MMT – The Good, the Bad and the Ugly

Modern Monetary Theory (MMT) is in the news a lot lately and has grown especially popular with non-economists and people who are attracted to the large government spending possibilities it promotes. MMT advocates frame the theory as a panacea and solution to mainstream economics and communicate the theory using simplistic explanations that are attractive to lay people. This has led to significant pushback from mainstream as well as heterodox economists who are uncomfortable with the overly simplified treatment of many well established concepts. Who is right and who is wrong? What’s good about MMT and what’s bad?

This post will provide an explanation of MMT and communicate, in layperson terms, what is good, bad and ugly about MMT. I hope you find it helpful. 

First, it’s useful to provide an overview of what MMT actually is because this is what trips most people up. While MMT is often communicated using simplistic explanations it is actually a complex theory.  MMT is a macroeconomic theory of full employment and price stability that argues that the government is the monopoly supplier of money. Because it prints 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). Therefore, deficits matter greatly, but not because the government could run out of money like a household, but because it could cause high 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’s Operational Description of Funding is Wrong.

When you first encounter MMT you will have to adapt to the idea that government bonds do not necessarily fund government spending. MMT is right about this. The government has a printing press and could theoretically print cash or credit accounts when it spends. They do not have to fund spending from bond issuance. But MMT takes this concept too far by saying 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.

This is easily debunked and there’s no kind way of saying this – the idea that “taxes don’t fund spending” displays an egregious misunderstanding of finance and economics. Every single entity in the economy needs income and benefits from having income. Income gives us credit and without credit no one would hold your financial assets. When the government spends, it does so, in part, by taxing existing resources and redistributing some of the value of those resources. When the government taxes us we extract some of the monetary value of the resources we produce and redistribute it to the government for public purpose. A government that has more access to resources has more funding because it can tax more (and spend more without printing money) and a government with fewer resources has less resources and funding capacity because it cannot spend by taxing and must instead print money to spend (and cause inflation). When MMT people say “taxes don’t fund government spending” and “resources constrain government spending” they are explicitly contradicting themselves and using a clever (and sloppy) rhetorical trick to make people think they’re saying something new and original. They are not. Their explanation of government funding is fundamentally wrong in a manner so basic that it’s almost hard to believe this is being taught anywhere in the world.

Let’s use a concrete example of spending and taxing in the USA. As of 2022 the US government spends about $6T per year. About $4T of that comes from taxing existing income and assets. The other $2T comes from printing money (running a deficit). That $4T is money/value that already exists and is merely being redistributed and much of that value is created endogenously in the private sector. If this $4T of value did not previously exist the government would not be able to spend $6T per year without creating much higher inflation. The US government isn’t able to spend a lot because it has a printing press. It’s able to sustainably spend a lot because it has an enormously productive private sector that creates abundant resources that the government can redistribute. The private sector is directly funding the government’s ability to spend by creating the very resources that the government can tax.

Another simple example is to consider two new economies where we form a government and agree to use a common currency that is issued endogenously via bank loans. Economy 1 is filled with people who sit on the beach all day and do nothing. Economy 2 is filled with people who invent Microsoft using banking funding. Microsoft Corp provides labor and income to its residents and also soars in value because of its technological advancements. As a result the citizens of Economy 2 are far wealthier than the citizens of Economy 1. If you have a government involved in all of this then the citizens of Economy 2 can use that government to tax some of this wealth and spend more than the government in Economy 1 can. In other words, Economy 2 is far better off and its government has more funding via taxes because its citizens endogenously innovated and created wealth that wouldn’t otherwise exist. Economy 1 can try to spend as much money as Economy 2, but they will simply create inflation because they didn’t create the real value and resources along the way to support new money creation. Keep in mind that there was zero government spending to fund or finance Microsoft’s creation, but Microsoft’s value creation gives us the ability to redistribute assets for public purpose without creating inflation.

Of course, MMT would say that the government had to create the money before it could be taxed, but the government did not create most of that money and value. Most of that money and value was created endogenously in the private sector and the only reason the government can tax it is because the private sector invested in real resources that gave them value. The government can also deficit spend so MMT is correct in saying that the US government doesn’t have to “pay for” all its spending $ for $, but they’re wrong in saying that the government doesn’t tax to fund spending.

In a technical sense, anyone can spend without income. Microsoft Corp doesn’t have to spend only from its current revenues. It can issue bonds or equity to fund its spending and people will happily hold those assets because MSFT is a highly credible entity. But the only reason anyone is willing to hold those assets is because MSFT has a huge amount of revenue that gives them credibility. It makes no sense to say MSFT income doesn’t fund its spending because MSFT income is what makes its financial assets valuable in the first place. It’s circular logic to say taxes don’t fund spending and inflation constrains spending because a government without income would have no credibility and super high inflation.

MMT people like to say “resources constrain government spending”, but conveniently leave out the fact that most resources in the economy are mobilized by the private sector. Therefore, the government has more spending capacity when the non government creates resources. Economic “resources” include things like land, labor, capital and technology. When the private sector creates and mobilizes resources the government has more funding because they’re able to tax and redistribute some of those resources and value creation. Importantly, this is often endogenous value creation and that value creation gives the government greater purchasing power than it would otherwise have.

Yes, the government has a printing press and can print money whether we build resources or not. But the kicker is that when we build real resources we have the ability to tax new endogenous asset value creation 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. MMT wants to frame this to give the appearance that the government doesn’t rely on the private sector to be able to spend, but the government does rely on the private sector to create resources and give it the fiscal space to be able to spend. And taxation is how the government moves some of that endogenous resource value to the public domain for public purpose. This can be a good thing as it redistributes spending power from wealthy people with a low marginal propensity to consume to less wealthy people with a higher marginal propensity to consume. This could reduce inequality and could boost aggregate demand.

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, when the government is becoming bankrupt it will occur in the form of hyperinflation 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 MMT is wrong to say that the government doesn’t fund its spending from taxes.

At a broader level the MMT concept of “funding” is a fallacy of aggregates. 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.

The idea that “taxes don’t fund spending” is a core operational description within MMT. And they promote this narrative by creating a fictional consolidation of the Central Bank and Treasury. But even with the fictional consolidation the narrative is still wrong as the government relies on its private sector to create value that the government can then tax and redistribute. The idea that taxes don’t fund spending is empirically wrong and no amount of mental gymnastics with the reserve settlement process can change that.

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. They often cite an old Kelton paper that discusses the consolidation concept and how taxes cannot “finance” government spending. But this paper is a 30 page way of saying “the government has a printing press”. Aside from being a literal misrepresentation of how the current system is structured, what this paper completely ignores is the way that the private sector creates assets that give the government spending power via taxation. The way this is “financed” in the TGA is 100% irrelevant to the fact that the government relies on its private sector to create assets that it can tax and redistribute.

More specifically, the MMT TGA consolidation is another messy accounting trick 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 I use that $100 to build a corporation that is valued at $500 then the government has new wealth it can tax that wouldn’t otherwise exist. My wealth creation has directly funded the government by giving them the ability to tax me. If the govt were to tax $20 of this wealth the government would debit a bank deposit and credit the TGA. My taxes are paid in deposits and I literally cannot even pay in “state money” like reserves. The $20 of taxes is funded by your wealth creation and it is “financed” by the bank deposit which you credit to the government. The government has more spending capacity than it otherwise would because it can now tax my pre-existing wealth and redistribute it. Without my wealth tax the government would have to print new money and potentially create inflation. The fact that this payment settles in the TGA via reserves is irrelevant to these facts and doesn’t change the reality that you funded and financed the government via private asset creation. There was no need for the government to spend a single dollar into the economy to allow this all to happen.

Since MMT advocates like to talk about hypothetical alternative banking systems it’s useful to think about reserves in the proper context here because they only exist because we have so many private banks that need interbank payment clearing. But consider a system where there was only one bank within a consolidated Treasury system. You would have no need for reserves or the Central Bank and this one bank would issue all the loans/deposits to the system. If this was a private bank the US government would be a user of this bank’s deposits in much the same way that the old TT&L accounts operated. This bank would create and finance all loans and taxes would be a clear redistribution of this bank’s deposits. In fact, the current system isn’t much different. It just has more than one bank requiring the Central Bank to provide interbank clearing.

Importantly, bank liabilities do 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 because it was created by the banking system. It is a very specific series of debits and credits that starts in the private sector banking system. But in the MMT world it is described to look as if the initial credit creation starts with the government. Depicting this as “destruction” and “creation” of money via government spending and taxes is enormously misleading as it takes money that was created in the banking system and depicts it as money that was created by government spending. This again, is another rather basic error in the specific flow of funds at work here.

Using our example above – if MicroSoft is created and valued at $100 based on the market value of its stock then the government can tax and redistribute $20 of that value creation without creating inflation because the assets are already supported by existing resource value. It does not matter at all how this funding settles in the interbank market of reserves. The fact is that the value was created outside of the government, taxed by the government and then the government redistributed it back into the private sector where it came from. If Economy 1 above tried to just spend $20 they could do so by printing $20 (because their citizens don’t create anything and instead sit on the beach all day), but all this would do is cause inflation. The interbank settlement narrative makes zero difference in this and MMT has concocted little more than a clever sounding narrative that actually makes no sense when you dig into the flow of funds and initial funding source. And all of this was “financed” without the government. We created MSFT wealth and it was financed in the private banking system. The government needs to tax that wealth creation in order to be able to spend without having to print new money.

The purpose of this narrative is to create a world view in which the flow of funds always starts with the government. But this is misleading because banks can create loans independent of government and most of the value creation in the economy is done so within the private sector. When banks make loans they create deposits and obtain reserves as required after the fact. The reserve settlement process is nothing more than a back office clearing process that occurs AFTER loans are created. But in the MMT world all government spending is depicted as having created reserves and deposits, when, in reality the exact opposite is often true. But again, none of the settlement technicalities change the fact that the government funds its spending, in part, by taxing endogenous private sector asset creation.

MMT types don’t like to talk about the fact that banks issue currency equivalent forms of money because that ruins their view that the State Theory of Money perfectly applies to the USA. It also ruins the whole “currency issuer” narrative because the banking system issues a currency equivalent that can be used to fund government spending. At this point they’ll say banks are “agents of the government” or something like that while ignoring that banks are very much private entities who work for their shareholders. They’ll then say something about how banks only issue “IOUs” for government money while ignoring the fact that it is literally impossible to banks to even give you reserve deposits or convert all deposits to cash. In reality, the US government has outsourced money creation to the banking system which allows the banking system to finance government spending.

This is all a distraction from the broader point at hand. It does not matter at all if this is all funded via banks or the government. Even if the banking system were fully nationalized and all “money” was a state liability the government would still rely on the private sector to be able to spend. This is because the government does not create most of the assets that are ultimately taxed. Therefore, the government would still rely on the private sector to create the valuable assets that can then be monetized and taxed. In other words, even with a fully state money system the government would still rely on the private sector to create the resources that make government spending viable in the first place.

Of course, deficit spending does indeed create new money and financial assets and government spending can potentially be “self funding” if it mobilizes resources and creates real value. So it isn’t an either/or story. Taxes can both fund the government’s spending by redistributing value that already exists AND government deficits can create new money (and new value). It isn’t an either/or process despite MMT framing it all as only starting with the government. This is again a case of overreach in describing the system and results in an unbalanced and unrealistic understanding of the actual flow of funds in the system. 

5) 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” or by saying comments like “absent…government deficit, the domestic private sector cannot net save“.  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.” They do this by intentionally depicting the economy as being just two sectors (private vs public). This is misleading as it makes it look like the private sector can only save if the government deficit 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).

The description of government debt as “private sector net wealth” is especially problematic and shows an egregious misunderstanding of financial accounting. Imagine that the country of Zimbabwe prints up $1 trillion and dumps it on the road for everyone to collect. Would you ever say that the private sector is now wealthier by $1 trillion? Of course not because that currency is a liability of the government and the very constituents that are represented by that government. In all likelihood this money printing creates inflation which actually reduces our net worth in real terms. But in the MMT world they claim that money printing necessarily adds to financial net wealth because they depict this concept in such a narrow and misleading manner that it makes sense in a theoretical manner, but is totally wrong in a realistic manner. This sort of thinking is like claiming that corporate debt is net wealth for the non-corporate sector without accepting the reality that corporations are owned by the people in the non-corporate sector. You would never assume that it’s good for corporations to create debt simply because it adds to someone else’s assets. And in fact, if corporations were run this way they would almost certainly become insolvent in the long-run. But MMT advocates use these various consolidations and misleading accounting depictions to make government debt look like it’s always a net positive when in fact government liabilities can be ruinous to the economy in certain scenarios.

More specifically, it is misleading to depict all of this in a 2 sector view (private vs public) 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 private sector isn’t a homogeneous sector and it can net save against many other sectors and entities, of which the government is only one. But MMT depicts net saving as only coming from the government because the entire theory is designed around the promotion of government deficit spending and a government Job Guarantee. This is one of many terminological issues wherein MMT uses the term “private sector” to create the appearance that every entity outside of the government is homogeneous, when, in fact, they are structured in very specifically separate manners for very specific economic purposes.

The most important relationship of these is the household sector versus other households and everything else. The household sector net saves in numerous types of financial assets relative to other households, 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 clear to anyone who has a retirement plan and owns stocks or bonds as the value of their savings is contingent on how well the corporate sector invests and creates value.

The MMT view is like understanding that there are no net financial assets on Earth in the aggregate because all assets have corresponding liabilities and then arguing that Earth must receive “net financial assets” from Martians in order to “net save” against the rest of the universe. This is a nonsensical two sector view of the universe because even MMT advocates know that Earthlings can “net save” against their own government, with or without Martian net liability issuance. But MMT makes the same misleading accounting narrative when discussing government deficits in the context of net saving on Earth. We should be blunt about this – it’s an extremely narrow and misleading depiction of the way households and the private sector, more broadly, net save.

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. This term is like going around saying “wealthy” people are financially free without providing the actual parameters necessary for financial freedom.

The way MMT talks about “sovereign currency” issuers makes it seem like any country can just choose to be sovereign. In reality many countries cannot choose to be sovereign and rely on the kindness of strangers to provide them with goods and services that they don’t produce domestically. Most emerging markets have this problem and rely on foreign debts and foreign investment to help them grow. They cannot simply choose to be sovereign any more so than a poor person can just choose to be rich. But in the MMT world the government just needs to spend and they’ll magically grow into a large developed and wealthy economy. This is, frankly, a naive treatment of balance of payments constraints.

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. MMT advocates do not and cannot quantify this constraint. They also intentionally neglect to mention that the private sector creates resources endogenously and therefore helps fund the government in doing so. All of this is part of a theory of inflation that is unquantified and based on vague generalizations.

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.

6) 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 entire world view of MMT starts with the state and focuses excessively on the state’s powers. In the MMT world all money creation starts with the state. Unemployment is caused by the state. Net financial assets can only be provided by the state. All of this is vaguely correct, but precisely wrong and the excessive focus on the state results in a wholly unbalanced view of what makes the economy function. In reality the private sector operates as the central source of money, financial assets, investment, consumption and saving, but in the MMT much of this is flipped around where the government is the centerpiece of the economy and the private sector is subservient to the government waiting for it to provide things like jobs, savings and money.

The reality is that the public sector vs private sector relationship is a symbiotic one with the state operating primarily as a facilitating feature, not the driving force. 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 truth, 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. It might be good for the government to do some or all of these things, but there is no “must”. 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”.

7) 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 to spend. They try to reconcile these two conflicting narratives by creating a fictional consolidation of the Fed and Treasury, but fail to account for the fact that existing institutional arrangements 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 banks and the Central Bank within this system.

MMTers will try to separate their descriptive aspects of the theory from the prescriptive, but the truth is that they’re directly intertwined. For instance, as we describe below, MMT describes the currency as a state monopoly and that the state causes everyone to be unemployed unless they provide that currency to be used for taxes. They then conclude that the only solution to unemployment is therefore a Job Guarantee program because they claim the government is the only entity that can solve the problem that the currency monopolist creates. This “description” is highly theoretical and misleading in specific ways which we discuss in detail below. But the important point is it explicitly ties into their prescriptions. There is no distinction between the description and the prescription because if you buy into their description then there is no choice but to buy into the prescription.

MMT’s core operational descriptions are also highly theoretical. For example, the theory claims that taxes don’t fund spending and that the government must actually issue currency before it can even tax. MMT founder Bill Mitchell says:

To understand the causality – start of at Day 1 of a new monetary system. How do the private sector pay their taxes or buy government bonds in the new currency which they do not issue? The answer is incredibly simple. The government has to spend first and put the currency into the hands of the non-government sector.

This is not necessarily true. The government can spend first by printing money, but it could also tax deposits created in the banking system before it spends. The correct statement is that the government must assign a unit of account first, but there is absolutely no need for it to spend before it can tax. In reality most taxes are paid using bank deposits and then settle in the interbank system after the fact. But in the MMT world the Fed and Treasury are consolidated and banks are positioned as “agents of the government” so it’s all distorted to give the appearance that government spends first.

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 distinctly different reasons. We have specific government entities for specific reasons. And we break up their accounting and assets and liabilities to show exactly what the role of those financial instruments are. For example, the Fed holds trillions of dollars of MBS and T-Bonds due to QE. The Fed quantifies them daily and accounts for them meticulously. They aren’t “destroyed” in any reasonable economic view and those assets have real world economic impacts. The Fed pays employees and operates their interbank clearing system, in part, by using the revenue from their balance sheet. Do the MMT people really believe this money isn’t there? Do they think it’s all a fiction just because the Fed has received a government liability? That would be misleading, but in the real world we precisely quantify those assets because they are real assets that have material economic impacts for real people. They aren’t just “destroyed” because some economic theory treats them as arbitrarily consolidated assets.

More 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 consolidating entities to spread overly simplistic generalizations that confuse how and why these institutions operate. Any theory that relies on consolidating the Fed and Treasury is not describing reality. They are specifically distorting reality to spread a false narrative based on a misrepresentation of the actual monetary system.

In reality, the Central Bank exists specifically because most modern economies do not have State Money, but have money systems developed around private banks. The US government has outsourced much of its money creation to private for profit entities and banks can create money entirely independent of the government’s spending and taxing. 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 likes to invoke the “State Theory of Money” to promote the theory and argue that this accurately describes the current monetary system, but the reality is that we don’t have state money. We reside in a system with bank controlled money as the US government has outsourced money creation to private profit seeking banks who create money when they create loans. The entire system is structured around banks and the Federal Reserve system exists specifically to service these banks. We don’t bailout banks once every few years just for fun. We bail them out because the entire system is dependent on their health. But rather than portraying this as a Bank Theory of Money, MMT twists reality to argue that banks just create “IOUs” denominated in Dollars and that we really have a state money system. Nothing could be further from the truth and it’s baffling that MMT advocates hide this because they are, at heart, Statists who should fully embrace a fully state based money system with nationalized banking. I can only presume they don’t embrace this because they know it would never be popular in countries like the USA.

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. MMT is a buffer stock of employment theory of economics. All modern developed economies are buffer stock of unemployment economies. MMT is an entirely different approach to economics based on controversial underlying theoretical causes. You cannot claim to be describing reality when MMT is based on an entirely different paradigm that has never even been attempted in developed economies.

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. This is important because MMT really boils down to a Job Guarantee. As Mitchell stated, it’s the essential aspect of the framework, but no country does this. So no, MMT does not describe the monetary system correctly and the current system is not similar to what a MMT style system would look like with a large scale Job Guarantee.

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. Their treatment of various institutions is at odds in the “general” and “specific” views. In the specific view, that is, the actual view, the reserve system is little more than a clearinghouse for bank reserves – 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.³

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.

Further, all of the spending and asset flows are 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. Or you can look at the Fed’s balance sheet right here. It’s a meticulous and simple flow of funds accounting that shows the balances to the dollar. These dollars aren’t just fictional accounting entries. They were not destroyed at all. They have specific economic ramifications and the credits/debits help fund specific parts of our government. Clearly, nothing has been destroyed here unless you misconstrue the institutional relationships to reflect something they don’t. But in the MMT world these accounts don’t really have money because the consolidated government supposedly holds its own assets where the assets get “destroyed”. This is a nonsensical view of the world as these specific balance sheets serve specific economic purposes that have real-world impacts. They aren’t “destroyed” in any meaningful sense and any theory claiming such things is not based in reality.⁴

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 to drive sufficient demand. The government does not necessarily have to create a single dollar in order for there to be sufficient demand, 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 (supposedly) 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 that is wholly unfounded, supported by virtually zero empirical and real world evidence and one 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 and what little evidence we do have does not support MMT’s bold claims.

A JG has never been tried in any developed economy and it has only been tried a handful of times in developing economies – India and Argentina. In the case of India the program has been halted at times after accusations of government corruption. Surjit Bhalla, one of India’s leading economists has described the program as a “horrendous failure” and one of the most corrupt programs in the entire world. India’s Finance Minister, Nirmala Sitharaman, says the program has been “infested” with ghost accounts and corruption.

In the case of Argentina the evidence was inconclusive, but inflation averaged 15% in the 5 years following the program and the program was subsequently terminated. There is considerable debate about whether the program was good or bad, but what’s clear is that it did not produce price stability or full employment in perpetuity.

It’s rather alarming that the central component of MMT is a theoretical policy idea that is based on a vaguely accurate description of the government as a currency monopolist. But what’s more alarming is the manner in which MMT advocates confidently promote this idea despite there being almost no evidence to support its efficacy. Given that this is the core component of MMT and a potentially economy altering policy approach, it would be nice to see more evidence to support the theory. Until then the often combative and overly confident tone of MMT advocates is unwarranted.

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?²

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. The theory is so delicately intertwined and lacking in empirical evidence that their proponents often get very frustrated when debating. 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.

The most disconcerting thing about MMT is that it boils down to an unproven Job Guarantee proposal promoted by people who appear to be driven by faith more than evidence. MMT advocates promote the theory as though it has earned a level of credibility that it simply has not. Their brash and combative tone treats the ideas as settled science when in fact they have not been properly modeled or tested in any relevant economic setting. Perhaps one day a developed economy will test MMT in its entirety and then this confident tone will have been earned. Until then I think it’s rational and responsible for people to be skeptical of MMT’s many descriptions and claims.

Conclusion

To summarize, there are some useful elements in MMT and it is very educational to learn. At the same time, many of its most important concepts are based on vague generalizations, sloppy terminology and policy ideas that are wholly unproven. It has become popular with lay people in large part because the narratives are enticing and complex enough that they can be misconstrued into something most lay people won’t understand. But most mainstream economists remain skeptical of it because parts of MMT are downright wrong, and its policy ideas have not earned the credibility that its proponents often assign to it. This is primarily due to the fact that the theorists have not done the proper econometric work to make the theory useful in a quantifiable economic model. Until the theory has been modeled and attempted in a developed economy it remains little more than an untested, but interesting mental exercise.

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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, in 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 contradicted her own writing saying “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 and in late 2021 was still promoting their $15 trillion Green New Deal package. In retrospect, this looks totally reckless and inflation have been much higher had MMT advocates been in charge. 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.

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 multiply 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. Banks leverage their capital position and reserves are potentially one piece of that capital position.

2 – MMT has always been weak when explaining foreign exchange transactions as so many elements of the theory conflict with operational realities of foreign exchange. For instance, they use the term “sovereign currency issuer” without really quantifying what this means. Many foreign governments rely heavily on foreign debts and income. They cannot simply choose to be “sovereign” any more so than you or I can choose to be rich yet they often assume this is a choice.

Aside from the issue of “sovereignty” they also run into problems in their “funding” narrative in the scope of international flows. For instance, China is a developing economy that relies heavily on foreign exports to grow sustainably. This means that they want large inflows of foreign investment to help build their domestic infrastructure and fund goods manufacturing for exports. This foreign capital flows into China and helps them grow as it creates jobs, infrastructure and trade that they would not otherwise have. Does this “fund” their domestic resource creation and ultimately government balance sheet? Of course it does. China doesn’t necessarily need it, but it’s certainly better off with it. So it’s incoherent to say that this income doesn’t help fund the government and the domestic economy. This is clearly reflected in foreign exchange rates where large balance of trade changes result in foreign exchange value changes. In fact, the inflow of foreign currency gives the domestic government ammunition to be able to manipulate their own foreign exchange rate. The idea that these exogenous income sources don’t help fund and finance government spending is incoherent and only makes sense in some theoretical consolidated government model.

3 – See Fullwiler 2010

4 – 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. 

Kelton’s 98 paper is interesting as a semantic accounting exercise, but this doesn’t even matter for the concept of funding. Even if the banking system was fully nationalized and all bank liabilities were government liabilities the government would still rely on taxation as a form of balance sheet funding because the government uses taxation of endogenous private sector assets to redistribute asset value it did not create.

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
4. Tom Palley has written a series of excellent MMT critiques (see here and here for example).