Modern Monetary Theory (“MMT”) is the new cool kid on the economic ideas block. Well, it’s not quite new: MMT traces its root back to the early 20th century and it was properly developed in the 1990ies by Australian Professor Bill Mitchell. But it has finally come to the fore of American politics with the much-hyped New Green Deal (“NGD”) promoted by “democratic socialist” superstar and newly elected Democratic Representative, Alexandria Ocasio-Cortez, a former bartender. Her 10-year plan for transforming the American economy to 100% sustainable clean energy is based on MMT – and that’s a good thing, because no other economic theory would be able to support the dual goals of multi-trillion dollar spending on a complete transformation of how Americans live and offering new-found prosperity for all.
MMT is based on the (fundamentally correct) idea that a government that issues its own money is always able to pay its bills. This is why politicians can afford to be more blasé about a public sector deficit than, say, you or I can about a similar hole in our personal finances. This is basic deficit spending and mainstream economics is familiar with that concept: J.M. Keynes has been interpreted since the 1980s as having been essentially in favour of deficit spending during periods of high unemployment. But even neo-Keynesians accept the premise that future, post-recession spending would have to be reduced to avoid debt from spiralling out of control. MMT goes much further than that and argues that governments are fundamentally not constrained when it comes to spending its own money.
To reach that conclusion MMT leans on two key ideas. Firstly, that the issuer of a sovereign fiat currency cannot become insolvent and the only limit is if price inflation leads spending to exceed what can be produced, and that happens only if there are insufficient resources in the economy to produce what the government is buying. Secondly, that the government’s deficit is the private sectors’ surplus (adjusting for the current account balance, i.e. the net foreign trading relationship), because for every borrower there is a lender somewhere in the economy – so for the private sector to be a net saver the government must run a deficit. The consequence of this is that taxation is not used by governments to raise revenue – that is simply unnecessary, as they can just turn to the printing press instead – but to regulate the private sector’s demand, and thus, the aggregate demand in the economy, to keep it from “overheating”.
But is it really true that if the government runs a budget surplus it is mathematically impossible for the private sector to be a net saver as well? What MMTers mean by “net saving” is that that private saving net of private investment must be matched by government net surplus or deficit. That’s true by definition: if the private sector saves more than they invest back in the private sector then they must have invested into the public sector (by buying government debt):
G – T = S – I,
where G = government spending, T = taxes, S = saving and I = investment.
The problem, therefore, is not their equations but the sleight of hand in their definition of “saving”: what “net saving” really means (that is, what it means to most economists), is that saving is larger than borrowing – that is, not just debt, but equity as well. And there is nothing to prevent the private sector from saving more than they borrow, completely independently of what the government does. It is only if the private sector is a net borrower that the government is involved, if they net accumulate assets without borrowing, the government balance sheet remains unchanged. Even Robinson Crusoe could save a fish today to eat it tomorrow. But it is true that in the real economy you must produce before you can consume: Crusoe could not eat a fish today which he only catches tomorrow. Government stimulus, on the other hand, allows this (in the short term). Note also that a supply-side economist could use the exact same relationship to argue for “crowding out” effects: when the government increases borrowing to be able to up spending, the private sector may react by lowering their investments. MMTers recognise this relationship and argue that government debt is not a financing instrument (the state can just print the money to buy what it wants), but an instrument to control private sector demand and the interest rate.
But the real magic in the equation above is the realisation that if the government runs a surplus then the private sector is going into debt, and for the MMTers, that’s because there is insufficient money in the system to satisfy investment demand; that is, there are plenty of resources available to increase production but not enough accounting units (money) to enable the transactions that activate these resources. This is why MMT is a powerful theory to provide a criticism of austerity. For the MMTers, the current economic orthodoxy has led to policies which have held back the flow of money to the private sector and that in turn has left the US with chronic unemployment due to a lack of aggregate demand. With that much slack in the economy there will be no “crowding out” from government spending.
A basic, Austrian critique of MMT is that money printing is not wealth creation. MMTers rely on the relationship between government and private sector debt to prove that the state can regulate the economy by printing money, but they are confusing a monetary relationship for a real one. The continuous stimulus of an economy through a surplus of liquidity is an artificial boom which will inevitably be followed by a bust: the government has kickstarted something by stimulating the economy, but it’s a false signal: there is not the saving available to sustain the investment projects undertaken by entrepreneurs.
Austrians adhere to the original definition of inflation: an increase in the money supply. The reason MMTers can afford not to be concerned about inflation is that not only do they subscribe to the mainstem view that inflation is a rise in prices, they take it one notch further by requiring it to be a continuous rise in prices. Their next argument is that that only happens when there is a chronic excess demand relative to the real capacity of the economy to produce, and they finish off with some real magic: if the government guarantees everyone a job, then they control the labour market and can much more effectively target price stability. And voila, not only do you have a politically appealing prescription for a government jobs guarantee, you have also solved the inflation problem caused by excessive money printing (remember that the MMTers believe the economy is experiencing a severe lack of aggregate demand).
We easily see why MMT is politically attractive: it provides intellectual justification for the frivolous public spending which gets politicians of the left elected. It is Keynesianism on steroids; the “broken window fallacy” times 1,000. It is why Ocasio-Cortez and her co-sponsor, Senator Ed Markey, can claim that having a problem like climate change is actually good for us, given that we have to spend big to solve it. The New Green Deal proposes to modify every building in America and replace air travel with trains as part of a transition to a 100% green renewable energy, all while offering everyone a job guarantee at a new, higher minimum wage. And the result: overall prosperity.
But the reality is different. If you combat a mortal threat, which is how the NGD paints climate change, with radical proposals like these, the outcome is not new-found wealth. The measures in the NGD will require immense sacrifice from ordinary Americans, as resources are directed towards a rebuild of the economy and away from other spending. MMT is fantasy economics, a theory which seems to have been designed to justify certain policies which no other economic theories could support. Its rise to prominence, however, is set to continue: the NGD has been backed by every declared Democratic presidential candidate and MMT may well prove attractive to mainstream politicians across the Atlantic too, as European countries seek remedies for failed policies which have led to their governments facing economic Armageddon. MMT may be wrong but it is political dynamite. Those of us who know MMTers are deluded must start to take them, if not their theory, seriously.