Here’s How Central Banks ‘Saves’ Our Economy: Understanding Modern Monetary Theory (MMT)

ZodiacTrader
5 min readMay 15, 2024

Introduction

Modern Monetary Theory (MMT) has emerged as a provocative and often controversial approach to understanding the role of government finance in modern economies. By challenging conventional wisdom about fiscal policy, debt, and inflation, MMT provides a different perspective on economic sustainability and policy-making. This article explores the core principles of MMT, compares it with traditional economic theories, and evaluates its implications through real-world data and examples.

Core Principles of MMT

MMT centers on the belief that sovereign countries that issue their own currencies can never “run out of money” the same way a business or an individual can. This is because they can always create more money to pay for goods and services and to fulfill their financial obligations.

Key tenets of MMT include:
1. Monetary Sovereignty:

Only countries that control their own currency can practice MMT. This excludes those using a foreign currency or fixed exchange rates.

2. Government Deficits:

MMT posits that deficits are not inherently bad and are necessary for the private sector to accumulate net savings.

3. Role of Taxes:

Taxes are not primarily for funding government operations but for controlling inflation and managing public demand.

4. Full Employment:

MMT advocates for the use of government spending to achieve full employment, arguing that unemployment is evidence that the public sector is not using available labor resources effectively.

MMT vs. Traditional Economic Theories

To understand MMT’s distinct approach, it’s crucial to compare it with traditional economic theories, particularly Keynesianism and Classical/Neoclassical Economics.

Keynesian Economics:

Like MMT, Keynesianism emphasizes the importance of government spending for economic stability and growth, especially during downturns. However, Keynesians typically stress the role of fiscal and monetary policy in tandem and worry about the long-term impacts of debt.

Classical/Neoclassical Economics:

These schools typically advocate for minimal government intervention in the economy, emphasizing free markets and equilibrium. Government deficits are viewed negatively, as they are believed to lead to inflation, higher interest rates, and less efficient markets.

Practical Implications and Examples

Example 1: Japan
Japan serves as a practical example of some MMT concepts. Despite having a debt-to-GDP ratio of over 200%, one of the highest in the world, it has not faced financial ruin, largely because it borrows in its own currency (Yen) and has a strong control over its monetary system. Japan’s experience challenges traditional fears related to high debt levels and supports MMT’s view on sovereign finance flexibility.

Example 2: United States during COVID-19 Pandemic
During the COVID-19 pandemic, the U.S. government engaged in substantial deficit spending to support the economy, implementing large-scale programs such as the CARES Act. Despite the increase in public debt, inflation remained relatively stable initially, although it rose after 2021 as the economy started recovering and supply chains were disrupted. This scenario underscores MMT’s claim that governments can spend in excess of revenues during crises without immediate inflationary consequences.

Criticisms and Challenges

MMT is not without its critics. Many economists argue that it underestimates the risks of inflation and currency devaluation, particularly in less stable political and economic environments. There is also concern about how such policies could be reversed or controlled once inflation starts accelerating.

Additionally, while MMT suggests that taxes can control inflation, the practical implementation of such tax policies can be politically and socially challenging.

One of the most significant aspects of MMT is its implications for economic sustainability. According to MMT, as long as a country has monetary sovereignty, it does not face solvency issues like a household or a business might, because it can always create more of its currency to meet its obligations. This notion supports a different framework for thinking about government budgets, deficits, and debt levels, suggesting these are tools to manage economic activity rather than ends in themselves.

However, the sustainability of MMT also depends on the productive capacity of the economy. MMT theorists assert that as long as there is slack in the economy (i.e., unemployed labor and underutilized resources), the government can spend without causing inflation. This can be seen as an extension of Keynesian demand management, but without the fear of deficits that typically accompanies Keynesian thought. This leads to a focus on achieving and maintaining full employment as a primary economic objective.

Comparison With Other Economic Theories: A Deeper Dive

Austrian Economics:

In stark contrast to MMT, Austrian economics argues that money should be tightly controlled and not manipulated by government policies. Austrians believe that economic cycles are natural and should be allowed to progress without interference, which includes avoiding artificial inflation of the money supply, as suggested by MMT.

Supply-Side Economics:

Supply-side theory suggests that lower taxes and decreased regulation will stimulate supply (production), leading to economic growth. MMT, conversely, focuses more on stimulating demand through government spending and sees taxes primarily as tools for fighting inflation rather than funding expenditure directly.

Global Perspectives and Challenges

Example 3: The Eurozone
The Eurozone presents a unique case where MMT principles are hard to apply because member countries do not control their own currency — the Euro is managed by the European Central Bank. This loss of monetary sovereignty means that countries like Greece and Italy cannot print money to pay off debt, which subjected them to severe austerity measures during the Eurozone debt crisis. This situation illustrates the limitations and challenges of implementing MMT in a multi-national context.

Example 4: Zimbabwe and Hyperinflation
A counterexample to the benign view of MMT on inflation is Zimbabwe in the late 2000s, where the government printed money excessively, leading to hyperinflation. This highlights the risks of uncontrolled money printing, particularly in economies with weak institutional frameworks, contrasting sharply with the more stable examples of Japan and the U.S.

Policy Implications and Criticisms

Policy Recommendations:

MMT advocates for policies such as a Job Guarantee (JG) program, which aims to provide a buffer against economic cycles by directly employing people in public works and services. This aligns with the goal of full employment and active fiscal policy.

Criticisms:

Critics argue that MMT provides a short-term solution but fails to address potential long-term impacts such as dependency on state employment, decreased labor market flexibility, and the difficulty of withdrawing monetary stimulus once inflation accelerates.

While MMT offers innovative insights into the use of fiscal and monetary policy, especially under conditions of economic slack and crisis, it also requires a nuanced understanding and careful implementation.

The theory’s focus on full employment and its unconventional views on debt and deficits challenge traditional economic paradigms and invite ongoing debate. As with all economic theories, the practical application of MMT depends on a country’s specific economic conditions and institutional robustness. Whether MMT can be a sustainable and effective economic policy remains a subject of significant scholarly and practical debate.

Conclusion

While MMT offers innovative insights into the use of fiscal and monetary policy, especially under conditions of economic slack and crisis, it also requires a nuanced understanding and careful implementation.

The theory’s focus on full employment and its unconventional views on debt and deficits challenge traditional economic paradigms and invite ongoing debate. As with all economic theories, the practical application of MMT depends on a country’s specific economic conditions and institutional robustness. Whether MMT can be a sustainable and effective economic policy remains a subject of significant scholarly and practical debate.

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