Modern Monetary Theory and its Critics

Modern Monetary Theory and its Critics is a bounded collection of papers and essays on the most talked-about new idea in economics, Modern Monetary Theory (MMT). The collection is a great summation of the various viewpoints of the theory, and on balance leans towards being a critique. 

To question whether MMT is correct or not is to commit what philosophers call a category error; for the term covers not a refutable intellectual theory so much as a theory, a perspective, some policy recommendations and a political movement. MMT’s popularity can be explained by several factors. Alexandria Ocasio Cortez, the populist left-wing U.S. Senator has lent support to the ideas of MMT, and Stephanie Kelton, advisor to the Bernie Sanders’ presidential campaign wrote a popular book on the theory. One idea is that MMT is a pushback against TINA- the idea that There Is No Alternative to the neoliberal Washington consensus that emerged from the collapse of communism. That lack of new policy ideas in the face of rising inequality and public discontent with both the causes and consequences of the 2007-2008 financial crisis created fertile ground for alternative ideas, and much of MMT’s thinking stands up well to the failure of austerity politics. 

So what is MMT? At its core, MMT is the idea that government spending is not limited by taxes or borrowing restrictions in the sense we tend to view it - that of a household budget. MMT contends that the only limit a government faces is on the resources available within a nation - and a direct consequence of this is that if there is involuntary unemployment, a nation is not fully utilising it’s resources, and government can remedy this by spending. 

There are some caveats to this idea. A country must create and use it’s own currency, its government must borrow in that currency, and its exchange rate must be free floating (these conditions are met by the U.S., Britain, Japan, Canada and many more nations). What MMT doesn’t say is that there are no limits to government spending whatsoever, as has been caricatured by critics.

The upshot of this idea is that no government who meets these conditions can ever unwillingly default on its financial obligations. This is obviously, logically true within the restrictions laid out above. If the British government were to decide to borrow £100 billion extra next week, it could create that sum on a computer and proceed without restriction (it is assumed for simplicity that the central bank and treasury are one and the same - this helps get to the heart of the matter; debates around this simplification are somewhat fruitless and  tedious). Equally, if the U.S. Government wished to, it could buy all outstanding government debt (which exists in the form of tradable bonds) overnight, and obliterate it - making the U.S. government debt free. This sounds fanciful, but is merely a logical extension of the Quantitative Easing programme both central banks have carried out on-and-off for over a decade. In QE, the central bank buys bonds on the open market (usually from private banks, pension funds etc), and simply creates the money on a computer screen, transferring it to the account of the recipient. Since a country holds a monopoly on the production of its own currency, there is nothing to theoretically prevent it from creating unlimited quantities. 

This is the basis of MMT. The policy proposals (centring around a job guarantee) that emerge from the theory will be discussed later. Before assessing the theory itself, it may be useful to tackle some of the noise around MMT, which can cloud the debate for non-economists. 

L. Randall Wray, arguably the intellectual leader of MMT, explains why the above description of modern economies is true by way of a historical critique of the origins of money. Rather than emerging as a consequence of barter, money is a consequence of a state’s desire to control economic activity. This view (Chartalism or Neo-Chartalism) contends that money derives its legitimacy from the fact that one has to pay taxes in that particular form of money - that we accept pieces of paper with the Queen’s head on in exchange for real goods because we need pounds sterling to pay the taxman. 

Whilst the historical story itself may be of passing interest to some, it isn’t especially germane to the MMT debate, insofar as to why a currency might be accepted by all in 2020. The legitimacy of dollars or pounds may or may not stem from the authority of the government to tax in that currency; nonetheless that legitimacy can hardly be in doubt at present. Where this origin story may be useful, is in explaining the reason that governments don’t need to tax first and spend later, or indeed that this is not the order of events as is commonly thought. By way of illustration, Randall Wray tells the story of a father who explains to his children that in exchange for washing his car, they will be paid a quantity of business cards. Why, they ask, would they want business cards? Because, he says, in exchange for food and board they must pay him a certain number of cards per week. Thus the desire to obtain the father’s ‘currency’ is derived from his requirement for payment in this currency. 

In addition to historical arguments about the origins of money, the book contains debates which hotly contest whether MMT is truly new or a derivative of post Keynesianism, as well as the significance of theoretically separating treasury and central bank. These are not central to MMT or it’s consequences, and so may be disregarded by non-economists. 

Is MMT correct in it’s assertion that the spending power of the government being only limited by resources? Technically, yes. The problem with this argument is that it is ultimately a simplification used as a tool to influence policy. 

Governments have debt ceilings and spending limits imposed on them by the constitution or by various limits to government power, all of which MMT argues are artificial limits. This is true, but what alternative is there? If, as MMT states, the only real limit is the level of resources in an economy, how may a government know when such a limit has been reached? The answer is inflation. If the British government printed £1 trillion tomorrow, and attempted to spend it in a short space of time, there would be insufficient goods available, and so prices would rise. But inflation is a difficult beast to tame - it is non-linear in it’s reaction to changes in spending, and once inflation takes off, it is difficult to stop. People start to factor expected price rises into wage bargaining, creating a self-perpetuating vehicle of more inflation. Moreover, the level of inflation can only be measured historically, and so any government spending that created inflation will have already happened, making adjustments messy and inexact. 

The framing of government budgets as being like a household budget (‘don’t spend what you don’t have’, ‘don’t borrow what you can’t pay back’ etc) is technically erroneous but socially useful. Firstly, because trust in a currency is a prerequisite for a functioning economy, and the breakdown of this trust would be disastrous (as seen in any country that suffered from hyperinflation). 

Secondly, because to convince a populace that restrictions on spending are artificial is to open the floodgates of irresponsibility in public policy. Proponents of The Green New Deal often cite MMT as ‘how it will be paid for’, allowing for a form of free lunch. One article in this book advocates a ‘Pink New Deal’ to create employment for women using MMT free-spending. The point is that any spending by government should be justifiable on its own merit since it has to be paid for. Whilst there may not be restrictions in nominal money, in real terms all things must be paid for by available resources. The economist Abba Lerner once argued in the presence of Keynes that budgets and deficits don’t matter, and to many people’s surprise Keynes vociferously disagreed. Later that evening Lerner said “Mr Keynes, why don’t we forget all this business of fiscal policy, public debt and all those things, and have some printing presses?”, to which Keynes replied “It’s the art of statesmanship to tell lies, but they must be plausible lies.” This is the crux of the problem with MMT. The restrictions on politicians’ spending are necessary, however technically mistaken those specific restrictions may be. This is evidenced by the fact that during times that maximum resources must be utilised (such as war,  existential financial crises, or global pandemics), politicians disregard those restrictions. 

So we can say that restrictions on government spending are artificial, or we can zoom out and look at the big picture, and see that such restrictions are a necessary component of the social contract. We can however, zoom out a little further, and observe that the populist message of MMT in fact serves its own meta-purpose. Greta Thunberg advocates that we give up on the idea of economic growth in order to save the planet. Giving up on economic growth would cause untold misery to millions of impoverished people, and so one could argue that this is a harmful message. Alternatively, one could say that since such a policy will never be adopted, it’s extreme stance forces corporations and governments part of the way, perhaps far enough to make a real impact. The same argument may hold for MMT. Whilst there may be (thankfully) little prospect of removing all spending restrictions on governments, if the general population understands better that running a deficit will not impoverish our grandchildren, the debate can shift to better policy. The idea of austerity, particularly in Greece after 2007 was extremely damaging, and predicated on the household budget fallacy. When an economy is in recession, to reduce net spending is crippling. MMTers argue that the idea that deficit spending ‘crowds out’ private spending by pushing up interest rates is mistaken. I agree with this, but even if one doesn’t, it is certainly mistaken when there is mass unemployment and an economy is under utilising resources. 

Thus whilst MMT, when taken literally, may lead to questionable policy decisions by cynical and short-termist politicians, may give a degree of intellectual force against dubious austerity policies. Where MMT is far weaker, is in its own policy ideas. So often economists blend theoretical insights with policy recommendations that have sociological and political implications. This is methodologically suspect, and MMT is guilty of this. Worse still, MMT often falsely portrays itself as naturally leading to left wing policies, which is not the case. Just as a government could spend as much as it wants, it could just as easily cut taxes as much as it wants (both with the inflation caveats above). 

The central policy recommendation I will discuss here is the job guarantee. MMT proponents argue that since the limiting factor of government spending are the available resources in a country, and since the citizens of a country are its most important resource, the elimination of involuntary unemployment can and ought to be a policy decision. If the government were to provide an unconditional job guarantee, where socially useful work (such as environmental clean up, or care giving) for all citizens, this would ensure full employment. As things stand, when there is an economic shock, it is somewhat mitigated by automatic government stabilizers such as unemployment benefit which, since it is automatic, immediately increases net government spending when private consumption and investment falls. Rather than unemployment benefit, a job guarantee would be much better for society, since the resources of those made unemployed would be put to good use, and the host of negative externalities resulting from unemployment (people leaving the workforce, crime, lower consumption causing more unemployment) would be eliminated. 

This is a great example of sound premises leading to an idiotic idea. It is how, not whether resources are used determines the prosperity of a nation. Any person working on the ‘job guarantee’ is a person not available to do something that the market desires. If a job that society needed was provided by this scheme, what would happen when the quantity of workers available was reduced, as an economy grows? Let’s say a financial crisis leads to a million extra unemployed in the space of a month. Those million people are given jobs caring for the elderly and disabled, and building a dam to provide water power for a region. Upon the recovery of the economy, when the private sector re-hires, what will happen to the dam and those receiving care? If they were paid more to retain them, the private sector would be unable to start new (and useful) companies owing to a shortage of labour. If not the dam and the elderly would be abandoned. And how would jobs be created en masse at such short notice? The job guarantee is a de-facto abandonment of the allocative efficiency of the market. The job guarantee is, in truth, a job guarantee for a massive bureaucracy that would not be beneficial to society. 

The reason such an idea isn’t workable (beyond the practical considerations above), is that it is focused on aggregate demand to the detriment of supply. Ultimately, what is being produced is what matters. The furlough scheme introduced recently in the UK to stop mass unemployment resulting from Covid-19 provides a stabilizer effect similar to the one envisaged by the job guarantee (as incidentally, does the cut in VAT and other taxes). Now imagine if furlough existed permanently, or if government guaranteed wages indefinitely. Companies that would have failed because of their long-term lack of usefulness to society would remain as unproductive zombie companies, whilst those who reacted successfully to the new paradigm would not be rewarded. The job guarantee is an even more insidious version of the above scenario, since jobs would be dreamt up years in advance or ad hoc by bureaucrats and politicians. I will follow this essay with an alternative idea in the MMT framework.

Modern Monetary Theory and its Critics tackles further aspects of MMT beyond its tenability as an idea. How can a country trapped by the Euro negate its lack of monetary sovereignty? (by issuing a parallel currency) Is monetary sovereignty a spectrum rather than a binary state of being? (in the case of developing countries, yes). These are discussions beyond the scope of this review. MMT is a perspective that is sparking new debates in both academic economics and mainstream politics. Let’s hope the outcome is more akin to Greta Thunberg's nudges and less like the job scheme of Warden Norton in The Shawshank Redemption.