The Big Explainer
What is Modern Monetary Theory?
This week Roger Hirst talks to Kevin Loane, Senior Economist at Fathom Consulting, about one of the main topics of conversation within economic circles, Modern Monetary Theory. It’s a driving force for increased government involvement in setting policy goals and shaping economies. MMT is a controversial strand of economics, but it can be quite difficult to give it a precise definition.
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Kevin [00:00:00] MMT, I think, is probably a framework that a lot of people who want more government spending are able to use this concept or this framework to argue for that.
Rog [00:00:11] Welcome to The Big Explainer. Modern Monetary Theory, or MMT, has become one of the main topics of conversation within economic circles. It's a driving force for increased government involvement in setting policy goals and shaping economies. It is a controversial strand of economics, but precisely defining exactly what MMT constitutes is proving quite tricky.
Kevin [00:00:48] So Modern Monetary Theory, it's hard to define it precisely because there's no single proponent and there's no document or piece of literature that you can read, that is that lines out all of the arguments.
Kevin [00:01:03] I think the key difference is that MMT advocates have over, or criticisms that they would have over orthodox economics, is that they view governments who print their own currency as having no financial constraint. So they say if you're a government that prints your own currency, you can borrow as much as you want. And you probably heard things such as 'deficits don't matter'. So they would say that governments don't tax people or they don't raise tax revenue to fund spending, that they use taxes to actually control inflation. So the implications for that for a lot of people is that governments are far less constrained in terms of how much they can borrow. And also, I would say that MMT advocates would argue that fiscal policymakers should really be controlling inflation, traditional economics, central banks, independent central banks, that interest rates to control inflation, whereas within MMT, the role of central banks is to finance or to fund governments, and then governments are able to adjust spending and taxes to control inflation.
Kevin [00:02:09] Traditionally, we would assume governments have set priorities and then they tax and get enough revenue to fund those priorities and then maybe borrow or have a surplus if they wish. MMT argues that there is no financial constraint, governments just spend as much as is required to either achieve optimal employment or achieve climate change mitigation, whatever their objectives maybe, they should just borrow it and the central bank should create that money and we live in a fiat currency world so the central bank can do that. And only the government then only fiscal policymakers should be in charge of inflation. So they don't argue that there won't be inflation and they accept that there is some sort of constraint, and if you print too much money and there's too few resources, that there will be inflation.
Rog [00:02:59] Kevin outlined the key elements of MMT. Governments who have sovereignty over their own currency can spend first, even if that means they build up a large deficit. The extent to which a country can spend will be constrained by inflation. Sovereignty over one's own currency means that they are an issuer of their own currency, like the US, the UK and Japan. Members of the eurozone such as Italy do not have sovereignty over their currency. Countries which issue their own currency but have high levels of debt denominated in different currencies, such as the US dollar, have also given away some of their sovereignty, because these debts are denominated in a foreign currency. Now the government is key. They are the fiscal authority who define spending levels and attempt to control inflation via taxes. Central banks, who are the monetary authority, would have less control over setting policy and would primarily be monetizing the government's debt. This would shift control of economic policy away from central banks and back to the government. MMT has come to the fore because existing policies have struggled to create true growth.
Kevin [00:04:05] One of the reasons is that the recovery from the global financial crisis was extremely sluggish. A lot of people were concerned about inequality. Wages were relatively stagnant, clearly, that was having political outcomes that some people may not have liked and so MMT, I think, is probably a framework that a lot of people who want more government spending are able to use this concept or this framework to argue for that. But I think the reason why it's really gained currency and why a lot of people are talking about it, partly because people like AOC, and Ice Cube are tweeting about it, so it's become very mainstream and popular. But it's also a way for people who really want to borrow and fund large government spending. Basically, it's a way for them to argue that this is feasible and this is possible and there aren't the same costs that would traditionally be associated with those types of programs.
Rog [00:04:57] MMT is by no means a mainstream idea yet, but it is gathering momentum. As always, there are ideas both for and against MMT.
Kevin [00:05:07] The key argument, I think, is that government can be far more proactive in ensuring the most, the highest number of people are employed at all times. And so you should have lower unemployment and generally higher social welfare because governments should be able to spend far more than they traditionally have and so there would normally be employment, a lot of advocates are in favor of MMT to fund Green New Deal and so big infrastructure projects to try and combat climate change. Essentially, a lot of the things that people are in favor of that previously people would say those are too expensive or we don't have enough money, a lot of advocates to use this as a way to say that we can actually do those things.
Rog [00:05:50] So proponents of MMT believe that an economy should be allowed to reach full employment where everyone who wants a job gets a job. One of the areas of focus would be modernizing a country's infrastructure, providing both jobs and an improved network of communications to help encourage growth. Although it sounds perfectly reasonable, MMT is not without its detractors.
Kevin [00:06:11] The main argument that you can just borrow as much as you want without any consequences, which some advocates they've reached that point, is not true. I would say that people who are in favor of all of those types of programs that I've just mentioned, some people who want to spend a lot more on unemployment and want to spend a lot on climate change, they use MMT as a way to to get around the difficult question of how do you pay for it by saying the money the government can just print money. If you draw that out, it's extreme. You could get inflation and then government could default that, they they don't bring anything really new in terms of solving the problem of how does government mobilize real resources? They want to have more real resources to spend on different projects. I don't think MMT really devises or brings a new a new solution to the age old problem, that there are scarce resources in the world and governments have to make difficult decisions about which ones to fund.
Rog [00:07:13] One of the main criticisms of MMT is that it focuses on spending money, but not on allocating capital. You can print money, but you can't print wealth. Creating money out of thin air distorts incentives and misallocats capital. But the allure of full employment and the ability to kickstart an economy by increasing fiscal expenditures still looks like an attractive option, especially after the havoc that has been created by the Covid-19 pandemic. Have many countries made the full jump to MMT yet?
Kevin [00:07:43] In the literal sense, no. No country has adopted it. But one thing that the MMT movement has done is clearly highlighted a flaw in traditional economic thinking, which was that governments are far more constrained fiscally, at least among some people, IMF and the OECD, for example, after the global financial crisis, that governments basically couldn't borrow as much as we now see that they can. So I don't think any country is really doing MMT in a real sense, but if you look at the response to Covid and how much governments have borrowed, central banks engaging in large QE essentially to sterilize all of the additional borrowing that governments have had, in the US sets up to three trillion dollars, there isn't you know, they're not they're kind of not doing it literally, but that's in the spirit of mentality in a lot of places at the moment.
Rog [00:08:34] Although there aren't any countries that have moved into full MMT mode, the response to the Covid crisis has been to increase government or fiscal spending, while central banks have expanded their balance sheets at a record speed in order to help hoover up this additional debt. Whilst most governments have responded to the crisis with an increase in fiscal expenditures, MMT is still seen as being firmly rooted in the politics of the left.
Kevin [00:08:57] If you read the various proponents, I'd say almost all of them are left wing and I think they would all be in favor of far more state control. In terms of inflation they accept that there is a demand and supply imbalance that can cause inflation. But they also blame or point to things such as financial markets and monopoly power as being really important in terms of driving inflation, and so to respond to that, they're in favor of far more government regulation in terms of either setting prices or setting wages, and just being more intrusive, I think in what we would traditionally see is the private sector. Outlining the framework is quite tricky, particularly I mean, I'd say for me even who is an economist, but if you're not an economist, there I think it is kind of obtuse the way that MMT advocates explain what the theory is. So I hope i've done, tried to do my best to to to give them credit for what they're trying to say, but it is a it's a fairly tricky kind of concept to get your head around it overall.
Rog [00:10:04] Proponents of MMT believe the countries who have sovereignty over their own currency should be able to spend freely because they will never run out of money, as these countries are issuers of their own currency, and their debts are denominated in that currency. The key constraint is inflation, though taxation can be used to reduce demand in the areas where inflation is starting to pick up. Detractors argue that central planners are very poor at allocating capital and that the impact on innovation and productivity and the distortion of incentives will create a financial and economic burden, even if it appears that the printing presses can keep the specter of increased debt at bay. Now, whether we like it or not, elements of MMT are already being incorporated into many economies. The MMT debate will continue to rumble on, and the intensity of the debate will only increase through time.