Modern Monetary Theory: Fiscal Miracle or Economic Disaster?Submitted by Reby Advisors | Certified Financial Planners | Danbury, CT on October 1st, 2020
By Devone McLeod, CFP®, October 1, 2020
Modern Monetary Theory, or MMT, has received a lot of attention over the past few years. The reason? It’s turning conventional economic policy on its head.
Some economists argue that Modern Monetary Theory offers hope of a more prosperous America where everyone who wants a job has one and the government has the resources required to solve the challenges of our time. Critics of the theory insist that it’s a utopian, pie-in-the-sky fantasy that would destroy our currency and lead to economic misery.
So, what is MMT? And… would it result in a fiscal miracle or an economic disaster?
Here’s an explanation of MMT, why it’s become a hot topic, and the arguments for and against this controversial economic theory.
MMT presents a significant departure from traditional economic views. The theory essentially proposes that governments which control their own currency should spend freely without considering budget deficits, since the government can always create more money to pay off debts in the future.
Moreover, MMT proposes that government spending can grow the economy to full capacity, eliminate unemployment, enrich the private sector, and finance major programs like free university tuition, green energy, and universal healthcare.
The emphasis on fiscal policy – government spending and taxation – shifts macroeconomic management from the Federal Reserve to the Legislative and Executive branches of government.
The Economists Behind Modern Monetary Theory
MMT’s origins date back to the early 1900s, when German economist Georg Friedrich Knapp introduced the concept of chartalism, arguing that the government can print paper money and make it valuable simply by recognizing it as legal tender and accepting it at public pay offices – a departure from the prevailing belief at the time that the value of any currency is linked to gold and other commodities.
Modern U.S. economists such as Warren Mosler, L. Randall Wray, Stephanie Kelton, and Bill Mitchell revived chartalism in recent decades, applied it to our current economic system, and ultimately arrived at what we now call Modern Monetary Theory. As the theory gained support on blogs and social media, mainstream publications and political figures took notice.
Even Federal Reserve Chairman Alan Greenspan admitted to the House of Representatives in 2005 that pay-as-you-go benefits aren’t insecure since “there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.”
Today, many U.S. politicians including Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez have advocated for adoption of MMT to fund large government spending programs.
In the United States, the Federal Reserve has a mandate "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."
The Fed carries out this monetary policy by buying or selling government bonds, modifying interest rates, regulating foreign exchange rates, and altering the amount of money banks must have on reserve. Currently, the U.S. the government creates programs which are paid for through taxes and debt.
However, many MMT backers have criticized this system as restrictive and prone to creating financial crises:
- Phil Armstrong of York College wrote, “The existence of unemployment is clear de facto evidence that net government spending is too small to move the economy to full employment.”
- L. Randall Wray, in Why Minsky Matters wrote, “A sovereign government can increase its spending - even if that results in a budget deficit - without increasing risk of insolvency and default. In contrast, if private spending leads the way, it will tend to outpace the income of households and firms, meaning that private indebtedness will grow. That is risky and ultimately unsustainable.”
The biggest question MMT proponents get asked is… wouldn’t all that spending create a harmful government deficit?
According to MMT, it wouldn’t.
In fact, the theory holds firmly that the government’s deficit is the private sector’s surplus. The theory proposes government spending won’t create inflation as long as there is unemployed labor or unused economic capacity.
It’s only when an economy reaches natural or physical constraints on productivity that inflation happens, since that’s when the supply of products and services fails to meet the demand, raising prices. MMT proponents suggest that governments can control inflation by simply spending less or withdrawing money from the economy through taxation, when needed.
Here are a few of the reasons MMT advocates praise the theory:
MMT suggests that as long as deficits are not inflationary, governments can and should borrow (through money creation) as much as necessary to reach full employment.
This money creation creates seigniorage, or “profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs.” In other words, if it costs $0.02 to print a one-dollar bill, the government profits by $0.98 when it prints and spends a dollar.
Money creation, according to the theory, only produces inflation when the economy is at full capacity. In a Huffington Post article by economists Kelton, Bernal, and Carlock, they state, “We must give up our obsession with trying to ‘pay for’ everything with new revenue or spending cuts.”
MMT proposes that unemployment is an unnecessary burden. When resources are idle in a recession, increasing the money supply and getting unemployed people back to work doesn’t require any tradeoffs. MMT creates a “free lunch” system to increase output at no cost.
Proponents of MMT point to the period from 2010 to 2019 as supporting evidence. Unemployment decreased significantly and government deficits skyrocketed – without creating problematic inflation.
One of the cruxes of the theory is a jobs guarantee from the Federal Government. In a talk on MMT, Warren Mosler, a pioneer behind the movement, suggests that everyone can have a job since we have no shortage of resources:
“The only thing between us and full employment and prosperity beyond what anyone can imagine, is the space between our ears. There’s nothing else in the way right now. There’s no food shortage. There’s no shortage of housing. We have surpluses of everything.”
Nevertheless, traditional economists have some issues with MMT.
While the proponents of MMT believe it’s the fiscal miracle America needs, many believe it would be a complete disaster.
Here are few of the reasons these economists oppose the theory:
Those against MMT believe the idea that governments can create money whenever it wants to fund spending is misleading. They believe the ability to print money isn’t enough, and that the government relies on actual income through valuable economic output to finance spending.
Nobel Prize-winning economist Paul Krugman, a progressive who often favors the type of big government programs that MMT would be used to pay for, opposes MMT due to the risk of hyperinflation. In his New York Times opinion column, he wrote:
“Do the math, and it becomes clear that any attempt to extract too much from seigniorage - more than a few percent of GDP, probably - leads to an infinite upward spiral in inflation. In effect, the currency is destroyed.”
In the 1970s, inflation significantly devalued bonds here in the United States. Rising prices also erode real investment returns and undermine quality of life.
Though the U.S. has not experienced serious inflation issues of late, inflation is not a relic of the past. World Economic Forum reports that Venezuela’s inflation rate, for example, exceeded 282,000% in March of 2019!
If the Federal Reserve follows the direction of Congress and the White House, it could be accused of corruption or political bias, eroding citizens’ trust in financial regulators. Central banks in Zimbabwe, Venezuela, and Argentina all printed a lot of money to please politicians in recent years, resulting in economic collapse due to hyperinflation.
Opponents of MMT also argue that a bureaucratic government is simply not set up to manage inflation as effectively as an autonomous central bank run by financial experts and economists with a streamlined decision-making process.
How many times has Congress been gridlocked during times of crisis, unable to pass emergency funding or an economic relief bill? Could the economy survive prolonged Legislative indecision as inflation spiraled out of control?
Additionally, increasing taxes to fend off inflation poses major economic risks, especially during periods of stagflation (inflation accompanied by slow or negative growth). Economist Michael R. Strain wrote in a Bloomberg article, “Raising taxes would only make a downturn worse, increasing unemployment and further slowing the economy.”
Printing money in excess could make foreign investors wary of currency volatility, leading them to take their money elsewhere. A selloff of the dollar in Forex markets could rapidly accelerate the devaluation of the currency.
International relations could suffer badly if foreign governments and investors believe U.S. government policy destroyed the value of trillions of dollars of treasuries and bonds purchased over the decades.
To some, Modern Monetary Theory offers a way to unlock the full potential of our economy by eliminating the constraints imposed by a zero-sum mentality and flawed assumptions. To others, it’s an economic disaster in the making.
Is there a middle ground?
Some might contend that we’re already implementing MMT: The national debt now exceeds annual economic production, neither political party has presented a balanced budget proposal, and yet inflation remains minimal. On the flipside, we cannot know the future consequences of our current deficits or how much worse those ramifications may be if we remove limits.
What can we do to prepare as the debate over government fiscal policy plays out? Revisit your financial plan and investment strategy.
Reby Advisors always strives to protect client wealth from rising prices, taxes, and economic volatility. Our mission is to help you achieve your lifestyle goals. If you need financial advice, please do not hesitate to contact us.