There has been a lot of debate recently about a newly popular economic idea called Modern Monetary Theory (MMT). Economists left, right, and centre are issuing think pieces and blog posts about it and it has begun to filter into the public consciousness. Even politicians like Alexandria Ocasio-Cortez have started to mention it in connection to their plans and ideas. While MMT may have gained prominence very recently, it has been rolling around at the fringes of the economics discipline for the better part of three decades. This long history and sudden prominence has caused MMT to have two different personas: the popular conception of it which is focussed around the policy implications, and the harder theoretical version which tries to be more comprehensive. The problem is that what the theory behind MMT argues may make the dreams engendered by the popular myth impossible.
In order to understand just what MMT is and means, it’s important to differentiate the popular conception of MMT from the theory itself. This is necessary with any idea that gains popularity as it pushes its way through the public discourse and morphs and simplifies in the rhetorical filter. Popular discussion around MMT focusses on increasing government spending, not needing to worry about government debt, and “printing money” to finance any debt. These concepts aren’t particularly novel, and the first two at least are not very controversial among economists. The controversy comes in the third and the implications that regularly printing money to finance spending has for the economy. This is also the only element of these three aspects that actually sits firmly within the theory of MMT.
Solving a Non-existent Problem
MMT has developed its popular following in a climate of economic polarisation. Years of austerity in the wake of the 2008 financial crisis has left many progressives bereft and disillusioned with how the state functions and provides services (or doesn’t). Met with the refrain of unaffordability and supposedly necessary restraint in the face of deficits, those who want to introduce new plans are endlessly frustrated by the question of how they will pay for new programs. This has led them to cast about for new answers, outside the system that is throwing up road blocks at every turn. The clear evidence for this is the embracing of MMT by many in the left-wing of the Democratic Party in the US and the Labour Party in the UK—these progressives have had enough of spurious questions about paying for future spending with past revenue and have instead turned to the counter-offer of MMT.
This, unfortunately, is an unnecessary answer to a disingenuous question. Deficit hawks have claimed the high ground, and many progressives are unwilling to challenge them on it—this is a particular failure of economists. As a discipline, we have allowed spurious positions about deficits to become accepted wisdom within the commentariat and in so doing have paved the way for the emergence of MMT.
Deficits are not inherently a bad thing. Government spending, when directed at productive investments and public programs (such as health care, child care, social assistance, and pensions) actually contributes to economic growth and expands both the wealth of society and the potential future tax base. Productive government spending allows an economy to effectively grow out of its debt. This is why economists talk about the debt-to-GDP ratio rather than the numerical size of the debt. As long as GDP is growing (or will grow) at a faster rate than the debt, this ratio will shrink and the overall debt load is reduced.
The important point here is that debt in and of itself is not a problem for a government. In theory, a government could borrow more money to repay previous debt and end up with the same debt load. Where debt becomes an issue is in terms of interest payments, these payments are new spending that needs to happen and if these necessary payments grow too fast they can force governments to cut in other places to free up enough budget room to pay the interest. So long as the economy grows and the tax base is expanding, these choices never need to be made.
Ultimately, there exists within current economic models all the justification for deficit spending on programs and policies that promote social welfare and redistribution; the problem is the way public discourse on the issue has moved and the unwillingness of those with the ability to challenge this false consensus against deficits. MMT is not the solution to this problem; the details of the theory behind it actually make it into a larger problem.
A Fiscal Sleight-of-Hand
The theory behind MMT makes several assumptions about the way the economy works and how policy should be implemented. At its core, MMT argues that interest rates should be kept at zero—effectively creating a permanent situation where monetary policy is not useable. This facilitates the idea that money can be printed to finance government spending (basically quantitative easing on steroids). MMT makes the case that so long as national debt is borrowed in domestic currency, new currency can always be printed to cover that debt and so there is no debt ceiling or fiscal constraint on government. This is the aspect that many policy advocates latch onto. The more important aspect is how this assertion interacts with the way MMT addresses inflation.
Inflation still exists in an MMT economy, its theorists accept the premise that both government spending and money creation can be inflationary but rather than the traditional controls that a central bank employs to contain inflation MMT suggests the use of taxation. The theory behind this seems simple: inflation is caused because there is too much money in circulation, therefore we need to take money out of circulation and taxes need to be paid to the government, thus we can increase taxes and take excess money out of the system.
The acceptance of inflation by MMT theorists and the claim that there is no fiscal constraint on the government are fundamentally inconsistent. A fiscal constraint does in fact exist in the MMT economy; it is just hidden by a subtle sleight-of-hand. The fiscal constraint is inherent in the inflation generated within the system: in the MMT economy if the government spends too much or prints too much money, inflation will increase, the solution is to either increase taxes or reduce spending/printing. This puts an implicit limit on government spending/printing by forcing the government to make the same choice a government in a non-MMT economy would need to make: increase taxes or decrease spending. MMT seems to define away the issue of fiscal constraints but ends up bringing them back, with reduced functionality, as “inflation controls”.
This is a more serious problem because taxation is not a very good tool to control inflation. The tax code is complex and involves many different moving parts; it’s not as simple as just changing one baseline figure. Added to this is the subtlety inherent in inflation control—the changes the central banks usually deal with are in the range of 1-2% or less. The ability of changes in tax policy to create such fine-tuned adjustments is suspect at best and the length of time they take to filter through the system makes quick responses difficult. The frequency of these changes is baked into the MMT system as well, in order to maintain constant inflation taxes will need to change every time government spending changes. The frequency of very small changes to tax rates to deal with small amounts of inflation is a problematic approach to economic management and would significantly undermine the ability of people to be certain about future tax rates. This issue is further aggravated by the fact that inflation can be caused by more things than just government spending or money creation. Price levels can increase because of expectations or other economic shocks and taxation has a much greater impact on the economy than just inflation—it shifts spending patterns, work choices, and much else within the system. Upending all these other equilibria in order to tackle inflation would be highly disruptive to economic stability. All the important points of which taxes to change, how frequently, and by how much are largely left unanswered by MMT and this leaves the question of its inflation targeting tool open to serious doubt.
No Taxation without Inflation?
Inflation adjustment through taxation may seem arcane and esoteric but it is actually a serious problem with the overall program offered by MMT. Despite claims about a job guarantee anchoring inflation, taxation and spending adjustment would remain the primary tool for inflation management. There is no reason to expect that the idea of a job guarantee with arbitrarily low wages would do much to supress inflation since most of the wage pressure on core inflation comes from wage growth in bands above the minimum wage. With such a structure to deal with inflation it seems likely that the host of spending policies would not be as feasible as expected under such a system. Large increases in spending for social programs would need to be countered by significant increases in taxation in order to control the inflation caused by the printing of money to cover the spending. There is potential that this could negate any possible benefits from such programs.
Added to this is the threat of non-spending based inflation crowding out the government’s ability to spend on programs is a long term problem. If inflation spikes for reasons other than increased printing due to spending, the government will have to either cut spending (and printing) or increase taxes in order to keep inflation under control. This means that government spending is subject to economic fluctuations beyond its control that can influence inflation and creates a crowding out of government spending by inflation. Such a relationship between spending and inflation for a government could have long term negative consequences for public services if governments find themselves in an inflationary crisis and needing to reign in printing fast. The slow trickle down of tax policy changes means that the first stop of governments in a crisis would be to slash the budget.
Finally, in a worst case scenario, there is a limit to what you can tax to pull money out of the system. In a slower burning inflationary crisis where tax policy could possibly be more effective, there is an upper-bound on how much you can tax the population before the economy suffers significant adverse demand and production consequences. The possibility of reaching such an upper-bound is not beyond the realm of possibility—the stagflation crisis of the 1970s is one recent example. It is likely that under MMT, a policy prescription similar to that proposed by conservatives in the 1980s would have been implemented, though with one modification. Governments under MMT would have needed to both slash spending and raise taxes, two policies which would have caused significant economic pain.
MMT offers itself as a solution to the supposed limits to government spending. It does this largely by obfuscating the hard limits its theory imposes on that same spending. The promise of MMT to progressive activists has always been the opportunity to use this supposed lack of a limit on government spending to cover proposed social programs. Under an MMT structure, significant increases in taxation would be needed to contain the resulting inflation from the printing of money to finance them. Ironically, this outcome is the exact charge falsely levelled against these programs by deficit hawks currently. We can currently afford to implement many of these proposed programs, the claims of the deficit hawks against productive government spending should be ignored and progressives should push forward with policies that will help people and, by extension, economic growth. As I’ve written before , now is the time for bold policy choices to help people through difficult circumstances; but these ideas are possible without MMT—we need to resist the deficit hawks and push for spending that helps the economy. The cruel twist of MMT is that what is currently not true about deficits and public spending would become reality under its auspices.