In this short blog essay I will present my perspective on Modern Monetary Theory or MMT after reading the Deficit Myth by Stephanie Kelton. It’s yet another book in developmental economics that I enjoyed a lot. I just find it interesting to study the wealth of nations and why some nations become prosperous while others do not (I particularly recommend Why Nations Fail). MMT is a novel and very interesting macroeconomic theory, but I am not convinced that it offers a sustainable and progressive alternative to existing paradigms.
What is MMT?#
Modern Monetary Theory is a macroeconomic theory that asserts that countries with monetary sovereignity (countries with full control over their currency and whose currency is held and desired by other central banks and which does not hold large foreign currency debts) like the US, Canada, UK, Japan and China, but not the EU (as member states with fiscal sovereignity do not have monetary sovereignity) and not countries like Pakistan, Chile or Argentina (whose currencies are not generally sought after by other central banks and their own citizens), are not constrained by tax revenues when it comes to government spending.
MMT postulates that governments can spend more than they receive in taxes since they can simply issue more currency to pay for the interest needed for the increase in spending. The resulting inflation can be controlled up to a reasonable degree with increased taxation (additionally it ensures that people use the currency as they have to pay taxes in it). According to MMT the government does not even need to issue bonds and can simply set a 0% interest rate, as inflation can be controlled with taxes.
The problems with MMT#
I see a couple of problems with MMT.
Taxes can only control inflation when the inflation is caused by demand-side inflationary pressure. What happens when the aggregate supply decreases? This happened worldwide during the Covid-pandemic and right after the imperialistic Russian invasion of Ukraine. In both cases the aggregate supply has decreased. There were simply less workers, supply chains were cut, production schedules were shortened. A greater scarcity of fuel lead to higher transportation costs, which lead to everything being more expensive. Raising taxes in this case would not decrease the inflation but worsen it.
The public sector’s deficit is the private sector’s surplus and that is true as given by the accounting identity. But I think the conclusions that people make from the accounting identity can be misleading. The whole economy can be growing even if there is a private sector deficit. When the US government was repaying its debts during the Clinton presidency, it didn’t mean that companies were worse off or that the private sector did not grow. The 2001 recession was caused by the dot-com bubble. Repaying debts has many benefits, including greater confidence in the economy and lower interest rates.
I agree that in times of crisis it’s a good idea to borrow money to stimulate the economy, especially with strategic investments. Economic stimuli in the US post the economic crisis lead to a faster recovery, reduced human suffering and made the US far more competitive. All the while Europe’s austerity lead to a significantly longer recovery, a lot more human suffering and years of economic growth lost. I don’t think that borrowing during times of plenty is a good idea. As explained by Picketty, borrowing largely benefits the affluent, who profit off the interests and the more the state borrows, the more of its future budget will be directly transferred to the affluent.
MMT is in a way a kind of shadowy regressive taxation. The introduction of new currency by a government and note that the amount of currency held by the currency’s users stays constant means that 2% of the economic value has been transferred to the government. But this kind of transfer is regressive as it doesn’t affect the assets of the affluent (whose value would inflate) quite as much as average or penniless household.
Finally, with MMT countries would sooner or later reach unsustainable levels of debt. After a while they would be caught in a vicious cycle of ever increasing inflation and the government having to issue even more currency just to pay the interest or risk a default. Such a country would be in constant danger, because the moment people in and outside the country would loose faith in the currency and begin selling it, the country would be left with very high inflation and crushing debt.
Sources#
- Stephanie Kelton, The Deficit Myth: Modern Monetary Theory
- https://www.socialeurope.eu/modern-monetary-theory-model
- https://www.vox.com/future-perfect/2019/4/16/18251646/modern-monetary-theory-new-moment-explained