Modern Monetary Theory (MMT) is an economic school of thought whose time seems to have arrived, in part because it offers progressives an intellectual justification for implementing massive new spending initiatives without raising offsetting revenue. To the extent that fiscal conservatives have thought about MMT at all, their critiques have been too dismissive. Modern Monetary Theory may offer some valid insights, but its surface validity comes with a massive warning: if MMT took hold, it would send our country down a very dangerous path.
A core precept of MMT is that sovereigns who control their currency cannot default because they can always create enough new money to service their debts. This is not entirely true. Bank of Canada’s sovereign default database includes several defaults on local currency bonds over the past half-century. These defaults occurred mostly in very poor countries, but a United States Treasury default is at least a theoretical possibility.
In the US, money creation is primarily the role of the Federal Reserve, whose chairman typically has some independence from the executive branch and the president. Although appointed by the president, the Federal Reserve chair’s term inevitably lasts into the next presidential administration. In a worst-case hypothetical scenario, if a Republican-appointed Fed chair refused to finance deficit spending by a newly elected president from the Democratic Party, the battle could potentially trigger a default. But this is obviously an extreme, and hypothetical, scenario.
In most cases, MMT’s assertion of the impossibility of a sovereign currency default is probably correct. If that’s true, MMT supporters argue the federal government only has to worry about deficits to the extent that the money printed to finance them causes unacceptable levels of inflation.
MMT goes on to argue that inflation should not be a threat unless there is full employment. Until then, the government can use freshly printed money to put unemployed capital and labor to work. Once all of the slack resources have been employed, further debt monetization would drive up prices and wages. Although MMT does not address an optimal inflation rate, I imagine that many MMT proponents would like to see a higher rate of inflation than most investors would. Inflation transfers wealth from creditors to debtors, a circumstance welcomed, for example, by Occupy Wall Street founder and MMT supporter David Graeber.
Regardless of the desired inflation rate, the MMT perspective on debt monetization, employment and price levels raises some major concerns. First, the 1970s saw periods of both high price inflation and high unemployment. These conditions overturned the then-prevailing Keynesian consensus and the infamous Phillips Curve, which depicted a trade-off between inflation and unemployment that, by 1980, had clearly broken down.
Also, full employment is a difficult term to define. At one time, full employment was thought to be associated with an unemployment rate of 5 percent —a minimum explained fully by individuals making job transitions. But we have now entered a period of much lower unemployment rates, mirroring the rock bottom jobless rates seen at the turn of the century. Today, however, we have much lower rates of labor force participation suggesting that more and better job opportunities could lure more people into, or back into, the workforce. In the absence of an economy in which every single able-bodied adult is working, it is very difficult to determine precisely what conditions would constitute full employment.
But these technical concerns are unlikely to deter MMT proponents because its narrative fits recent history so well. Fiscal Cassandras have been warning about large deficits since the early days of the Obama administration. But despite the ongoing failure to balance the federal budget—or even come anywhere close —we continue to see a thriving economy with low interest rates and minimal price inflation. While it may be possible that excessive debt monetization has contributed to an asset price bubble, we have yet to see meaningful adverse effects.
So, if the U.S. economy can run trillion-dollar deficits with nothing terrible happening, the theory goes, why not try two, three or four trillion-dollar deficits? MMT adds theoretical heft to the casually empirical observation, which has also been bolstered by the actions of both major political parties, that deficits don’t matter.
And in the short term, it may be that deficits do not pose immediate dangers. That scary thing about MMT is that it could work for a while, indeed it could work for quite a long while, but it would stop working very suddenly when some random event causes the public to lose faith in its currency. By the time this happens, deficits would be so large that the printing press could not be turned off without a massive realignment of the economy and workers. If, for example, the federal government was running a $4 trillion deficit and needed to balance its budget to prevent runaway inflation the human consequences of, and the political pressure against, a course correction and fiscal consolidation would be severe. A sovereign default—that remote scenario I raised above—might make sense to policymakers under these conditions, but it would devastate the value of investment portfolios around the world.
Unfortunately, the case against massive new government spending has been poorly argued and often undermined by its putative supporters. While the Republican Party claimed deficits were an emergency under President Obama, they suddenly became defensible under President Trump. And, for some reason, deficit spending on programs like food stamps and Medicare attracts far more criticism from Republicans than deficit spending on the military.
Congress’ actions and budgets have been suggesting the federal government need not balance its budget or pay off its debt. But the risk posed by these budgetary actions — and by MMT’s ascendancy —is that once the US completely lets go of the balanced budget yardstick, we would lack an obvious standard of fiscal prudence. If a balanced budget isn’t needed and a $1 trillion deficit is okay why not a $2 trillion or $3 trillion deficit?
One approach to this issue that might be able to achieve some bipartisan support is that of stabilizing the debt-to-GDP ratio. While we don’t know what level of debt-to-GDP might trigger a crisis, perhaps we can agree that persistent increases in this ratio are ultimately unsustainable. Here we might make an analogy to climate change: we don’t know with any precision how much of an increase in greenhouse gas emissions over the long-term it would take to cause a calamity, but we can be confident that there is a maximum tolerable level and we would be wise not to test it.
Sen. Bernie Sanders, Rep. Alexandria Ocasio-Cortez and many progressives want the government to fund single-payer health care and a ‘Green New Deal.’ But they’re unlikely to find the massive amounts of money needed to pay for these programs. Taxing the rich won’t be enough to pay for them and nearly everyone in politics has a limited appetite for middle-class tax hikes. While cutting military spending might generate a decent chunk of money to spend elsewhere, it would not produce enough to fund their top policy priorities. Thus, MMT serves as sort of the intellectual framework that would let politicians have their cake and eat it too — spend money and don’t worry about debt or deficits.
True deficit hawks, not those who only argue against deficits when the other political party is in power, need to present realistic and consistent arguments about the long-term financial risks of growing debt and deficits if we hope to push back against the federal government’s budget-busting behavior and the potential onslaught of even greater spending.