Originally published in Spanish as “¿De dónde viene el dinero?” by Política Exterior
Modern monetary theory, or MMT as it is widely known, has achieved remarkable visibility in recent years. Despite the title, MMT can resemble a political campaign as much as a monetary theory, characterised by activists promoting job guarantee schemes alongside more scholarly activity. The core ideas of MMT coalesced in the early 1990s, developed and promoted by a small group who largely bypassed academia, instead using blogs to accumulate a dedicated band of followers. As Bill Mitchell, one of the founders of MMT, said at the recent “International MMT Conference” in New York, “This is the first body of economic theory that has grown through activists”. In recent years that following has expanded substantially, leading to global prominence for key MMT figures, and widespread media coverage and commentary.
The main propositions of MMT are derived from one simple observation: a country with its own currency cannot run out of that currency. The U.S. government cannot run out of dollars because dollars are issued by the Federal Reserve, which is controlled by the U.S government. As a result, the U.S. government will never face a situation in which it cannot find the money to pay the interest on its debt, to hire workers, or to purchase goods and services. This, MMT proponents argue, turns conventional thinking on its head: mainstream economics promotes misconceptions about public debt, imposing false barriers to public spending. In contrast, it is claimed, MMT identifies the true constraints faced by currency-issuing governments, liberating policy-makers from misguided concerns about “finding the money” to pay for government spending.
The reality, as we shall see, is a bit more complicated. But first, some history. The MMT story starts with Warren Mosler, an ex-Wall Street trader who, in the 1980s, founded both a hedge fund and a supercar manufacturer, before relocating to the Virgin Islands, a Caribbean tax haven. In the early 1990s, Mosler took his ideas on sovereign debt to Donald Rumsfeld who sent him to Arthur Laffer (of “Laffer Curve” fame). Laffer told Mosler that the high priests of economic orthodoxy were unlikely to be interested in his ideas, and suggested he instead try the Post-Keynesians: a group of left-leaning non-mainstream economists. Mosler joined a Post-Keynesian email discussion list and found common ground with academics such as L. Randall Wray and his colleagues in the US, and Bill Mitchell in Australia. The group embarked on the project of developing a new synthesis of ideas on monetary economics.
Mosler convinced the group that the commonly held view that taxes provide the funds required for government spending is false. Instead, when a currency-issuing government spends, it creates new money: when the U.S. government makes a payment, new dollars are brought into existence at the point of expenditure. Discussions framed in terms such as “where will the government find the money?” are therefore based on a flawed understanding of the monetary system, Mosler argues.
According to Mosler, the purpose of taxation is instead to create the demand for government-issued currency. In the absence of taxes, Mosler contends, there would be no demand for essentially worthless pieces of paper. But in declaring and imposing the unit (the dollar) in which tax obligations must be discharged, the government ensures widespread use and acceptability of its currency.
These ideas turned out to be compatible with those of Randall Wray, an academic who was working on “Chartalist” ideas concerning the role of the state in defining and enforcing what is used as money. In the Chartalist view, money is not and has never been a commodity such as gold. Instead, money is essentially a system of IOUs that keeps track of credit and debit positions across a society too large and complex to rely on direct credit relationships. While credit theories of money have a longstanding tradition, the novelty of Chartalism lies with the claim that “money is a creature of the state”. By imposing the use of its own currency, Chartalists argue, the government, as monopoly issuer of that currency, attains powers not available to any other economic actor.
The core of MMT is a synthesis of Mosler and Wray’s ideas about government money with elements such as Abba Lerner’s “functional finance”. Lerner argues that government finances are not appropriate targets for government policy. Instead, the government should judge its actions on the basis of real outcomes, such as the level of employment. When combined with Mosler’s assertion that a currency-issuing government is never unable to service its debt, the claim that the appropriate target for macroeconomic policy is full employment appears logical. For MMT, the limit to government spending is therefore not financial but real, imposed by the physical capacity of the economic system to produce goods and services. The limit to fiscal activism is therefore the “inflation barrier” – the point at which increases in government spending generate rising prices, rather than higher employment and production.
The last piece of the MMT puzzle is the “employer of last resort” policy. Functional finance says that government spending should be used to eliminate unemployment – but there is a catch. As unemployment is reduced, inflation is likely to strengthen. It is unlikely that true zero unemployment can be achieved simply by raising government spending: at some point inflation will set in.
The employer of last resort (ELR) is MMT’s proposed solution to this problem. The policy is deceptively simple: the government should stand ready to employ all those who want work, offering a wage set at a level below the prevailing private sector wage rate. The justification claimed is twofold. First the policy will eliminate the social ill of unemployment: all those who want work will have it. Second, by setting wages below the level in the private sector, the ELR will create a “nominal anchor”: the below-market-rate ELR wage will restrain wage demands across the economy, preventing inflation, even in the absence of unemployment. When inflation sets in, the government should respond by reducing total spending, leading to lay-offs in the private sector. These laid off workers will be picked up by the ELR, at lower wages than the private sector. This increase in the “buffer stock” of ELR workers will serve to dampen wage demands in the private sector, reducing inflationary pressure.
These three elements: sovereign money, functional finance and the employer of last resort comprise the theoretical and policy core of MMT.
Before assessing whether this provides a sound basis for policy, we need to first briefly consider some history of the relationship between economic theory and macroeconomic policy. In the advanced economic nations, the post-war years were characterised by rapid growth and very low unemployment rates. By the middle of 1970s, this benign macroeconomic environment had given way to oil price hikes, the breakdown of the Bretton Woods managed exchange rate system and rising labour militancy. Policy-makers switched their focus from employment to inflation: the influence of Milton Friedman’s monetarism led to a growing belief that using macroeconomic policy for anything other than controlling inflation was futile, and that employment should be abandoned as a policy target. Through the 1980s and 1990s, academic economics coalesced around an increasingly mathematical formalisation of Friedman’s ideas (confusingly, this acquired the title of “New Keynesian economics”). While mathematically complex, this boils down to three main propositions.
First, total spending by households and businesses – what economists refer to as aggregate demand – is determined, in the short run, by the rate of interest. Since the rate of interest is assumed to be under the control of the central bank, total spending is therefore under direct policy control. Second, inflation is determined by two factors: firstly by total spending relative to the productive capacity of the economy and, secondly, by expectations about future inflation. In this view, if inflation is too high, the central bank should raise the rate of interest, reducing total spending and thus reducing inflationary pressure. The speed at which inflation will return to target will depend on the “credibility” of the central bank: if households and businesses believe that the central bank is serious about getting inflation under control, even at the cost of higher short-run unemployment, then inflation will adjust quickly. The conclusion – the third proposition – is that the optimal way to implement macroeconomic policy is for an independent central bank to adopt a policy rule, explicitly stating how it will adjust interest rates when inflation is above target. This, it is argued, is the most effective way to ensure that the central bank is credible – and is not susceptible to politicians seeking to temporarily lower unemployment as a way to improve their electoral prospects.
A small group of dissenting “heterodox” economists maintained a position of opposition to the ascendancy of monetarist ideas, arguing that Friedman’s diagnosis relied on an over-simplified view of inflation as the result of “too much money chasing too few goods”. Drawing inspiration from Keynes and his contemporaries Michal Kalecki, Joan Robinson and Nicholas Kaldor, this group adopted the term “Post-Keynesian” to distinguish their position from that of the mainstream. The Post-Keynesians rejected the key monetarist assertion that the central bank can always influence economic activity by adjusting either the quantity of money or the policy rate of interest. As Keynes put it, monetary policy is like “pushing on a string”: tighter policy will dampen economic activity, but looser policy will not automatically act as a stimulus. Fiscal policy is therefore required for macroeconomic stabilisation.
From around the mid-1970s, Post-Keynesian economics was characterised by a transatlantic division of labour. In the UK, with Cambridge at the centre, much attention was focused on growth and distribution. In the US, a closer interest was taken in monetary and financial issues. It was with members of this group of US Post-Keynesians that Mosler formed an alliance in the 1990s. Mosler’s financial backing enabled institutional support at the University of Missouri-Kansas, where several prominent MMT developers gained employment, including a PhD training programme to incubate the next generation of MMT advocates.
While the theoretical core of MMT is close to the ideas of Post-Keynesian economics, MMT stole a march on their Post-Keynesians colleagues in exploiting social media and non-academic activism. With hindsight, however, these tactics turn out to be something of a double-edged sword: success relied on the use of slogans such as “money doesn’t grow on rich people”, “taxes don’t pay for spending” and “money is no object”. These slogans, and the zeal with which advocates adopted them, arguably serve to obscure the underlying ideas, making MMT claims appear more groundbreaking than is really the case.
Take the claim that “taxes don’t pay for spending”. It has long been taught in elementary macroeconomics classes that government spending adds to total national expenditure, while taxes are a deduction. The two variables are treated as moving independently of one another: taxation doesn’t constrain government spending. Since at least the time of Keynes, it has been understood that tax plays an important macroeconomic role in limiting total private sector spending, thus ensuring that economic capacity is available for government programmes. Whether this function should be characterised as taxes “paying for” spending is perhaps semantic.
Textbooks usually explain that the gap between government spending and taxation is covered by issuance of government bonds. MMT goes further, claiming that government spending is not financed by either taxes or bond issuance: Governments first spend, creating new money, then withdraw money from circulation by imposing taxes or issuing bonds. As a result, MMT proponents claim, taxes can be cut dramatically, without affecting the ability of government to spend, while bond issuance can be eliminated entirely.
Does MMT provide a good guide for policy? MMT proponents tend to deny that MMT provides policy proposals. Instead, it is claimed, MMT is a “lens” through which one comprehends the true nature of the monetary system. MMT is not a policy package, it is argued, because MMT is simply a description of how the system already works.
This claim stretches credibility. Putting the ELR proposal aside, MMT proponents do make policy proposals (such as those already noted). The common feature of such proposals is the use of deficit monetisation: issuing central bank money directly to pay for government programmes. For example, Warren Mosler proposes abolishing all payroll taxes, while Stephanie Kelton has argued that the Green New Deal, a massive public spending programme championed by the left of Democratic Party, can be implemented without needing to tax the wealthy.
Complaints by proponents that MMT is mischaracterised as “printing money” are therefore misplaced. The suggestion that MMT claims “deficits don’t matter” likewise causes protest: MMT proponents respond that deficits matter, but what matters is the so-called “real resource constraint”. As a result, as MMT proponents correctly note, deficits can be too small as well as too large – an obvious current example is Germany, where demand clearly falls short of real constraints, and there is substantial capacity for fiscal expansion. Despits this, MMT complaints are again misleading: MMT does argue that there is no financial constraint to government deficits. While it is almost certainly the case that the US and other advanced nations still have substantial fiscal space, despite running large deficits in some cases, the MMT claim is too extreme; at some point, fiscal limits will be reached even in rich nations. For countries further down the international currency hierarchy which face binding externally-imposed constraints related to foreign exchange needs, fiscal limits are very real.
Further, despite MMT proponents emphasising the “inflation barrier” as the true limit to deficit spending, little effort is devoted to the crucial questions of how real resources are to be mobilised: how to ensure that large government spending programmes such as the Green New Deal can be implemented without hitting supply side bottlenecks, capacity limits and political resistance. In framing everything in monetary terms, rather than real economic activity, MMT therefore obscures rather than illuminates important macroeconomic relationships.
Once the esoteric use of language and the more extreme claims are stripped away, there is arguably a rather conventional core to MMT. US economists JW Mason and Arun Jayadev argue that, in policy terms, MMT effectively amounts to a reversal of the “consensus assignment”. This refers to the idea that the two main tools of macroeconomic management, fiscal policy and monetary policy, should each be assigned a single target. The consensus assignment is that monetary policy (setting interest rates and, more recently, quantitative easing) should be used to manage aggregate demand, while fiscal policy is used to maintain sustainable debt-to-GDP ratios. In contrast, MMT proposes the use of fiscal policy to manage demand, and monetary policy (in the form of deficit monetisation and zero interest rates) to manage the public finances.
MMT is usually portrayed as a left-wing economic programme: Stephanie Kelton is an economic advisor to Bernie Sanders and Alexandria Ocasio-Cortez has said that MMT should be “part of the conversation”. But although much of the MMT activist base is on the left, the relationship between MMT and politics is more complex. The line that “money doesn’t grow on rich people” can potentially play well on the right, as much as the left. As already noted, Mosler, a self-described “Tea Party Democrat” proposes the abolition of payroll taxes. Bill Mitchell argues that MMT is politically neutral, and MMT insights can inform either left- or right-wing political programmes. Care therefore needs to be taken when associating government deficits with the political left: US Republicans use deficit scaremongering to constrain public spending by Democrat administrations, but Republican governments are often less fiscally cautious in office — Trump’s tax cuts provide a recent example. Similarly, in the UK, after nearly a decade of government cuts premised on the false threat of a run on bond markets, the Conservative government has decided to embrace deficits, cutting taxes and making eye-catching spending claims.
The ideas of MMT could also be adopted by political groups that combine socially right-wing ideas with activist fiscal policy. In their recent book, “Reclaiming The State”, Bill Mitchell and his co-author Thomas Fazi note the successful use of deficit monetisation in Nazi Germany, while decrying the “tragedy” of the Left’s focus in recent decades on “identity politics”: opposition to racism, homophobia and other forms of bigotry. This, Mitchell argues, serves to radicalise the “ethnocentrism of the proletariat”. This framing of MMT in terms of national sovereignty will have obvious appeal to those wishing to implement nativist policies, such as restricting migration, while using deficit spending to ensure employment for those on the inside.
MMT has had remarkable success in opposing needless deficit hysteria and in popularising more enlightened ideas on macroeconomic management than those prevailing since the rise of monetarism in the 1970s. Recent events have demonstrated the ineffectiveness of monetary policy as a demand management tool: it is now widely accepted that fiscal policy must play a more active role. MMT activists should therefore be commended: they have succeeded where other heterodox economists have failed in popularising these important ideas. But the use of obscurantist language, oversimplification of complex issues and the tendency to make excessive claims ultimately undermines their case.
Time will tell if MMT is destined to become a passing phase or a more permanent “part of the conversation”. What seems more certain is that the days of reliance on monetary policy as the sole macroeconomic stabilisation tool are over: fiscal policy is back on the agenda.