Making Sense of Modern Monetary Theory, Part 1
What we don’t know can’t hurt us. Right?
Given the challenges inherent in predicting the innumerable factors of economic behavior in the long term, this aphorism is rarely true with regard to economic policy. When we fail to investigate the deeper implications of any economic worldview, we risk repeating the same mistakes that have led to some of history’s greatest economic catastrophes, from the Great Depression of the 1930s to the Financial Crisis of 2008.
In light of this, the vageness surrounding Modern Monetary Theory, Washington’s newest and most controversial economic ideology, is especially striking. Attention-grabbing headlines obfuscate the topic with distinctly partisan taglines: promises of grand idealistic potential on the Left, and dire warnings of certain economic doom on the Right. Although Modern Monetary Theory indeed owes much of its current limelight to the promotion of self-proclaimed ‘democratic-socialists’ Sen. Bernie Sanders and Rep. Alexandria Ocasio-Cortez, relatively few on either side of the political arena seem to demonstrate a comprehensive grasp of what Modern Monetary Theory implies, appearing relatively uninterested in fully considering the breadth of its potential long-term impact.
Modern Monetary Theory, or ‘MMT’ is, in fact, a bit of a misnomer. MMT actually contests the effectiveness of monetary policy (as it has historically been understood), instead advocating for a near-complete reliance on fiscal policy to stabilize the economy. This, in turn, isn’t an entirely new idea either. In the wake of the Great Depression, John Maynard Keynes’ brainchild, the Keynesian school of macroeconomic thought, was adapted to the day’s realities, creating a ‘neo-Keynesian’ paradigm, which posited essentially the same thing: that governments should play a central role in stimulating the economy during a downturn, and an equally critical part in reining in inflationary excess during periods of growth. When Keynesian policies, which influenced the New Deal of 1930s America and dominated economic policy for nearly 40 years, foundered in the stagflation of the 1970s, a brief resurgence of the pro-small government Neoclassical school of economics sprang up during the Reagan era, only to subsequently lose favor amidst the turbulence it wrought at the end of the 1980’s. Since then, a hybridization of core Keynesian and Neoclassical ideas, dubbed the ‘New Keynesian classical-synthesis’ economic school, has guided the core objectives of fiscal and monetary policy: the minimization of government deficits, and the maximization of employment with the responsible management of inflation by the Federal Reserve Bank.
Acolytes of MMT instead argue that the New Keynesian approach is in fact inhibited from achieving its full potential, primarily because it pays too much attention to deficits and minimizing the national debt. Both Keynesian and New Keynesian economics argue that government deficit spending in bad times (like FDR’s New Deal) should be counterbalanced by surplus budgets during good times (like those seen briefly in the 1990s) to avoid long-term debt growth that could eventually imperil investors’ faith in the United States’ ability to pay back what it owes.
MMT asserts that because the dollar is the primary currency of global business, and because the United States borrows in its own currency, unlike smaller countries, it can borrow more money than it currently does without losing investor confidence.
If this sounds dangerous, that’s because a central tenet of conventional economics teaches us that runaway government borrowing leads to out-of-control inflation. Highly-leveraged countries like circa-2008 Greece and present-day Venezuela must pay the bulk of their interest payments in amounts denominated by the dollar, which retains a higher value than the borrower’s domestic currency. This steady devaluation occurs because of the borrowing country’s high debt load, and inflation caused by government initiatives to ‘print money,’ or increase the money supply for the sole purpose of paying that debt. If the borrowing country’s currency value eventually falls too low relative to the dollar, it can no longer be used to pay back its debt, triggering a default.
Modern Monetary theorists counter this argument by indicating that, because the US in fact pays interest on its debt in the same dollar denomination that it borrows with (the US dollar), the US can always pay back its debt at the same face value of currency it owes. This, MMT theorists suggest, means that the government can carry higher debt loads than it currently does, and that the economy has a greater productive capacity than is being currently harnessed under current fiscal policies.
MMTers also point to the behavior of the US economy since the 2008 Financial Crisis to assuage concerns over the inflationary effects of monetary policy aimed at increasing the money supply. In the months following the collapse of the market, the Federal Reserve bank engaged in standard interest rate-decreasing activity and the relatively-new practice of ‘Quantitative Easing’ at an unprecedented scale, to maintain market liquidity and restore the confidence of investors and depositors in the financial system. In short, following established policy procedures, interest rates were driven lower when the Federal Reserve purchased large quantities of Treasury bonds (government debt securities) from commercial banks on the open market, increasing the money supply and stimulating the economy. Quantitative Easing (or QE) is the same procedure applied to non-treasury securities, with the same cash-generating results. This plunged interest rates to near-zero levels, increasing investment and lending activity and staving off the total collapse of the financial system.
The US Congress then increased spending in 2008 by issuing more debt, or ‘printing money’, knowing that investors would be willing to buy the bonds because they could sell them to the Federal Reserve, which had essentially guaranteed the bonds’ value by purchasing them on the market en-masse. This works because, when the government pays interest to the Federal reserve on debt that the Fed has purchased, the Fed returns that money to the Treasury at year end. Money lent to the government by the Fed comes with no charge, and because the value of the dollar is not dependent on gold or any other commodity reserve, that loaned money has essentially been ‘printed’ out of thin air.
At the time, opponents of these drastic actions made many of the same claims that opponents of MMT do today: that low interest rates, high government debt, and ‘printing money’ would lead to international loss of investor faith in the dollar, the decline of the currency’s value, and the possible default of the government on its debt. None of this happened: with relatively low interest rates and reasonably easy money still around more than ten years after the crisis, the dollar remains the world’s currency of value. From the uncertainty surrounding these circumstances springs the impetus for Modern Monetary Theory’s surge in popularity.
In Part 2, we will discuss MMT’s alternate approach to monetary and fiscal policy, examining both the sizeable uncertainties that undermine MMT’s initial promise, and the potentially beneficial effects of its impact on the broader macroeconomic discourse.