5 August 2020

Beware the siren call of Modern Monetary Theory


Imagine that the government could simply print whatever money it needs to guarantee everyone a decent income, fantastic public services, and a secure job if they wanted one – with enough left over to save the planet too. That, for many, is the promise of a new economic paradigm known as Modern Monetary Theory (MMT).

If you’re already thinking that this sounds too good to be true, you are not alone. Many economists – myself included – think that MMT is a frustrating muddle.

To be fair, MMT has a respectable academic pedigree, helpfully summarised here, which some trace all the way back to Keynes himself. It has several prominent advocates, notably Professor Stephanie Kelton, author of The Deficit Myth and an advisor to the Democrats in the US.

In particular, MMT appears to offer a credible alternative to conventional thinking on the importance of balancing the government’s books. The global economic slump and the explosion of debt and money printing during the pandemic have added to its popular appeal. But I remain a sceptic.

To explain, MMT can be broken down into three propositions. The first is that a sovereign country with its own fiat currency can always print more money to pay its bills and service its debts. So far, so good. The UK, for example, is clearly in a better position here than members of the euro, such as Italy and Greece. However, this is neither a new idea, nor does it give the government a free hand to spend and borrow as much as it likes.

For a start, the cost of government borrowing does not depend solely on the risk of default. It also depends on expectations for inflation and exchange rates (the domestic and international value of the currency in which debts will be paid), as well as the opportunity cost of diverting resources from the private sector.

In contrast, many followers of MMT have looked at the recent surge in government borrowing and concluded that there never has been – and never can be – a lack of money to pay for better healthcare, education, welfare, or a Green New Deal. Sadly, this is baloney.

Money itself may not be a “scarce resource”, but the same cannot be said of the goods and services that it is expected to buy. Otherwise, any country with its own currency could use its “magic money tree” to pay for world-leading healthcare, education, and so on.

Indeed, these constraints are recognised by the more sensible MMTers. The second proposition of MMT is that if the government spends so much that the total demand for goods and services exceeds the capacity of the economy to supply them, the result will be higher inflation. Again, this is pretty standard stuff. Where MMTers differ is on the appropriate policy response.

More orthodox economists would see this kind of overheating as something to be tackled by monetary policy. But most MMTers would argue that the natural rate of interest is zero, or at least that central banks should set official interest rates close to zero indefinitely.

Instead, in the topsy-turvy world of MMT, ‘well-targeted taxes’ should be used to control inflation by managing private demand. Many MMTers are also keen on wage and price controls, and rationing, despite the miserable track record of these forms of state intervention.

Third, MMTers argue that government deficits play a crucial role in balancing the economy and are therefore essential, rather than something to fear. The key point here is that deficits and surpluses have to balance out. If the private sector needs to run a surplus to repay debts that have become unsustainably high, then the government has to run a deficit.

What’s more, instead of public spending being financed by taxes, either now or in the future, MMTers claim that all public spending is in fact paid for (in some way) by the creation of money. Some go even further and argue that government deficits provide the additional money required to support economic growth.

However, it is simply not right to say that budget deficits are necessary for a successful economy. Many countries, notably in Scandinavia, have run budget surpluses for long periods in the past and still enjoyed sustained increases in living standards.

In addition, deficits are usually financed by conventional borrowing, not money printing. This is true even now during the pandemic. Central banks have been buying more government bonds from private investors as part of their programmes of quantitative easing (QE), but direct monetary financing of deficits is (mostly) still taboo.

You certainly do not have to be an MMTer to recognise what Keynes called the “paradox of thrift”, which is that if everyone tries to repair their finances at the same time the result is likely to be an even longer depression.

If all that MMTers are saying is that governments should be willing to borrow more to stimulate demand during recessions, and especially when interest rates are already close to zero, that’s hardly new or controversial either. Nor do you have to be an MMTer to argue that QE, or even ‘helicopter money’, might be helpful in some exceptional circumstances.

MMT also comes with a lot of unhelpful baggage. If MMTers had their way, central banks would lose what independence they have, risking higher inflation and a complete loss of fiscal discipline. It is also unclear what people working on government-guaranteed jobs would actually be doing, or what would happen when they move on.

Above all, MMT is being used to support a “big state” agenda. It would mean that the government plays a much larger role in the economy, for good or ill, and in good times as well as bad. Higher public spending would also still mean higher taxes, even if the rationale is to prevent overheating rather than balance the books.

In short, MMT is simply a repackaging of some old ideas to appeal to a new audience. There really is no such thing as a free lunch – even from a magic money tree.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.