‘Modern Monetary Theory’ or the Monetary Financing of Government Spending

A new economic approach backed by the left wing of the Democratic Party in the United States, “MMT,” also seems to appeal to Wall Street.

The debate over economic policy in the United States centers in part on “Modern Monetary Theory.” This approach, whose main advocate, Stephanie Kelton, was the top economic adviser for Bernie Sanders’ campaign, has largely been adopted by the left wing of the Democratic Party, notably by Alexandria Ocasio-Cortez. Even though MMT has led to controversies with economists both conservative (Kenneth Rogoff) and centrist (Paul Krugman), it has also found a certain success with some Wall Street financiers; we shall see why.

More than a radical novelty, MMT, its supporters themselves will admit, picks up old ideas and repackages them as “modern,” a label that always sells. Nevertheless, its originality lies in radically changing the thinking on how to finance government spending and on the role of fiscal policy.

The context is one where the left wing of the Democratic Party envisions vastly expanding the social welfare state; a recurring question obviously concerns the funding of this program. A classic response would be to say that in order to respect budgetary constraints, it would be necessary to raise taxes, which runs the risk of upsetting the middle classes. MMT, in theory, offers a way around the problem by stipulating that there is no fiscal limit to government spending.

The main idea behind MMT is that a country that controls its currency knows no budgetary constraints because it can always pay its bills with that currency. At its limit, a government does not even need to go into debt when it issues government securities; currency can take care of that. There is no risk of defaulting on that loan since the state controls the issuing of currency. This debt thus has a nominal interest rate of zero.

The first objection that arises in the debate between MMT and the rest of the world involves inflation. Will an unrestrained state issue too much money and thereby bring down its value? The state will always pay back these debts, of course, but in fake money. Proponents of MMT argue that there is only a risk of inflation when unemployment does not exist and when the supply constraint appears. And that is where fiscal policy must step in to control inflation.

If inflation poses a threat because overall demand exceeds supply, a tax hike should bring that demand down and ease inflationary pressures. The responsibility of economic policy is thus not a balanced budget or the amount of national debt, but keeping inflation within a target rate.

Not everyone on the left shares this understanding of inflation. Other unorthodox currents of economic thought point out that an excess of demand is neither the only nor the main source of rising prices. Other determining factors like the oligopolistic structure of the markets or the capital-labor conflict around the distribution of wealth would require other types of intervention, more regulatory or institutional than a simple fiscal policy.

But if fiscal policy’s goal is to control inflation, how can it make certain that the economy will remain at full employment? MMT picks up an old idea – guaranteed employment – that makes the government an employer of last resort. It commits to hiring those seeking work at minimum wage, an idea that is simple in principle but probably less so in practice. This mechanism functions as an automatic stabilizer, allowing for the conservation of a high level of overall demand in the event of poor market conditions. This policy would thus get us out of the famous inflation-unemployment dilemma: The fight against rising prices would no longer depend on a lower employment rate and would save us from the social costs associated with it.

Why does MMT appeal to some Wall Street financiers? One might guess that a way of funding government spending that does not involve higher taxes has everything to attract them – especially considering that the role attributed to fiscal policy, limiting demand in order to fight inflation, shows that these financiers would not be the first targets of this type of action. If the goal is to moderate overall demand, the main contributors would likely be those who are the most inclined to consume and not, therefore, the most well-to-do households.