Beware the siren call of Modern Monetary Theory
6 August 2020
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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.
This article was first published on CapX.
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.
This article was first published on CapX.
5 thoughts on “Beware the siren call of Modern Monetary Theory”
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I read The Deficit Myth and was convinced. However, I was taught Economics up to ‘A’ level, perhaps this was above my pay grade. So I was happy that someone who knew what they were talking about had identified weaknesses.
I wish you’d done a better job.
I’d like to start my critique of your critique at the end.
“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.”
This is what you want to show, “Above all”. You want to say, this and this and this and this, therefore that. I think you’ve failed. Not only do this and this and this and this not, in my opinion, make sense , but they don’t lead to that. You don’t approve of big government, fine, so therefore you don’t approve of MMT, but your arguments fail to show why MMT is bad.
I think MMT is probably based on the proposition that our Governments should be using their power to direct our economies in a particular way, specifically I think for the greatest benefit for the maximum number of people. Arguably that’s what many people elect our Governments to do. To the extent that we do, I think that MMT provides effective tools to do that, and I believe that you’ve failed to identify substantial weaknesses in using that tool to achieve that objective. Equally many people believe that Governments should interfere in the economy as little as possible. I personally think they’re wrong, but maybe it’s me that’s wrong. In this case we should not be using MMT to achieve the objective of directing the economy, not because it’s the wrong tool, but because it’s the wrong objective.
However, to return to your criticisms of MMT as a tool.
You explained what MMT was about, the creation of money:
“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.”
Your critique of this theory was based on Government borrowing
“For a start, the cost of government borrowing does not depend solely on the risk of default…”
I may be weak on economics, but surely any criticism of a theory should be based on what it does say, not on what it specifically doesn’t say.
You then go on to say
“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.”
Exactly, “these constraints are recognised by the more sensible MMTers” including Stephanie Kelton. Once again, you’re criticising MMT for something it doesn’t say when it does. It acknowledges explicitly that it’s not a bottomless pit, there are consequences both to putting too much money into the economy and to taking too much out.
Could do better.
“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.”
There must be a word for this sort of criticism, defining something as topsy-turvy or nonsense and then assuming it is. Actually I think even this is a slight misrepresentation of MMT, at least as I’ve understood it from reading one book. Taxes are presented as a way of taking money out of the economy to control inflation. You haven’t made the case that it doesn’t, just stated that it’s topsy-turvy. Maybe monetary policyis used to control inflation when it occurs, that doesn’t mean that fiscal policy can’t do the same. Well targeted taxes are presented as a way of achieving other things, stopping people smoking, eating unhealthily, taking money from rich people to address inequality. People disapprove of these things, people disapprove of Governments compelling people to do anything. This isn’t a criticism of MMT, it’s a criticism of over-controlling Governments.
“Many MMTers are also keen on wage and price controls, and rationing, despite the miserable track record of these forms of state intervention.”
I’m sure there is a word for this. Nut Picking. The opposite of Cherry Picking. Taking the worst examples of behaviour and using it to criticise the whole thought process. Perhaps some people associated with MMT also say these things, that doesn’t mean it is or has to be part of the MMT philosophy.
“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.”
As in the first case, this is an adequate explanation of the MMT position.
“However, it is simply not right to say that budget deficits are necessary for a successful economy.”
This is not.
MMT says that, in terms of a successful economy, however that’s defined, the size of the number and operator attached to it is an unnecessary distraction, what’s relevant is that the right amount of money is in the economy to make it work effectively.
“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.”
Maybe they are. I’m not sure that’s actually true, but let’s assume it is. If it’s true, then this is the way things are done, not necessarily the way they should be done.
“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.”
Once again, that is specifically what they’re not saying, they’re saying that governments should be willing to create more money to stimulate demand during recessions
“Nor do you have to be an MMTer to argue that QE, or even ‘helicopter money’, might be helpful in some exceptional circumstances.
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.”
No, you don’t but that’s not a criticism of MMT, that they agree with other economists on some things, you don’t have to disagree with everything other people say to disagree with some things
“MMT also comes with a lot of unhelpful baggage. If MMTers had their way, central banks would lose what independence they have, risking …a complete loss of fiscal discipline.”
Here I am going to acknowledge that this definitely is above my pay grade, I don’t know how fiscal and monetary policy work, whether MMT would indeed lead to a loss of fiscal discipline or why that would be bad, also whether why central banks would lose their independence and why that would necessarily be a bad thing. This is a weakness I really must address.
However, to add back in the missing bit of this quote
higher inflation and
MMT specifically guards against this problem, it acknowledges that inflation is the effect of putting too much money into the economy, and if that that happens, taxes and borrowing should be used to take money out of the economy. It’s not a weakness of MMT, it’s, if anything, a strength. The consequence of putting too little money into the economy is unemployed, or underemployed resources, including people. Surely this is something equally to be avoided.
“It is also unclear what people working on government-guaranteed jobs would actually be doing, or what would happen when they move on.”
Now here I agree with you. MMT hasn’t dotted every i and crossed every t, and the plans to do this seemed low on detail. However, this isn’t a weakness of MMT as a concept, but an acknowledgement that it’s a work in progress.
One of the things Stephanie Kelton speaks about is the Kennedy Space Programme. I think this is generally acknowledged as a triumph, although some people will inevitably see it as a disaster or a fake, but that hadn’t worked through every single detail , that doesn’t mean it wasn’t a good idea.
To return to where I started
“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.”
Yes. MMT argues for a “big state” agenda. It argues that Governments are the only players with the clout, and arguably the mandate, to direct our economies in particular ways. If you disagree with that role for Government, you’ll disagree with MMT as a tool to help them fulfil that role.
“Higher public spending would also still mean higher taxes, even if the rationale is to prevent overheating rather than balance the books.”
Yet again, that is specifically what MMT is not saying. It’s saying that since the world abandoned the Gold standard, spending, taxing and borrowing have been decoupled, each can be used, in isolation, to achieve different objectives.
In short, MMT is simply a repackaging of some old ideas to appeal to a new audience.
If that’s all it is, then why are you objecting. Quite clearly it’s not that, it’s a novel way at looking at our economies and how they could be managed
There really is no such thing as a free lunch – even from a magic money tree.
And finally. That’s not what MMT is saying. MMT is not a free lunch, it’s a lunch which quite clearly comes with consequences, and if we over indulge, or under indulge, costs. A lunch is a good thing, we need to eat, if we don’t, ultimately, we’ll die. Too much lunch will make you fat, ultimately it too will kill you. That shouldn’t stop you eating lunch.
The is usual misrepresentation of MMT:
MMT does NOT say the Govt can’t ‘print’ whatever it likes. It can only buy what is for sale. If it is not available to purchase, or does not exists, it cannot but it.
The cost of Govt borrowing is defined by Govt. It defines the terms and interest rate, not the borrower.
No Govt that issues it own currency can be forced to default.
Public services are not financed by taxes. The spending always come first. As Covid has aptly demonstrated and as the BoE, have confirmed more than once.
MMT would argue for tax cuts now, NOT tax rises, as there is minimal inflation as fall into recession, thought they will be to little benefit.
Norway can run a surplus due to its external surplus (sectoral balances)
However, you are right, your article is baloney. It is the the usual misrepresentation of what MMT actually says and a regurgitation of prejudice by those have have been found out.
Taxes are too slow.
Inflation cure :Deficit spending properly directed to alleviate shortages. > interest rates make money more valuable.
With the greatest of respect you don’t seem to actually understand what you are writing about. Reading incoherent ‘criticisms’ like this always gives me renewed confidence in MMT.
I wonder if the author supports Milton Friedman’s incredibly flawed economic theory usually referred to as the “trickle down effect economy”. So far as I can ascertain its never really worked.
I am a retired accountant with limited Economic training but I could never accept that Keynes got it so wrong that countries did a 180. That manoeuvre seemed to only make the wealthy richer and the poor destitute.
MMT does concern me because it seems too obvious and having read S Kelton’s book once I am not completely satisfied.
That aside I personally believe that any economic model relying on some of its citizens being homeless and without access to basic free healthcare has failed.