While there's been lots of talk about modern monetary theory—or MMT—in recent weeks, clear and accessible definitions remain in relatively short supply.
Modern monetary theory (MMT) is an unorthodox school of macroeconomic thought that characterizes currency as a public monopoly and cites unemployment as evidence of a restricted currency supply.¹
Advocates argue that, rather than attempting to balance the federal budget each year, the government should calibrate fiscal policy toward full employment, with deliberate deficit spending to boost aggregate demand when needed.
Critics counter that MMT is a recipe for runaway inflation.
While MMT remains controversial, it’s become less obscure. Recent work from Stephanie Kelton, a former chief economist on the U.S. Senate Budget Committee, has helped raise the profile of MMT in the public discourse. Investment industry luminaries Warren Buffet and Howard Marks have weighed in with views on the topic, as have economists Paul Krugman and Larry Summers. With a rising number of politicians and policymakers joining the debate, MMT is likely to draw more attention before the 2020 U.S. election season ends. Still, many investors remain unfamiliar with it and its potential implications. Here, we walk through key tenets of MMT and distill some of the views of its champions and its critics.
Modern monetary theory acknowledges money as a creature of the state
Modern monetary theory starts with an observation: The U.S. dollar comes from the U.S. government, and it can’t come from anywhere else. While trying to issue your own money might be easy enough, getting it accepted would be another matter. The proliferation in cryptocurrency demonstrates the difficulty of breaking a government monopoly on money. Bitcoin’s volatility, for example, limits its utility as a medium of exchange, a store of value, and a unit of account. What makes U.S. currency valuable is the U.S. government’s ability to impose taxes—and its promise to honor the U.S. dollar as an accepted form of payment.
Ever since the United States gave up the gold standard in 1971, the U.S. dollar has been backed only by faith in that promise—“it works because we all willingly suspend our disbelief. In the final analysis, though, it’s just paper or, in the case of demand-deposit checking accounts, entries in a bank ledger.”² Nearly a half-century into this era of fiat money—notes deemed legal tender by government decree—MMT supporters maintain it’s time to ditch certain fiscal conventions dating from the days when greenbacks were linked to gold bricks.
The U.S. government can’t be forced into insolvency
One such convention concerns a misplaced analogy between the public and private sectors. MMT proponents emphasize the fundamental distinction between the federal budget and a family budget. While businesses and households must come up with the cash to keep up with their bills, “the United States can pay any debt it has because we can always print money.”³ So too for Canada, Japan, the United Kingdom, and any government that does three things:
- issues its own currency
- allows its exchange rate to float
- avoids borrowing funds that require repayment in a foreign currency
While eurozone members and most emerging-market countries don’t meet those three criteria, a monetarily sovereign government, such as the United States, can’t be forced into insolvency. MMT reminds us that the government’s ability to meet its financial obligations in the digital age is merely a matter of a few keystrokes.
MMT claims a balanced budget isn't a barometer for a balanced economy
Modern monetary theorists aim to soften the stigma associated with deficit spending; history suggests the notion isn’t as radical as it may sound on the surface. After all, the United States has run a federal budget deficit in 46 of the last 50 fiscal years, including this one.⁴
What does a federal budget deficit really mean?
If the U.S. government spends $100 into the economy and taxes $90 out of the economy, then the residual $10 represents a federal budget deficit for the fiscal period. While that may sound like bad news, MMT’s supporters are quick to point out a silver lining: There’s now an additional $10 in the economy that wasn’t there before. Just as every purchase is also a sale, every dollar the government spends represents a dollar of income for someone else; the government’s deficit is simultaneously a surplus for the private sector, with the potential to boost aggregate demand.
MMT doesn't imply that deficits don't matter
Does MMT imply that deficits don’t matter? No. Its backers concede that deficits can indeed be too big. Evidence of a deficit that’s grown too big is inflation, which is the only relevant constraint on government spending, according to the MMT argument. When aggregate demand outstrips what real resources—including commodities, factories, and workers—in the economy can produce, then the government should curb deficit spending and entertain other aggregate demand offsets, such as higher taxes and more stringent business and financial regulations.
While the historical consensus among policymakers, the press, and the public has lamented the dangers of large deficits, MMT’s adherents assert that deficits can actually be too small under certain circumstances. Evidence of a deficit that’s too small, they say, is unemployment. Rather than aiming for a balanced budget every year, the government should be paying more attention to the return on investment prospects of its outlays. Deficit spending to bolster aggregate demand when the economy is flagging—especially spending on long-run productivity enhancers, such as education, infrastructure, and research and development—may help raise potential GDP over time, making the economy more resilient in the future.
Sound policy or a gateway to hyperinflation?
Love it or hate it, MMT has spurred debate about appropriate civic goals and the way that fiscal policy might be shaped in an effort to achieve them. But it's still an untested theory. If U.S. politicians sympathetic to MMT were to gain an upper hand in 2020 and some form of MMT were implemented, the implications for investors could be immense, for better or for worse. On the one hand, MMT’s holy grail—maintaining near-full employment throughout the business cycle—would be bullish for most financial asset classes; on the other hand, a failed quest, resulting in hyperinflation, would leave investors with few places to turn.
1 “ME/MMT: The Currency as a Public Monopoly,” Warren Mosler, 2014. 2 Principles of Business: Economics, by the editors at Salem Press, p. 356, 2018. 3 “No Chance of Default, US Can Print Money: Greenspan,” CNBC, 8/7/11 << cnbc.com/id/44051683 >>. 4 Federal Reserve Bank of St. Louis, 2019.