Is MMT a theory?

The short answer is no.

MMT

The origin of MMT

MMT (Modern Monetary Theory) was originally developed based on Chartalism (by Knapp - a German economist, in 1905). It centers around the idea that money is a way for the state to control and direct economic activities rather than just mere means of exchange. MMT also inherits a lot of Keynesian ideas about an active fiscal policy and demand-driven economics. In 1986, Hyman Minsky wrote a book called Stabilizing an Unstable Economy, which revived the central role of the state in fixing market failure that later became very influential to MMT thinkers. Nevertheless, it did not catch a lot of attention due to the lack of a firmly grounded mathematical foundation and the lack of political empathy (the late 20ᵀᴴ century favored small governments and deregulation). However, it has recently resurfaced and drawn significant attention from the mainstream media. The global financial crisis, unusual zero interest rate policy, low inflation, rounds of quantitative easing, and the Eurozone Debt Crisis have triggered questions about the consequence of fiat money, the limitations of monetary policies, and the roles of the states. These questions inspired economists like Warren Mosler, L. Randall Wray, Stephanie Kelton (University of Missouri-Kansas City), Bill Mitchell (University of Newcastle, NSW), and Pavlina R. Tcherneva (Bard College) to formally systemize the idea into a new theory. With heavy prominence on fiscal policy and money creation discretion, MMT claims itself to be a branch of Post-Keynesian Economics.

The key points in MMT

The best way to understand MMT is to compare its core theory with other dominant economic ideologies (e.g. monetarist) on some main premises.

Sovereign Currency & The role of money

The first and one of the most important set-up for MMT is laid in the notion of sovereign currency. According to MMT, a sovereign currency is a currency that is (1) monopolistically issued by the central government, (2) tax payments and bonds must be based on this currency and most importantly (3) the currency does not peg on other currencies (free-floating exchange rate). Given these conditions, there are only a handful of countries in the world that “truly” have a sovereign currency, such as the United States (with its USD), Japan (with its JPY), Australia (with its AUD), and the United Kingdom (with its GBP). One special case is the Euro (EUR). It is one of the free-floated currencies, Eurozone governments collect taxes and issue bonds based on EUR but it is not considered a sovereign currency because countries that adopt EUR have abolished its monopoly power of currency-issuing. With this foundation, MMT and its policy implications have a critical precaution since it will lose a lot of its logical senses when applied to other economies that do not satisfy the above 4 criteria.

Assuming that a currency is sovereign, it brings us to a new identity of money. In classical thought, under Gold Standard or its successor, Gold Exchange Standard, money was based and pegged on gold or a reserve currency (the USD). Because gold is finite, money was believed to be finite, and therefore government must honor fiscal responsibility. However, things have changed since the abolishment of the gold standard, giving way to fiat currencies that are based on nothing. Therefore, for countries like the US, UK, Japan, and Australia, the government can “de facto” service their debts denominated in their own currencies just by “printing” money. Sovereign money now can be considered infinite.

By this new definition, one wonders whether the money will tend to lose its value because it can be printed without any consequences. The answer is “not necessarily”. A sovereign government (like the US) can keep the demand for its currency at a high level by the means of taxes because taxpayers must pay taxes in the designated currency. Furthermore, the economic performance and economic influence of such sovereign currency are also important to keep the world’s demand for its currency stable. As the result, fitting in this criterion, we can see that only a handful of economies are satisfied to adopt MMT, such as the US, Japan, UK, Australia, etc. Incidentally, these are also the countries that have been very active in Quantitative Easing programs (QEs), a.k.a helicopter money. Even when the USD, the JPY lose their values by 5, 10, or even 20%, I bet almost nobody would walk away if they saw a $100 or ¥10,000 note on the ground because you know these economies are strong and their currencies will regain their values in the long run. The developing countries want the USD even more so because that is the prime currency in their reserves. On the other hand, the whole premise of MMT will collapse if money is not sovereign because currency devaluation can continue forever (since they are pegged on the USD).

Inflation and Government Deficit

Now with the foundation established in section a., MMT can give us some provoking insights to counter mainstream economics’ concerns on inflation and government debt.

Following the aftermath of the GFC in 2008, central banks (notably Fed, BOE, BOJ, ECB) have started to boost their respective economy by using extremely expansionary monetary policies, raising bank reserves (disposable credit), and easing financial conditions through Quantitative Easing. The monetary base expanded and interest rates reached historically low levels in these nations.

Assets in the Balance Sheet. 2008=100

Fig 1. Assets in the Central Banks’ Balance Sheets. 2008=100

This is the unorthodox (unconventional) response of central banks to battle deflation. Critics were concerned at that time that the overwhelming monetary supply can lead to hyperinflation in Japan or the US as it happened in Zimbabwe in 2008 or Venezuela in recent years. However, there was nothing of the sort happened in reality. Surprisingly, especially in the case of Japan, these actions were not considered “big” enough to lead to desired inflation (2%), let alone hyperinflation. Why?

According to MMT, the are 2 big reasons that can be derived. First of all, the USD, JPY, GBP, and other sovereign currencies are of different status from Zimbabwe’s and Venezuela’s. They are sovereign currencies, fully controlled by the government, while Zimbabwe and Venezuela in fact peg their currencies to USD, which is totally out of the government’s control. Furthermore, MMT defines inflation as “demand > supply”, when demand surpasses the capacity of the economy to supply adequate goods and services. Consequently, if the demand for these currencies is high enough to absorb the new supply of money, in other words, the demand for stable and highly-regarded currencies is inelastic to the supply side, then inflation may not happen. In terms of goods, for countries that have a strong supply power like the US, UK, or Japan, the problem lies on the demand side, not the supply side. To reach a certain desired rate of inflation, actively boosting demand is the answer. The fact that QE or monetary policy failed to raise the inflation rate despite the huge amount of money supply implies that there are some severe lags, a lack of demand that the market finds it hard to utilize by itself. Therefore, by the use of fiscal policy, the government sector appears to be the main key to driving growth. By this logic, MMT can be considered the successor of Keynesian economics, now known as Post Keynesian.

This brings us to the next questions that mainstream economists will ask: What about government deficits? We all know what happened to Greece, Spain, and Italy in 2015 as the result of a huge accumulation of public debt for fiscal funding? The answer to that question by MMT is simple. Government deficits are not necessarily a bad thing. Remember, the sovereign government can finance its debts because it has discretion in money creation. But Greece and other countries in the Eurozone had abandoned their currencies for the unified Euro and gave up their monetary autonomy, therefore they lost the crucial tool to service debts. Moreover, MMT asserts that government deficits go in hand with or equal to private sector savings, because the government will spend the money on the economy and this becomes private income. A higher level of wealth means more spending for the private sector. Thus, a government deficit is not a bad thing because it is by nature, cyclical. In a closed economy, this is merely an accounting exercise and there is nothing new about it in economic theory.

Fig 2. Japan Sectoral Balances

Fig 3. US Sectoral Balances


Fig 4. UK Sectoral Balances

In this way, a 2% government-debt-to-GDP ratio is no better than a 10% government-debt-to-GDP ratio. The necessary fiscal stimulus for each country is different, so long as fiscal policy can be used to utilize available resources that the private sector cannot, a sovereign government does not need to worry about debts growing. This fact in turn may diminish the role of taxation in MMT because the governments do not need to rely on tax to fund their spending. However, MMT insisted that tax is needed to maintain sovereign currency demand. The tax also plays a vital role in redistributing wealth and protecting the environment through the carbon tax. Tax is also an alternative tool to control inflation in the situation where business is inflexible to interest rates, as in the case of Japan.

Employment

Employment is another facet that MMT touches. It argues that an economy actually can reach “zero unemployment”, unlike the settling idea advocated by Milton Friedman that there is always a natural rate of unemployment that exists, that unemployment cannot reach zero. In general, mainstream economists consent that the natural rate of unemployment includes frictional unemployment (people temporary moving jobs) and structural unemployment (people lost jobs due to technological advances). We will focus on structural unemployment. One way to tackle this is to rely on the government sector for job creation programs. According to Warren Mosler, the idea is to create many skills improving or training jobs where structural unemployed people can join. They will be temporarily employed by government programs to be trained, learn new working skills, produce income, and prepare for one day to be employed back in the private sector.

As we have already established that fiscal policy is necessary to utilize the unused resources available in the economy and the government has sufficient funds in their sovereign currency, MMT holds a strong implication for policymakers.

MMT’s policy implications for Japan

Japan is a sovereign state that holds monopoly power on its own currency, the Japanese Yen (JPY), therefore there is no doubt that it is an MMT material. Japan has been relying on monetary policy to battle against deflation ever since 1999 with the Zero Interest Rate policy. However, the expansion of the monetary base and decreasing interest rates have failed to help Japan reach desired 2% inflation rate. Accumulation of government debt of over 200% of GDP has created fear among the public, forcing the government to raise consumption tax in order to fund fiscal stimulus, thus weakening domestic demand.

In this manner, a lot of research has proved that monetary policy in Japan has actually run out of stimulating instruments. Indeed, it is expected that the key player in boosting the Japanese economy will be P.M Shinzo Abe’s fiscal stimulus. On December 05, 2019, the Japanese government approved an extra 121 billion USD of fiscal stimulus for this fiscal year (which shall last until March 2020). This package will be spent on infrastructure for the Olympic 2020, repairing some damaged buildings, and investing in highway expansions. P.M Abe asserts that more fiscal stimulus will be on the way, focusing on subsidizing small and middle-size businesses, especially in digital-driven industries, or sensitive industries like forestry & fisheries.

It is unquestionable how MMT has become popular in Japanese debates. By applying this doctrine, the government possesses the means to justify its spending and further the accumulation of debts. This degree of freedom in money creation can be beneficial if fiscal stimulus utilized resources in the economy. However, it also poses the peril of corruption and misallocation of funds for political gains, as money is now at the government’s total disposal.

Is it a theory?

I don’t think so. It may be true in reality, in monetary policy practice, but to call itself a theory can be exaggerated.

First, let us stick with the key points in MMT.

(1) Sovereign Currency can only apply to very limited and rich countries, hence its application is not very useful for the rest. Furthermore, let’s do a thought experiment. If these governments DO recognize the potentiality of using helicopter money and financing debt by issuing more money (because the demand for their currencies is close to infinity), then they are running a big Ponzi scheme. And if a Ponzi scheme exists, all economic modeling will be destroyed because there is no place for optimization, knowing you will always be solvent, which is not how economics works (since Economics is the study of how individuals and societies choose to allocate scarce resource). We haven’t seen infinite money printing in the US or Japan.

(2) The cycle of government deficits. In economic modeling, this is nothing new because, from both theoretical and empirical perspectives, it is an accounting exercise. Government transfers to the private sector and households appear all the time in the literature. Furthermore, in real business cycle literature, money is neutral. In the end, especially as long as growth is concerned, we care more about the real values, not nominal.

(3) Employment: The job creation program may as well be the only viable application of MMT. Personally, I think this is already common.

In summary, most of the concepts asserted to-be-different in MMT are actually not new and have been existed in the literature for decades. Furthermore, a key weakness in MMT is the lack of a vigorous mathematical background for quantitative analysis, or the impossible to formalize one because it tries to liberate itself from constraints. Therefore, I don’t consider MMT a theory.

Written on January 6, 2020

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