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MMT – The Good, the Bad and the Ugly

** For a longer and more thorough critique of MMT please see this piece.**

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, trash. You see, 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 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. 

1) MMT plays A LOT of word games. MMT has created a whole new taxonomy for their version of economics. This creates a lot of confusion and often times makes their theory appear different, when, in fact, they’re just saying well known things in different 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. This 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 savings comes from). While obviously true at a basic micro accounting level it’s also extremely misleading at the aggregate level since all financial assets and liabilities net to zero. This sort of comment is like assuming that the government can print $100T, dump it on the street in front of the White House and declare that we’re all wealthier or saving more. This is a silly way to think about deficits unless you assume that $100T of real resources will be created in the future (which is also a silly assumption about government deficits).

MMT also 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.

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.

All of this makes for a slippery sort of understanding of things and can lead to some very bad conclusions such as this prediction about the sustainability of Turkey’s budget. Look, it’s fine to make generalizations to understand macro concepts, but those generalizations should be communicated in a manner so as to help people understand the specifics as well. MMT, unfortunately, often gets the specifics wrong while making strange hand wavy sorts of generalizations.

2) 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 NEEDS 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 everything.

3) 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 actually 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 their hand wavy vaguely general description 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 actually obtains 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.

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. MMT also relies on assuming that a country is “sovereign” (despite not knowing what exactly that means) and that the Central Bank can be consolidated into the Treasury (which deludes their followers of the reality that Central Banks exist, explicitly within modern capitalist economies to help facilitate the transfer of interbank deposits and help stabilize non-government monies). All of this is highly theoretical and stretches reality.

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, they don’t merely describe reality. They describe what they believe is reality and provide proposals for how to conform to that reality with certain policy ideas that are directly intertwined to that controversial operational description.

4) MMTers muddy the concept of “funding”. When they describe government spending and banking they describe it as being independent of income often repeating the idea that “taxes don’t fund spending” or that government spending is constrained by resources. It’s correct to say that the government does not need to tax $1 for every $1 they spend. This is true of everyone since anyone can spend on credit. But it doesn’t make sense to say that resources constrain spending and that governments don’t need taxes. After all, any country with greater domestic resources, by definition, will have greater domestic product and income. Therefore, that country has more balance sheet flexibility because it can tax more domestic income without expanding its balance sheet.

More specifically, anyone can fund their spending in one of three ways:

    1. Obtain existing money via income (such as revenue).
    2. Issue a new endogenous asset in exchange for another asset (such as bond issuance).
    3. Issue a new endogenous asset in exchange for real resources (such as “money printing” or equity issuance to pay employees).

We can all spend on credit without having income so any entity/person can spend first and get income later. That’s basic endogenous money. But in reality, assets and income give us the ability to spend more on credit so it’s erroneous to imply that income doesn’t fund future spending. The key point regarding government spending is, new private bank loans create new deposits that are secured by existing or future resources. For instance, let’s say I invent a world changing widget and incorporate to sell that widget. My firm creates endogenous resources and endogenous financial assets that wouldn’t have otherwise existed and the corporate revenue from this new invention is a source of resource supported taxable income that the government can draw on. In a counterfactual world without this invention and my firm’s financial assets the government would have fewer resources and taxable non-government financial assets that would require it to expand its own balance sheet to spend without the equivalent taxable income.

So, taxes fund spending in the sense that a large base of existing deposits, supported by existing resources, gives the government the ability to redistribute more existing money rather than having to print new money. So yes, a government might not need income to spend, but having existing taxable money definitely gives a government more funding capability just like a very rich person with a high income has a more flexible balance sheet than someone without income. As noted in point 1, this appears to be another instance of MMT playing games with words that serve only to confuse rather than enlighten.¹

Of course, MMT would say that a “sovereign” government can mobilize resources and “pay for” everything it needs by printing money. And while this is true it’s also true that the government and the domestic economy optimizes and enhances resources in a more efficient manner when its non-government financial sector is investing and creating endogenous money to fund projects the government might not otherwise fund. This gives the government more balance sheet space by providing them with the ability to transfer existing non-government financial assets for public purpose by enhancing existing or non-existing resources. MMTers talk out of both sides of their mouths when they claim that resources constrain government spending and that taxes don’t fund spending. After all, if government spending is resource constrained and your private sector enhances and innovates resources more efficiently than your public sector, then, by definition, the private sector has created balance sheet space for the government by providing it with taxable resource supported assets that wouldn’t otherwise exist.

5) 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. If the govt 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 govt 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.  This simple example is a clear debunking of the idea that government spending “must” precede taxes.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. Clearly, nothing has been destroyed here unless you misconstrue the institutional relationships to portray something they don’t.

6) The Job Guarantee is a virtually unproven program. The central idea within MMT is the idea of a Job Guarantee. MMT claims that a large scale JG is needed to solve the problem of unemployment that the government causes. 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 non-existent. I have a hard time supporting a large policy idea that isn’t well supported by actual real-life data.

7) MMT doesn’t have a proven theory of 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. 

1) 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”. Anyone who is remotely familiar with my work knows that calling me a “neocon” is laughable and misleading to the point of being embarrassing. But 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.

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.

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 income to fund its spending. But banks do need deposits to fund loans. 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. 

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.