Modern Monetary Theory (MMT)
Modern Monetary Theory (MMT) is a relatively new macroeconomic theory in the field of monetary economics. The theory emphasizes the role of the government in managing the economy and the use of government spending and taxation as the primary tools for achieving economic goals. Governments that have a sovereign currency are not constrained constrained by tax revenues for their spending.
According to MMT:
- taxation is not to finance spending but rather to regulate aggregate demand in the economy and avoid deflation.
- government borrowing is not to finance government spending, but to absorb excess money from the economy and avoid inflation.
On this page, we provide a short primer Modern Monetary Theory. We discuss the primary mechanism and how MMT can be used to solve some pending issues.
What is Modern Monetary Theory?
Modern Monetary Theory (MMT) is discussed in the context of policy debates of whether governments should focus on limiting budget deficits. Modern Monetary Theorists argue that budget deficits are not as harmful as many traditional economists argue.
In fact, MMT argues that government debt is money created by the government that has not been taken back using taxes. Thus, the government could increase the money supply by issuing additional debt or just printing money as the two are equivalent. The money collected with issuing debt (or printed) can then be used to pay for government programs such as health care or to fight climate change. The increase in government debt, MMT argues is not a big problem. Many developed countries have government debt levels far higher than what they currently are, without adverse effects.
The only limit a government has, is the resources in a country. But if growth is too high and too many projects require the same inputs, inflation can go up. At that point, MMT argues that the government can take the excess money back out of the economy. To do this, the government can increase taxes. This is a very unconventional way at looking at taxes. Rather than collecting taxes to pay for projects (infrastructure, national defence,…), taxes would be used as a monetary policy instrument.
With the basics of Modern Monetary Theory explained, we now to turn to some of the criticisms.
Criticisms to MMT
There are at least three main criticisms of Modern Monetary Theory:
- Inflation: under MMT politicians are in charge of the money supply. When it becomes necessary to increase taxes, politicians may be unwilling to do so. If the fiscal policy is not carefully managed, this can lead to inflation.
- Complexity: MMT can be complex and may be difficult to communicate to the public or implement in practice. There may be considerable lags between the time a decision is taken and when it impacts the real economy.
- Political feasibility: Some critics argue that MMT may be politically infeasible, as it may be difficult to convince the public or policymakers to support increased government spending or deficits.
Advantages of MMT
The advantages of MMT include:
- Increased flexibility: the government can use fiscal policy more flexibly in order to achieve economic goals, such as full employment and price stability.
- Greater focus on outcomes: MMT emphasizes the importance of outcomes, such as employment and inflation, rather than the size of the budget deficit or the level of government debt.
- Potential to address inequality: the government can play a role in addressing inequality and promoting social welfare, and can use fiscal policy to achieve these goals.
Summary
We explained Modern Monetary Theory (MMT), a heterodox monetary theory first proposed by Warren Mosler in the 1990s. The theory has been gaining traction but many implications of such an approach are still unclear.