of the economy since the end of World War II. And more debt is piling up, as the government is already spending several trillion dollars to try to bail out key sectors of the economy.

The obvious constraint that even MMT proponents concede is that a huge influx of money to the economy would, at some point, lead to price inflation. Inflation has been classically described as “too much money chasing too few goods.”

For more than a century, controlling inflation has been the responsibility of the Federal Reserve. The Fed is charged with providing a stable currency, maintaining order in the financial system, ensuring moderate price inflation, and acting as the lender of last resort in a crisis. The Fed typically manipulates the key short-term interest rate (the fed funds rate) to contain inflation or stimulate economic activity. To tamp down an overheated economy and the potential for increased inflation, the Fed raises the rate to reduce the incentive to borrow and spend. To spark a recovery in a sluggish economy, it slashes the rate to induce more borrowing and spending.

Not so under MMT. The Fed would no longer control interest rates. Instead, the Fed would set the key short-term interest rate at close to zero and leave it there, regardless of economic conditions.

Federal government spending would be based on policy priorities, and the necessary money would be created out of thin air (“printed”) by the process of the government’s spending dollars on goods and services. When the government writes a check to a contractor to help build the high-speed rail system of the future (we can dream, right?), the money supply expands.

The role of controlling inflation would shift to Congress through setting fiscal policy (taxing and spending). That’s the rub. Under MMT, when the economy is overheated and resource scarcity forces prices up, Congress would have to identify the threat from inflation and act in a timely manner by cutting spending or raising taxes to suck money from the economy. We think this is a flaw in how one might implement MMT, as there is perennially little appetite for raising taxes or cutting spending in the halls of Congress.

In a key sense, MMT is consistent with classical Keynesian theory. Back in the 1930s, renowned British economist John Maynard Keynes devised a comprehensive theory to describe the workings of the financial and economic realms. A key policy, devised to pull the world out of the Great Depression, was that governments should borrow and spend as needed to pump up spending in bad times. Conversely, governments should run budget surpluses (from surging tax revenue) during good times. It’s good in theory, but Keynesian economics hasn’t worked well in practice. We know why: As noted above, Congress isn’t a fan of spending restraint or raising taxes.

Another risk from MMT seems to be the assumption that because the U.S. issues its own currency, it is not vulnerable to international constraints. Foreigners, however, already own about 40% of U.S. government marketable debt. With the current system of floating exchange rates, which are determined by the market, if foreign owners lose confidence in the financial soundness of the U.S., they are likely to sell U.S. investments and withdraw their money by selling dollars and buying foreign currencies. This would drive down the value of the dollar and increase the prices of imported goods. Inflationary pressure would intensify, which would require Congress to raise taxes further, etc. You get the point.

We are intrigued by MMT as an economic theory that challenges orthodoxy and offers fresh perspectives. But we are wary of its promise of nearly limitless government spending without consequence. Hundreds of years of history have shown that printing money to solve a country’s problems is a risky endeavor.