Modern Monetary Theory, Explained

By Rebecca Lake · June 15, 2021 · 6 minute read

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Modern Monetary Theory, Explained

Money Monetary Theory or MMT is an alternative economic theory which says that governments that create and control their own currency should be able to do so without limits. More specifically, the heterodox theory argues that these governments shouldn’t fear incurring debt to further economic growth because they can not run out of money.

MMT emphasizes the creation of more money to meet a variety of economic needs, such as improving infrastructure, improving the quality of government-funded education, or expanding access to healthcare. While that may sound appealing, critics of the theory believe it could lead to an increase in inflation and skyrocketing national debt.

As the politicians and academics continue to debate whether Modern Monetary Theory could live up to its promise of growing an economy to its full capacity, it’s helpful to know more about how this modern economic theory works.

What Is MMT?

Modern Monetary Theory is a theory of economics often associated with investment fund manager Warren Mosler, author of “The 7 Deadly Innocent Frauds of Economic Policy.” In the 2010 book, Mosler suggests governments that control their own currency can never run out of money or go bankrupt, since they can simply print more money.

In recent years, Modern Monetary Theory has become a frequent topic of discussion among American economists and lawmakers, including Rep. Alexandria Ocasio-Cortez (D-NY) and Bernie Sanders’ 2016 economic advisor Stephanie Kelton.

Modern Monetary Theory challenges the idea that governments should pay for spending with taxes. Instead, the theory holds that taxes are a means of controlling inflation amid rising prices rather than funding the government’s spending initiatives. MMT can be seen as an extension of quantitative easing, in which a government’s central bank purchases long-term securities in order to boost the money supply.

Both seek to put more money into circulation, though Modern Monetary Theory doesn’t necessarily support the idea of resorting to negative interest rates to stimulate spending, which can occur with quantitative easing.

Traditional Economics vs. Modern Monetary Theory

In terms of its application, MMT economics is quite different from traditional economic theory. Specifically, it challenges the idea that printing more money to fund spending is inherently bad. Traditional economists view printing money as a less-than-ideal way to manage fiscal policy, since doing so can lead to rising inflation or a devaluation of currency.

Here’s a closer look at how traditional economic theories and modern economic theory compare.

Traditional Monetary Theory Explained: Key Concepts

•  When the economy is struggling, the government can give it a boost using monetary and fiscal stimulus, or quantitative easing.

•  Governments rely on interest rate policy to control inflation and the stability of currency values.

•  Interest rate policy can also be used to stimulate spending during recessionary environments by encouraging borrowing while rates are low.

•  Taxes and debt insurance are the two primary means by which governments fund their spending.

•  Unlimited government spending and debt can lead to economic destabilization.

Modern Monetary Theory Explained: Key Concepts

•  Governments that control their own currency effectively have access to unlimited spending, as they can always print more money.

•  A country that follows MMT cannot go bankrupt or become insolvent unless it’s by political choice.

•  Unlimited spending fuels economic growth and reduces unemployment.

•  Taxes can curb inflation but they’re not their primary source of government funding.

•  If a government incurs national debt, it can print more money to meet those obligations without fear of runaway inflation, deflation, or devaluing its currency.

In terms of inflation theory, MMT says the biggest risk is a government outspending its available supply of resources, such as raw materials or workers. But this scenario is rare, since it would require full employment or a shortage of supplies. If it did occur, MMT would dictate that the government could use taxation to manage inflation.

Modern Monetary Theory also states that governments don’t need to sell bonds to raise funds, since they can print their own money. Under this theory, the bond market becomes optional, rather than a requirement for maintaining government cash flows.

Modern Monetary Theory: Potential Benefits

While MMT is considered a radical theory in some circles, it has a simplistic appeal. If governments that control their currency can simply print more money as needed, then they have endless resources to promote economic growth. Deficits don’t disappear under this type of modern economic theory, rather they may grow.

From a taxpayer perspective, Modern Monetary Theory also has benefits, since it may mean fewer tax hikes to pay for government funding initiatives. Just like deficits, taxes wouldn’t disappear. But there’d be less fear of the government introducing new tax measures solely as a means of managing its own spending or debt.

Modern Monetary Theory Flaws

While MMT has many vocal supporters, it’s also drawn plenty of critics, including Federal Reserve Chair Jerome Powell and Kenneth Rogoff, former Chief Economist and Director of Research at the International Monetary Fund. The consensus, for the most part, is that Modern Monetary Theory poses too great of a risk to national economies. Specifically, critics raise these arguments:

•  Unlimited spending is not a catch-all solution. While MMT gives governments leeway to print money as needed, doing so is not necessarily a foolproof solution for tackling problems like unemployment or rising inflation. Again, if there’s a scarcity of resources or full employment, governments still have to rely on taxation to bring inflation under control.

•  Unchecked debt is problematic. When an economy experiences a boom cycle, the national deficit may receive less attention. But it can become a very real financial problem governments have to deal with when the economy enters a recession and printing more money may not be a realistic solution.

•  Rising rates could trigger hyperinflation. If rising deficits are accompanied by rising interest rates, the scales could tip from inflation to hyperinflation. This means rapid, out-of-control price increases and steep declines in currency values. Both of those can contribute to an economic crisis or collapse.

Those who suggest MMT is problematic may point to countries like Venezuela and Zimbabwe as examples of how it can go wrong. Though neither country specifically subscribed to Modern Monetary Theory, both relied on the printing of currency to navigate economic troubles. In both cases, the end result was severe hyperinflation and financial crises.

Invest With MMT In Mind

If applied to the U.S. economy, Modern Monetary Theory could potentially impact your investments in different ways. So it’s important to keep this theory in mind when building a portfolio.

For example, it’s important to consider how inflation might affect the value of your investments. If inflation rises or the government has to impose tax increases to fund spending, that could affect the profitability and spending of the companies you invest in. Investing in companies that are more inflation- or recession-proof may help to insulate your portfolio against those risks.

When deciding where to invest, it’s important to choose a brokerage that’s cost-friendly and offers access to the type of securities you’re most interested in. Opening an online brokerage account is a great way to start building a diversified portfolio of stocks and exchange-traded funds.

With SoFi Invest, stock and ETF trades have no commissions and you can trade fractional shares of top companies through fractional share investing. Consider opening a SoFi Invest account today as you work toward your short- and long-term financial goals.

Photo credit: iStock/ferrantraite

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