Modern Monetary Theory (MMT) is a non-mainstream macroeconomic theory. The theory has actually fragmentally existed throughout the works of several historical economists all the way back to Adam Smith. Although it is Warren Mosler, an American economist who, due to his own intuition and culminating the works of previous economists, is credited for developing MMT the 1970s. MMT started to gain popularity after the 2008 financial crisis and has become significantly more popular with the advent of the Covid-19 pandemic. Its American supporters understand the new perspective it provides would allow the US government to effectively re-prioritize its goals to truly function for the people. The root of MMT is disproving the myth that the larger the financial deficit is, the more anxious a monetarily sovereign country’s citizens should be about owing “debt” to someone sometime. That is partly why MMT has not yet become common knowledge. The more people who believe the government’s fiscal house is the same as a household’s, the more politicians can weaponize people’s fear that the billions of dollars of government “debt” is getting out of hand. This allows them to cut programs they otherwise have no justification to cut (Kelton 2020, 39). Therefore, for some politicians it is better to resist making the modern monetary system completely transparent. At its most basic, MMT describes what monetary sovereignty is, how the United States got there, and that the true budget constraint is inflation, not the national deficit.
Modern Monetary Theory is based on the concept of monetary sovereignty. Three criteria must be met to achieve monetary sovereignty: A country must issue currency; the currency must be the country’s own non-convertible (fiat) currency; and the country must only borrow in its own currency (Kelton 2020, 19). According to MMT, the origin of money came from the government issuance of it. This origin of money theory is called chartalism. Chartalism states that money originated from the government creating and supplying currency in order to enforce taxation (Kelton 2020, 27). The resulting demand in the private-sector for the provided currency makes it an acceptable payment for goods and services (Mosler, 169, 175, 177). Therefore, the purpose of taxation is to direct economic activity, besides that, the government has no use for the currency it taxes away from people. If it needs more currency it can always create more. A government financial deficit itself is not a problem. Because the government must supply the currency first by spending it into existence before it can ever tax, it turns this accepted modern paradigm on its head. Taxing and borrowing do not come before spending, they come after (Kelton 2020, 23).
The financial system of a country that has attained monetary sovereignty is distinctly different from the financial system of a household. Households, and other currency users like businesses and state governments in the private-sector, can run out of money. And when they need more they have to find a way to get paid or borrow money from someone else. Private-sector currency users have a real monetary budget constraint. In contrast, the government’s budget constraint is not based on finances, it is based on real available resources. The government does not need money, they supply it. Taxes direct economic activity, and borrowing is done to support interest rates by adding or removing dollars from the money supply. It is a misconception that when the government borrows they are removing a limited supply of savings from the private-sector (Kelton 2020, 114). Remember, the government first supplies money; they are not a household with a limited supply of money. “Borrowing” is simply allowing the private-sector to recycle excess dollars issued during deficit spending into US Treasury bonds to earn a positive nominal rate of interest (Kelton 2020, 115; Mosler 1997-1998, 175). Therefore, they are not competing with private-sector people who are trying to borrow and not raising interest rates (Kelton 2020, 116). Monetarily sovereign countries running fiscal deficits, with or without borrowing, increase collective savings in the private-sector (Kelton 2020, 110), and allow for increased spending which creates a virtuous cycle of increasing profitable investment (Kelton 2020, 126).
When the US left the gold standard they attained full monetary sovereignty. The gold standard tied the value of currency to gold. It required the Federal Reserve “...to buy or sell gold… to meet any supply or demand imbalance arising from international trade” (Kelton 2020, 139). In order to be able to convert currency into gold at a consistent rate, there needed to be enough gold. And that is where the mainstream government paradigm comes from: On the gold standard the best way to build up reserves was to run a trade surplus. As long as the US exported more than it imported the gold reserves increased, and there would be no worries about the promised rate of currency conversion. After WWII, Bretton Woods brought about the new gold standard which pegged international currencies to the US dollar which could still be converted into gold (Kelton 2020, 140). Then President Nixon permanently suspended the dollar’s convertibility in 1973, effectively abandoning the gold standard. With the end of the gold standard, the US attained total monetary sovereignty, and the age of Modern Monetary Theory took hold. There was no longer a gold convertibility constraint on the dollar supply, only the more real and important resource constraint.
Even a monetarily sovereign country like the US needs to do careful accounting, and with the advent of electronic currency, dollars going through the government can be thought of more like points on a scoreboard. The Federal Reserve, or the central bank, is the government’s scorekeeper. And like a scorekeeper they can never run out of points. All they have to do is keep track, do simple accounting, and make sure the points are allocated properly. A currency issuer never runs out of money. Government taxing and borrowing has nothing to do with getting money, the way a household might need to get money when they are running low. That is why federal deficit spending is so important, when running a trade deficit as well. If the private sector spends more on imports than it exports, and then is not left with a financial surplus, the private-sector, a user of currency, will be left with debt it cannot sustain (Kelton 2020, 133). As helpful as a government deficit can be to the private-sector, bigger does not necessarily mean better. It’s the right size deficit, one that respects the real resource constraint and “...provides just enough support to keep our economy humming along without rising inflation” (Kelton 2020, 109).
The spending “speed limit,” or tipping point for when to stop increasing the money supply, is inflation, not some large and undefined level of deficit spending. Taxation can be utilized to help control inflation. Inflation is typically considered to be caused by demand-pull inflation or cost-push inflation. Demand-pull inflation occurs when too much money is chasing too few goods and prices increase. Taxes prevent demand-pull inflation by pulling competing dollars out of the private sector (Kelton 2020, 47). To prevent demand-pull inflation in the event that the government wants to increase spending and the country is already risking crossing the two percent inflation limit the government can choose to increase taxes on its citizens as a way to pull competing buying power from the private sector to “...ensure resources match spending” (Kelton 2020, 33). Demand-pull inflation is not caused by simply printing more money, it's caused by how that money is spent.
The other kind of inflation, cost-push inflation, occurs after natural disasters cause supply shortages and prices spike, and when companies, such as monopolies and oligopolies, have enough market power to unilaterally raise prices or powerful unions raise wages (Kelton 2020, 46-47). Taxes can also fight cost-push inflation. Natural disasters can generally not be prevented, but tackling climate change, with tax-rebates to encourage green behavior or taxes to discourage polluting behavior, would significantly limit more from occurring. Wealth means power, so limiting market power through high taxation of the extremely wealthy would prevent unilateral price rises. In theory unions also could cause a type of cost-push inflation, however, the empirical evidence of this correlation is weak. A 2008 study found that “Despite the different methodologies, data periods and data sources, most studies … found that a 10 percent US minimum wage increase raises … overall prices by no more than 0.4%” (Lemos 2008, 208). And a 2016 study, from the Upjohn Institute, found that a 10 percent increase in the minimum wage generally results in only a 0.36 percent increase in the price level (MacDonald and Nilsson 2016, 5). Real wage is calculated by subtracting inflation from the nominal wage. This means if you increase the nominal wage by 10 percent and the resulting inflation is 0.36 percent then the real wage still increases by 9.64 percent. Although these studies are related to the minimum wage, the data is still relevant because a union wage increase is unlikely to affect the broader economy as much as a federally mandated wage increase. Increasing the minimum wage to keep pace with inflation and productivity isn’t a problem, and is in fact a necessity, as long as wages do not increase too much too fast (Economic Policy Institute 2019; Luhby 2021; Mosler 1997-1998, 178).
Deficit spending is not overspending, inflationary spending is overspending. But some inflation is a good thing. The Federal Reserve long-term inflation average target is 2 percent because that would indicate strength in the broader economy. Too little inflation, below that 2 percent level, is what the US has had (The United States Federal Reserve 2020). The reasons for this slow growth are considered to be either poor inflation expectations or unequal wealth distribution and wage stagnation (Kelton 2020, 46).
The government, instead of properly using taxation, and/or other tools at their disposal, assumes there is a “natural level of unemployment” that must be targeted to keep inflation in check. The Federal Reserve assumes a “natural rate of unemployment” level, at or below which they are supposed to raise interest rates. Higher interest rates are impactful because they mean reduced business investment which then leads to higher rates of unemployment. The Fed even includes the underemployed with the employed data and still tends to raise interest rates too soon despite the unproven relationship between unemployment and inflation. The level of unemployment that can be reached without causing inflation has been consistently wrong (Kelton 2020, 50-55). In 2015, the Fed raised interest rates even though inflation remained below 2 percent, and for the next few years they tried to increase unemployment with interest rate hikes but unemployment just kept going down and inflation didn’t increase (Kelton 2020, 52). But even without the Fed’s interventions, capitalist economies suffer from chronic insufficient aggregate demand. Without enough demand to incentivize businesses to hire more workers a “...slack in the form of unemployed resources, including labor” (Kelton 2020, 56) is formed. That’s why the US has had no true full employment except during WWII. The Fed could also set lower interest rates in an attempt to lower unemployment. Lower interest rates make it cheaper to borrow and invest, but there needs a sense of optimism in the market too. In times when people and businesses are void of optimism, like during a depression or a pandemic, what is really needed is some fiscal relief (Kelton 2020, 57-58).
Not only can taxes be used to stabilize inflation, MMT states that real full employment can be used to help stabilize the price level. As long as there is underemployment, the country is running below productive capacity, and therefore is underspending (Kelton 2020, 59-60). If the government provides a job guarantee, becoming the employer of last resort, the price level can be brought up to a balanced and stable level, as well as provide all citizens the right to full time employment. The government can choose to set the price of goods and let the market determine quantity demanded or it can set the quantity and let the market determine the price because it is the monopoly issuer of currency. The more popular and volatile option is the latter. If the government has determined its chosen quantity of government spending limit, or the “natural rate of unemployment,” and the market is left to determine the price, the price level will inevitably be unstable. However, as a rational monopoly power the government would choose to set the employer of last resort wage rate, then let the market determine the total quantity of government spending, which would determine the amount of people earning wages from the employer of last resort (Mosler 1997-1998, 174). The fixed wage rate would provide price stability. Warren Mosler used a gold standard analogy to describe the capabilities of the government job guarantee wage rate indicating that,“...the price of [labor] set by the government [would establish] the value of the currency, not only in terms of [labor], but in terms of other goods relative to the price of [labor]” (Mosler 1997-1998, 175, 177). The government job guarantee would also work as an automatic “countercyclical influence” safety mechanism to business cycles. In a recession, government spending and employment would make up for the jobs lost in the private sector and vice versa in an expansion (Mosler 1997-1998, 169). The price level would be stabilized even through the business cycles.
It is important more people learn about the key elements of MMT, because knowledge about the way the world truly works provides the tools to create change for the better. Especially when voters understand how their government’s financial deficit really works, how it more often than not benefits them, they can call out misinformation and make better informed voting decisions. American voters can finally pave a path for themselves. American voters no longer need to worry about the financial constraint. They can vote to create taxation that enhances their quality of life and their power. They can have free education. They can have a clean environment. They can have the infrastructure they need. They can have real full employment. They can live without worrying about their basic needs. They can do all this knowing the real cost of spending is real resources and the real budget constraint is inflation.
Bibliography
Economic Policy Institute. 2019. “The Productivity-Pay Gap.” Economic Policy Institute. https://www.epi.org/productivity-pay-gap/.
Kelton, Stephanie. 2020. The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy. New York: PublicAffairs.
Lemos, Sara. 2008. “A Survey of the Effects of the Minimum Wage on Prices.” Journal of Economic Surveys 22 (1): 187-212.
Luhby, Tami. 2021. “These two charts show how much minimum wage workers have fallen behind.” CNN politics. https://www.cnn.com/2021/02/21/politics/minimum-wage-inflation-productivity/index.html.
MacDonald, Daniel, and Eric Nilsson. 2016. “The Effects of Increasing the Minimum Wage on Prices: Analyzing the Incidence of Policy Design and Context.” Upjohn Institute Working Papers 16, no. 20 (June): 1-53. 10.17848/wp16-260.
Mosler, Warren. 1997-1998. “Full employment and price stability.” Journal of Post Keynesian Economics 20, no. 2 (Winter): 167-182.
The United States Federal Reserve. 2020. “Why does the Federal Reserve aim for inflation of 2 percent over the longer run?” Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/faqs/economy_14400.htm.
