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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, 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 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. 

1) 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). 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 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 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.

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.

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?

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.

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 “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”.

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. 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 a hugely 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 only exist 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 the MMT world the Central Bank is merely part of the Treasury and helps to process government payments and support public purpose. 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.

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.

4) 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 absolutely does not have to fund all of its spending from current income. The government doesn’t have to balance its budget and it definitely 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 simplest way to understand this is that the government operates much like anyone with a line of credit. The difference being that the government doesn’t get taken to bankruptcy court when the demand for its assets collapse. It just hyperinflates into oblivion. But they still rely on credit and demand for their money. So, for instance, let’s just pretend that you go out and borrow $100,000 to build a new house. Then the house gets reassessed at a value of $200,000. You created a $200,000 asset that the government can now impose a tax on. In other words, you mobilized resources and created net wealth for the economy that can now be leveraged into public purpose. Our economy is wealthier than it was before and our government can now fund more spending than it could before because there is more capital for the economy to leverage. For example, if a bank sent you a mailer the next week saying “hey you, you have $100,000 of equity, why don’t you take out a HELOC?” You would certainly say you have more funding capacity. The same exact thing is true of the government when the private sector builds net wealth.

So, just like you have more potential credit due to the change in the home’s value, so too does our government. Both the government and the homeowner have more funding capacity because the increase in net wealth expands the economy’s potential credit because the demand for money is higher thanks to the fact that there are new valuable assets. In this sense, the private sector absolutely funds government spending because it contributes to the capital base that makes government spending sustainable. Additionally, the whole process of this necessarily results in financial assets that the government can easily redistribute along the way – assets they didn’t have to print into existence – assets that are supported by the resources that were made in the process.

Of course, it’s also true that the government could have just printed up some money without imposing the tax. But the important fact is that the capital from our home building did not exist before this. So we are better off when those resources are mobilized and used for construction. In other words, when the private sector builds net wealth our government has more funding capacity than it otherwise would have because there is more overall capital to leverage. As MMTers might say, “resources constrain government spending”, but they conveniently leave out the fact that resource creation also expands potential government spending. The point is, the government can direct and mobilize resources that enhance demand for its money and credit, but the government is far better off when the private sector also does this independently. So the private sector has a massive influence on how much funding capacity the government actually has because the private sector can massively influence the quantity of capital and resources that are created that support government spending.

The bottom line is that it’s misleading to say taxes don’t fund spending. It’s more accurate to say that taxes fund spending and also the government can print money therefore it does not need to fund all of its spending $ for $ from existing taxes.

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 all…. This is a semantic distraction and has nothing to do with the above point and whether the government funds its spending from taxes. Frankly, MMT should drop this whole narrative about how “taxes don’t fund spending”. Anyone who understands credit theories of money and endogenous money can see how obviously wrong it is. More importantly, you can support MMT’s policies without spreading this fallacious narrative about taxes.

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, 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. 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.

A central operational error in MMT is the idea that the government causes unemployment and must therefore fix it.

The central policy 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.

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. 

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”. 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.

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. 

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