What is modern monetary theory is a question that requires a deep understanding and analysis of a school of thought.
Modern Monetary Theory suffers from straw man syndrome. For some, it is much easier to construct a straw man version than to try to understand MMT. Below, I explode that strawman with 30 things you know when you understand MMT.
What is Modern Monetary Theory?
Straw man. Noun. An intentionally misrepresented proposition that is set up because it is easier to defeat than an opponent’s real argument.
Every idea, concept, or school of thought can be boiled down to its basics. This is useful when time is short, and the concept is new. Being able to sum up something like Modern Monetary Theory succinctly is very useful as a starting point. For example, saying:
‘MMT observes that governments that issue their own currency are not fiscally constrained in the way that is represented by most politicians, economists and commentators’
is a great way to introduce MMT to someone who is ready and willing to listen to an alternative view of how the monetary system works. “Really? tell me more.” That’s the reply you hope to hear!
Over the last five years, this has been happening much more often. Much of the credit goes to Stephanie Kelton, whose book The Deficit Myth appeared on the New York Times Bestseller list in 2020 and popularised the movement outside of forensic-minded academics. But unfortunately, and of course, predictably, its popularity also led to the straw man version of MMT.
As a heterodox economic school of thought, MMT economists are very open to criticism. Constantly questioning and being open to questions is how any science advances. According to Professor Sheila Dow, this harks back to Adam Smith. Concepts, assumptions, and observations are poked and prodded, and alternations are made to hone the usefulness of the insights. MMT economists welcome this challenge.
However, much of the opposition to MMT, as is wonderfully demonstrated here in this article by columnist Gordon MacIntyre-Kemp in The National, is, well, something less than a forensic examination of MMT. It is well worth reading to understand the extent of the straw man that is created (you should read the comments too).
James Meadway recently argued that MMT offers nothing to help us understand or respond to the climate crisis. This is a bold claim, particularly considering the growing number of progressive economists who find it valuable. Yet again, he uses a strawman argument. I think I did a good job of dismantling his argument here.
But in this piece, rather than tread old ground or reignite an old argument, I wanted to give readers an understanding of the depth of MMT. Many commentators think they ‘know’ MMT. Hopefully, a quick scan of this list will prove that most people who comment on MMT scarcely understand it.
Like almost all schools of economics, MMT has a descriptive side and a prescriptive side. By focusing only on the descriptive element, I hope to expose the depth of the analytical framework.
MMT does, however, have policy proposals, and younger MMT economists like Dirk Ehnts and Eric Tymoigne are focusing much more on the prescriptive side. One of the founding ideas of MMT is the need for a government job guarantee scheme as a way to achieve full employment. There are other policies, such as a reduced role for central banks in controlling the economy and a zero interest rate.
I’ve put together this brief list to highlight what MMT helps us understand. If more policymakers grasp how a modern fiat-driven economy functions, they’ll have a much broader range of policy options to consider. I’ve focused on the key points, but feel free to share any additional important concepts I may have missed in the comments.
30 things you know when you understand MMT
What is Modern Monetary Theory? With an understanding of MMT, you know:
- In a sense, all monetary sovereign governments already do MMT. MMT is an observation of how a modern monetary system based on fiat currency works. It focuses principally on governments that issue their own currency.
- The decision for a nation to create or continue to use its own currency or use someone else’s currency is a decision that has significant impacts across the economy, especially for a nation like Scotland
- Liquidity isn’t one big homogeneous blob of money but can be broken down into settlement, market, and funding liquidy, and this really matters when you look at how a financial system works (or doesn’t work)
- Taxes don’t fund government spending, but they are very useful in i. creating and sustaining a demand for the domestic currency, ii. creating room in the economy for the capacity of the government to spend money, iii. changing the distribution of income and wealth, iv. encouraging and discouraging spending on certain things or changing behaviours, v. work as a kind of social cement encouraging people to engage in an economy, and vi. help control aggregate demand and inflation
- Bond sales don’t fund government spending, but they are very useful to: 1, drain reserve balance accounts of private banks held at the central bank to control the base rate of interest with funds swapped for bonds, or bonds are swopped for cash to maintain a required base rate, aka the price of cash, 2, provide a ‘safe’ interest-bearing financial asset for the private sector and 3, set a default risk-free interest rate across the economy, allowing all other products to have a benchmark when institutions and individuals price risk.
- Taxes and bond sales are used to account for government spending, and this is an accounting decision rather than an economic one.
- Fiscal responsibility, the idea that a government must run a balanced budget, is based on one particular school of thought, and it is not supported by economists from many other schools of thought.
- The idea of functional finance is well-developed and is an alternative to fiscal responsibility.
- Assuming a balanced trade position, a government deficit is the surplus for the private sector.
- QE was enacted differently at different times and principally involved swapping one type of money (bonds) for another type of money (reserve balances).
- All monetary sovereign governments ‘print money’; this is how they finance new spending.
- Taxes, when collected, disappear from the monetary system; they are not stockpiled somewhere or used to pay for future expenditures.
- 80% of the money supply in the economy comes from commercial banks.
- Bank deposits do not create loans. In fact, bank loans create deposits.
- The Central Bank must decide the base rate. The market does not.
- Central banks are not really independent.
- Why financial crises tend to come from certain institutions and markets and not from others, owing to the hierarchy of liquidity.
- MMT economist Steve Keen predicted the financial crash in 2007 because, unlike neoclassical economic models, money is observed in MMT models of the economy.
- Why stability breeds instability in financial markets.
- Financial crises that occur in monetary sovereign governments tend to happen when the private sector is overindebted, not when the government has debt.
- Debt can always be repaid plus interest if it is held in the currency of the currency-issuing government.
- If a government borrows in a foreign currency, it can lead to debt defaults.
- Government debt is essential for an economy to function properly.
- Government debt is the amount of money injected into the economy that has not been taxed back.
- Why Bitcoin or other fixed assets can never replace a fiat currency.
- Governments can always afford what they prioritise, as stated by the US Treasury Secretary in October.
- Governments historically, have always run budget deficits, and this is an essential part of how the financial system works.
- Governments face real material constraints on their spending, principally the availability of resources in their own currency, the impact of total spending in the economy on prices, and the ecological constraints of consumption.
- Currency was often developed as a way to persuade (or force) people to accept currency issued by a ruling elite and was not backed by precious metals.
- Interest rate manipulation is unlikely to have the desired effect on supply-side inflation
What is Modern Monetary Theory? Well, the full answer is complicated and detailed. Of course it is! But the above list is hopefully helpful if you want to have an idea of the light that MMT can shine on our economy.
The depth and scope of MMT explain why those who are not open to new ideas or are tied to supporting the status quo create a straw-man version of MMT.
