In recent years, a radical and unorthodox school of thought called “Modern Monetary Theory” (MMT) has become popular with some progressive economists, as well as with policymakers and activists on the political left. One of MMT’s most prominent advocates is Stephanie Kelton, a professor at Stony Brook University who advised Senator Bernie Sanders during his 2016 presidential run. The theory has received enough traction that the popular Planet Money podcast recently ran an episode on the topic.
A central idea of MMT is that a government that issues its own fiat currency can pay its bills in that same currency. These governments need not worry about budget deficits when contemplating additional spending. Thus because the US government has a monopoly on money creation, our federal government does not need to raise all its revenue through tax or bond finance. A government with its own currency cannot go bankrupt because it can always issue more currency to cover any budget deficit. Kelton and other MMT advocates argue that this why the US government can afford expensive programs such as a jobs guarantee and universal healthcare.
While MMTers do not see government debt per se as a problem, they do concede that were the government to spend beyond the capacity of the economy there would be a risk of higher inflation. MMTers argue that if high inflation were to become a danger, the government can increase taxation to remove excess currency from the economy. In the Planet Money podcast, however, Kelton indicated that she is not currently worried about inflation. When asked if putting even more money into the economy might lead to higher inflation, she noted that inflation has been quite low in recent years:
“Well, where is it? We've been doing it. We just did it with a $1.5 trillion tax cut. We did it with the $300 billion in additional spending. We've done it and done it and done it. Where is the inflation problem? I don't see it in the UK. I don't see it in Japan. I don't see it in the US.”
Kelton is right that inflation has been low in the US and other developed countries, but she and other MMTers are wrong in assuming that fiscal policy determines inflation in those economies. Since 1990, inflation in the US and many other developed countries has averaged two percent. This was accomplished through very specific decisions taken by monetary authorities, indeed fiscal policymakers wouldn’t even know how to begin the difficult process of inflation targeting.
Market monetarists argue that nominal GDP (total dollar spending on all goods and services in the economy) is the best way to determine whether monetary policy is too tight (leading to a recession) or too loose (leading to high inflation). During the recovery from the Great Recession, nominal GDP growth has averaged only four percent per year, which largely explains the low inflation rate. The 1980s was also a period of expansionary fiscal policy and rising government debt, and inflation also fell during this period, as the Fed reduced the growth rate of the money supply. And contrary to the predictions of MMT, the expansionary monetary policy of the 1960s and 1970s pushed inflation sharply higher, even though government spending and deficits were not unusually large. While the market monetarist model (as well as some other conventional models) can explain why inflation has remained near two percent since 1990, MMT has no clear explanation for the relative success of inflation targeting.
To be sure, there are cases of governments pressuring central banks to create money to finance fiscal deficits. Examples of reckless fiscal policy generating inflation include Zimbabwe, Argentina, and Venezuela, where central banks are far less independent than the Federal Reserve. Indeed, Paul Krugman and other MMT critics have warned that money-financed debt could lead to hyperinflation. As Krugman wrote in 2011:
“When people expect inflation, they become reluctant to hold cash, which drive prices up and means that the government has to print more money to extract a given amount of real resources, which means higher inflation, etc... Do the math, and it becomes clear that any attempt to extract too much from seigniorage — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation. In effect, the currency is destroyed.”
MMTers might respond that what they are calling for in the US is nowhere near what the governments in Zimbabwe, Argentina, and Venezuela have done, so it’s unreasonable to claim that we’d see similarly high inflation. In fairness, the United States has much stronger institutions and less corruption than those countries. Nonetheless, as Krugman and others have pointed out, attempting to implement an MMT program of money-financed government spending would risk triggering an excessively sharp increase in inflation, especially as the economy strengthens. Experience shows that when inflation gets out of control, it leads to many other economic and social problems, from the erosion of people’s savings to political turmoil. The MMT agenda is not an experiment worth risking.
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