Modern Monetary Theory: Can the U.S. Print its way to Prosperity?

John Jacobs is an MPP graduate student, specializing in regulatory policy.

The following is an op-ed and does not necessarily reflect the views of Policy Perspectives or the Trachtenberg school.

Over budget and ahead of schedule, the U.S. federal debt surpassed $20 trillion at the end of June, making it larger than the total national economy. This staggering bill might cause some anxiety, but a burgeoning macroeconomic theory, Modern Monetary Theory (MMT),  argues the fear is unwarranted. Drawing on a combination of heterodox economic theories (some more heterodox than others), MMT challenges the common notion that the U.S. federal government should balance its checkbook like an ordinary household.

The Power of a Currency Issuer

While MMT is mostly constrained to the Twittersphere, where economists discuss the topic frequently, do not let this medium undermine its credibility. Federal Reserve Chairman, Jerome Powell, is a known observer of Econ Twitter. Additionally, the release of Stephanie Kelton’s book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, has pushed the theory into the mainstream. 

Instead of acting as a currency user that uses dollars for transactions like the average American, MMT emphasizes the U.S. federal government’s unique role as a sovereign currency issuer. While banks and other large holders of the dollar can increase or decrease the money supply, as a currency issuer, only the central bank of the United States, the Federal Reserve, can create new dollars. Using this lens, all dollars must originate from the Fed, therefore, the federal government does not need to collect taxes or sell Treasury bonds prior to spending. Rather, it’s the other way around. 

To pay taxes, a person first must receive the currency that, in one way or another, originated from the issuer. Since the federal government demands taxes be paid in dollars, and Americans must pay taxes, dollars become valuable. According to MMT, this is the primary reason for taxes,  rather than raising revenue for the government to spend.

This relationship between the U.S. federal government and its money supply is the least controversial aspect of MMT, yet it is seldom recognized by politicians and ordinary citizens. According to MMT theorists, if the federal government wants to spend big on a new program, or cut taxes, it does not need to come up with the revenue to cover its costs. The Fed just needs to print, or in today’s terms, type the necessary money into a keyboard.

MMT in Action

When President Trump signed the $2 trillion CARES Act into law, the federal government sold bonds to fund the new spending, expanding the government debt. However, the largest purchaser of those bonds was the Fed. The Treasury traded interest-bearing bonds to the Federal Reserve for cash, simply moving money between the government’s bank accounts. The upshot is that when the Fed buys U.S. Treasuries, the federal government no longer owes the debt to a second party, essentially retiring it. As a currency issuer, the federal government can create more money to buy Treasuries and pay off its debts, making an involuntary default impossible.  Under the Fed’s jurisdiction, it could purchase all U.S. Treasuries tomorrow and retire the entire U.S. federal debt, something Japan has already done with nearly half of its debt. According to MMT, the U.S. federal government can spend without collecting taxes and can do so without expanding the government debt, but there’s a catch: inflation.

Inflation

MMT stresses that the critical measurement for federal spending is not the size of the debt or the debt to GDP ratio, but the inflation rate. If the federal government pumps too much money into the economy, exceeding the U.S.’s productive capacity, inflation will rise. If inflation rises too quickly, Americans will feel it in their pocketbook as prices increase and wages lag behind. Is the Fed’s financing of the debt created by the CARES Act fueling inflation? Not quite. The annual U.S. inflation rate currently stands at around one percent, half of the Fed’s two percent target. In fact, over the past decade, the Fed has struggled to increase the U.S. inflation rate. There actually is not enough spending (aggregate demand) in the U.S. economy to hit the Fed’s inflation goal.

Critics Fear MMT is Promising a “Free Lunch”

While MMT’s prominence is surging in the macroeconomic field, the theory has gained some notable critics. Last year, Chairman Powell, seemingly referring to MMT, dismissed the idea that “deficits don’t matter for countries that can borrow in their own currency” and added that he worries government debt is growing faster than GDP. Powell failed to elaborate, but many mainstream economists argue that as the government borrows money to cover the deficit, the increased demand for loans “crowds out” the private sector as interest rates increase, making loans more expensive for businesses. MMT takes issue with the crowding out premise, arguing that government deficits enable private investment rather than preventing it, and in the age of high government debt and near zero interest rates, the critique has largely subsided.

Larry Summers, former director of the National Economic Council for President Obama, also provided a critique of MMT. Summers argues that unchecked federal spending that is paid for by creating new dollars will eventually cause hyperinflation, leading to higher long-term interest rates, the weakening of the USD and lower real wages for American workers. This is not a critique of MMT’s descriptive currency issuer framework, which already places inflation as the key metric of focus. Instead, this critique applies to the policy recommendations made by many MMT supporters who advocate for programs that would greatly increase the government deficit as prescriptions for America’s economic woes.

MMT’s Economic Prescriptions

With inflation low, many MMT advocates argue for an expansion of the federal deficit.  If inflation begins to rise, supporters of the theory propose several policies to slow the expansion of the money supply. Per MMT, the second primary purpose of taxes is to decrease the money supply. When the government collects taxes, it removes money from the economy and slows growth. The theory’s supporters also advocate for a Jobs Guarantee, a more controversial policy that would provide all Americans with access to a job at some set minimum wage. The MMT Jobs Guarantee would work as a replacement for the current, problematic labor market inflationary control, the non-accelerating inflation rate of unemployment, or NAIRU. The NAIRU is an indicator/theory that argues when unemployment gets too low, and the labor market becomes too tight, wage growth will accelerate at an unsustainable rate causing an inflationary spiral.

The underlying goal of MMT’s prescriptions is the utilization of the U.S.’s real resources; its educated workforce, raw materials, factories, and machines. MMT critics will note that the theory is not the only discipline that emphasizes real resources; however, its solution is unique. Whether its idle labor, unused/unbuilt housing, or untapped natural and renewable resources, MMT argues that a currency that takes advantage of the full fiscal space available in the U.S. economy is needed to put these resources to work.

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