In the last decade, there has been a rising interest in Modern Monetary Theory (MMT). MMT has attracted the attention of a wide array of international audiences, ranging from the Occupy movement to the Labour Party in the UK, from Podemos in Spain to Syriza in Greece, and from Jeremy Corbyn in the UK to Bernie Sanders in the USA. While MMT offers some interesting insights into the workings of the monetary system in advanced capitalist economies, it is also a heterodox macroeconomic lens that recontextualizes the role of monetary and fiscal policy in sovereign governments that borrow and issue national debt in their own monetary instrument. As such, it is a policy agenda that has gained increasing “currency” in progressive political parties discussing the “costs” involved in ambitious projects to develop society.

This article provides a short introduction to MMT. It explains how the government spends, taxes, and borrows, and how the interplay between these activities has shaped the economy. It then presents the basic tenets of MMT, and finally discussed some criticisms of the theory.

The Mainstream View

Economists use the term macroeconomics to refer to the study of the economy at the level of the nation as a whole. Macroeconomics does not take into account the division of the economy into different industries, but rather focuses on the behavior of the economy in aggregate. It deals with aggregates such as gross domestic product (GDP), unemployment, interest rates, and inflation, and seeks to explain their behavior in terms of interactions between different sectors of the economy. In other words, it tries to explain macroeconomic phenomena in terms of the behavior of the whole economy.

The macroeconomy can be divided into two sectors: the private sector and the public sector. The private sector consists of households, businesses and corporations. The public sector consists of the government and the central bank. The private sector produces goods and services that are sold for money, whereas the public sector produces goods and services that are generally not sold for money.

In the United States and other advanced capitalist economies, the government spends money by issuing checks and, in the process, it borrows money by selling bonds. In doing so, it injects money into the economy and expands the monetary base. It does so in order to finance its spending. At a high level, in the United States, the government spends money by issuing a check to the recipient. The recipient deposits the check with a commercial bank. The commercial bank deposits the government’s check (a demand deposit) with the central bank. The central bank credits the commercial bank’s reserve account and the commercial bank credits the recipient’s reserve account. The government has spent money, and the central bank has created the money to pay for it. The resulting increase in the monetary base is a result of the government’s spending.

The government’s spending is financed by taxes and borrowing. The government taxes in order to reduce the amount of money in the economy and to “sterilize” the effects of its spending. It borrows to finance its spending in excess of its revenue. To borrow, the government issues bonds and sells them to the public. The government’s bonds are placed with commercial banks. The commercial banks hold them in their reserves. The central bank credits the commercial bank’s reserve account for the face value of the bonds. By issuing bonds, the government’s balance sheet is reduced by the amount of the bonds’ face value. The central bank’s balance sheet is increased by that same amount, and so is the commercial bank’s balance sheet. In other words, the government’s spending is financed by borrowing.

The central bank is a government agency that is responsible for monetary policy. It has the task of maintaining price stability, and it is the institution that issues the currency of the country. The central bank does not usually finance the government’s spending by issuing currency directly. Instead, it creates money by crediting banks’ reserve accounts. The central bank has a dual mandate of price stability and maximum employment. It is responsible for keeping the price level stable by adjusting the money supply in order to keep the rate of inflation within a certain band. In the United States, the central bank is the Federal Reserve, and it is governed by the Federal Reserve Act of 1913. The Federal Reserve is a bank, but it is not like other commercial banks. The Federal Reserve Act of 1913 makes it a public monopoly. The Federal Reserve Board is the governing body of the Federal Reserve, and it is responsible for all of the Reserve Banks and their branches. The chair of the Federal Reserve Board is appointed by the president, and the other members are appointed by the president with the consent of the Senate.

Modern Monetary Theory (MMT)

The term “MMT” was coined by the economists Bill Mitchell and Warren Mosler, who first used it in 2002. MMT expert Stephanie Kelton explains:

“Modern Monetary Theory (MMT) is a new approach to macroeconomics that is based on three main ideas. First, sovereign governments, unlike private businesses, can never become insolvent, i.e. they can never be unable to pay their bills. Second, a sovereign government is not revenue constrained because it issues the currency. Third, and consequently, the spending of money into the economy is an effective way to boost economic activity and to reduce unemployment.”

In the case of the US, the Federal Reserve Bank is the issuer of the US dollar, which is the unit of account for the US government and the US private sector. The dollar is also the currency that the US private sector uses when they buy or sell their imports and exports. The Federal Reserve Bank, as the issuer of the dollar, can never run out of dollars. In fact, the Federal Reserve Bank can issue as many dollars as it wants. In the words of Warren Mosler: “it’s no more complicated than that.”

The Federal Reserve Bank can issue dollars, but it cannot issue gold, or oil, or houses, or anything else that the US government needs to pay its bills. The US federal government, like any sovereign government, can only spend dollars that it has first received as taxes, fees, or other forms of revenues. This means that the US federal government has no “money problem” because it issues the dollar. There is always enough money for the government to spend. As long as the US government can secure a tax base that is large enough to cover its spending commitments, it can spend as much as it wants without running into a “money problem.”

The Promise of MMT

The MMT framework has the potential to be transformative for the US economy, if its promises are taken at face value. Some key tenets are:

1. Federal Reserve Bank independence. MMT argues that the Federal Reserve Bank, the issuer of the US dollar, should be completely independent of the US government and the federal government’s fiscal policy. If the Federal Reserve Bank is not independent, then the US government can engage in deficit spending to cover its spending commitments. The Federal Reserve Bank will then be forced to monetize the government’s deficit spending by issuing additional currency. If the Federal Reserve Bank is fully independent, then it can simply refuse to monetize the government’s deficit spending and allow the government to go into debt. In other words, the Federal Reserve Bank can refuse to act as the lender of last resort for the US government.

2. The Treasury can run a deficit if it wants to. MMT argues that the US Treasury can run a deficit if it wants to. If the Treasury chooses to run a deficit, then the Treasury simply issues additional Treasury bonds and uses the newly issued Treasury bonds to cover the government’s spending commitments. In other words, the US Treasury can never run out of Treasury bonds. As long as the US Treasury can find a willing buyer to purchase the Treasury bonds, then it can issue as many Treasury bonds as it wants. In the words of Warren Mosler once again: “the Treasury can always find buyers for its debt.”

3. Government spending can increase private incomes and profits. MMT argues that government spending can increase private incomes and profits. MMT argues that government spending can go into three different channels – it can increase the incomes of private individuals (for example, government spending on education can increase the incomes of private teachers, government spending on healthcare can increase the incomes of private doctors); increase the profits of private businesses; or increase their output.

4. Government spending can be used to cover the government’s other spending commitments. MMT argues that government spending can be used to cover other spending commitments for the government, such as paying interest on the national debt, paying social security benefits, or paying for the government’s regulatory costs. For example, if the government needs to pay interest on the national debt, then it can simply issue more Treasuries and use the newly issued Treasuries to pay the interest on the national debt.

5. The US government can never be insolvent. MMT argues that the US government can never become insolvent. MMT argues that, because the US government can always issue more Treasuries, then there can never be a situation where the US government has a balance sheet deficit. MMT also argues that the US government’s net worth can never become negative. In other words, the US government’s assets can never become less than its liabilities.

Criticism of MMT

MMT is clearly a heterodox economic theory. It is a theoretical framework that is not accepted by mainstream economists. For example, prominent macroeconomists such as Paul Krugman and Brad DeLong have expressed their skepticism about the theoretical premises of MMT and in MMT’s understanding of the Federal Reserve Bank and the US Treasury.

The theoretical premise of MMT is that the US Treasury can issue an unlimited amount of Treasury bonds. According to critics, this contradicts basic principles of macroeconomics, which point out that an individual or a country can only borrow an amount of money that it can realistically pay back. In other words, if the US government borrows too much money, then it risks defaulting on its debt.

MMT’s theoretical premise, critics say, is also flawed. Many of the core tenets of MMT are based on the assumption that the Federal Reserve Bank will act in the interests of all the US citizens, not just the US Congress. In particular, MMT assumes that the Federal Reserve Bank will act in the interests of the US Treasury. But the Federal Reserve Bank is run by a small group of unelected, private bankers. There are no guarantees that the Federal Reserve Bank will act in the interests of the US Treasury.

MMT’s theoretical premise is also criticised because it assumes that the US Congress will always act in the interests of all the US citizens. Many of the economic problems in the US today are caused by the power-hungry politicians in the US government. For example, the US Congress has been involved in many debt ceiling debates in recent years. The debt ceiling debates have created uncertainty in the US economy, which some claim caused the US economy to underperform. It is not clear that the US Congress will continue to act in the best interests of the American people.

In a nutshell, critics argue that money does not come for free, and that what we spend, we must pay for.

MMT is a theory that is increasing it prominence, and economics that previously discounted the ideas outright are beginning to take it more seriously. Due to the necessity of ongoing economic stimulus measures in response to the COVID-19 pandemic, attention to it (including both its promises and potential drawbacks) is necessary. Is it a revolution in economics, or simply a way to avoid paying our debts?

We probably won’t know for sure for at least another decade.