MMT – The Good, the Bad and the Ugly

Modern Monetary Theory (MMT) is in the news a lot lately. And that has resulted in a number of “critiques”. Most of these critiques are, to be blunt, bad. The thing is, MMT is really, really confusing and most people don’t get it right at first. So we tend to see lots of “critiques” of MMT that aren’t based on a sound understanding of it. I know this because I went through a phase almost 10 years ago where I first encountered MMT, thought it was largely right and then realized it had a bunch of problems. I critiqued it and learned along the way that some of my early critiques were wrong. I’ve learned a lot over this time and I still think there’s more good than bad in MMT. But for those interested, here’s how I see the good, the bad and the ugly in MMT.

First, it’s useful to provide an overview of what MMT actually is because this is what trips most people up. MMT is a macroeconomic theory of full employment and price stability that argues that the government is the monopoly supplier of money. Because it issues THE money (currency) it can always afford to spend in nominal terms. In other words, the government cannot run out of money. This also means that the traditional idea that the government needs money before it spends is misleading. The government doesn’t need our tax dollars to spend money because it can literally print money if it has to.

Further, the government causes all sorts of problems by creating a currency. This includes the need to obtain money from the government to pay taxes in the money that it creates as well as the need to obtain jobs so we can obtain an income denominated in the currency that the government requires those taxes to be paid in. So, MMT argues that unemployment and a shortage of desired financial assets can result if the government does not spend enough into the economy. They propose to resolve this mainly through a Job Guarantee program that would provide full employment to everyone willing to work. The Job Guarantee is an essential part of the theory because it is the element that supposedly solves the problem of full employment and price stability.

Importantly, MMT does not say deficits don’t matter or that the government has NO constraint. While the government has no nominal budget constraint it does have a real budget constraint (ie, inflation).

Okay, I don’t agree with all of that, but it’s a decent general description of how the monetary system works. Anyhow, moving on….

The Good. 

1) MMT gets banking (mostly) right. This is a biggie because mainstream economists have had this confused for a long time and it’s distorted the way we emphasize certain policies and ideas. The traditional money multiplier is wrong and MMT advocates have long emphasized endogenous money.

2) Fiscal Policy over Monetary policy. Mainstream economics relies heavily on interest rates and the powers of Central Banks to set policy. MMT turns a lot of this on its head and argues for more fiscal policy focus and less monetary policy focus. Concepts like the natural rate of interest and NAIRU have rightly come under attack and it’s nice to see MMT shedding some doubt on these ideas that are pretty central to mainstream economics. This is particularly relevant in an age where it appears as though Central Banks have become somewhat impotent.

3) Governments have an inflation constraint and not a nominal constraint. This is important because most people think of the government like a household. When a household runs out of income it probably cannot spend. It has a true nominal budget constraint because intra-sector entities and persons are subject to bankruptcy laws. When a federal government wants to spend and doesn’t have enough income it just runs a deficit. The only thing that stops the government from spending too much is when its spending causes out of control inflation. Again, this is useful because it gets people out of the mentality that deficits are necessarily bad or that the government can’t “afford” things just because it doesn’t cover them entirely with current tax receipts. As mentioned before, it also gets us out of the mentality that all government spending and debt is going to cause hyperinflation.

The Bad. 

4) MMT plays A LOT of word games. MMT has created a whole new taxonomy for their version of economics. When you first come across MMT it will sound like an entirely new paradigm because they speak their own economic language, but as you translate many of these terms you slowly realize that a lot of what they’re doing is just saying well known concepts in different (often times misleading) ways.

For instance, MMT advocates often claim to be accounting experts, but regularly misconstrue specific accounting constructs to make them appear as something they’re not. The most egregious misuse of accounting is the way MMT redefines private sector net saving as saving net of investment in an effort to argue that the government “must be in deficit”. They do this by intentionally depicting the economy as being just two sectors (private vs public). They even go so far as to say “If the government always runs a balanced budget, with its spending always equal to its tax revenue, the private sector’s net financial wealth will be zero.”  This is extremely misleading as it makes it look like the private sector can only save if the government spends (when in fact we mostly save intra-sector within the private sector). This is often communicated with an accounting tautology such as “their red ink is our black in” as if to imply that government deficits are always a good thing (because, in the MMT world that’s where private saving comes from). A proper accounting of this requires a much more granular view (as described here) since there are actually hundreds or even thousands of different potential sectors in the economy.

It is misleading to depict all of this in a 2 sector view where we define “net saving” in such a narrow sense that the reader comes away thinking that the government “must” be in deficit, when, in reality, there is absolutely no need for the government to be in deficit in order for the private sector to accumulate net savings on its own. In reality, a more granular view would breakdown the private sector into its many various sectors (households, corporations, non-corporations, etc) to show how these entities save relative to one another.

The most important relationship of these is the household sector versus everything else. The household sector net saves in numerous types of financial assets relative to the corporate sector, foreign sector, financial sector and government sector. But the government is just one sector from which the household sector can net save. And there is, emphatically, absolutely, positively no need for the government to spend a single dime to allow the household sector to net save against other sectors. Saying the government “must be in deficit” is not just misleading, it is wrong in a very basic sense. And in fact, the corporate sector is the most important issuer of net financial assets as they are the firms that invest and produce most of the things that make money valuable in the first place. This is obvious to anyone who has a retirement plan and owns stocks or bonds. This pool of savings is a primary source of household sector net saving. Netting out the corporate sector vs the household sector is a misrepresentation of the way

Further, MMT redefines full employment to mean zero involuntary unemployment (while most economists define it as optimal employment). This is convenient for MMT because they promote a Job Guarantee so, until there is a Job Guarantee they will always view the economy as operating at a sub-optimal level of employment. The extreme (and unsupported) assumption here is that a Job Guarantee IS optimal employment. So, in the MMT paradigm the definition completely shifts based on the assumption that giving everyone a government job is the equivalent of optimal employment.

They also use the term “sovereign currency issuer” in a manner that is nearly useless since they can’t define when a country is sovereign or not or how various economic environments might reduce or even eliminate sovereignty. They use this term in a hand-wavy sort of fashion to dismiss anyone who says MMT might or might not apply to a certain country. It’s like going around saying “wealthy” people are financially free. What does that mean exactly?

They do something similar in their use of the term “resources” often talking about how “resources constrain spending”. The implication is a vague constraint on government spending that is hard to pin down. But if you swap out the term “resources” for “capital” it becomes clearer. For instance, as we discuss below in MMT’s errors on “funding”, if you say governments are “capital” constrained then it becomes clear that a domestic economy whose private sector creates more capital creates more capacity for government spending because that capital can be leveraged into public spending.

All of this slippery jargon makes for an interesting general conversation, but creates confusion when you get into the important details. More importantly, it is outright misleading in many specific cases.

5) MMT has an excessively state-centric view of the world. The entire theory can be summarized as “the government has a printing press and it should use this power to offer everyone a job”. I don’t necessarily think this is wrong. There are good reasons why the government might WANT to spend money or provide jobs. But MMT tortures and twists reality to try to make a coherent economic argument for why the government “MUST” do these things.

The reality is that the public sector vs private sector relationship is a symbiotic one. It isn’t an either/or and MMT too often constructs their narrative in such a way that makes it appear as though we’re all entirely dependent on government to do certain things. In reality, there is no “must” in any of this. The government doesn’t need to spend money or offer everyone jobs or distribute net financial savings. But in the MMT framing you come away thinking there is no alternative because they’ve framed everything in such a state centric extreme view. In many cases it’s simply overreaching and turning “should” or “could” into “must”.

6) MMT tries to claim they are describing reality when they’re really describing an alternative reality. MMTers sometimes claim that they’re just describing how things work. But MMT is actually based on two conflicting views of the financial system – what they refer to as the “general” and “specific” view. The general view is a vague overview of how things work. The specific view is how they try to mesh this vague general view with the actual reality of the monetary system. For instance, in the general view the government spends first and taxes second. But in the specific view the government is required to obtain bank deposits when it taxes and clears them with reserves. They try to reconcile these two conflicting narratives, but fail to account for the fact that existing institutional arrangements specifically conflict with MMT’s general narrative. Specifically, the existing system is designed primarily around private competitive banks that create most of the money, but in the MMT world it’s not the banks that create the money “first”, but the government that “spends first”. This is completely contradicted by the actual structure of the existing system and misconstrues the purpose of the Central Bank within this system (to support private banks).

This is an important flaw in the MMT framework as it confuses the roles of monetary policy and fiscal policy by consolidating them into the same thing when in fact they exist for very specific and distinctly different reasons. Specifically, reserves exist primarily because the current private clearing system requires interbank deposit settlement. Deposits, by definition, must precede reserves. But in the MMT world this is all backwards and reserves reflect government money creation in the first instance, when, in reality, reserves only exist because the Central Bank expands their balance sheet to facilitate the movement of existing financial assets (mainly deposits).

This confusion is why we often see MMT consolidate the Fed into the Treasury. In reality the Fed and Treasury are separate entities serving specific purposes. The Fed operates as the bank for banks as well as the bank for the Treasury. You cannot consolidate the Federal Reserve into the Treasury and also tell people that you’re describing reality. No, they are specifically consolidating things to spread overly simplistic generalizations that confuse how and why these institutions operate.

In reality, the Central Bank exists specifically because most modern economies do not have State Money, but have money systems developed around private banks. This is a central contradiction for MMTers, who are economists who should be fully supportive of nationalized banking and a fully state money system, but instead of promoting that view they try to argue that the current system is a State Money system despite being primarily designed around private banks. Consolidating the Fed and Treasury can be useful for theoretical purposes, but in the actual system the Fed and Treasury exist for specific reasons that MMT ignores.

These various “consolidations” are part of how MMT misconstrues the inner workings of the monetary system when they explain how things work. They consolidate the Fed into the Treasury to give the appearance that taxes don’t fund spending. And they consolidate households into corporations when they discuss how the private sector can only “net save” by obtaining public sector assets. This is all interesting as tautological macroeconomic generalizations, but it’s very misleading at a precise microeconomic level and the microeconomic level is where the important operational understandings exist.

MMT also relies on assuming that a country is “sovereign” (despite not knowing what exactly that means) in the first instance. This is why MMT is applicable only to developed world countries and cannot be usefully implemented in undeveloped countries that don’t have the resources to support large public purpose spending programs like Job Guarantees.

Further, MMT is based on several controversial claims such as the idea that the government causes unemployment by creating the monetary system. This is not merely an operational description. This is a controversial description that is central to how their world view is constructed.

This leads to much confusion among MMT’s advocates who often claim that MMT has a “descriptive” and “prescriptive” component when, in reality, the description and prescription are explicitly intertwined. As Bill Mitchell stated in 2011:

The reality is that the JG is a central aspect of MMT because it is much more than a job creation program. It is an essential aspect of the MMT framework for full employment and price stability.

More importantly, no government or economy runs a full MMT style regime with a consolidated Central Bank and Treasury managing a large scale Job Guarantee. So, not only do they not describe reality correctly, but they haven’t even tested the alternative reality that they fervently support.

7) MMTers muddy the concept of “funding”. When they describe government spending they describe it as being independent of income often repeating the idea that “taxes don’t fund spending”. MMTers love to berate Conservatives for claiming that government spending needs to be “paid for” with taxes and they’re right. The government does not have to fund all of its spending from current income ($ for $). The government doesn’t have to balance its budget and it doesn’t have to pay back the national debt. But saying “taxes don’t fund spending” is also rhetorical overreach, except in the opposite political extreme.

The crucial point here is that every entity in the economy leverages their capital. And every entity benefits from having income/wealth because that income/wealth allows them to spend more than they otherwise could. For example, if you have an income of $100K and a line of credit of $20K then you can not only spend your line of credit, but you can also spend from existing income without having to expand your line of credit. Without the income you rely entirely on the line of credit and the need to expand your balance sheet. The same basic fact is true of a government. A government with huge domestic taxable output can redistribute that income and spend for public purpose without having to expand the government’s balance sheet (what we might call “printing money”). On the other hand, a government without substantial domestic income must expand their balance sheet and potentially create inflation along the way. In other words, the government and economy with a larger domestic tax base has more spending capacity because they can simply redistribute existing resource supported money.

One crucial difference between a household and the government is that the government operates with a much more flexible line of credit because it can tax all domestic output without needing to worry about being taken to bankruptcy court (the government won’t willingly choose to default on itself and so it has no solvency constraint like your or I do). Instead, it hyperinflates the currency as the demand for government assets declines. So MMT is correct that the government operates with a real resource constraint or an inflation constraint as opposed to a solvency constraint. But they most certainly benefit from having a large domestic resource base and income stream to fund their spending.

I think a lot of the confusion in MMT circles comes down to whether the government needs to obtain money from the private sector to spend (which it doesn’t) vs whether the government benefits from taxing resources it doesn’t create (which it does). A government that can tax a large endogenously created private resource base has vastly more spending capacity and funding than a government that cannot tax a large endogenously created private resource base. So yes, the government doesn’t need to obtain money from the private sector because it can just print money, but it certainly benefits from being able to tax resources that wouldn’t otherwise exist (because that allows it to spend without printing money).

For example, the USA and Somalian governments both have printing presses and the ability to tax and enforce laws. But the US government spends trillions of dollars a year while the Somalian government can only spend millions. The primary difference here is that the US government has a private sector that produces trillions of dollars per year in domestic income and resources. And so the government benefits from this by being able to leverage those resources and income into public spending. If the Somali government tried to spend as much as the US government they’d have to print trillions of dollars (as opposed to being able to tax AND print). This would result in hyperinflation because they don’t have the resources and domestic income to support that level of spending. In fact, the US government doesn’t even need to print money to spend trillions of dollars every year because they can simply redistribute existing money while the Somalian government doesn’t even have the option to print trillions without collapsing their currency. Said differently, it’s incoherent to say that taxes don’t fund spending because taxes reflect domestic resource production and domestic income and are directly linked to how much the government can ultimately leverage its balance sheet without causing a currency collapse.

But let’s be a little more specific here to clarify the matter. For instance, let’s pretend that XYZ Corp, a US based corporation, invents a world changing technology. As a result of this technology the firms gets revalued at billions of dollars and they subsequently pay out millions of dollars of income every year. This is endogenous value creation and income that can now be taxed. It’s value and income that wouldn’t otherwise exist. If a similar firm in Somalia invents a competing technology that fails because it is an inferior technology then the Somalian government has that much less domestic income and resources to leverage into public spending. Both governments can theoretically print trillions to fund spending. But the USA has a much more sustainable operating position because they can redistribute existing money by taxing the existing value of XYZ Corp and its income. If Somalia wants to spend the equivalent amount they have to print new money that isn’t supported by underlying resources. The USA isn’t better off because it has a better government or a better printing press. It is better off because it has better and more valuable private entities/resources that allow the government to leverage income and resources into more public spending.

At a more basic accounting level we should be clear that government taxes do not “destroy money” as MMT advocates like to say. As mentioned previously, the specific system we exist in today is structured primarily around private banks. When the government taxes the private sector they obtain bank deposits and clear through the Central Bank. These bank deposits cannot be destroyed in perpetuity as they are not liabilities of the government and must be redistributed back into the banking system to allow the banking system to operate smoothly. The only entity that can permanently “destroy” an asset is the issuing entity when they retire that instrument. The government structures itself in a modern banking system as a user of bank deposits and cannot destroy those deposits as it is not the issuer. This is why the government must, on occasion, “bailout” banks. We have structured a system in which the government is beholden to banks in numerous ways. This is just one way in which the “general” vs “specific” narrative is at odds with the existing progressive political narrative in MMT as it becomes clear that private banking is a conflict of interest for any advocate of the state theory of money.

MMT’s funding narrative also contradicts their own theory of inflation. MMT people like to say that resources constrain government spending via inflation, but conveniently leave out the fact that the government has more spending capacity when the non government creates resources. When we make more resources the government has more funding because they’re now able to leverage more real resources into more public purpose. Yes, the government has a printing press and can print money whether we built houses or not. But the kicker is that when we build real assets like houses we have the ability to tax existing money that is already supported by existing resources thereby resulting in the ability for the government to tax and enact public purpose WITHOUT having to print money. If the government wanted to spend for public purpose, but we hadn’t built those assets and funded them with existing financial assets then the government would have to print NEW money that isn’t supported by existing assets. This would result in higher inflation than we’d otherwise have and lower future balance sheet capacity for the government.

It should be obvious that a wealthy country with a huge taxable capital base can afford to have a much larger government than a poor country with a small capital base. Mind you, these countries don’t have different printing presses. They have different production bases that can be leveraged into public policy not only via taxable income, but also via leveraged debt. The critical error in the MMT funding narrative is the idea that government spending necessarily creates the resources that support that spending when in fact this is often untrue of government spending. A lot of government spending (such as wars) has a negative net present value and therefore cannot be self funding. This is why governments benefits from having large positive present value entities within the domestic economy – they form the capital base that the government can leverage into public policy.

MMT loves to talk about how the government doesn’t need to fund its spending through bond issuance often referring to this “self imposed” constraint. And it’s true – a government could theoretically print cash to cover its funding needs. And they would still rely on issuing that cash to the non-government whose demand for that cash would be reflected in the rate of inflation (the government’s funding cost). Yes, the government has a printing press. But MMT sometimes talks about this funding concept as if it is some great discovery. As if MMT discovered that the government has a printing press….

This is essential to understanding why MMT’s theory of inflation is flawed. MMT assumes that the government can set prices as the currency monopolist, but the cost of government funding occurs at the rate of inflation and inflation is a deeply complex phenomenon with many factors impacting it that are outside of government control. The government cannot simply conjure resources out of thin air to support the money they can conjure out of thin air. In fact, governments are notoriously bad at creating the incentive structures to do so and end up being less efficient than the private sector for numerous reasons. But the important point here is that the government always relies on non-government demand for its assets to maintain price stability. The government can have a large impact on price stability, but this whole idea that the government doesn’t need to “fund” its spending implies some sort of omnipotent price control mechanism through government policy. This sort of omnipotence is unsupported by empirical evidence.

At a broader level the MMT concept of “funding” is a fallacy of composition. For instance, the government cannot run out of money, but this is true of any aggregated sector. The private sector as a whole can’t go bankrupt and the private sector can also print money and financial assets. This doesn’t mean we should create a whole new “school” of economics based on the premise that the private sector can print money and can’t go insolvent. Yes, it’s useful to understand the macroeconomic constraint of aggregated sectors, but there’s no need to misconstrue this to mean that the aggregated sectors don’t need income or don’t have a fiscal constraint.

It’s one thing to say the government doesn’t need to fund spending $ for $ or that the government can spend without tax revenue. But the government does benefit from the ability to tax private sector wealth/income therefore taxes play an essential role in funding the sustainability of the government’s balance sheet.

More recently I’ve noticed that MMT advocates realize this isn’t entirely true and have started saying that private output “gives the government fiscal space”. Yes, when an entity has more fiscal space it has the ability to obtain more funding. So for instance, when we produce more GDP we increase domestic income which naturally means the government has more domestic income to tax and more income to move to the public domain thereby allowing it to spend more than it otherwise could. This is yet another terminological sleight of hand wherein MMT is saying “taxes fund spending” without admitting that their “taxes don’t fund spending” narrative is economically incorrect.

MMTers like to respond to this sort of comment talking about the way the Treasury General Account is structured inside the Federal Reserve system and how you could theoretically consolidate those accounts and that this means taxes “destroy” money since the government is receiving its own liability within the TGA. But this is a massive sleight of hand based on a misrepresentation of the reserve system and it can be easily debunked. For instance, if I borrow $100 a private bank creates a $100 deposit and $100 loan. If the govt were to tax $20 of those deposits the government would debit your tax liability and credit the TGA. Importantly, this liability did not initiate with the government and therefore cannot be destroyed by the government. This liability MUST be reissued back into the banking system in the future. The reserve settlement reflects nothing more than the transfer of this deposit from the banking system into the TGA until it must be redistributed back into the banking system. Depicting this as “destruction” and “creation” of money via government spending and taxes is enormously misleading as it distorts the fact that this money originated via bank loan. 

8) MMTers Misconstrue Institutional Relationships. MMTers would fit under the Post-Keynesian tent as Institutionalists. That is, they focus heavily on institutions, accounting and the inter-sector relationships between those institutions. This is another case where the “general” and “specific” views conflict. For example, in the “general” view the MMTers consolidate the Fed into the Treasury. In doing so they effectively eliminate the fact that the Federal Reserve exists because it is needed to service private banks. This view establishes the state as the primary money creating entity and creates the illusion that all government spending is money creation and that all taxes are money destruction.

In the specific view, that is, the actual view, the reserve system is little more than a clearinghouse for bank reserves – that is, reserves exist specifically to transfer non-government liabilities to the government. And since private banks create most of the money in the system a public clearinghouse is helpful for interbank payment clearing. MMT advocates consolidate the Fed into the Treasury which misconstrues the fact that the Fed exists for a specific reason – because we have private banks that need interbank clearing and the government spends in part by redistributing these non-government liabilities.

Importantly, this contradicts the flow of funds in the MMT narrative. Instead of government spending appearing like money creation it now becomes clear that most government taxing and spending is just a redistribution of existing bank deposits because most money is created independent of the government and the Fed operates as the clearing entity for deposit transfers. The specific view contradicts many of the narratives espoused in the general view.²

For example, if a bank creates a $100 loan then this will create a $100 deposit. If there is a 10% reserve requirement then the loan will also require the Fed to create $10 of reserves. In other words, the loan creates deposits and also creates reserves, but those reserves come after the deposit. If the government decides to spend $1 by taxing $1 then the taxpayer’s payment is cleared when their bank debits $1 of deposits. The bank then credits $1 of existing reserves to the Treasury’s account at the Fed. When the government spends this $1 the bank is credited with $1 of reserves and the recipient is simultaneously credited with $1 of deposits. The balance sheets, in aggregate, did not expand at all because of government spending or lending operations. They only expanded because of the original loan creation. Weirdly, in the MMT world the circuit of spending actually starts with the Fed’s reserve creation. Monetary policy IS fiscal policy since they claim the real money creation started with the government expanding their balance sheet. This is totally incoherent and misconstrues everything about how modern banking really operates.³

All of this is tracked in real-time by the Federal Government. MMTers like to say that taxes destroy money, but you can literally see the money, in its actual accounts whenever you want to. The TGA balance, for instance, is right here. Or you can look at the Treasury Daily Statement where they show the actual flow of funds into and out of the TGA on a daily basis. It’s a meticulous and simple flow of funds accounting that shows the balances to the dollar. Clearly, nothing has been destroyed here unless you misconstrue the institutional relationships to portray something they don’t.

9) The Job Guarantee is a virtually unproven program.

A central operational error in MMT is the idea that the government causes unemployment and must therefore fix it. The basic thinking is that the government introduces a currency and requires people to obtain it via a tax. If you can’t obtain it then you are unemployed. The problem with this theory is that it assumes the government is the only entity that creates money when in reality the private sector creates many different forms of money (primarily bank deposits via bank lending). The actual cause of unemployment in any economy is a lack of investment and sufficient savings/income that is properly distributed. The government does not have to create a single dollar in order for their to be sufficient savings or employment.

This error leads MMT advocates to promote a Job Guarantee since they arrive at the conclusion that the government must fix unemployment since they caused it. In addition to saying this program can provide “full employment” they also claim this program can provide price stability. This is a claim I have always been skeptical of. It’s not that I think it’s necessarily wrong. It’s more so that the evidence supporting these claims is thin at best. I have a hard time supporting a large policy idea that isn’t well supported by actual real-life data.

Read more about the Job Guarantee here.

10) MMT doesn’t have a proven theory of inflation.

One thing that gives many economists pause about MMT is that it isn’t just a standard countercylical Monetarist or Keynesian economic theory. MMT is an inherently procyclical economic theory with sustained deficits and sustained full employment. There is no countercyclical inflation fighting mechanism as seen in all traditional schools of economics. The problem is this perpetual procyclical policy response has no empirically supported inflation controlling mechanism. It has never been attempted or  successfully achieved in a controlled inflation environment.

As I’ve written before, there are several empirical flaws in MMT’s approach to inflation. This includes:

– A Job Guarantee acting as a price buoy and not a price anchor.

– Discretionary tax changes as an imprecise and inefficient inflation control tool.

– Price controls as a flawed inflation control tool.

– A broad rejection of Monetary Policy despite ample evidence of its efficacy controlling high inflation.

MMT people often say that a sovereign currency issuer has a real resource constraint. But they never model what this means and the terms are intentionally vague to the point of being useless. When is a government “sovereign” exactly? And how do we model “real resources”? When does all of this actually create inflation?

It seems as though MMT is moving the debate from governments having solvency constraints to inflation constraints without actually explaining and being able to predict when the inflation constraint becomes a problem. I agree it’s useful to understand that governments don’t go bankrupt, but none of this is very useful if you can’t explain the precise parameters within which the inflation constraint is a problem.

The Ugly. 

11) MMT advocates are often combative and cultish. I’ve greatly enjoyed learning from and interacting with many MMT advocates over the years. Others are, um, more problematic. I critique a lot of things here with the goal of being constructive, but the MMT people have a uniquely combative mentality when confronted with criticism. One of their founders once wrote an entire blog post about me where he started by claiming to have no idea who I was before jumping into a literal 10 paragraph lie about my character as a “neocon”. This is the kind of crap you often run into with MMT and I think it’s a major red flag because the theory is so delicately intertwined that weaknesses in it are exposed as potential fatal flaws. You could actually argue that the biggest red flag in MMT is the way in which their advocates defend it without ever admitting that there could even be the slightest potential flaw in it. I’ve spent most of my life studying economic theories and there are no economic theories that don’t contain flaws. Anyone ideologically spreading a theory as if it is absolutely airtight

To summarize, there’s a lot of good in MMT and I’ve always maintained that, but it’s foolish to think that MMT is a panacea for a period where people think mainstream economics hasn’t served us well. There is, after all, a lot more right with mainstream econ than most people want to admit and this “burn it all down” mentality is not constructive. That said, I am glad MMT is part of the new narrative, but I do hope they defend that narrative with more empirics and less combativeness.

Update – We mention above that MMT doesn’t have a viable evidence based theory of inflation. Part of this is their rejection of a balance of payments constraint and the rejection of traditional monetary policy as an inflation fighting tool. Recent evidence regarding these views and the 2021 high global inflation is worrisome to say the least. For instance, in Turkey the Lira has collapsed under high inflation due to a balance of payments constraint and high domestic debts. In 2005 Randall Wray is on record explicitly stating that Turkey could not have a balance of payment constraint. MMTers often claim that raising interest rates causes higher inflation. So, 2021 MMT founder Warren Mosler recommended a 0% overnight rate to “firm the Lira”. Coincidentally, Turkey began cutting the overnight rate at this time and the Lira collapsed 50% in response in just a matter of months. A common criticism of MMT is how they’d respond to a high inflation. We now know that a lot of what they’d recommend can make matters worse.

More recently, MMT has come under criticism for their response to inflation in the USA (or lack thereof). In the MMT literature they consistently endorse tax hikes to combat high inflation. Here are Mosler, Kelton and Wray all explicitly endorsing this view in their books:

“Government should raise taxes in the future (or cut other kinds of spending) only if aggregate demand is excessive at that time.”

• Wray, Understanding Modern Money

“If the economy is “too hot,” then raising taxes will cool it down, and if it’s “too cold,” likewise, cutting taxes will warm it up.”

• Mosler, 7 Deadly Innocent Frauds

“We agree that we should rely on adjustments in taxes and spending (fiscal policy) rather than interest rates (monetary policy) to balance our economy. We also agree that fiscal deficits, in and of themselves, are neither good nor bad. What matters is not whether the government’s budget is in surplus or deficit but whether the government is using its budget to achieve good outcomes for the rest of the economy. We agree that taxes are an important way to reduce spending power and that taxes should never be increased simply to appear fiscally responsible.”

• Kelton, the Deficit Myth

But as inflation soared in 2021 they not only didn’t promote tax hikes, but actually promoted spending increases. In 2022 Stephanie Kelton said MMT “never said to fight inflation with tax hikes”. Not only do they not have a viable inflation fighting toolkit, but they don’t even seem to be able to remember the toolkit they’ve promoted in the past. It’s all very bizarre to be honest and discredits what appears to be a flimsy theory of inflation to begin with. Worse, Kelton is on record throughout 2021 declaring that inflation would be transitory. She didn’t stop there though. Kelton said that the government should be spending MORE to fight inflation. So, not only did they not predict the high inflation, but when it arrived they said it would be transitory and actually claimed that we should spend even more to fight the inflation. This is a  dangerous view of inflation and it’s clear that they do not have viable tools to fight inflation when it actually arrives. In fact, MMT policies make inflation worse when it arrives because their policies are inherently procyclical.

Update 2 – Here’s an odd twist. In her recent commentary Stephanie Kelton has been claiming that rising interest rates will cause debt deflation. Which directly contradicts Mosler’s view on rates as well as her past statements that rising interest rates can cause higher inflation. There are so many internal inconsistencies across the theory that the leading thinkers can’t even keep them all straight at this point.

¹ – MMT people might respond to this by saying “but how did the deposits get there in the first place?” Well, the bank created them independent of a government reserve position. That’s how banks create money – independent of the government. Of course, then they’d say “but banks are ‘agents’ of the government who are licensed to create government money”. Well, not really. Banks are private entities that create stable and very money-like liabilities, but those liabilities are most definitely not government liabilities and the banking system, as a private for profit sector, is most certainly not an “agent of government”. They are agents for their shareholders and that’s part of why the US government has to keep bailing them out periodically. Why the MMT people try to consolidate the Fed and the banking system into the government is beyond me as it confuses their followers on the topic of financialization and the way in which our private banking system is structured specifically so that the government is beholden to banks at all times. Not that any of this matters as it pertains to the funding concept. Even if banks were part of the government their quantity of liabilities, reflected on private sector balance sheets as financial assets with resources to support them, is indicative of a vast quantity of financial assets that can be moved to the public domain without the government having to expand its own balance sheet further than the loans/deposits have already done. 

MMTers play the same game with banking. Above, I said that MMT gets banking “mostly” right. Some MMT advocates have a tendency to argue that banks don’t need deposits to fund their loans. This is an extension of their concept of government funding wherein they argue that a government doesn’t need taxes/income to fund its spending. But banks do need deposits to fund loans as deposits are essential to forming the sustainable capital position that makes a bank balance sheet viable. After all, bank deposits exist as cheap liabilities within the banking system and are crucial liabilities for optimizing net interest margins and future capital. And while it’s improper to imply that banks lend out their deposits in some sort of strict money multiplier manner, it’s equally wrong to argue that banks don’t need deposits or that cheap deposits don’t make bank deposits more viable for the purpose of funding future loans. More on that here. 

Even worse, MMTers actually advocate a form of the money multiplier despite knowing that banks don’t lend reserves. But instead of advocating the strict money multiplier MMT advocates endorse a looser version in which “banks leverage their currency reserves”. This is another inaccurate operational concept. Banks do not leverage their reserves. Banks leverage their capital position into loans. It is correct to say that reserves can add to capital or that reserves can smooth the interbank settlement process, but it is incorrect to say that banks leverage their reserve position.  

2 – See Fullwiler 2010

³ – Bell (now Kelton) actually gets this right in her 1998 paper saying “if the government ran a balanced budget with daily tax receipts and government spending timed to offset one another, there would be no effect on bank reserves.”  This is particularly true in an environment with QE in which there are so many excess reserves. 

Technically, this doesn’t even matter for the concept of funding though. Even if the banking system was fully nationalized and all bank liabilities were actually government liabilities the government would still rely on taxation as a form of balance sheet funding since those liabilities would reflect previously created assets that were directly tied to a certain amount of collateralized resources. That is, ALL balance sheet expansions are essentially collateralized from some quantity of existing real resources and so it makes no sense to say that taxes don’t fund spending while simultaneously saying that resources constrain spending. 

Related:

1. The Monetary and Fiscal Nexus of NeoChartalism, by Marc Lavoie
2. MMT and the Real World Accounting of 1-1<0, by Brett Feibiger
3. A Critique of MMT, by Steve Waldman