Modern Monetary Theory - Modern Monetary Theory or Just a Pipe Dream?

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Modern Monetary Theory - Modern Monetary Theory (MMT) is one of the heterodox macroeconomic theories (different from widely recognized conventional economic theory) that emerged from the 1900s… But recently, this theory has been put on the scales in heated discussions about economic policy – especially from politicians.

One of the key points of this policy is allowing the government to print money to address fiscal deficits. This policy also asserts that the government does not use taxes as a revenue source… but as a tool to curb inflation from money issuance. This theory also supports regulating inflation through government fiscal policy – rather than through the central bank's monetary policy as in mainstream Keynesian economics.

Surely recently, Viet Hustler readers all know that: the public debt and budget deficit issues in the US are increasingly becoming hot topics – and a growing concern for the global financial system.

Therefore, discussions about MMT by politicians further stir up suspicions about the moral hazard risk of politicians: supporting printing money to solve public debt!

For this reason, this Macro Economics column of Viet Hustler dedicates some space to discuss this Modern Monetary Theory, including main discussions on

Content of Modern Monetary Theory
What are the problems with Modern Monetary Theory?
Is MMT the way for the government to escape public debt crises?

Disclaimer: This article contains many personal views of the author – and is not investment advice or policy prediction! Viet Hustler is not responsible for readers' economic decisions after this article.

I. Overview of Modern Monetary Theory

I.1. History of Formation

The heterodox MMT school of economics is a synthesis of ideas from:
- State Theory of Money (The State Theory of Money) by Georg Friedrich Knapp - 1905 (also known as chartalism)
- Credit Theory of Money (The Credit Theory of Money) by Alfred Mitchell-Innes – 1914
- Other proposals by Abba Lerner, Hyman Minsky, Wynne Godley on the functions of the financial sector and banking system…
The main difference between chartalism (Knapp) and traditional monetary theory is:
- Traditional view: Money emerges from the commodity exchange system… and serves as a medium of exchange - store of value - medium of circulation.
  - Read more: Basic Macroeconomics - Money Supply and Money Market
- However, Knapp argued that "money is created by law", not as a commodity – inaugurating the state theory of money in 1905.
For a long time, this “heterodox” school of economics did not receive much attention.
Until 1996, Wynne Godley published an article on the revenue/expenditure balance between economic agents (sectoral balance) – using chartalist reasoning.
The success of the article brought more attention to this theory.
- A few economists such as Warren Mosler, L. Randall Wray, Stephanie Kelton, Bill Mitchell, and Pavlina R. Tcherneva have revived chartalism to explain how governments create money.
Bill Mitchell (University of Newcastle - Australia) coined the term 'Modern Monetary Theory' (MMT) for this 'post-chartalism'.
In 2019, MMT became a major debate topic after Alexandria Ocasio-Cortez (in the US Congress) brought this theory to the discussion table.
In February 2019, Bill Mitchell, Randall Wray, and Martin Watts published the first Macroeconomics textbook based on MMT – instead of the orthodox Keynesian school of economics.
In June 2020, the book MMT The Deficit Myth by Stephanie Kelton became the New York Times bestseller.
- Stephanie Kelton (former economic advisor to Bernie Sanders) has built her entire career based on Modern Monetary Theory (MMT):
  Kelton supports the government being able to print money to spend at will!
  - Kelton argues that government spending deficits are surpluses for the private sector.
  - When the government spends more than its tax revenue: people and businesses benefit from this difference.
  - This can be bad if most of the deficit money falls into the hands of a small group in society.
  - But if these deficit expenditures are spent on the people (as during the Covid period in the form of subsidies), then the people benefit.

I.2. Main content of Modern Monetary Theory

Modern Monetary Theory revolves around the origin of money and the view of money from the government's perspective – the issuer of money…

(not people / businesses / private sector: users of money)

(a) Origin of money

Banks can create money by lending and collecting interest, but these 'horizontal' transactions do not increase net financial assets (because assets = liabilities in society).

But money enters circulation 'vertically': through government spending.

MMT argues that this is why the currency issued by governments is not in the 'assets' column on the government's balance sheet; but on the liabilities side.

Fiat money issued by the state creates its own value by creating demand for this money in the form of tax obligations from the private sector.

The state collects taxes – in its assets column – only to balance the debt obligation.

(b) According to MMT, the main principles of government issuing fiat money include:

1- To allow the government to pay for goods, services, and financial assets without needing to collect taxes first or issue debt.

2- Cannot be forced to default on debt denominated in its own currency.

3- Money issuance is only limited by the risk of inflation:

This only happens when:

The economy's resources (labor, capital, and natural resources) are fully utilized…
… causing the economy to achieve full employment (unemployment only at the natural rate of unemployment).

4- In the case of demand-pull inflation (abundant spending causing demand > supply): government imposes taxes at will to control inflation

5- Issuing bonds is also a policy tool to control inflation – not a tool to finance government spending.

6- The tax tool is used to prevent inflation and also to create demand for money from the private sector to pay taxes – thereby creating value for the currency.

Taxes mentioned in MMT are not to finance government spending – but to create value for fiat money and regulate inflation!

(c) Operation of money and the economy

Government bonds, banking system, and interest rates

According to the MMT framework: government spending injects new reserves into the commercial banking system and taxes drain liquidity from the banking system.
If the government spends more than taxes: it leads to surplus reserves across the entire commercial banking system
- => Banks seek to lend out their excess reserves, forcing short-term interest rates down to low levels (or 0%).
While when the government receives more taxes than spending => creates a reserve deficit across the entire commercial banking system.
- => Demand for money will be higher than supply in the interbank market => short-term interest rates will rise according to the discount rate.

» This is the main principle that makes the government's spending-revenue balance affect interest rates!

Central banks manage liquidity by buying and selling government bonds in the open market.
- To have money to buy bonds: The central bank will create money.

Balance of trade:

MMT argues that trade deficits are sustainable and beneficial for people's living standards in the short term.
Imports bring economic benefits to the importing country because they provide real goods to that country.
Exports are an economic cost to the exporting country because they are losing real goods that they could consume.

II. What is the problem with Modern Monetary Theory?

II.1. Purpose of Chartalism

Chartalism (the precursor to MMT) was originally constructed as an economic lens to understand the creation of fiat money.

To support the idea that the USD (or other currencies) is no longer constrained by the amount of gold held by the Treasury – but simply backed by the state that issues it.

Thus, the government cannot default on debt in its own currency that it issues: It is not constrained by currency!

The government does not tax to balance the budget: it taxes to withdraw money from the system to combat inflation.

However, the development of the post-Chartalism school into the current MMT has been distorted: by advocating for the government to print money to solve fiscal deficits!

The first three MMT principles in section I.2 (b) above do not conflict with the basic definitions of money and inflation in mainstream economics.

However, the remaining principles are opposed by most mainstream economists today!

II.2. Problems with Modern Monetary Theory (MMT)

Three problems with this theory include:

1. MMT encourages monopolistic and market-manipulating behavior by the government in the money market / economy when:

Public debt or budget deficits are not important because the government can print money to pay debt.
Tax levels are closely related to government spending (deficit or surplus) – but not as a means of self-financing government spending – but actually as a tool to adjust inflation and unemployment.
Thus, the government can impose high taxes and issue more bonds (increasing deficits) to control inflation

» According to MMT: Inflation control is in the hands of the government – through fiscal policy…
» In contrast to Mainstream Economic Theory (Keynesian): Inflation control must be carried out by an independent agency like the Fed – and through monetary policy!
And of course, Viet Hustler supports Keynesianism:
Because no democratic government (elected by the people) wants to lose public favor by raising taxes to control inflation!

2. MMT does not point out the cause of the impact from government budget deficits on interest rates (as is happening now).

Read more: Impact of public debt and macroeconomic data on bond yields and financial markets…
In reality:
Interest rates directly affect borrowing costs for businesses / government and determine saving-spending decisions of the public (which in turn affects inflation).

3 - The constraint on the government is 'resources', not money:

If the government tries to buy scarce resources from the private sector: it will still bid – causing prices to rise.
Similarly, if the private sector has too much money but is still limited by resources… they will bid / compete themselves.

=> Both of these are causes of inflation!

Thus, the money printed by the government itself has no intrinsic value – its value is the goods it can buy.

This is why there is the definition of Purchasing Power Parity of the currency (Purchasing power parity - PPP):
- PPP compares the real value of (currencies) across space and time – based on its purchasing power.
- $1 today only buys 1 McDonald's coffee in 2020 but could buy 10 bottles of beer in 1933 (worth $19.91 in 2020).
  - That is, the value of a $20 bill in 2020 is only equal to $1 in 1933!

Thus, whether the government budget is in deficit or balanced… is not due to the government printing enough or too little money …
… but rather whether the government's money can buy the actual resources the government needs!

III. MMT: A way to irresponsibly solve public debt problems by politicians!

According to Viet Hustler's view, Modern Monetary Theory cis simply an observation about how money is created and balanced in the public finance - private finance system.
Thus, some MMT observations about how money operates in the interbank system are not wrong.
But this should not be considered an economic theory on money…
… because it is constructed quite loosely and lacks knowledge of monetary history — definitions of money and functions of money.
However, this theory has recently been deliberately exaggerated and extrapolated to make it sound like a world-shaking economic theory….
Support for MMT mainly comes from politicians (or mostly political economists), typically Alexandria Ocasio-Cortez and Stephanie Kelton.
This raises suspicions about moral hazard risks from politicians!
They may support MMT as a reason for the government to escape debt ceiling constraints – legitimizing printing money to cover budget deficits!

III.1. Can MMT be used to escape the public debt crisis? — Case study of Sri Lanka

In 2020, the Central Bank of Sri Lanka also cited MMT as a legitimate reason to apply this unconventional monetary policy.

But Sri Lanka's monetary policy was heavily criticized.
This policy is said to be the cause of runaway inflation and the economic crisis here from 2019.

Sri Lanka's money printing to resolve public debt led to

Further causing this government's currency to depreciate (runaway inflation)
Yields on this government's bonds skyrocketed.
Causing this country's public debt not to be resolved — but even becoming more severe:
(FYI:
- Debt/GDP ratio of developing countries exceeding 60% is an alarming ratio.
- In addition, Sri Lanka had to issue debt in foreign currency due to the influence of Original SinIII.2.
MMT scholars like Stephanie Kelton and Fadhel Kaboub later argued that the Sri Lankan government's fiscal and monetary policies were not like MMT's recommendations.

Of course, Sri Lanka's case is not like the US because they cannot issue debt in their own currency.

At this point, both MMT and mainstream economists agree that: Debt in foreign currency is a financial risk for the government (Original SinIII.2.

Can a developed economy apply MMT? — Case study of Japan MMT was once hotly debated by Japanese lawmakers in 2019:

…. when Japan was planning to raise taxes to address the budget deficit and public debt issues for many consecutive years.

Many MMT-supporting economists asserted: Japan has followed the path of MMT…

… because this country does not set a public debt ceiling like other developed countries + BOJ holds a massive amount of government bonds.

Stephanie Kelton argues that Japan has succeeded with MMT:
Despite high public debt, this country's economy is still recovering steadily and living standards are also high.
However, by 2023, Japan's living standards have declined due to stagnant wage growth…
Meanwhile, the pace of public debt increase has accelerated since 2019:
Prime Minister Shinzo Abe and BOJ Governor Haruhiko Kuroda at that time rejected the claims of MMT-supporting economists:

The government's commitment to rearrange the fiscal deficit situation here.

Professor

Sayuri Shirai (Keiyo University, Japan) also pointed out that the approaches to economic policies of both BOJ and the Japanese government differ from MMT…. …. and pointed out that applying MMT is not suitable for Japan's economic situation.

Therefore, the assertion by MMT school scholars that Japan is a successful example of applying this theory is completely baseless!

CONCLUSION

Modern Monetary Theory (MMT) has become the center of fierce debates about the role of government in the economy and how to handle financial crises. MMT's core arguments about using fiscal policy to control inflation and eliminate limits on public spending are challenging the foundations of traditional economics.

However, the practical issues MMT faces, such as the risk of runaway inflation or moral hazard risks from politicizing economic tools, make this theory a double-edged sword. Sri Lanka is a typical example of misapplying MMT principles, leading to serious consequences.

Meanwhile, in the US, MMT's appeal to some politicians raises concerns about using this theory as a "pretext" to legitimize uncontrolled money printing. Emphasizing unlimited fiscal spending risks undermining long-term economic stability, especially in the current context of inflation pressures not being effectively controlled.

Encouraging a doctrine that allows government intervention in regulating inflation— and removes the role of an independent agency like the Fed in monetary policy regulation — has created the greatest skepticism about the moral hazard potential of politicians supporting this idea!

It can be seen that the value of MMT does not lie in its ability to replace traditional monetary economic theory, but in its ability to evoke new perspectives on how governments operate public finance. Is MMT truly an innovative tool or just a justification for the money printing machine?

It can be seen that the value of MMT does not lie in its ability to replace traditional economic theories on currency, but rather in its capacity to inspire new perspectives on how governments manage public finances. Is MMT truly an innovative tool or just a justification for the money-printing machine?