A very detailed walkthrough of the big new left economic idea.
Modern Monetary Theory is having a moment.
The theory, in brief, argues that countries that issue their own currencies can never “run out of money” the way people or businesses can. But what was once an obscure “heterodox” branch of economics has now become a major topic of debate among Democrats and economists with astonishing speed.
For that, we can thank Rep. Alexandria Ocasio-Cortez (D-NY), who told Business Insider in January that MMT “absolutely” needs to be “a larger part of our conversation.” That was the most vocal mainstream support MMT had gotten, which for years had been championed by economists like Stephanie Kelton (a former adviser to Bernie Sanders), L. Randall Wray, Bill Mitchell (who coined the name Modern Monetary Theory), and Warren Mosler — as well as a growing number of economists at Wall Street institutions.
With AOC on board, a wave of denunciations from mainstream economists and others followed. Fed Chair Jerome Powell, Bill Gates, former Treasury Secretary Larry Summers, and former IMF chief economist Kenneth Rogoff all attacked the theory.
Or, more accurately, they attacked what they thought the theory to be. MMT is more nuanced than the “governments never have to pay for stuff” caricature it’s earned among other economists, and MMT advocates are famously (and often understandably) ornery when they sense they’re being misrepresented.
At the same, that caricature gets at what may ultimately be the most important effect of MMT as an idea: It could convince some Democrats to break away from the view that spending always has to be “paid for” with tax increases. How many Democrats buy that conclusion, and how far they’re willing to take it, remains to be seen. But some are already moving in that direction: While emphasizing that “debt matters,” Sen. Elizabeth Warren (D-MA) recently noted, “we need to rethink our system in a way that is genuinely about investments that pay off over time.”
The rise of MMT could allow Democrats to embrace the de facto fiscal policy of Republican presidents, who tend to explode the deficit to finance pet initiatives like tax cuts and defense spending, leaving Democrats to clean up afterward. MMT could be Democrats’ way of saying, “We don’t want to be suckers anymore.”
That would be a big deal. Getting comfortable with new deficit-financed programs would help Democrats overcome the single biggest impediment to their agenda: raising taxes to fund their programs. MMT could offer a way to justify passing big priorities like single-payer health care or free college without resorting to major middle-class tax hikes.
And if the idea behind MMT is wrong, that shift could be a false promise, one that offers short-term political benefits at the expense of hard to foresee economic costs.
So let’s dive into the wonky details of MMT. And I do mean wonky — this is a pretty technical article that gets into the nitty-gritty of why MMT is different from mainstream economics. But I think those details are important, and they’re easy for even very smart, very informed people to get wrong.
I’ll explain MMT theories about deficits, inflation, and employment, and what it all means for Democratic Party politics in 2020 and beyond.
The standard story about deficits
If you ask a mainstream economist why budget deficits can be harmful, they’ll probably tell you a story about interest rates and investment.
In the standard story, the government levies taxes and then uses them to pay for what it can. To pay for the rest of its expenses, it then borrows money by issuing bonds that investors can buy up. But such borrowing has a big downside. Budget deficits increase demand for loans, because the government needs loans on top of all the loans that private individuals and businesses are demanding.
And just as a surge in demand for, say, tickets to a newly cool band should increase the going price of those tickets (at least on StubHub), a surge in demand for loans makes loans more expensive: The average interest charged goes up.
For the government, this is an additional expense it has to incur. But the higher interest rate applies to private companies and individuals too. And that means fewer families taking out mortgages and student loans, fewer businesses taking out loans to build new factories, and just generally slower economic growth (this is called “crowding out”).
If things get really bad and the government is struggling to cover its interest payments, it has a few options, none of which mainstream economists typically like: financial repression (using regulation to force down interest rates); paying for the interest by printing more money (which risks hyperinflation); and defaulting on the debt and saying that lenders just won’t get all their money back (which makes interest rates permanently higher in the future, because investors demand to be compensated for the risk that they won’t be paid back).
The MMT story about deficits
MMTers think this is all, essentially, confused. (Because MMT is a school of thought with many distinct thinkers, I will be using a recent textbook by MMT-supportive economists Mitchell, Wray, and Martin Watts as my main source when describing the school as a whole. But do keep in mind that individual MMT thinkers may depart from the textbook’s analysis at some points.)
For one thing, they adopt an older view, known as the endogenous money theory, that rejects the idea that there’s a supply of loanable funds out there that private businesses and governments compete over. Instead, they believe that loans by banks themselves create money in accordance with market demands for money, meaning there isn’t a firm trade-off between loaning to governments and loaning to businesses of a kind that forces interest rates to rise when governments borrow too much.
MMTers go beyond endogenous money theory, however, and argue that government should never have to default so long as it’s sovereign in its currency: that is, so long as it issues and controls the kind of money it taxes and spends. The US government, for instance, can’t go bankrupt because that would mean it ran out of dollars to pay creditors; but it can’t run out of dollars, because it is the only agency allowed to create dollars. It would be like a bowling alley running out of points to give players.
A consequence of this view, and of MMTers’ understanding of how the mechanics of government taxing and spending work, is that taxes and bonds do not and indeed cannot directly pay for spending. Instead, the government creates money whenever it spends.
So why, then, does the government tax, under the MMT view? Two big reasons: One, taxation gets people in the country to use the government-issued currency. Because they have to pay income taxes in dollars, Americans have a reason to earn dollars, spend dollars, and otherwise use dollars as opposed to, say, bitcoins or euros. Second, taxes are one tool governments can use to control inflation. They take money out of the economy, which keeps people from bidding up prices.
And why does the government issue bonds? According to MMT, government-issued bonds aren’t strictly necessary. The US government could, instead of issuing $1 in Treasury bonds for every $1 in deficit spending, just create the money directly without issuing bonds.
The Mitchell/Wray/Watts MMT textbook argues that the purpose of these bond issuances is to prevent interest rates in the private economy from falling too low. When the government spends, they argue, that adds more money to private bank accounts and increases the amount of “reserves” (cash the bank has stocked away, not lent out) in the banking system. The reserves earn a very low interest rate, pushing down interest rates overall. If the Fed wants higher interest rates, it will sell Treasury bonds to banks. Those Treasury bonds earn higher interest than the reserves, pushing overall interest rates higher.
“These activities are coordinated with the treasury, which will usually issue new bonds more or less in step with its deficit spending,” Mitchell, Wray, and Watts write. “This is because the central bank would run out of bonds to sell to drain the excess reserves created by deficit spending.”
But the basic upshot of all this is that taxing less than the government spends, and issuing bonds in tandem, isn’t a problem under most prevailing circumstances, per MMT. The main constraint on government deficits is inflation, but at a time like now when inflation is low, that’s not a serious concern.
Indeed, MMT has incorporated an approach to analyzing deficits — the “sectoral balances” framework — developed by the late British economist Wynne Godley, which implies that government deficits are often necessary to boost savings in the private sector. Godley’s insight was that when the government is in debt, that necessarily means another segment of the economy is running a surplus, either the domestic US economy or the external economy.
So when the US is importing more stuff than it exports (as is normally the case), and the domestic US economy is overwhelmed with debt that it’s trying to get rid of (as was the case after the 2008 crash, as private homeowners and others were left underwater), the government, as a matter of arithmetic, has to run deficits if it wants to help the private sector recover. Indeed, in their textbook Mitchell, Wray, and Watts suggest that the 2001 recession was the result of the US fiscal surplus at that time forcing the private sector into deficit: “In most advanced economies, sharp, severe economic downturns typically follow a period when fiscal surpluses are accompanied by large private sector deficits.”
“In the long term,” they conclude, “the only sustainable position is for the private domestic sector to be in surplus.” As long as the US runs a current account deficit with other countries, that means the government budget has to be in deficit. It isn’t “crowding out” investment in the private sector, but enabling it.
MMT and inflation
When you lay out the MMT view on deficits, non-MMTers typically have one of two reactions:
- This will lead to hyperinflation.
- This isn’t all that different from regular economics.
The first reaction flows from MMT’s rhetoric about the government always being able to print more money. The image of a government creating infinite piles of cash to finance whatever it wants to spend brings to mind Weimar-era wheelbarrows of cash, as Larry Summers wrote in his critique of MMT:
[i]t is not true that governments can simply create new money to pay all liabilities coming due and avoid default. As the experience of any number of emerging markets demonstrates, past a certain point, this approach leads to hyperinflation. Indeed, in emerging markets that have practiced modern monetary theory, situations could arise where people could buy two drinks at bars at once to avoid the hourly price increases. As with any tax, there is a limit to the amount of revenue that can be raised via such an inflation tax. If this limit is exceeded, hyperinflation will result.
The MMT reply to this is simple: No, our approach won’t lead to hyperinflation, because we take inflation incredibly seriously. Taxes are, they concede, sometimes necessary to stave off inflation, and as a consequence, preventing inflation can require cutting back on deficit spending by hiking taxes. But the lower inflation caused by higher taxes is not an effect of “lowering the deficit”; the lower deficit is just an artifact of the choice to raise taxes to fight inflation.
In a podcast debate that Vox’s Ezra Klein hosted between Furman and MMTer Stephanie Kelton, Klein asked what Kelton would do if her former boss Bernie Sanders were elected president and how much of a single-payer plan he had to pay for with taxes. She replied, “I’d tell him, ‘Give me a team of economists and about six months and I’ll let you know.’ … I think that is an extremely important question that would require some very serious, time-consuming, patient analytical work to try to arrive at the right answer.”
Other MMTers are more optimistic. Warren Mosler, a hedge funder who’s helped popularize MMT especially within the finance world, has argued that the government doesn’t need to levy any taxes to pay for Medicare-for-all. Laying off the millions of people doing health care administration for private insurers and hospitals would be a major deflationary event, he argues, so if anything, the government should offer a tax cut or another spending increase to “pay for” Medicare-for-all in inflation terms:
Mosler’s view isn’t universal even among MMTers, so I don’t think MMT will single-handedly solve the problem of financing Democrats’ 2021 (or 2025, or 2029, depending on how the elections go) agenda. But it might help solve it by making Democrats comfortable with paying for a sizable portion of their program with debt.