Modern Monetary Theory: The Solution to Underdevelopment?

It was while reading The Deficit Myth by Stephanie Kelton that I first encountered Modern Monetary Theory (MMT). Chances are, I had a similar response to yours: I was impressed and puzzled at the same time. However, as I read through the book, I started to question some of the previous beliefs we, as economics students, possess about our monetary system. Is there actually a new way of thinking about government spending and fiscal deficits? Can we finance development the same way John F. Kennedy funded the Apollo 11 project?

MMT is a macroeconomic approach that attempts to explain how the monetary system and governmental fiscal operations work in countries that issue a sovereign currency. It emphasizes the role of the state in being able to run fiscal deficits in order to spend on areas of the economy that have weaknesses.

But what are sovereign currency issuers? MMT makes a key distinction between currency issuers and currency users. On one hand, households and firms are currency users, which means they need to budget as such, facing financial constraints. On the other hand, governments are currency issuers, which means that they are not limited in their spending. An important remark to make at this point is that MMT acknowledges that governments cannot run deficits and as they see fit. Sovereign currency issuers have one key constraint: inflation. If additional net government spending cannot stimulate the domestic economy due to supply-side rigidities, inflation will be the result. Essentially, as Kelton argues in her book, this theory helps us to see why “countries that fix their exchange rates like Argentina did until 2001, or that take on debt denominated in a foreign currency, like Venezuela has done, undermine their monetary sovereignty”.

So if governments can spend with the only limit of inflation, why bother with taxes? Well, MMT explains 4 main reasons why governments should tax (hint: it’s not to fund spending).

First, to manage inflationary pressures; more than any other school of thought, MMT highlights the importance of deciding when and which taxes are most effective at restraining inflationary pressures. Second, taxes enable governments to provide for themselves without the use of explicit force. Third, taxes are a powerful way for governments to alter the distribution of wealth and income. Capitalism runs on sails, hence, you need a reasonable distribution of income so that businesses have enough customers to stay profitable enough to employ to keep the economy running. Lastly, governments can use taxes to encourage and discourage behaviors. You might have heard of economists referring to “sin taxes” because they’re used to deter people from engaging in harmful activities.

In fact, MMT says that the tax is there to create a demand for the government’s currency. To be more precise, this theory lies on an extensive body of scholarship known as chartalism, which shows that taxes were the vehicle that allowed ancient rulers in early nation-states to introduce their own currencies. No one can pay the tax until the government first supplies its tokens.

This theory has been gaining traction as it deviates from what is commonly taught in economics classes. It challenges the idea that all government spending leads to inflation and explains that a government deficit means there is a surplus in the private or foreign sector, which is beneficial for the economy as a whole. The MMT view is that increased aggregate demand can cause prices to increase if firms face constraints in their ability to meet new demands in the short term.

To give a famous example, John F. Kennedy, in his famous moon-shot speech, made no reference to taxes or taxpayers. To fund his program, he simply asked the space committees and congress. As Kelton argues “He knew that Congress had the power to increase the discretionary budget to provide the billions of dollars he was requesting”. However, the real challenge, as Kennedy explained, is that the government would need to command more of the economy’s real resources. Furthermore, to manage the inflation risk, his administration pressured unions and the private industry, urging them to keep wage and price increases to a minimum to avoid inflation higher- and it worked.

Does this mean we just print our way to prosperity? Absolutely not! MMT is not a free lunch. Quoting Kelton, MMT is about “distinguishing the real limits from the self-imposed constraints that have the power to change (...) it's about replacing our current approach, one obsessed with budget outcomes, with one that prioritizes human outcomes while at the same time recognizing and respecting our economy’s real resource constraints”

At this point, you might be thinking that MMT is simply too good to be true, and in fact, it might be. There are many controversies and criticisms towards it mainly because its empirical evidence is limited and it contradicts much of what has been thought for so many years.

It can be easily pointed out that MMT undermines the independence of the Central Bank of a country to its political issues. It is true that in many developing countries the independence of the Central Bank from the government is essential for economic stability, mainly because their corrupt governments don’t have a transparent management of the national budget. Some other critiques mention there is not a strong mathematical model behind it. However, MMT scholars have made counter-arguments that would need a whole new article to summarize.

What MMT teaches us, besides its different axioms, is that new ideas will always be hard to digest. It’s important to question the status quo, but at the same time keeping in mind the empiric evidence that has been collected over the years. Nothing is guaranteed; MMT is no exception to that rule, but exposing ourselves to different perspectives of our economic system might give us a broader perspective of the challenges our economy currently faces.