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Promoters of modern monetary theory (MMT) — including a growing number of pundits and policymakers — are toying with the idea that "deficits don't matter." They are tempted to believe that a government can merge fiscal and monetary policy and simply print currency to pay for its expenditures indefinitely without economic costs or constraints. This core tenet of MMT, which has permeated the public debate, worries economists of all stripes — not just "mainstream" economists, but also traditional Keynesians and heterodox economists.1

A key aspect of MMT is that it seems to present a cost-free solution to many economic and social problems. While a critique of current monetary and fiscal policy approaches may certainly be warranted, proponents of MMT go one step further. As we argue in this brief, implementing MMT would reverse the role of policy institutions and would fundamentally change the nature of U.S. currency both domestically and internationally. Arguably, implementing MMT policy prescriptions would therefore require a fundamental overhaul of the relationship between the individual and the state, and MMT's outcomes are potentially catastrophic. Nonetheless, some aspects of MMT are perfectly consistent with the dominant monetary paradigm in economics and are, in fact, the subject of much ongoing macroeconomic research and debate. But MMT differs greatly in its policy prescriptions.

It is not hard to see that this spray and pray mentality of shooting bundles of cash into the economy and hoping it does not have any negative consequences was ripe for massive inflation from the beginning. Despite what MMT proponents may want you to believe, there is no way to abolish the laws of supply and demand. When there is a lot of something, it is less valuable. Massively increasing the supply of money in the economy will decrease the value of said money.

MMT economists seemed woefully unaware of this reality prior to the pandemic. Lecturing at Stoney Brook University, Kelton attempted to soothe worries about inflation by explaining that (in the modern economy) the government simply instructs banks to increase the number of dollars in someone’s bank account rather than physically printing the US Dollar and putting it into circulation. Somehow–– through means that were never entirely clear–– this fact was supposed to make people feel better.

First, is it really true that the MMT policy of keeping interest rates low and fiscal policy oriented to full employment, subject to an inflation constraint, amount to a stable policy? Palley, for example, has pointed out the difficulties of implementing such a fine-tuned policy, given lags in policy, uncertainty, and shocks, and the dynamic evolution of the economy such that policies can lose their effectiveness and predictable effects over time. (Palley 2019a, b). We simply do not know to what extent this kind of “fine-tuning” can succeed to stabilize the economy.

Second, there is a far larger problem that the MMT policy might engender, one that the MMT focus on sovereign money, and ignoring credit, leaves in the shadows: the possible impact of excessive private credit creation on financial speculation, bubbles and financial instability.

Inflation is when goods and services increase in price over time. If there's a shortage of the raw materials used to produce goods, that can increase inflation. Likewise, increased demand for products and services can also trigger inflation. Economists also report that a higher price of oil can majorly affect inflation rates because it is used to make and deliver so many goods.

What is the Relationship Between Poverty and Inflation?

There are many explanations of this phenomenon, such as globalization and skillbiased technological changes, but the redistributive impact of inflation has been understated. This is puzzling, taking into consideration the correlation between rising income inequality and the accelerated pace of monetary inflation after the final abandonment of the gold standard. One potential reason for their lacuna may be that mainstream economists focus nowadays on price inflation rather than monetary inflation, and on price (and wage) rigidity rather than the Cantillon effect. In consequence, they consider inflation a regressive tax, or examine only the redistribution from creditors to debtors. Their observations are often very insightful; however, the redistributive effects of inflation are much more complex. This is because the inflationary redistribution of income (and wealth) depends on many things, such as institutional factors, access to new money, the differences in consumption baskets, or the structure of economic agents’ assets and liabilities (Laidler, Parkin, 1975). In other words, changes in the relative income (and wealth) position of different groups depend in large measure on movements in relative prices of goods and assets and differences in the composition of ownership of goods and assets. This is why analyses that focus only on one type of redistribution, such as Piketty (2014), who focuses on the redistribution from labour to capital, cannot be fully satisfactory.8

In this paper we have offered a more systematic analysis of the redistributive effects of inflation. We demonstrated that even uniform monetary inflation increases income inequality because lower-income people generally have less ability to protect themselves against inflation than higher-income people. Moreover, they possess a greater part of their wealth in cash and may suffer more due to institutional reasons such as tax-bracket creep or imperfect indexation of social benefits.

4. Effects of Inflation on Income Inequality In the previous section we presented empirical evidence of the relationship between inflation and income inequality. Of course, correlation does not imply causation; however, there are also strong theoretical arguments that inflation may contribute to the rise of income inequality.

First, inflation decreases the real value of social benefits (Yeager, 1997a). Because of imperfect indexation (e.g. due to the fact that the index is the past inflation rate), the nominal value of social benefits lags behind price changes reducing the real income of the beneficiaries. People receiving social benefits generally have low incomes (Romer, Romer, 1998); therefore, inflation contributes to income inequality.

MMT proponents argue that central banks can print money without triggering dangerous levels of inflation. This claim not only overlooks the theoretical considerations outlined above, it also ignores the dark history of debt monetization leading to hyperinflation. As Thomas Sargent famously documented in his 1982 classic, The Ends of Four Big Inflations, printing money and monetizing debt — even when that debt was partly denominated in local currency — led to devastating inflation in Austria, Hungary, Poland, and Weimar Germany during the first half of the 20th century.

Austria and Hungary — two states formed through the dissolution of the Austro-Hungarian Empire — found themselves greatly diminished in both size and power following WWI. Since Austria-Hungary was deemed an aggressor of the war, its successor states owed the Allies substantial amounts in war reparations. To pay off the reparations while alleviating large-scale food shortages and unemployment, the Austrian government ran significant deficits — which it financed by selling treasury bills to the Austrian section of the liquidated Austro-Hungarian bank. At the same time in Hungary, political turmoil led to considerable budget shortfalls, which the government financed by borrowing heavily from the Hungarian section of the bank and increasing the volume of low-interest loans issued to private entities. As a result, both the Austrian crown and the Hungarian krone depreciated rapidly while domestic prices rose. This led to flight from each currency by domestic actors and foreign investors alike and, ultimately, to hyperinflation in both countries.

Modern Monetary Theory (or MMT) is a macroeconomic model that has become popular among some heterodox economists and progressive policymakers, and is often cited by those who favor expanding the size of government. To understand the MMT model, it helps to start with some basic accounting relationships for government finance. For instance, government spending is paid for with either taxes, debt, or money creation. MMT proponents argue that a government that issues its own currency will not default on its bonds because it has the power to issue as much money as needed to pay off the public debt. In their view, this gives governments the ability to fund expensive public projects such as universal healthcare and a universal jobs guarantee without concern for the cost of these programs.

According to MMT proponents, there is a risk that deficit spending could lead to higher inflation once the economy is pushing beyond full capacity. If inflation were to rise, MMT proponents advocate raising taxes to hold down inflation. Most MMT proponents, however, do not regard inflation as a current risk for the US economy.

In 2008, then-presidential candidate Barack Obama said, “We’re just taking out a credit card from the Bank of China, essentially. We’re borrowing that money. And we’ve added $4 trillion worth of debt since George Bush took office. Keep in mind, just to give you some perspective, the first 42 presidents amassed $5 trillion worth of debt.”

During his two terms, Obama added $8.6 trillion to the national debt — more than double his predecessor. President Trump added $6.7 trillion. In one term.

Free lunches have a long tradition in policy debates. They are politically popular and have recurred many times in the twentieth century and before. The experience with all economies that have swallowed the particular free lunch proposed by MMT enthusiasts is that it is very costly, and it can take a long time before unsustainable pressures eventually cause a disastrous outcome. The evidence on approaches like those proposed by advocates of MMT is that it always results in hyperinflation, massive social and economic destruction, and a crisis, followed by the imposition of more conventional economic policies. All existing experience– Venezuela today; Zimbabwe in 2008; Yugoslavia in 1994; Hungary in 1946; Greece in 1944; Wiemar Germany in 1923 — demonstrates the large costs.

Is it possible that traditional economics has missed something? Is it possible that this time MMT will perform differently?

MMT puts countercyclical policy and inflation control in fiscal hands, substantially rewriting the Federal Reserve Act [Kelton (2021, chapter 8)]. Proponents argue that moving interest rates around to fight inflation tends to destabilize financial markets. So, the only remaining tasks for the Fed are banking supervision, financial stability, and maintaining low and stable interest rates.

There are two good arguments for making an operationally independent central bank the first line of attack against recession and inflation. The first is pragmatic. Monetary policy is more nimble than fiscal policy: it can and does react immediately to worrisome incoming data. Hundreds of economists across the Federal Reserve System provide policymakers with theoretical and empirical input. No other American policy institutions devote comparable resources to a rigorous understanding of the economy. Although Congress did act swiftly to pass COVID-relief legislation, the American Recovery and Reinvestment Act in response to the global financial crisis was enacted in January 2009, over a year after the recession started and the Fed had begun to lower interest rates. Many recessions come and go with no congressional action.

Under an MMT regime, policymakers would need to respond to inflation by doing two of the most unpopular things ever: raising taxes and cutting spending.

With MMT, if inflation starts to get out of control, money needs to be pulled out of the economy either by taxing people more or spending less. Raising taxes is, of course, historically difficult in America. For example, the last time Congress passed a meaningful increase in the payroll tax was in 1993 when the earnings limit was repealed for the Medicare portion of FICA.3 The last Republican president to sign a tax increase into law was President George H.W. Bush in 1991.4 With one party adamantly opposed to increasing taxes, it seems like a fantasy to believe that politicians would approve a tax increase while people’s earning power is being eroded by inflation. On the spending side, do we see Democrats actually cutting spending and taking an ax to things like national parks, food inspection, and health care services? They shouldn’t have to—and they won’t.

Kelton has in recent days compared tax increases to “a helmet” – a proactive tool that would prevent inflation from happening, but would have little benefit once inflation has already materialized (without ever producing a model that would plausibly justify the distinction). In a New York Times profile published last weekend, Kelton says that the Congressional Budget Office should “analyze possible inflation ahead of time” and then lawmakers should try to offset the impact of inflation with tax increases. How useful is an economic theory that tells us how to avoid inflation, but has no credible recommendations for reducing inflation once it’s higher than desired?

There is also no reason to believe that advocates of MMT would support such precautionary fiscal restraint. CBO did produce an estimate of the gap between projected and potential economic output in 2021, and it was just one fifth of the size of the $1.9 trillion American Rescue Plan enacted last March. Yet at no point did Kelton or other leading advocates of MMT join the calls of other economists to shrink the bill or propose pairing it with tax increases. In fact, some argued the bill should be even bigger – and they did so without producing any alternative model to suggest CBO was underestimating potential output. Leeper’s paper makes clear that the lack of testable models that can be analyzed and debated is a pervasive problem with MMT.

In recent years, politicians on the far left have leaned on Modern Monetary Theory (MMT) to justify offering increasingly exorbitant spending proposals without plans to pay for them. Then roughly $6 trillion in deficit-financed stimulus approved by Congress in 2020 and 2021 provided policymakers a natural experiment to evaluate the claims proponents of MMT made. The results exposed the critical flaws in their approach, and rather than being able to take a victory lap, MMT is now on its last legs.

The idea that government should use deficit spending to support an economy in crisis is not unique to MMT – economists across the political spectrum supported an aggressive fiscal response in 2020. The core tenet of MMT is that a monetarily sovereign nation, like the United States, can always simply print however much currency it needs to buy whatever goods and services programs require. This is the lens through which proponents of MMT have argued that the only constraint on deficit spending should be inflation that materializes when the economy is utilizing all available resources.

Modern Monetary Theory (MMT) represents a structural change in how we think about money, inflation and asset prices. It is an increasingly popular narrative that is widely discussed in the markets today. While the current debate is immediately unlikely to have a significant impact on asset prices, it has the potential to affect the future of economic policy in a way that may present longer- term risks.

As a basic breakdown of a complex topic, MMT can be understood in basic form to be the opposite of fiscal austerity. Fiscal austerity is the notion that a country’s deficit—or rather, its deficit/GDP ratio—matters. This ratio is akin to a default-risk level. MMT, by contrast, suggests that the deficit/GDP ratio is less important because as long as a country can print its own money, it can pay off its debts in perpetuity and without problems. In this theory, the creation of money by the government is what directs economic activity.

One of the most vehement critiques of MMT comes from Larry Summers, formerly Treasury Secretary and president of Harvard University. His opinion piece about MMT, titled, “The left’s embrace of modern monetary theory is a recipe for disaster,” was published in The Washington Post March 5, 2019.

His chief complaint was that, “contrary to the claims of modern monetary theorists, it is not true that governments can simply create new money to pay all liabilities coming due and avoid default. As the experience of any number of emerging markets demonstrates, past a certain point, this approach leads to hyperinflation.”

3.2.1 Financial markets, the complex of interest rates, and asset prices

Government is likely to face significant financial market blowback if financial markets believe it is engaging in excessive money issue. In particular, long-term interest rates will tend to rise if financial market participants anticipate risks of future financial turmoil or higher future inflation. Current financial market conditions are affected by expectations about the future, which means the future is always already here and in the present. Consequently, inflationary bias in MMT's reliance on money-financed deficits will creep into present financial market conditions long before full employment.

Leaning too heavily on extreme cases can lull us into the belief that as long as monetary policy decisions are independent of political leaders, the economy is insulated from fiscal dominance. This policy brief led with three subtle examples of fiscal dominance to make this point: each case involved an operationally independent central bank. Fiscal dominance need not imply fiscal policy run amok. It can arise anytime policy makes the path of primary budget surpluses impervious to economic conditions such as inflation.

Monetary policy independence is a bulwark but not an impenetrable barrier against fiscal dominance. The Reagan administration began with inconsistent plans for monetary and fiscal policy (Sargent 1986). At the same time that the administration supported Federal Reserve Chair Paul Volcker’s goal of wringing inflation out of the economy through tight monetary policy (monetary dominance), it announced tax cuts and defense spending increases that implied a persistent path of primary deficits (fiscal dominance). Two dominant policies cannot coexist indefinitely because they cannot achieve the prime directive: each policy requires a different inflation path and neither policy stabilizes debt. Sargent credits Neil Wallace with describing the conflict between policies as a game of chicken. Which policy would flinch to avoid an economic crash? As Sargent (1986, 36) put it, “Reaganomics was not credible because it was not feasible.”

The Federal Reserve provides an important macroeconomic safety net for the country. And it is able to play the role of an independent steward in the economy free, or mostly free, from political intrusion. For example, in the wake of the Great Recession, Congress worked to provide stimulus to bring the economy out of the tank. But it wasn’t enough. Fortunately, the Federal Reserve stepped in to help the economy through the fiscal policy doldrums in 2011 and 2012.

Further, our current economic situation is one of low inflation and low-interest rates. This is because markets trust the Federal Reserve and, as a result, businesses and individuals have well-anchored inflation expectations (i.e. they think inflation is going to be low and stable). Under MMT, however, the Fed’s role would be upended. A shift in strategy and relationship to inflation would have an uncertain effect on individuals’ and businesses’ inflation expectations. And possibly more dangerous during economic downturns, we would move from having both monetary and fiscal policy tools to only having fiscal ones.

It’s been a rough year for advocates of modern monetary theory (MMT). After nearly two years with all the budget deficits and money printing MMTers could have wanted, the doctrine’s popularity seems to have faded now that we’re well passed the honeymoon phase. Twenty twenty-two [2022] has clearly demonstrated that creating a lot of new money and running massive government deficits does, in fact, come at a cost. We should let this theory die before it causes any more destruction.

MMT is a school of thought born and raised on the internet during a thirty-year period of low price inflation with constant debate over government budgets. Advocates argue that because the US government is a currency issuer, we can drop all the talk about finding money for government programs. All that is needed is the political will to fund things with newly printed money. Suddenly in early 2020, that political will appeared overnight at a scale no one could have imagined even weeks before.