Modern Monetary Theory
by Carlos
This article serves as a shallow introduction into the world of MMT. I tried to stay general and describe comprehensively to allow anyone a first glimpse at this new approach.
Modern Monetary Theory
There is a new theory in town! MMT is a new approach to fiscal deficits and the true meaning of money. The highly controversial movement has emerged in recent years and since then has found a large fanbase in politics and economic literature.
The Modern Monetary Theory (MMT) is basically a new approach to explain the monetary interaction of state and the private sector. Its main argument is that a sovereign state, which has a monopoly over its money supply (meaning it is the only one that can produce money), can never go bankrupt. Therefore, the public debate, whether we can still afford our social state, is misleading. Be aware that one might not apply this to Germany, as Germany along other states, belongs to the Euro and has therefore no control over its money supply. This competence lies in Frankfurt at the European Central Bank (ECB). The ECB, under Christine Lagarde, decides when and by how much the interest rate should be cut or risen and by that control implicitly the money supply in the Euro area. If we look at the USA, where this new theory has emerged roughly twenty years ago, the approach can be applied much better. Though the Federal Reserve Bank (FED) is a sovereign independent institution (hopefully it stays this way), which should base decisions not on political developments, it still belongs to the USA and can be put under control of the U.S. Department of Treasury (I leave the juridical fine tuning to someone more competent).
The MMT alone should not be political as it only serves as a description of the perceived reality. The main topic of MMT, as you might have guessed, is money. As already stated, the MMT-affiliated economists claim that a state, under several circumstances, can never go bankrupt. If it has direct control over its money supply, it can simply print new money. This gives the state the opportunity to simply create money via a keyboard and pay their debt with that money. So, no need to stress about an increasing deficit, right?
Well, not so easy unfortunately. There still is this one haunting phenomenon called inflation, which basically describes increasing prices. Economists have long argued where it comes from and how it should be prevented, but as we see on the MMT, they still have not come to a unified conclusion. While the so-called Monetarists (rather conservative economists) call out an uncontrolled expansion of the money supply as the key problem, MMT economists take a different stance. They blame not directly the expansion of money, but rather the consequential effect of rising demand. When the aggregate demand exceeds the aggregate surplus, there is too much money chasing too few goods. Therefore, there will be an increasing of prices, meaning inflation. Another possible factor of inflation is a so-called exogenous shock, where an unforeseen event triggers a decline of supply of certain products or input factors. The Ukraine War serves as a good example. The invasion of Russia was the exogenous shock, and the rise of oil price triggered an inflation in Europe.
This different understanding of inflation leads to different takes on fighting inflation. The MMT side wants to use taxes in a way of controlling inflation. If inflation only happens when the purchasing power is too high, then it is only logical to cut that purchasing power by raising taxes. This leads to less money in the pockets of the private sector and therefore to less purchasing power and less demand. Keep in mind that taxes do not serve as a tool of financing the state expenditures. In the MMT-world, the state should not operate as a business financially and does not need to balance its budget. Money can be simply created!
To ensure a smooth governing regarding taxes and state finances, the Central Bank should be put under control of the Department of Treasury (Finanzministerium). The minister of finance would then be responsible for the state finances, taxes and for money supply. This is a key difference between our mainstream thinking, where we want to explicitly separate the consequences, and the MMT-way of thinking. If the minister of finance wants to spend more money or raise/lower taxes, he should be able to do this without the intervention of any non-state institution.
Another claim for a better society is the Job-guarantee. The MMT severely criticizes the acceptance of unemployment. Especially the NAIRU (Non-Accelerating-Inflation-Rate of Unemployment) is being questioned sharply as it only leads to people being prevented from doing a job, because some economists think that a certain rate is necessary to keep inflation low. The MMT therefore proposes a state-regulated job program, where anyone, who wishes to work, would be able to do so. The whole program is run by the government. Hence bureaucrats decide what to produce, where to produce and at what price.
The Modern Monetary Theory is turning the whole economic and especially fiscal understanding upside down. In their world, there is no limit to social spending, as it always helps the one, who do not have enough. This would increase demand which would then increase production and employment. This approach is being labelled as rather simplifying and ignorant to affiliated problems like inflation, particularly in a world of globalized trade. Almost every country is dependent on imports. But when a country starts to produce money based on an opinion of a politician, who has the incentive to get re-elected, without any institutional constraints, there will most likely be a devaluation of the home currency. This would consequently make the imports more expensive, as the home currency is worth less. Imported Inflation, as economists call it, would be the necessary consequence.
I hope this article gave a valuable insight into the world of MMT with a little bit of critical questioning. Thanks for reading!