What is modern monetary theory?

The term “modern” in modern monetary theory (MMT) is probably not the best choice of words, as it implies that there is something new in MMT. As many MMT critics point out, looking for something new in MMT is a pointless activity. Nothing new has been found.

To understand this situation, it is important to first figure out what is MMT and what is not. At least, as I understand this theory, the term “modern” in MMT does not refer to something new or novel, but to the modern way of conducting monetary policy. Namely, the term “modern” refers to an era that begins with the abandonment of the remaining remnants of the 1971 gold standard. “Modern” means full acceptance of paper money; it is not a reference to a new model or theory. We can agree that the introduction of paper money will change the rules of the game, but we do not agree with the consequences of such a change in the monetary regime.

The fact that central banks issue paper money means that they have no debt obligations to exchange banknotes for gold or any other assets. Consequently, if a government can issue debt denominated in its currency, Treasury bonds can be paid for through monetary expansion without any risk of default. In addition, there is no limit to how much debt the Treasury can issue. Consequently, there is no limit to the possible increase in government spending. Monetization of the deficit is not associated with inflationary risk. Since this country issues the world’s reserve currency, the demand for it is unlimited.

This is, in short, the MMT thesis. Suppose a country can issue debt denominated in its currency. In this case, the conditions of the modern world mean that its government can increase its spending without any restrictions. MMT’s conclusion that making money is a free lunch has been seriously questioned in the economics profession. MMT’s conclusions seem more magical than real. It’s no wonder that progress-minded politicians like MMT. This theory promises that paying for large programs, such as the Green New Deal, is not related to economic problems.

Nothing new under the sun I: The model

“If MMT confuses a large audience of professional economists, as it seems, then the problem is not in the audience, but MMT”. One of MMT’s problems is the lack of clarity, especially when it comes to explaining why its bold predictions are consistent, even if not self-evident, and contradict the profession as a whole. The lack of transparency makes it difficult to determine the uniqueness of the MMT. One way to emphasize the uniqueness of MMT is to reformulate MMT in terms of standard economic models. Thus, any difference between MMT and well-known models or theories should become obvious. So far, MMT has not provided this exercise. It’s not so much about the mathematical model as such., but we’re about creating it as a way to bring clarity and awareness of what MMT means. If a large audience of professional economists finds MMT confusing, which it is, then the problem is not in the audience, but in MMT.

We already have models and theories that offer the same predictions as MMT. Old Keynesian models, such as IS-LM and Keynesian cross, predict the possibility of an increase in aggregate demand without affecting the price level. These models achieve this prediction by assuming that the price level is constant (the price level is not part of the model) due to a large number of unused resources. MMT achieves the same prediction, assuming an infinite demand for money. Leaving aside the advantages and disadvantages of these Keynesian models, the MMT cannot offer a significant difference. Consider, for example, what the assumption of infinite demand for money implies for the MMT model. The assumption of an infinite demand for money means that the price level remains stable even if monetary expansion occurs at full employment.

Moreover, the simple Keynesian characterization of MMT does not work in its favor. The stability of the price level of these models depends on very specific conditions, such as a large number of idle resources. However, as the economy approaches full employment, inflation should be expected. When pressed on this situation, MMT supporters admit that inflation can be a problem the limit. In this case, fiscal policy (taxes) should be used to curb inflation. This step back makes MMT look like simple Keynesian models with a new cover. The alternative is that MMT is a theory that adheres to the irrefutable assumption that there is no shortage of resources.

MMT’s recognition that inflation can be a problem is an important detail. This means that the MMT forecast depends on current economic conditions, and not on universal assumptions. However, the recognition of this randomness gives a distinction between the Keynesian episode of the 1930s and MMT. The Keynesian Revolution occurred during the Great Depression when the assumption of high unemployment was appropriate. It was also a time with smaller governments and a lower level of public debt than the one we are seeing today. However, MMT emerged in a context closer to full employment and already large governments with a lot of debt on their shoulders.

The fact is that, unlike the times of the general theory of Keynes, today central banks issue non-refundable paper money. However, it does not follow from this that the opportunity to monetize the deficit is a free lunch. MMT’s conclusion does not follow its premises. If MMT’s conclusions are correct, we should expect a decrease in inflation rates in the countries issuing the world reserve currency. However, we know that this did not happen. In countries such as the United States, inflation has been rising due to the adoption of paper money, rather than falling.

Nothing New under the Sun 2: Political Economy MMT

There is no mystery about MMT’s political appeal. This idea promises a way to do away with the cost of large government projects such as the Green New Deal, free healthcare and education for all, or any full-time employment programs. MMT is a gospel for politicians who support the government’s big plans. For them, MMT means no budget constraints. The limit is their imagination and any opposition from other political parties. Unsurprisingly, this description sounds familiar. Again, MMT offers a parallel with the Keynesian episode.

MMT is known not only for its bold predictions. He is also known for his confusing, opaque, and contradictory rhetoric. Anyone familiar with Keynes’ general theory probably remembers how confusing, opaque, and contradictory it is. However, for politicians, such semantic confusion turned out to be an advantage rather than a disadvantage. Keynes’ general theory provided the ideal platform (or pretext) for starting a large government project.

John Maynard Keynes, a well-known British professor, discovered an unclear economic understanding justifying the implementation of large government programs. Keynes did not provide theoretical support to supporters of large expenditures; he also provided psychological support. The success of the Keynesian view of the world was partly due to a combination of moral requirements and the political convenience of accepting Keynes’ ideas. As Keynes said, we will all die eventually; therefore, it is immoral to sit and wait for the free market to finally fix itself. The government has the ability and the moral obligation to take responsibility when the market crashes.

The highly moral justification that the government “has to do something” during a crisis means that the theoretical shortcomings of the Keynes and MMT theories become less relevant. Since the moral argument takes precedence, those who oppose the extensive spending program or MMT ideas must either have ideological blindfolds or defend their interests. James Galbraith’s recent defense of MMT is an example of this situation. Maybe the fact that MMT protection has to resort to such an ad-hominem strategy does not indicate its inconsistency problems. This is a rhetorical argument around the MMT policy. The government has a moral duty to create jobs or preserve the environment. And MMT is an eye-opening theoretical discovery that only those who can (or want to) understand it can see.

There is extensive literature in the field of public choice that explains how and why poorly thought-out policies are adopted by politicians. It is characteristic of economic history that many generally accepted economic conclusions diverge from the ambitions of politicians. Minimum wage avoidance, free trade, and peaceful immigration, as well as low and simple taxes, are just some examples of how far the political world is from the basic economy. Perhaps the quick and enthusiastic embrace of progressive-minded MMT politicians should be seen as a warning sign, and not as a missed opportunity to start implementing Pharaonic projects.

Nothing New under the Sun III: Historical evidence

Another distinguishing feature of MMT is its speculative tone. MMT predicts what will happen under certain conditions if a specific policy is followed. The explanation of what happened seems less relevant. This creates some tension between historical records and MMT forecasts. It seems useless to point to countries that are suffering or have suffered from inflation as evidence of MMT inconsistencies. The reason is that these countries do not demonstrate the conditions necessary for MMT.

That is, they either cannot issue debt obligations in their currency, or they do not issue the world reserve currency. Take, for example, Argentina, which has been suffering from high inflation rates for more than a decade. Argentina cannot issue debts in pesos, and its currency is not in demand in the rest of the world. This is not even the best means of saving for Argentines. Inflation in Argentina does not provide MMT with contradictory evidence, since the necessary prerequisites are missing.

And this is the situation for any country with high inflation. Suppose it was necessary to compare MMT with real experience. In this case, it can be found that either inflation is present in countries that do not meet MMT requirements, or in countries that do demonstrate MMT requirements but do not apply MMT policies in practice. In any case, MMT does not cause empirical tests.

However, the lack of empirical data regarding the MMT forecast will change significantly if we revise the question of the previous paragraph. Instead of asking if countries with high inflation contradict MMT forecasts, we should ask if MMT is the reason why these countries are where they are today. By changing the focus of the issue from current conditions to past policies, the historical record becomes clearer. These countries are becoming economically problematic (high inflation and inability to issue debt in their currency), following what we can call “MMT ideas”. Latin America can be seen as a continent-wide experiment based on the results of MMT-inspired policies. Countries like Argentina are not a problem for MMT because they suffer from inflation if they print too much money, but because MMT-type policies are what they should be in their current situation. A historical perspective is important to avoid misinterpretation of empirical data. The experience of countries like Argentina is relevant because they have lost MMT requirements precisely because of the adoption of MMT ideas.

Conclusions

MMT was enthusiastically received in some corners of the political world. It is not surprising that in the short term its popularity will increase. MMT offers a convenient gospel and rhetorical device for high-spending programs approved by the new government administration.

The critical reaction to MMT from a wide range of economists is not because this theory is complicated. It may seem that the economic profession has reacted sharply to MMT. After all, there is no clear theory or new understanding to answer. The reason for such a critical reaction is that the adoption of MMT is not just a free lunch policy, but a game with fire. As for the growing popularity of MMT, we can draw the opposite conclusion, that the critical reaction was not strong enough. To paraphrase George Selgin, MMT is too good to be true, although it is a very attractive doctrine for politicians.