Modern Monetary Theory 101

Can the act of printing money by the government be done without any consequences? The idea that money has to be backed by gold or silver has faded away. Our modern Fiat currency system (the one that we know as paper money) ties the value of money to the consumer confidence in a certain government. Independent countries such as the USA, the UK, Japan, and Canada, which do not rely heavily on other currencies, are less likely to worry about balancing their budget. For instance, if the revenue is $10 they can spend $12, $15, and even $20! Let’s dive deeper into this article!

The Modern Monetary Theory concept came in 1970 when Mosler and Bears worked as Wall Street traders. Under MMT, governments do not need to rely on taxes or bonds and argue that independent countries can never run out of money. This theory may be able to convince some politicians and democrats to break the view of government spending that should always have to be covered with tax increases. In its principle, the government can borrow funds from the central bank for an unlimited amount without charging interest or demanding repayment of the government bonds.

According to the theory, debt is simply the government’s money distributed to the economy and is not being taxed. Comparing the government’s budget to the household is mistakenly compared. Thus, it is widely heard that “If I ran my household the way the governments do, I would go bankrupt.” This view encourages the governments to take care of their deficit under control. However, MMT believes that a country can not become insolvent in its currency and clearly, the governments do not need tax revenue before they can spend. Moreover, if taxpayers pay their tax by currency, the government has to spend first before the taxes can be paid because in reality, before they can pay their income tax, households require the government to spend!

How did the idea of MMT come out?

The discussion of money as a credit or debt started long time ago, while many currency issuers abandoned the gold standard in 1914. MMT itself described the reality of modern theory since 1971 when a free-floating currency replaced the fixed exchange rates (The Bretton Woods System)

Image 1: rising debt of the advanced economies

Source: Asia Nikkei

The debt level in most countries had always risen especially when crises led to a budget deficit. Budget deficits can be harmful in specific ways due to the obligation of the governments to levy taxes and borrow money by issuing bonds to pay the rest of the expenses. This will lead to loan demand increase, which will make loans more expensive and the average interest rate will rise. Higher interest rates will also be implemented for companies and individuals, and therefore fewer will take mortgages and business credits to do the expansion. As a consequence, the economy will grow slower. The worst thing is, if the government struggles to cover its interest charge, they might do financial repression, which is regulated to force down the interest rates, paying by printing more money (which could lead to hyperinflation) and debt default, which lead to a permanently higher interest rate in the future.

On the other hand, the government’s debt is very crucial for the growth of a nation as they expend on research and development, education, and so forth, which will lead to higher debt that can not be covered by tax revenue alone! Therefore, MMT comes up with a solution to boost economic growth by ignoring the debt level. MMTers argue that governments should never have to default as long as it issues and controls the money they tax and spend.

Criticism of MMT

MMT has still been debated by some experts over the past decade for several reasons and mostly said that MMT is backed with no foundation. Below are some criticisms regarding MMT.

  1. MMT is naive and irresponsible

Many parties have debated MMT because it claims that the government deficits will not cause a problem in themselves for the nation. Furthermore, the core of MMT theories is that inflation and economic conditions can be regulated by fiscal policy instead of implementing monetary policy. However, in reality, uncontrolled money printing usually leads to higher inflation than what the US is facing now, and inflation will affect the demand and supply equilibrium. Therefore, will bring a wider impact on economic stability.

2. MMT ignored the effort of policy separation

Its proposal of using tax as a monetary policy instrument has ignored the efforts that have been planned for decades for separation between monetary policy and fiscal policy spending decisions.

3. MMT is an unsuccessful attempt

Jerome Powell, the Fed Chair, Bill Gates, Larry Summers, the former Treasury Secretary, and Kenneth Rogoff, the former IMF Chief Economist, argue that MMT is an unsuccessful attempt to convince programs to run painlessly with unlimited money printing as printing money produces free lunches.

4. MMT is a nonsense theory from misunderstanding

Kenneth Rogoff, an economist, called MMT a nonsense theory born from a fundamental misunderstanding. Many economists doubt the possibility of printing limitless money with a low and controllable inflation rate, and the foundation of MMT believes high deficits will not impact the exchange rate.

MMT rejects the traditional Keynesian Analysis as they think that the government should ignore the debt they generated as it is unequal to household finance. Therefore, it is still too early to deploy this theory to government policy and needs further research and development because of the huge impact that it may lead on inflation. Furthermore, MMT is only suitable for the national government because of the power to issue the sovereign currency. However, local governments must act like households’ budgets in spending decisions because they are not issuers but users.

Written By: Wennie

Coats, W(2019). Modern Monetary Theory: A Critique. Retrieved 4 April 2022. from https://www.cato.org/cato-journal/fall-2019/modern-monetary-theory-critique

Fulwiler, S et al. (2012). Modern Monetary Theory: A Debate. Retrieved 5 April 2022. From https://peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-300/WP279.pdf

Mckibbin, W. (2019). Is Modern Monetary Theory Too Good To Be True?. Retrieved 3 April 2022. from https://www.brookings.edu/opinions/is-modern-monetary-theory-too-good-to-be-true/

Matthews, D. (2019). Modern Monetary Theory, explained: A very detailed walkthrough of the big new left economic idea. Retrieved 4 April 2022 from https://www.vox.com/future-perfect/2019/4/16/18251646/modern-monetary-theory-new-moment-explained

D’Souza, D (2021). Modern Monetary Theory. Retrieved 5 April 2022. From https://www.investopedia.com/modern-monetary-theory-mmt-4588060

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