By: Rohan Bhagat
Wait, what? Surely, that can’t be right. If the government just printed as much money as it wanted, it would devalue its currency to the point where it is worth nothing! Indeed, that is the commonly accepted viewpoint throughout virtually all of macroeconomics. But there is a small, growing faction of economists who believe that the government can actually create as much money as it wants with little repercussion. Their theory, Modern Monetary Theory (MMT), suggests that there is really no fiscal consequence of public debt.
How do we manage the economy today?
To understand MMT, it is important to understand how we manage the US economy today. Traditionally, economists have agreed that keeping a cyclically balanced budget, one that is not necessarily balanced each year but is balanced in the long-term, is key. Most argue that although deficits stimulate economic growth in the short term, they burden future generations. This is because economic growth, something that can be rather accurately measured by GDP, is linked to increased inflation. Naturally, greater deficit spending will encourage spending and economic production. As a result, employers will be more inclined to hire additional workers to keep up with the additional demand created by the extra spending, decreasing unemployment.
Unemployment and inflation are inversely related to one another. More people joining the workforce puts upwards pressure on the labor market by decreasing the availability of cheap labor, while the allure of high economic growth keeps the demand for additional employees, who are necessary for additional production, high. Increased labor costs will eventually force the price of goods up, causing inflation.
Monetary Policy
To counter this inflation, the government will use a variety of policy tools they have at their disposal. Typically, the Federal Reserve, which oversees US Monetary Policy, will take the first action. The Fed can sell Treasury bonds on the open market to take money out of the economy, which will naturally increase the value of money in circulation, countering inflation. They can also increase interest rates and increase the cash reserve ratio: the percentage of money banks are required to hold and not lend to consumers [2]. Both actions will decrease lending and investment and constrain inflation. By contributing to increased interest rates, reduced savings, and stifled private investment, deficits can reduce the size of the economy in the long run [3].
By contrast, if the economy was not growing too slowly, the Fed could take the opposite action, expanding the economy by encouraging spending, lending, and investment to reduce unemployment.
Fiscal Policy
However, sometimes monetary policy alone does not work. For example, during a recession, the Fed will lower interest rates to encourage spending, sometimes even to zero. Since the Fed remains averse to utilizing negative interest rates [4], this is the most they can manipulate the rates to stimulate economic growth.
This is where fiscal policy can step in. Fiscal policy refers to the adjustment of government spending and taxation to influence the economy and is mostly handled by Congress and the President’s Administration. For example, to cool an excessively growing economy, the government can choose to raise taxes, thus discouraging spending and fighting inflation. To stimulate a stagnant or contracting economy, the government could lower taxes, or as done recently, pass a stimulus package, literally giving money to people and businesses [5].
Modern Monetary Theory
So typically, economists believe that governments use taxes to pay for their expenses, and can utilize budget deficits and surpluses, as well as other policies, to influence the economy. But MMT challenges this belief. The core idea of MMT is that because a country that is the sole issuer of its own currency (like the US), it cannot be forced to default on debts in its own currency because it controls the supply of said currency. It argues that these countries can and should print as much money as they need to spend, often creating huge deficits in the process. They can pour money into the economy to encourage rapid growth and increased production.
Among this spending could be a job guarantee. Every individual who wanted a job could get one working for the government on minimum wage. Theoretically, this idea would fight inflation by creating a pool of workers whom private companies can hire for cheap, while also increasing economic production. This means they do not need to increase wages and then increase prices to make up for lost profits [6].
Paying for these programs would be quite expensive, but one has to remember that according to MMT, the government can simply print extra money to finance it. Simply put, the government does not need to collect taxes to pay for stuff. Rather, taxes are used to control inflation in two ways.
One: they create demand for currency. You must pay US taxes in US Dollars. This requirement creates a constant demand for the US Dollar, giving it value.
And two: taxes take money out of the economy, thus reducing the supply of currency and further increasing its value [7].
Together, the increased demand for currency and the decreased supply of said currency naturally increase its value.
But what about inflation?
But surely if the government just printed money all willy-nilly, we would experience rampant inflation, even with taxes, right? Not according to MMT theorists. They point to Japan, where the debt to GDP ratio is well over 230% [8] (in the US the number is about 130% [9]), but the country is actually experiencing slight deflation. They argue that this phenomenon is possible because inflation is not actually this scary, unstoppable force but rather can be managed through smart fiscal policy.
Most MMT theorists argue that inflation will not actually occur until we reach full employment (typically estimated to be about 4.4% unemployment in the US) as long as government spending is used to increase economic production, as, until this point, deficit spending would be used to increase nominal output.
Beyond this point, they believe inflation can be managed by several tools, including increased taxes. MMT writers Scott Fullwiler, Nathan Tankus, and Rohan Grey argue that taxes are a part of a “whole suite of potential demand offsets, which also includes things like tightening financial and credit regulations to reduce bank lending, market finance, speculation and fraud” [6]. It is the effective employment of these tools that theorists believe makes the inflation situation in Japan possible.
Don’t Get Excited Yet
Now it is important to emphasize that MMT is still just a theory and not a theory without criticism. Many major economists and individuals, including Jerome Powell, Paul Krugman, and Bill Gates, have objected to the theory. Critics have argued that MMT is a reckless and foolish idea for failing to recognize the true effects of excessively high government spending. They believe that MMT’s view of inflation is wildly fantastical and will simply not work in the real world. Many claim that MMT will cause hyperinflation, decrease the stability of the economy as investors grow wary of heavy deficit spending, and eliminate taxes’ role in redistributing some wealth from the rich to the poor.
But if MMT somehow works, it opens a whole new world of possibilities. It makes improved public schools, quality universal healthcare, and an environmentally friendly society, among other policies, not just possible, but decidedly realistic.