A small revolution is brewing in the world of macroeconomics – a dive into Modern Monetary Theory.
A small revolution is brewing in the world of macroeconomics. It’s an idea that counts a Democratic socialist presidential candidate and a hedge fund manager among its adherents. The economics team at Payden & Rygel, manager of GSFM’s Payden Global Income Opportunities Fund, write about Modern Monetary Theory, popularly known as MMT. The team breaks down MMT’s foundational underpinnings, evaluates some of its claims, and concludes that while it may be plausible at face value, investors would do well to doubt its legitimacy.
In 1916, Albert Einstein provided a mathematical proof that when two black holes collide they create ripples in space and time, leading to the creation of gravitational waves. What sounded insane turned out to be provable in September 2015, when scientists at the Laser Interferometer Gravitational-Wave Observatory (LIGO) observatories found the first evidence of such waves.
Unfortunately for us economists, no such giant feats of human engineering exist to test our theories – only bad jokes, which we promise we don’t take personally (except that one about the $20 note lying on the footpath; that one stings). As a result, we observe the world around us and make our best guess as to what theories will stand the test of time.
In the aftermath of the Great Financial Crisis of 2008, interest rates across the world were cut to zero (and even negative in some cases), and governments spent scads of money attempting to return their economies to normal with varying degrees of success. The uneven results set many economists casting about for non-standard policy solutions. One such new idea was MMT.
Modern Monetary Theory (MMT) is one of the few theories that brings together Bernie Sanders, a self-described democratic socialist, and Warren Mosler, a retired hedge fund manager living on the island of St. Croix.
MMT is a theory that states that the government can simply print money to fund projects to bring an economy to full capacity, without necessarily suffering the repercussions of hyperinflation. We discuss a core idea underpinning MMT, address the inflation issue, and conclude by seeing if it’s even worth all the trouble to begin with.
Chicago…meet Kansas City
Two schools of thought dominated developed world macroeconomic policy in the post-World War II era: the Keynesians and the Chicago School. The Chicago School economists, most notably Milton Friedman, were monetarists. They largely believed that economic output and inflation were influenced by changes to the supply and cost of money (interest rates). Hence the term “monetary policy.”
In contrast, Keynesians, named after John Maynard Keynes, believed when the economy suffered a shock, the government needed to spend more money, using expansionary fiscal policy to plug the gap left by deficient private spending. Both of these policies remain the bedrock of modern macroeconomic policymaking. Into this world comes a new player, MMT.
MMT finds its roots in many places, but most prominently at the University of Missouri—Kansas City (UMKC). Prominent adherents of MMT like Stephanie Kelton, a former advisor to presidential candidate Bernie Sanders, Randall Wray, and Mat Forstater all cut their teeth at UMKC. Onlookers shouldn’t be surprised, given that one of MMT’s most prominent proponents, the aforementioned Warren Mosler, was one of the founders of the Centre for Full Employment and Price Stability at UMKC[1].
Is it really that modern?
German economist Georg Knapp unwittingly founded the MMT movement almost 100 years ago when he propounded a theory of chartalism. In this theory, Knapp stipulated that money is anything “accepted at the public pay offices”[2] and not a commodity backed by a precious metal.
In 1947, economist Abba Lerner took Knapp’s theory one step further, arguing that since “money is a creature of state,”[3] the state could print as much money as it wants. Money in this world did not derive value from gold or from its status as an accepted medium of exchange, but simply as something the government had decided to call money. As a result, there was no need to borrow money, the government could print more. Lerner called this “functional finance,” and it is a core tenet of MMT theory.
MMT is then really not that modern after all. In fact, MMT theorists refer to their theory as neo-chartalism, a modern version of Knapp’s old chartalism. MMT takes Lerner’s functional finance to the next level. Since the government can increase its deficit as much as it wants by printing its own money, large scale government programs such as a government job guarantee are possible. Medical care for everyone in the economy? Much more feasible when you can simply print money!
Did it really take us this long to mention “Weimar?”
If you, dear reader, have made it this far into this article, you must be wondering about hyperinflation. After all, isn’t printing more money what the Weimar Republic did? Isn’t that what Zimbabwe did? Isn’t that what pains Venezuela today? Hyperinflation is the number one critique of MMT cynics.
MMT theorists have an answer ready. Zimbabwe and the Weimar Republic tried to extract more out of their economies than they could produce[4]. As such, they created inflation, where too much money was chasing too few goods.
In an MMT world, the government would spend until it saw signs of inflation and then increase taxes to take money out of the system. Fiscal policy would ensure full employment because, according to MMT proponents, “unemployment is de facto evidence that the deficit is too small.”[5] Once there is full employment, the economy would have reached its potential, and the deficit could be inflationary. Here, the government in its infinite wisdom and ultimate timing would halt the printing presses.
MMT proponents also point to the US as an example of where their theory is working! After all, the debt-to-GDP ratio in the US has almost doubled, while we have seen no “inflationary” period in that time (Figure 1). Keep the printing presses running, they say.
The issue in Zimbabwe and Venezuela today is not just about too much money but also the faith that people have in the local currency. While Zimbabwe and Venezuela’s governments had the state stamp of approval on their money, the public lost faith in their currencies. In Zimbabwe, people use the US dollar, in addition to the South African rand, the euro, and the Chinese yuan[6]. The demand for the US dollar is so strong that Zimbabwe’s central bank decided to start printing notes backed by the US dollar! This is almost a decade after hyperinflation was an issue in the country. Just take out your dollar bill and look, the word “trust” is there for a reason.
Politicians…the monetary disciplinarians!?
Where we take the most issue with our MMT friends is with the idea that the government will be able to fine-tune inflation. No politician beholden to election cycles will increase taxes to tame inflation. Neither will government programs like job guarantees or universal medical insurance be easy to control and cut when inflation starts to appear. While we do not think that central banks are omniscient, they are certainly set up in a way that is conducive to being independent.
MMT proponents have also not outlined an institutional framework to ensure that any new fiscal body would be independent[7]. Even if they did outline the plans for such a body, they would go against the principles upon which the United States was founded. Americans, and many people around the world demand “no taxation without representation.”
But what is the point?
Whether one agrees with MMT or not, we question the very assumption that is implicit in the theory: that government spending can create full employment and economic growth. This point is easily refuted by looking at Japan, which has a higher debt-to-GDP ratio than any other country in the world (almost 250%), and yet growth has been lacklustre at best.
While employment in Japan is strong, the economy is operating below its potential. If debt was all it took, Japan would be growing much faster than the US. The annual average growth rate in the US between 2010 and 2017 was 3.8% compared to Japan’s 1.4%.
Meanwhile, the US debt-to-GDP ratio averaged 103%, while Japan was more than 229% (see Figure 2).
Additionally, MMT assumes that governments know the highest and best use of capital (whether created out of thin air or not). This is a gross misunderstanding of what creates economic growth in an economy. Economic growth requires the most efficient allocation of both physical capital and labour to increasingly productive and profitable enterprises. If the government guaranteed you a job, would your incentives to increase productivity and growth be lessened?
Neo-charlatanism
If you are confused at this point, don’t worry: an inherent issue with MMT is that it is an ever-changing theory with multiple meanings depending on which proponent you are speaking to. While US budget deficits are increasing, inflation remains stubbornly low, making the average reader believe that at face value this is a plausible theory.
Our thinking is that even the best theoretical economic models seldom accurately explain the world around us. Unfortunately, we are unable to test economic theories fully like we can many theories in the physical sciences. Economists’ LIGO machine is simply our ability to investigate and evaluate the claims MMT is founded on. We see more neo-Charlatanism than neo-Chartalism.
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