Modern Monetary Theory: Genius or Ridiculous?

By Neil Tamhankar and Eshan Gupta

Modern Monetary Theory (or MMT for short) is an idea so revolutionary it’s either brilliantly simple or flat-out absurd. To put it as simply as possible, MMT states that governments can print (and spend) as much money as they want, even if they go into debt. Before we can get into the idea itself, we have to understand the normal, accepted monetary theory. 

Normal Monetary Theory

Governments need to pay for various things, from social security checks to military spending, and they generally levy taxes to raise the necessary revenue. If the costs are greater than the revenue, they will borrow money to make up the difference, which is called deficit spending. This borrowing, which is added on top of all the everyday borrowing being done by private entities, increases the overall demand for loans. That increase in demand raises interest rates because when the demand for a good increases, its price increases (interest rates are the price of borrowing money). The higher interest rates don’t hurt the government too much, but they do severely affect private businesses and individuals. Suddenly, fewer people are taking out loans for houses or cars because the interest rates are too high for them to afford. With less loans and less spending, economic growth slows down. This is called the “crowding out” effect, and it's why governments are afraid to deficit spend. For example, let’s say the government borrows a ton of money to deficit spend and interest rates rise from 2% to 5%. A family that was planning on taking a $50,000 loan for a car would have paid an extra $1000 in interest with the 2% interest rate. With the new 5% interest rate, the family has to pay an extra $2,500, which may force them to not take the loan at all. To recap: the government deficit spends, increasing interest rates, which increase prices for loans for private businesses/individuals, prevent them from taking loans. With less loans comes less overall spending in the economy, leading to slow economic growth.

The MMT Perspective

To reiterate, MMT states that governments can issue and spend currency as they deem necessary. As opposed to normal monetary theory, MMT argues that as long as the resources exist, deficit spending is neutral at worst, and maybe even beneficial. For example, let's say that the government wants to build a new subway system and they need to deficit spend in order to build it. MMT completely approves of the spending as long as the construction workers and materials (both of which are resources) are in ready supply. But what about the demand for loans increasing, increasing interest rates and “crowding out” private businesses and individuals? Advocates of MMT don’t even believe that demand for loans exists. Demand for loans (and interest rates rising when demand increases) means that loans are a scarce resource. But remember, MMT states that money is not a scarce resource, and can be printed as it is necessary. If loans aren’t a scarce resource, then there is no rise in interest rates when demand for loans increases. This completely eliminates the downside of deficit spending. What’s the upside?

Pros

Let’s say the government suddenly accepts MMT and uses it as a guide for fiscal policy going forward. The government could start spending enormous amounts of money for the public good. They could fund a Green New Deal that would shift the nation to a green economy or fund universal health care, both of which would be greatly beneficial to the public.

Cons

MMT has been criticized by economists who believe that printing unlimited amounts of money will cause hyperinflation. The most extreme example of hyperinflation in history was Hungary in 1945 with an inflation rate of 41.9 quadrillion percent. The hyperinflation was caused by massive amounts of money printing, among other factors like World War 2. There has been significant backlash to this idea because it goes against the core of economics as it has existed for centuries.

The Real World

Until the pandemic, MMT was a completely theoretical idea and no government was insane enough to test it out (if they did and MMT turned out to be flawed, the financial effects would be catastrophic). When the pandemic hit, MMT got a test run in the form of massive government stimulus spending to counter the recession. The government wasn’t thinking about how it could pay for the stimulus; it merely did. And what were the consequences? Without the early stimulus, the recession would have assuredly been far more brutal and long-lasting than it was. The nation is currently experiencing high inflation (the average inflation rate from 2012 - 2020 was 1.6%; the current inflation rate is 7.5%.) As you may recall, rising inflation is one of the main critiques of the theory, but proponents of MMT blame it on supply chain issues, claiming it is not an effect of the stimulus spending. MMT advocates argue that even if the spending caused inflation, a recession with no government intervention would have been worse. Of course, it's entirely possible that the inflation was caused by both the supply chain issues and the stimulus spending.

Modern Monetary Theory has the potential to rapidly change the way governments spend. If proven effective, it could break barriers that previously obstructed the nation from advancing our society. It could lead to larger green investments, progress towards a universal healthcare system, and increased spending on infrastructure, all increasing the quality of life. MMT has a long way to go for being accepted in mainstream economic circles, but it is certainly on its way.