Modern Monetary Theory (MMT) is a political reaction to the constraints and costs of private financing for public spending. It is the explicit position that fiscal policy and monetary policy should be coordinated in order to avoid these constraints and costs. History is relevant. The future is untold. Money is currency is money. I hope you enjoy the read.
What is debt, what is money?
The linchpin of Modern Monetary Theory is an ontological glitch which is more profound than it first appears. Our notions of debt and money are being stretched. In their Platonic ideals, Debt is a loan you have to pay back, and Money is in short supply. In an item of unsurprising non-news, politicians, academics, the financial system, and Western culture are collaborating to change the rules. We’ve been here before. In fact, we’ve been here for a while.
The authority to create money has always flirted with the temptation to spend (too much of) it. This is the well-worn story of crooked sovereigns, diluted coins, paper money, and bankrupted peoples. But also of ‘normal’ governments in ‘abnormal’ times, also of QE, of Nixon, of Bretton Woods; also, yes, even of the gold standard. While in principle an international institution securing paper money’s value in relation to gold, the gold standard also provided a centralized mechanism (used many times) to devalue it!
Whose debt, whose money?
The circumstances which have put ‘MMT’ on the tips of tongues are a long time coming. When we weren’t looking, and then when we were, government debt in many developed countries reached a point where we had to stop counting levels, and start counting ratios, first derivatives, and second derivatives. The magnitude of outstanding debt just didn’t make sense anymore. The American people didn’t exactly agree to this. A more principled component of the Millennial malaise is an ongoing generational and sectoral transfer, a component of which is the interest paid on past public spending. The private creditors, however, did agree to this, even when it was clear that the Platonic ideal of Repayment must also be sacrificed. Why? Because there is only one thing that the US-led global financial system hates more than default: not enough debt! Yes, instead of repayment they prefer the ‘subscription model’, which 1) furnishes consistent income and 2) maintains a political dependency on the banks by the state, corporations, and households, meanwhile 3) generating the instruments which undergird the entire global financial system.
Modern Monetary Theory is a political reaction to the constraints and costs of private financing for public spending. It is the explicit position that fiscal policy and monetary policy should be coordinated in order to avoid these constraints and costs. This can be done both by ‘monetizing’ debt (for past spending) and by creating ‘helicopter money’ (for new spending). In the hands of the MMT proponents currently on stage, this agenda is a precisely redistributive one, with a focus on social programs. But it doesn’t have to be. It could just as easily be a military agenda driving the de-linking of private finance and public spending. In fact, the past creation of debt is just as much an impetus in this direction as new social spending objectives, and tax cuts do just as much as big social (or ‘other’) bills to bring this idea into the realm of possibility—or necessity. This is why both sides of the aisle have equally contributed to the present circumstances which now demand and generate a ‘theory’.
The US has been the main stage for the MMT debate. But it’s creeping up everywhere, not least because the fiscal, monetary, and social conditions which brought it into the light are not special to the US. It’s safe to expect that we won’t see it in the Eurozone anytime soon for reasons explained below, but it’s not absent within discourse in the UK, in the form of ‘People’s Quantitative Easing’.
The power of bending the rules comes only when ‘everybody else’ still follows them. Governments, who often have monopoly powers over money creation, are in a special position to spend more ¥€$ than they have (had). There is still a widespread stigma against doing so, which in the European Monetary Union is codified as constitutional law. There, government spending has to be financed by taxes or debt. ‘Helicopter money’ won’t do. That’s because the private sector is understood to provide the right discipline on governments’ monetary policy, steering the nation away from high inflation and the waste of resources. That’s where critics of MMT come in. Remember the central theorem in monetarist macroeconomics: mo’ money, mo’ higher prices.
And yet, very few politicians or academics would suggest that a government should ever need to default on its own debt in its own currency. Where do these two ends meet? They meet exactly where both creditors and debtors pretend that those extreme circumstances will never happen until they do–not exactly a rigorous position, either.
Can the theory be tested?
MMT is partially about wearing down that stigma against printing money for fiscal spending. The bolder side of wearing down a stigma, and where the idea definitely leans left, is the direct implication that governments should not be subject to private finance, ever. In this regard, MMT sits alongside the idea of establishing a public bank for public spending, which is Jeremy Corbyn’s version of the idea. MMT and ‘public banking’ are conceptually continuous, but the latter arguably contravenes the DNA of Amurrica herself, for two reasons. It leaves the entrepreneurial private sector out of the equation, and it’s honest about the government’s intentions. The other side of that honest naiveté is an ignorance about the consequences. But all of modern central banking is vulnerable to this criticism. Inflation targeting, output gaps, Taylor rules, single mandates, dual mandates, forward guidance, zero lower bounds, negative interest rates, narrow money, broad money, quantitative easing, qualitative easing, natural rates, equilibrium rates, real rates, stimulus, big mean birds and small mean birds, U3, U5, U6: a real soup of tricks to assure everyone that everything’s gonna be alright. Because perhaps the ‘central theorem’ in economics and finance (especially around inflation) is that the belief that it’s gonna be alright is a necessary and sometimes sufficient condition for everything to be all right.
MMT is aiming for the same message, but in that world where fiscal and monetary authorities have melded into one because the stakes feel simply too high, where the employment portion of the monetary mandate is interpreted a bit more broadly, and where the capital markets are not a primary subject of focus. Do MMT theorists have an acceptable answer to the question of inflation? Probably not. At the back of everyone’s mind is the sneaking (exciting?) suspicion that inflation is a thing of the past. Innovative and elastic production techniques, an evolving sectoral composition, global competition, and other secular trends do go some distance in explaining the G10 central banks’ challenge in raising inflation to target. Do we understand those dynamics well enough to bet on them? When MMT supporters do have an answer about inflation, it centres on taxation, which they claim is a much more precise tool for containing inflation, because it can be applied with high resolution to economic and social goals by differentiating between sectors, demographic groups, etc. Yet, others argue that it’s been tried and failed. However, more important than whether tax can be an effective tool is the question of whether it would be used: can democratic processes match the financial system’s ability to generate the structural incentive to contain inflation? Perhaps not, but can the financial system contain its own incentive to generate asset price inflation at the cost of real wages? Either way, is MMT more experimental than other ideas coming from central banks in the past century?
Modern currency theory
Where does money become currency, and monetary policy become currency policy? In a narrow but useful definition, the currency market is the market between moneys (usually fiat). Sometimes states do have a ‘currency policy’ which targets their exchange rates, in which case the toolbox includes both fiscal and monetary policies, as well as politics, trade, etc. ‘Currency policy’ even under free-floating regimes does sometimes drive monetary decisions, such as when interest rates have been used to make the currency either more appealing (after a currency crisis) or less (to benefit exporters). Yet the stability of the currency or full employment in the export sector circle back to macroeconomic objectives that also sit firmly within the purview of monetary policy. So the distinction is hard to argue. I think it’s fair to say that MMT in its current form is led by domestic objectives, and the impact on exchange rates features less as a factor, and is perhaps less understood.
We know that inflation is generally bad for the exchange rate, and MMT presents an inflation risk, even if primarily through a mechanism of inflation expectations. It may also balance some risks, however, in particular growth risks and US government solvency risks. My sense, however, is that the more important impact on currency is not so much that of medium-term exchange rates dependent on growth and inflation dynamics, but more the structural questions surrounding the international monetary system. Who is allowed to create and govern our reserve currency? Who is allowed to borrow; who is allowed to lend? What are equilibrium rates as monetary policy steps into the next stage of its experiment? What are equilibrium rates when monetary authorities lose their authority?
Yes, it is perhaps not a coincidence that these threads of US politics are leaning in to the government’s money monopoly exactly when that monopoly is under threat: by a shifting international reserve and trade system, by good old fashioned crisis risks, and by alternative currencies including crypto. (Beyond its allure for anarchists and tech-fetishists, crypto holds the renewed promise of a currency in short supply.) So while currency exchange rates will continue to equilibrate demand and supply between monetary zones, including if and when MMT officially features in policy, it’s the discontinuities in that equilibrium that really deserve our attention. If monetary disorder begins in the US, I’m not certain that this won’t also be an effective export, on the back of its currency and inflation exports.