What is Modern Monetary Theory? Understanding the alternative economic theory that's becoming more mainstream
- Modern Monetary Theory is an alternative economic theory that suggests the US government can create more money.
- Modern Monetary Theory claims that because the government is the issuer of money, it can create more since it's no longer backed by gold.
- Proponents think Modern Monetary Theory can counter many economic problems, while opponents fear inflation and increased deficits.
Modern Monetary Theory (
Instead of relying on tax revenue or borrowing to support federal government spending, according to MMT supporters, the government can simply create more money instead. This is a big departure from how many economists think about government spending and has become a popular alternative theory as discussions about debt and government spending hit the national stage.
Understanding Modern Monetary Theory
The term "Modern Monetary Theory" was originally coined by Bill Mitchell, an Australian economist, and has become more mainstream over the past few years with politicians like Alexandra Ocasio-Cortez popularizing the concept.
"The whole idea of MMT is that since a sovereign entity can borrow in its own currency, it can print more money when it needs to pay off all its debt. The central bank just needs to keep interest rates low," says Robert R. Johnson, professor of finance at the Heider College of Business at Creighton University.
MMT is essentially a paradigm shift when it comes to economic theory and a new way of thinking about governments with fiat currencies.
Quick tip: Fiat currency is money that is issued by a government authority that isn't backed by a particular commodity such as gold. The US has fiat currency that is issued by the government and is considered legal tender, which is used to exchange value in the form of money.
"In essence, governments like the US, Japan, the UK, and Canada that use fiat currencies are not constrained by their tax revenues when it comes to government spending and can perpetually run a budget deficit. This is due to the fact that the central banks in these counties have a monopoly on the supply of money," explains Ryan Cullen, CEO and founder of Cullen Investment Group.
This differs from the way things used to be with the Bretton Woods System, which started in 1944 and ended with Nixon in 1971. According to FederalReserveHistory.org, the system became operational in 1958 and pegged currencies to the dollar, which were backed by gold.
"This is opposed to when the USD was on the gold standard and we had a fixed number of dollars in circulation based on the amount of gold we had in vaults," notes Cullen. "This was an archaic form of monetary policy because governments with full control of their money supply do not need to confine themselves to a traditional household budget that manages revenues and expenses, because they essentially have an AMEX black card of unlimited money that they do not have to pay back."
Quick Tip: Learn more about the Bretton Woods System and the "gold standard" as part of Federal Reserve History.
Main tenets of Modern Monetary Theory
The main tenets of Modern Monetary Theory are:
- Government deficits aren't inherently bad. According to the MMT theory, deficits don't matter as much as we think they do and aren't necessarily a signal of a shaky
economy. If the government can simply create more money, then the government deficits can be easily fixed. This concept is a hallmark of MMT and one of the most controversial aspects of the theory.
- Governments can create more money without threat of economic collapse. Given the fact that money is no longer backed by gold and is more theoretical in the sense it can be created at any time, many MMT supporters believe that money can be created without tanking the economy. In 2005, former Federal Reserve Chairman, Alan Greenspan, followed that line of thought: "There's nothing to prevent the federal government creating as much money as it wants."
- Because the government is the creator of the currency, it doesn't need to adhere to the same individual budgeting principles. As individuals we know that our expenses shouldn't exceed our income or it'll lead to debt. Proponents of MMT say that the government doesn't need to abide by such standards since it's also the creator of the money and theoretically can create more.
- A federal jobs guarantee program is possible. Again, given the core tenet that the government can create more money, MMT theorists support the idea of a federal job guarantee as a way to stabilize the economy and put money toward human capital.
- The Federal Interest rate should be at 0%. Many MMT supporters believe that the "natural rate of interest is zero" and there should be no bond sales. On top of that, MMT supporters want to do away with the increasing and lowering of interest rates as they're ultimately not that relevant when it comes to growth and long-term business decisions.
Quick Tip: To learn more about Modern Monetary Theory, you can check out episode 866 of the podcast Planet Money.
Brief history of MMT
- The term "Modern Monetary Theory" was coined by Australian economist Bill Mitchell in the early 90s, however some of the ideas are based on earlier themes in Keynesian economics.
- Ideas around MMT were developed by economists Bill Mitchell, Warren Mosler, and L. Randall Wray as early as 1992 through email listservs.
- In 2019, politician Alexandria Ocasio-Cortez noted that MMT should be a "a larger part of our conversation" as it relates to balancing the federal budget.
- As of 2020/2021 during the pandemic, MMT has grown in popularity and has become more mainstream.
Concerns over Modern Monetary Theory
On the surface, outsiders and those with more traditional beliefs may think that Modern Monetary Theory seems like an idealistic solution to growing economic problems. Though the theory is increasing in popularity, there are also many skeptics and opponents of the theory as well. "It was originally a kind of cult in macroeconomics, it's still somewhat of a cult, except that it's entered the popular press. Basically, what it is is late 1940s Keynesian economics with a wacky theory of money creation tacked onto it," says Mark Kuperberg, professor of economics at Swarthmore.
The primary criticisms and concerns over MMT include:
- Increased inflation. One of the chief concerns of MMT is widespread inflation, though MMT supporters have looked at instances such as the financial crisis, which led to lots of government spending and didn't result in inflation. However, this theory shouldn't set a precedent, as all other factors are not the same and one of the primary indicators of inflation - economic scarcity - has not been part of the equation.
- More deficits. Given the core beliefs of MMT, if implemented, it could lead to even higher deficits. While that isn't a concern for MMT proponents, it's concerning for others, like Nobel Prize winner Paul Krugman, who think that lending and interest rates may be compromised and cause inflation.
- Examples in Venezuela, Zimbabwe, Germany, and more have shown potential downsides, destruction, and hyperinflation. According to the Brookings Institution, previous historical examples show clearly that creating more money can lead to hyperinflation and unrest.
Though inflation is a big concern, there are other ways to manage government spending and taxation to deal with it.
"The government can essentially print as much money as it would like to fund essential services and programs and also stimulate the economy, and when inflation rises to an undesired level, you can increase taxes to bring inflation back down to your target rate," says Cullen. "It's sort of a seesaw because the government can add money to the money supply when needed, then tax more to take that money back out of circulation and decrease inflation."
In regards to concerns about MMT theories being put in place and having similar results as other countries, that might not be an apples-to-apples comparison, and there's more to the equation to consider.
"The United States is not Venezuela … the US government borrows a lot of money. About a third of the borrowing is from foreigners … it's not a problem in the way that, let's say, if Venezuela borrowed from foreigners, or Argentina, or a lot of developing and less-developed countries," explains Kuperberg. "Because those countries, when they borrow from foreigners, borrow in dollars. They can't print the dollars. So if their currency starts to depreciate against the dollar for whatever reason, it becomes almost impossible for them to pay off their debt. The MMT people totally understand this and they say that for a country that borrows in its own currency, this is not a problem, and they're right."
So while historical examples of hyperinflation and unrest can give us a glimpse into what might happen with MMT policies, it's important to consider all relevant factors and unique considerations with the US government.
Another concern of MMT is the potential transfer of wealth from everyday people to the one percent if the theory turned into actual policy with real-world ramifications.
"Modern monetary policy is the most effective way to transfer wealth from the working class to the elite. When more money is created it generally goes directly to the largest investment banks, which have the closest relationship with the central bank and the Treasury Department," says Shaun Heng, vice president of operations at CoinMarketCap. "This means that the wealth of the working class, generally stored in cash or bank accounts, loses its purchasing power. Meanwhile the purchasing power of investment banks grows exponentially."
Modern Monetary Theory and investing
MMT policies could have ramifications on investments as well. It could potentially lead to an increase in inflation that could affect investments and lower the overall value. On top of that, it may lead to higher stock prices, which could make it more difficult to get into the market if you have limited means.
According to Heng, MMT-related policies are contributing to the growth of cryptocurrency trading as well.
MMT-related policy "is one of the things driving growth in cryptocurrency. There have been a variety of programs that go hand in hand with MMT," notes Heng. "The first is the Troubled Asset Relief Program (TARP), which was one of the tools used in the bank bailout following the recent financial crisis. The other is quantitative easing. All of these programs have devalued many assets linked to dollars and have caused many to invest in cryptocurrency."
On top of affecting retail investors, MMT policies would also potentially affect private investment as well, according to Johnson.
"One of the consequences of MMT would be that government spending and debt would rise, and this would crowd out private investment," explains Johnson. "Many advocates of MMT in Congress, like AOC, would use MMT to fund wide-reaching proposals like Medicare for All, Free College, and the Green New Deal. The biggest problem is that citizens ultimately have to eventually pay for these proposals via either higher taxes or by suffering inflation."
Readings related to Modern Monetary Theory
There have been a number of books published on MMT that can offer more background and a deeper look into the theories.
- "Macroeconomics" by William Mitchell, L. Randall Wray, and Martin Watts, which is a 604-page textbook based on MMT theories and its predecessors.
- "Soft Currency Economics II" by American economist, Warren Mosler, who is one of the founders of MMT. The book is often noted as a seminal text in the MMT movement.
- "The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy" by Stephanie Kelton, Bernie Sanders' former economic adviser, tackles MMT and why government deficits aren't as bad as we think.
The financial takeaway
Modern Monetary Theory is still on the fringes of economic thought but is becoming more mainstream. The theory is still just that - a theory - but with a growing number of proponents and opponents on each side.
Either way, there are potential real-world ramifications for the economy and investors alike to be aware of if the theory is put to the test.
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