Debunking Modern Monetary Theory

Modern Monetary Theory contends that governments can endlessly run budget deficits when the economy is not at full capacity. It comes from the belief that the state, the issuer of a sovereign currency, can never go bankrupt as it can print money. The theory also holds that taxation exists simply to prevent inflation and to ensure that citizens use the nation’s currency, rather than to fund public services. As long as the Central Bank sets low-interest rates and purchases government bonds, the government can never go bankrupt. Whilst this Utopian thinking sounds attractive, in practice, it doesn’t work. The University of Chicago conducted a survey that contended that no economist nor economic expert believed that countries can finance their debt through printing money. Failed experiments in Weimar Germany, Zimbabwe and now Venezuela show this, with economic catastrophe following the large increases in the money supply that MMT advocates for.

Flaws with MMT

Stephanie Kelton in her book ‘The Deficit Myth’ outlines her belief in Modern Monetary Theory. In her view, government spending is not financed by tax revenues but rather by the Central Bank issuing its sovereign currency. As a result, it contends that it is possible to fund ever-increasing public spending if the economy has spare capacity. The theory became popularised following the Great Financial Crisis and subsequent Great Recession of 2008, as a justification and means for large scale government projects. More recently, Bernie Sanders when running for the Democratic Party nomination for President in 2020, referenced MMT when asked how he would finance the Green New Deal and Medicare-for-all amongst a bucket-list of spending proposals.

The main notion popularised by MMT is that taxes don’t exist to fund government spending.

“The idea that taxes pay for government expenditures is pure fantasy”

Stephanie Kelton – The Deficit Myth

However, this is far detached from the reality of government financing. In the world of MMT, governments can fund large social projects as Central Banks can purchase government bonds without the need for investors to do so, thereby monopolising the issuance of government debt. At the same time, MMT contends that there is no need to raise taxes in such a scenario, as aforementioned in the quote. As increases in the money supply follow, this lowers the value of the currency relative to goods and services in the economy. This effectively taxes assets that are fixed in nominal terms, such as retirement savings which slowly deteriorate as excessive government spending is not accompanied by equal tax increases. This acts as an effective tax on these nominally fixed assets. From this, we can safely conclude all government spending is paid for by some form of taxation.

The more the government prints money without the necessary equivalent increases in tax revenues, the greater the inflation that follows. The result of excessive money printing is hyperinflation. This results in tax collection breaking down as the value of the money received through taxation becoming essentially worthless. At the same time, money borrowed from the Central Bank with their sovereign currency also becomes worthless. The government faces the prospect of default even as it faces no restraint as to how much money can be printed. Such a phenomenon was infamously witnessed in Weimar Germany during the 1920s. As the German government was saddled with large amounts of debt, the Central Bank thought to pay it off through printing money. The end result was hyperinflation, with the paper that the money was printed on becoming more valuable than the money itself. Living standards quickly fell and the Germans fell into recession. More recently, Venezuela has been experiencing ever-rising levels of inflation. For much of the 2000s, the South-American nation had an overly generous and unsustainable welfare state, that was funded by ever-increasing deficits. However, once the price of oil fell in 2015, the budget deficit exploded, resulting in the hyperinflation crisis that we witness today.

Kelton also references an unemployment system by which those who cannot find a job in the private sector can be allocated a public sector role, regardless of skill level. These workers would be paid a generous salary, greater than that of many jobs in the private sector, thereby forcing private firms to raise their salaries to maintain workers. However, in practice, there are a large number of jobs that are unprofitable at higher wages, particularly in the service sector. These jobs would soon be left with vacancies, resulting in the shut-down of many sectors of the economy. If the minimum wage at $15 is such a good idea, then why not raise it to $25 or even $40? Would this not result in ever-increasing living standards as everyone is subjected to a high wage? Through this employment scheme, the central government would wipe out low paid sectors of the economy, thereby crowding out much of the labour market.

As with all things that sound too good to be true, Modern Monetary Theory just isn’t feasible in the real world. The idea of ever-increasing budget deficits, financed by the Central Bank, has been a disaster in many countries across the globe over past decades, particularly in Weimar Germany and Venezuela. Modern Monetary Theory does not justify the existence of a Magic Money Tree; it is simply a new excuse for the same old blunders of creating money to support government expenditure that exceeds its means.