Modern Monetary Theory and the future of deficit spending

  • Modern Monetary Theory has recently been brought into mainstream discourse through progressive leaders like Sen. Bernie Sanders and Rep. Alexandria Ocasio-Cortez.
  • The theory argues governments can spend as much money as they like and don’t need to worry about deficits because they can print money to pay for expenses.
  • Most critiques of MMT warn that it is too likely to trigger spiraling inflation.

The rise of Modern Monetary Theory

For decades, proponents of Modern Monetary Theory (MMT) existed on the fringes of academia and the Internet and were hardly given any serious consideration by economists on both the left and the right. In recent years, however, the emergence of progressive leaders like Vermont Senator Bernie Sanders and freshman House Representative Alexandria Ocasio-Cortez (D-N.Y.) has brought the controversial theory into mainstream discourse.

MMT basically argues that governments can spend as much money as they like and don’t need to worry about deficits because they can create the dollars they need to pay for their expenses. The only thing they need to worry about is inflation. As long as that can be contained, governments should feel free to spend as much as the economy can absorb.

The theory has been maligned by economists across the spectrum including Nobel laureate Paul Krugman, former Obama economic advisor Lawrence Summers, and former chief economist at the International Monetary Fund Oliver Blanchard. But that hasn’t stopped lawmakers from making budget decisions that reflect a de facto embrace of MMT. As Patrick Watson, a senior editor at Mauldin Economics, argued in Forbes this week, the core tenants of MMT for all intents and purposes are already being practiced in the U.S. He notes that government spending is spiking (though admittedly the Trump administration’s particular spending priorities are different than MMT proponents) while tax revenue has flatlined and interest rates have increased significantly over the past two years.

This is why, according to a recent Bloomberg report, “advocates say MMT shouldn’t be seen as a policy package that might get adopted one day. Instead, it’s more like a framework for understanding what tools are available to a government. And some of those tools are already being used.”

Critiques and the threat of inflation

There’s no shortage of voices warning about the growing national debt, but the U.S. has yet to face significant consequences for its unprecedented spending—at least not among investors, Bloomberg reported Monday. The U.S. budget gap has increased drastically and is predicted to keep expanding over the next three years, yet the government still has no trouble borrowing at around 3 percent interest. This has given the theory some additional credibility, especially as the Democratic party veers left heading into the 2020 presidential election.

The most persistent critiques of MMT center around the risk that monetizing debt would triggering spiraling inflation, the effects of which would be economically catastrophic. As Krugman wrote in 2011:

“When people expect inflation, they become reluctant to hold cash, which drive prices up and means that the government has to print more money to extract a given amount of real resources, which means higher inflation, etc. . . Do the math, and it becomes clear that any attempt to extract too much from seigniorage — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation. In effect, the currency is destroyed.”

In other words, this is not something to be trifled with, and if it goes wrong the effects will be virtually impossible to undo.

“What’s being proposed is a fundamental reordering of how economic institutions and priorities work,” wrote Neil Irwin, a senior economics correspondent for the New York Times’ The Upshot. He suggested that if anything MMT should be tested on a smaller economy first, rather than imposing so much risk on the U.S., the world’s economic powerhouse.

“For neither the right nor the left is there any such thing as a free lunch,” wrote Summers in a recent article for The Day. “It’s the responsibility of serious economists, whatever their political party, to make this clear.”

Whether lawmakers will heed Summers’ warning remains to be seen. But they have shown little appetite for deficit reduction of late.

Read a more in-depth critique of MMT at the Mercatus Center.

Image Credit: Photo by Vladimir Solomyani on Unsplash

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