Modern Monetary Theory (MMT) is a contemporary, increasingly fashionable, heterodox doctrine of economic thought. It is captivating many on the political left, who consider that traditional macroeconomic frameworks have been found wanting, especially in the aftermath of the 2008 Global Financial Crisis.
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Modern Monetary Theory (MMT) is a contemporary, increasingly fashionable, heterodox doctrine of economic thought. It is captivating many on the political left, who consider that traditional macroeconomic frameworks have been found wanting, especially in the aftermath of the 2008 Global Financial Crisis.
Much like early-1980s Laffer Curve ‘supply-siders’, MMT’s disciples are often near-messianic in tone, while somewhat vague in exposition. Today, some of the most vocal proselytisers of MMT include Warren Mosler, Randall Wray, Stephanie Kelton, Bill Mitchell and Pavlina Tcherneva. They are prone to presenting their ideas as a pathbreaking, revolutionary, approach to economic analysis and management, that can free policymakers from the shackles of fiscal and monetary orthodoxy.
What is MMT?
The essential elements of MMT can be summarised as follows:
• A government that creates its own money generally need not, and will not, default on debt denominated in its own currency.
• A government deficit is necessarily mirrored by an equivalent private sector surplus.
• Monetary policy is relatively ineffective in a slump: fiscal policy is more powerful.
• A government can buy goods and services without the need to collect taxes or issue debt.
• Through money creation, interest costs can be constrained. Indeed, a substantial and persistent budget deficit can be financed at low, if not near-zero, cost.
• Government spending and money creation need be limited only to the extent that employment becomes ‘over-full’ and encourages inflation.
• Inflation, should it arise, can readily be controlled by higher taxation and bond issuance to remove excess liquidity.
Thus, the core inference and contention of MMT is that the budget deficit and public sector indebtedness should be allowed to adjust to the level necessary to secure full employment. This goal should be achieved through a government-sponsored blanket jobs guarantee, which would act as an automatic stabiliser. When private sector jobs were plentiful, government spending on the guarantee would be lower, and vice versa. Alternatively, full employment could be achieved by large-scale spending on infrastructure, climate change, and the environment, such as via a ‘Green New Deal’ – all financed, if necessary, by the central bank.
Nothing New Under the Sun
The truth about MMT is more complicated and less trailblazing than its supporters suggest. Closer inspection reveals a methodology that has its roots firmly in the past, and in particular in early 20th century ‘chartalism’, initial Keynesian thinking and the ‘Functional Finance’ gospel preached by Abba Lerner in the late 1930s and 1940s.
Whatever its intellectual heritage, MMT is little more than an expression of a macroeconomic judgement and a political reality. High unemployment and excessive inflation are ills best avoided, and which almost all politicians want to minimise. Hence, government policy should prioritise their prevention. In the process, policymakers may need, in extremis, to be inventive in how they combine monetary and fiscal policy to achieve these goals.
Hence, the policy inferences of MMT need to be considered seriously. At the very least, they do not compare unfavourably with calls for fiscal and monetary rectitude that are grounded either in narrow accounting logic or myopic adherence to the quantity theory of money.
The Devil is in the Detail
As always, however, the devil is in the detail. And the cheer-leaders for MMT are inclined to skate over many of the technical and political complexities of their prescriptions. For example:
1. MMT is based implicitly on a closed economy model. It makes no allowance for the possibility of monetary expansion causing the exchange rate to fall rapidly.
2. MMT overlooks the potential for monetary expansion and an extended period of low interest rates to create the conditions for domestic financial instability, excess, and perhaps disaster.
3. MMT’s disciples pay little attention to the structural component of unemployment, which is unlikely to prove responsive to stimulus of demand and, more likely, raise inflation.
4. They say little about the effects on wealth distribution of a reliance on monetary finance.
5. They ignore the fact that interest is regularly paid on the new money that is created in the form of reserves held by the commercial banks at central banks. Hence, even entirely money financed deficits cause public sectors to incur debt
6. They ignore the vexed issue of moral hazard. MMT could at a stroke destroy one of the most important disciplines the market imposes on politicians. And with that discipline swept away, the door is open to irresponsible fiscal policies, and a plethora of crack-pot schemes.
7. Finally, it is inescapable that debt accumulation cannot go on indefinitely. Public sector debt ratios are already historically high. If the average interest rate payable on debt is higher than the economy’s sustainable growth rate, then debt will snowball.
8. Hence, at some point a government would be obliged to run a large enough primary budget surplus to stabilise debt growth. And this could involve dramatic tax increases or public expenditure cuts, which are politically unpalatable, if not impossible, to deliver.
Special Case Rather Than General Theory
At best, the policy prescription of MMT is appropriate only in exceptional situations, where economies are far from full employment, deflationary pressures are in evidence, and interest rates are at the zero bound. In short, MMT is a policy polemic for chronic demand deficiency. And even then, robust checks and balances would need to be put in place before an MMT-inspired remedy could be safely implemented.
What Next?
Even with this more realistic assessment of MMT, there will likely be growing espousal of MMT by the leadership of left-of-centre political parties. Support for MMT will broaden during the next recession. There will be growing backing for blanket job guarantees to address income and wealth inequality. Moreover, we will likely hear more calls for revisions to central bank mandates to facilitate monetary finance. Finally, many will advocate for the application of MMT policy prescriptions without the needed checks and balances.
Authored by John Llewellyn and Russell Jones.
John Llewellyn is the co-founder of Llewellyn Consulting. Before this, he was Global Chief Economist and then Senior Economic Policy Advisor at Lehman Brothers. This followed almost twenty years at the Organisation for Economic Cooperation and Development (OECD) in Paris, where variously he was Head of International Forecasting and Policy Analysis, Editor of the OECD Economic Outlook, Deputy Director for Social Affairs, Manpower and Education, and finally Chef de Cabinet to the Secretary-General. Prior to that he spent nearly ten years at the Faculty of Economics of the University of Cambridge, and he was also a Fellow of St. John’s College.
Russell Jones joined Llewellyn Consulting as a Partner in early 2013, plays a leadership role in the firm’s economic and financial market research, and writes extensively.He has been a macroeconomist in the financial markets for 35 years, occupying senior roles in London, Tokyo, the Middle East, and Sydney, and working on both the ‘buy’ and ‘sell’ sides. He spent ten years at Lehman Brothers, where he was Chief Economist for Asia and Head of Foreign Exchange Research, and for a period was Chief Economist for the Treasury Department of the Abu Dhabi Investment Authority. Most recently, he was Global Head of Fixed Income Strategy at Westpac Institutional Bank, where his team was ranked number one in the analysis of the Australian and New Zealand debt markets.
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