Understanding Modern Monetary Theory


While the world seems to be divided on many issues, one theory that’s quickly getting into debates and criticisms is the “Modern Monetary Theory”. Brought to attention by the US congresswoman Alexandra Ocasio-Cortez in early 2019, she said MMT should be talked about more as it can help balance the federal budget.

Simply put, it is a theory wherein any country that prints its own money (fiat currency), shall never be in debt as it can just print more money to cover its expenses and budget deficits, rather than depending majorly on tax collection to mind its expenditures.

Fiat currency is the money that is not backed by anything precious or valuable.

In the past, the amount of money that could be printed by the US was in proportion to the amount of gold held. But after the Bretton Woods system was scrapped in 1971, fiat currency didn’t apply such constraints on printing of money.

“Modern Monetary Theory” or MMT was coined by Bill Mitchel, an Australian economist in early 90’s. Economists L. Randall Wray, Warren Mosler, Bill Mitchell, Stephanie Kelton

and Pavlina R. Tcherneva have developed ideas around MMT since 1992 and are great proponents to carry forward the theory to mainstream debates on economics.

The school of thought had economists at a drift as it challenges the conventional way an economy works, that’s similar to how a household handles its finances in theory. It is a heterodox macroeconomic theory which says the governments using fiat money need not worry about tax collections, issuing of bonds and loans to finance its expenditure and budget deficits. The next time governments find themselves out of funds for better healthcare or education, they can just print more money and finance these.

Nobel prize winning economist Paul Krugman, and other mainstream economists Lawrence Summers, Kenneth Rogoff and billionaire Bill Gates, have shown their disagreement with the theory.

Traditionally it is the job of monetary policies to handle the employment and price levels. It is after steps taken in accordance with monetary policy that the fiscal policy starts working, such as the economic stimulus provided by the government to keep demand at normal levels. MMT essentially replaces the job of fiscal policy with monetary policy. “Our preferred position is a natural rate of zero and no bond sales. Then allow fiscal policy to make all the adjustments. It is much cleaner that way”, wrote Bill Mitchel in a blogpost in 2009.

According to the theory, the budget deficit shouldn’t be considered bad when governments can print more money and the deficits can be paid. The theorists in support of MMT believe the deficit is only the money that the government put into the economy and didn’t tax back. MMT has roots from chartalism, a 20th century school of thought.

The government need not function like with a household economic model where it’ll spend only the amount of money it actually holds in the bank or need to borrow when it runs out of money. Governments can print money when needed. If this shoots up inflation, taxes can be raised to take away the excess money in the economy.

Even unemployment can be farewelled with MMT, as governments can print more money, inject the money into the economy giving job guarantees to labor that is not being used by the private sector.

The theory has received mostly criticism as it leads to the belief that it can solve all deficit troubles and stimulate economic activity to a level which reduces unemployment. If the amount of money printed by governments exceeds the capacity of the economy to produce, it’ll cause inflation or worse, hyperinflation. Should we have so much confidence in the taxation policies to control inflation that would follow after excess money in the economy? Or what would be the long-term effects of change in tax rates on investments and demand in the economy?

As long as there is unemployment, printing money and injecting it into the economy can lower its levels (this logic takes its course from the theory of “Functional Finance”). However, if the money printed and spent in the economy is much larger than human resources and capital, inflation can rise to scary levels. Therefore, the amount of money a government can print without causing inflation is limited by the unemployment level and availability of resources in the economy.

MMT is concerned mostly with economies that face normal to low demand but have high production capacity. However, we don't have the same scenario in India. Neither do we only borrow money in rupees. We also borrow dollars and other currencies from different countries. We have the problem of seasonal and disguised unemployment and need strong upskilling of the masses to add them in the secondary and tertiary production sectors. MMT could be a boost to give employment but mere increase in aggregate demand is not a solution for the kind of unemployment present here.

If MMT is taken into consideration in countries like the US, UK and Japan, the inflationary effects of it will be felt by everyone around the world. We can already see the government stimulus, introduced during the course of the pandemic in many countries, is raising concerns of hyperinflation everywhere. With its rising acceptability rate, bitcoin and other cryptocurrencies are a challenge to MMT as they aren’t backed by any government or national body anywhere in the world. We are yet to hear what the supporters of MMT have to integrate cryptocurrency in this heterodox theory.

Reference:

  1. https://www.vox.com/future-perfect/2019/4/16/18251646/modern-monetary-theory-new-moment-explained

  2. https://www.livemint.com/opinion/columns/modern-monetary-theory-let-s-look-at-it-from-india-s-perspective-11612886536139.html

  3. https://www.businessinsider.in/investment/news/what-is-modern-monetary-theory-understanding-the-alternative-economic-theory-thats-becoming-more-mainstream/articleshow/86821173.cms

  4. https://www.forbes.com/sites/johntharvey/2019/03/05/mmt-sense-or-nonsense/?sh=45726a4a5852

  5. https://www.investopedia.com/modern-monetary-theory-mmt-4588060

Written by Teesta Bose (teesta247@gmail.com)

Edited by Mehak Vohra