Modern monetary theory (MMT) is an economic theory that has become popular in the blogosphere and heterodox academic circles. It’s also caught the eye of some politicians. Notably, Zack Polanski has been learning about MMT and using it to answer questions about government debt.
According to MMT, the Treasury should use higher deficits – funded by money creation – to help run the economy at full capacity and increase prosperity. But wait a minute. Doesn’t this sound like quantitative easing (QE), a tool already used by central banks to stimulate the economy through money creation?
The widespread use of QE, especially after the Covid pandemic, has made some people think that MMT is not just hypothetical – it may be here with us already. Notably, a New York Times article said the pandemic response could be seen as a ‘victory lap’ for MMT. In addition, academics have argued that QE and MMT share the same underlying economic theory and only differ in practical manners.
In this article, I’ll explain why MMT has little to do with QE, both in theory and in practice. We’ll also see that MMT’s policy recommendations could cause a gigantic mess.
MMT’s policy recommendations could cause a gigantic mess
Standard economic theory says that economies tend to run close to their maximum level of production, known as potential output.
However, from time to time, a shock causes the economy to temporarily operate away from its potential – think of a financial crisis or an oil shock causing recession and unemployment. This situation is known as an output gap. While market economies eventually self-correct, the gap can last for an unnecessarily long time due to price rigidities and financial frictions. The goal of QE is to help the economy get out of the rut and eliminate the output gap more quickly – it expedites the process and reduces the pain.
On the other hand, MMT has a very different understanding of the output gap. According to this theory, a market economy always runs well below its potential, as the private sector is incapable of generating enough demand for resources. Even if the price of resources adjusted, entrepreneurs would still generate overly low demand, due to their stubbornness and pessimism. So, the output gap is permanent rather than a rough patch.
MMT diagnoses a surprisingly large output gap, much higher than the one calculated by mainstream economists. For example, MMT proponents Yeva Nersisyan and Randall Wray say that European economies are ‘probably operating 25% or more below full capacity. Even the US today has substantial excess capacity’.
So, a major difference between QE and MMT is their justification for money creation. In the QE case, money creation is used to give the economy a push to narrow the output gap more quickly – QE stops once the output gap disappears. In the MMT case, money creation is used permanently to fill a never-ending output gap. New money is constantly pumped into the economy for this. MMT assumes this extra money is hoarded by savers, so inflation doesn’t accelerate, as the money stays under the mattress instead of circulating.
Unfortunately, MMT doesn’t offer a credible theory to explain the existence, size and persistence of its purported gap. MMT tries to explain this gap through a nonstandard interpretation of the Keynes’ General Theory, written in 1936. However, such an interpretation was proven incorrect a long time ago, as it suffers from multiple mathematical and logical issues.
In addition, MMT’s theory of inflation is subpar in numerous ways. For example, it ignores the role of expectations and currency devaluation, which are central to modern economic theory. It also assumes people are willing to hoard ever-increasing amounts of money, which most economists wouldn’t agree with.
As a consequence of its subpar theory, MMT overestimates the output gap and underestimates the threat of inflation. This could lead to excessive money creation to fill an imaginary gap without anticipating the consequences.
This seems to have happened repeatedly in Latin America. For example, in 1972, the Chilean minister of finance argued that ‘it was possible to increase production, due to subutilisation, by more than 30%’. Inflation soared to 500% soon after. More recently, in 2019, soon-to-become Argentine president Alberto Fernandez explained, ‘The great deficit is that Argentina’s economy has turned off. We need to reignite industry, make closed shops reopen their doors, make machines function, fill factories with workers who produce and export goods.’ Inflation soared above 200% during his mandate.
In QE, an independent central bank creates money to buy assets – most often government bonds – from the financial sector. QE is intended to increase spending across different sectors of the economy through multiple channels. For example, these asset purchases reduce interest rates, which encourages loan-taking across the board.
MMT’s mechanism of action is different: newly created money is used directly to fund government spending, such as pensions, public works and healthcare.
A major difference between QE and MMT is that the former intends to be fiscally neutral – it doesn’t seek to favor any type of spending above others. MMT, in contrast, specifically enables the Treasury to spend more. In addition, QE acts indirectly, as the newly created money lands first into the depths of the financial sector, and its effects only seep outward slowly. In the MMT case, the money goes much more quickly into consumers’ pockets.
But perhaps the greatest difference between QE and MMT is political. In the case of QE, a major assumption is that money creation should be managed by an independent central bank, insulated from the electoral cycle. This seeks to prevent the indiscriminate use of money creation by elected politicians for short-lived political gains.
In contrast, MMT asks us to trust elected politicians to use money creation wisely. MMT advocate William Mitchell explains, ‘A wise government using the fiscal capacity provided to it by a fiat monetary system can engender full employment and equity yet also sustain price stability’. I’ll let readers draw their own conclusions.
If central bank independence is progressively eroded, QE may be used in a non-standard way to provide unconditional funding to the Treasury. Economist George Selgin calls this the ‘menace of fiscal QE’ If this were the case, we could slide into an MMT era.
If you want to learn more about MMT – including its views on cryptocurrencies, hyperinflation, and the job guarantee program – check out my book, ‘If You Can Just Print Money, Why Do I Pay Taxes?’, published by Wiley in April 2026.
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