What is modern monetary theory?

Modern monetary theory (MMT) is an unorthodox school of macroeconomic thought that characterizes currency as a public monopoly and cites unemployment as evidence of a restricted currency supply.¹

Advocates argue that, rather than attempting to balance the federal budget each year, the government should calibrate fiscal policy toward full employment, with deliberate deficit spending to boost aggregate demand when needed.

Critics counter that MMT is a recipe for runaway inflation.

While MMT remains controversial, it’s become less obscure. Work from Stephanie Kelton, a former chief economist on the U.S. Senate Budget Committee, has helped raise the profile of MMT in the public discourse. Investment industry luminaries Warren Buffet and Howard Marks have weighed in with views on the topic, as have economists Paul Krugman and Larry Summers.

MMT is likely to draw even more attention in light of recent U.S. government-sponsored relief packages designed to limit the economic damage linked to COVID-19 containment efforts. In fact, MMT is no longer an academic abstraction—it’s here. “Whether we like it or not, we’ll get to see its impact much quicker” than most would’ve imagined.²

Modern monetary theory is no longer an academic abstraction—it’s here.

Modern monetary theory starts with an observation: The U.S. dollar comes from the U.S. government, and it can’t come from anywhere else. While trying to issue your own money might be easy enough, getting it accepted would be another matter. The proliferation in cryptocurrency demonstrates the difficulty of breaking a government monopoly on money. Bitcoin’s volatility, for example, limits its utility as a medium of exchange, a store of value, and a unit of account. What makes U.S. currency valuable is the U.S. government’s ability to impose taxes—and its promise to honor the U.S. dollar as an accepted form of payment.

Ever since the United States gave up the gold standard in 1971, the U.S. dollar has been backed only by faith in that promise—“it works because we all willingly suspend our disbelief. In the final analysis, though, it’s just paper or, in the case of demand-deposit checking accounts, entries in a bank ledger.”³ Nearly a half-century into this era of fiat money—notes deemed legal tender by government decree—MMT supporters maintain it’s time to ditch certain fiscal conventions dating from the days when greenbacks were linked to gold bricks.

MMT supporters say it’s time to ditch fiscal conventions dating from the days when greenbacks were linked to gold bricks.

One such convention concerns a misplaced analogy between the public and private sectors. MMT proponents emphasize the fundamental distinction between the federal budget and a family budget. While businesses and households must come up with the cash to keep up with their bills, “the United States can pay any debt it has because we can always print money.”⁴ So too for Canada, Japan, the United Kingdom, and any government that does three things:

1. Issues its own currency
2. Allows its exchange rate to float
3. Avoids borrowing funds that require repayment in a foreign currency

While eurozone members and most emerging-market countries don’t meet those three criteria, a monetarily sovereign government, such as the United States, can’t be forced into insolvency. MMT reminds us that the government’s ability to meet its financial obligations in the digital age is merely a matter of a few keystrokes.

Modern monetary theorists aim to soften the stigma associated with deficit spending; history suggests the notion isn’t as radical as it may sound on the surface. After all, the United States has run a federal budget deficit in 46 of the last 50 fiscal years.⁵

If the U.S. government spends $100 into the economy and taxes $90 out of the economy, then the residual $10 represents a federal budget deficit for the fiscal period. While that may sound like bad news, MMT’s supporters are quick to point out a silver lining: There’s now an additional $10 in the economy that wasn’t there before. Just as every purchase is also a sale, every dollar the government spends represents a dollar of income for someone else; the government’s deficit is simultaneously a surplus for the private sector, with the potential to boost aggregate demand. That’s the basic idea behind the U.S. government’s plan to send $1,200 checks to millions of U.S. households in Coronavirus Tax Relief.⁶

Does MMT imply that deficits don’t matter? No. Its backers concede that deficits can indeed be too big. Evidence of a deficit that’s grown too big is inflation, which is the only relevant constraint on government spending, according to the MMT argument. When aggregate demand outstrips what real resources—including commodities, factories, and workers—in the economy can produce, then the government should curb deficit spending and entertain other aggregate demand offsets, such as higher taxes and more stringent business and financial regulations.

While the historical consensus among policymakers, the press, and the public has lamented the dangers of large deficits, MMT’s adherents assert that deficits can actually be too small under certain circumstances. Evidence of a deficit that’s too small, they say, is unemployment. Rather than aiming for a balanced budget every year, the government should be paying more attention to the return on investment prospects of its outlays. Deficit spending to bolster aggregate demand when the economy is flagging—especially spending on long-run productivity enhancers, such as education, infrastructure, and research and development—may help raise potential GDP over time, making the economy more resilient in the future.

Love it or hate it, MMT has spurred debate about appropriate civic goals and the way that fiscal policy might be shaped in an effort to achieve them. Until recently it was a completely untested theory. Now that it’s actually being implemented, the long-run implications for investors could be immense, for better or for worse. On the one hand, MMT’s holy grail—helping limit unemployment throughout the business cycle—would be bullish for most financial asset classes; on the other hand, a failed quest, resulting in hyperinflation, would leave investors with few places to turn.

1 “ME/MMT: The Currency as a Public Monopoly,” Warren Mosler, 2014. 2 “Which Way Now”? Howard Marks, March 31, 2020. 3 Principles of Business: Economics, by the editors at Salem Press, p. 356, 2018. 4 “No Chance of Default, US Can Print Money: Greenspan,” CNBC, August 7, 2011 << cnbc.com/id/44051683 >>. 5 Federal Reserve Bank of St. Louis, 2019. 6 irs.gov/coronavirus/economic-impact-payment-information-center