Modern Monetary Theory (MMT) is an economic idea suggesting that governments can utilise deficit spending with minimal negative consequences to foster full employment and facilitate private savings.
For advocates of MMT, money fundamentally derives from government, a concept known as Chartalism, asserting that all money is essentially Fiat arising from the state's necessity to levy taxes. In this perspective, money is not seen as a commodity that emerges from market interactions, but rather a function of law.
However, this understanding of the origin of money is fundamentally flawed.
The emergence of exchange mediums is a natural market phenomenon, observed in diverse settings like prisons (cigarettes as currency), black markets during state collapse (e.g., Somalia), or even virtual economies (e.g., the virtual currency of World of Warcraft once being worth significantly more than the Venezuelan Bolivar). The idea that all money originates from government is demonstrably incorrect.
A second major area of disagreement, even before examining specific policy proposals, lies in MMT's understanding of inflation. MMT advocates are said to hold an erroneous view of what causes inflation.
Inflation is, in fact, always and everywhere a monetary phenomenon, caused by an increase in the money supply. This is evident in historical hyperinflationary episodes like the German Weimar Republic, Zimbabwe, and Venezuela, where governments resorted to printing vast amounts of money. It's not solely tied to government or central bank actions; for instance, the California Gold Rush in the 1850s more than doubled gold production, which was the monetary base at the time, resulting in a 30% increase in wholesale prices between 1850 and 1855.
MMT proponents often point to rounds of quantitative easing (QE) since the 2008 crisis not causing serious inflation. This, however, is because much of the liquidity generated by QE remained within the financial system (sitting on asset balance sheets as part of the M3 money supply) and did not significantly enter the real economy. In contrast, MMT proposals involve injecting money directly into the real economy, such as through government employee wages (increasing the M1 money supply), which would undoubtedly be inflationary.
MMT suggests that inflation only becomes a significant concern at "full employment", when the economy's resources are fully utilised (excluding imports). At this point, the government and the private sector would compete directly for resources, leading to a bidding war and price increases.
This perspective echoes the long-discredited theory of "idle resources" associated with John Maynard Keynes, which was effectively refuted decades ago. The underlying argument that a permanent condition of full employment should be the economic goal is flawed. Full employment is not easily definable or even necessarily desirable, as economic growth requires shifts of assets and workers, inevitably leading to temporary unemployment.
Defining inflation solely as a phenomenon arising when the economy hits 100% employment and government competes for resources is absurd and an obvious nonsense. Inflation fundamentally arises when the money supply expands, altering the exchange ratio between money and all other goods in the economy.
Furthermore, the rise in prices across the economy due to money supply expansion does not occur uniformly but is staggered. New money enters the economy at specific points, raising demand and prices for certain goods first. As this money ripples through the economy, it continues to affect demand and prices.
This process, known as the Canton effect, redistributes income and wealth from those who receive the new money later or are on fixed incomes to those who receive it early. Aggregate macroeconomic statistics like the purchasing power of money or a unitary inflation rate are crude abstractions; they are quite meaningless when examining the real economy where prices are staggered and specific.
To truly understand changes, it is often necessary to look at real prices, which represent exchange ratios relative to other goods. For example, while the nominal price of goods like eggs and televisions has risen over time, their real price relative to a McDonald's worker's wages has fallen. Similarly, the real price of a television set has fallen faster than the real price of eggs, a reality obscured by inflation.
MMT's core policy reasoning often stems from examining the calculation of Gross Domestic Product (GDP) and manipulating accounting identities. They focus on an equation derived from GDP calculation: G - T = S - I, where G is government spending, T is taxation, S is private savings, and I is private investment. This identity can be restated as Government budget deficit = Net private savings. From this, MMT advocates assert claims such as "government spending creates a demand for saving".
However, this approach operates at an extraordinary level of abstraction from the real economy. The figures used in GDP calculation are incredibly broad, rough, aggregate numbers that reveal very little about the underlying economic reality.
The notion that manipulating this aggregate statistical construct using algebra possesses causal explanatory power in the real world is frankly ridiculous and has no such power whatsoever. The idea that individuals forego consumption (save) because the government employs people to dig ditches or build bridges is an absurdity. While the claim is that aggregate savings increase when government spends more, the mechanism is unclear.
Consider government spending purely on ditch digging and bridge building: this would first affect the prices of related goods (shovels, bricks, etc.). When the workers are paid, they are the first receivers of the new money. They get to buy goods first, potentially at lower prices before the money ripples through the economy and inflationary effects take hold. Savers who saved money under her bed, see the real value of their savings diminished by rising prices.
The spending effectively becomes a redistribution scheme, transferring wealth from savers to the recipients of the new money. Far from increasing aggregate savings, such a policy, especially one that increases the M1 money supply, actually hurts savers by affecting real prices in the real economy.
Modern Monetary Theory is not a novel economic framework. Instead, it comprises a collection of old, flawed ideas that have been disproven repeatedly in both theory and practice. These concepts have been repackaged and rebranded, unfortunately finding receptive audiences among journalists and politicians interested in appealing to voters with promises of government spending. It appears that, despite historical evidence of their failure, these ideas persist.