The crisis has given rise to a range of new ideas and theories to replace the discredited view of the economy. The newest and most imaginative of these is known as Modern Monetary Theory (MMT) and is one of the first theories to owe its growth to the internet. Without a doubt MMT is radical and completely turns established economic thinking on its head. If it is correct then it would change the way we think about the economy forever.
As surprising as it may seem to an ordinary person, economists rarely discuss money or banking, the two topics that most come to mind when one thinks of economics. This is because most of mainstream economics has its roots in the 19th century when the financial sector was tiny and money was not seen as important (to the extent that economists would imagine barter economies for simplicity). MMT is the first theory to recognise the importance of the massive growth in the financial sector and the fundamental role money plays in the economy (especially since it is no longer backed by gold). It addresses head on the idea that perplexes most ordinary people, how is that paper money with no intrinsic value of its own is so valuable and how are banks able to create money “out of thin air”?
MMT argues that money is by itself worthless and only has value due to the fact that the government requires people to use it to pay taxes. Governments can use whatever they want as money and give it whatever value they choose. This runs contrary to the common notion that money is independent of markets; rather MMT argues that without the government money has no value. As government controls money, it can also manipulate it to affect the economy. MMT views unemployment and the recession as the greatest problem and argue we should keep printing money until we reach full employment where everyone who wants a job has one.
The most rational and attention grabbing of MMT’s claims is that deficits are not a serious problem nor should they be our main concern at the moment. Instead they claim that no country that prints its own currency can ever be forced to default. If the debt grows too high, then it can just print money to plug the gap. The casual inverse of mainstream economic thought and public discussion is why MMT is such a radical theory. In contrary to the obsession in America with debt, MMT argues that this is missing the point. Not that debt doesn’t matter; just that it isn’t very high on the list of concerns. Nor are higher interest rates a worry. This is because printing money increases the level of reserves in a bank which then has to offer a lower interest rate in order to lend out all this extra money. So contrary to a higher interest rate, MMT claims it would receive a lower interest rate and cites Japan as an example of a country with enormous levels of debt and low interest rates.
But isn’t printing money just going to cause hyperinflation? Is it not childish to believe we can just print all the money we need and solve all our problems? To understand why MMT claims otherwise we need to examine Why We Print Money (a previous detailed post of mine of which this will be a summary). Firstly, hyperinflation has never occurred in stable economies. Every case of hyperinflation in history has occurred during times of massive social unrest and war. It seems that political unrest and war is a larger cause of hyperinflation than printing money alone. So it is unlikely based on the historical record that peaceful, democratic, developed and politically stable countries like America and Western Europe are likely to experience hyperinflation. After all, the policy of Quantitative Easing has lead to a massive amount of money being printed yet inflation has remained below average.
Secondly, major inflation does not occur when the economy is under capacity. That is to say, when the economy is suffering from high unemployment and idle machinery (such as right now), printing money would only boost production but not cause inflation. To understand why, let’s examine how printing money works. If money is printed it is either deposited in banks or used to directly make purchases. If the banks do not lend out the money but only use it to repair their balance sheets (as what happened with QE), then there is little effect on the economy in terms of either growth or inflation. If instead purchases are made then these businesses receive a boost. They can start using idle capital and hiring new workers which in turn boost the economy. Most economists agree on this point, the disagreement is about what comes next. Traditional it is thought that eventually businesses will hit a wall and have more orders than they can fill. Demand will be such that they can easily expand and instead their costs will start to rise. This may be because they require more overtime from their staff or a labour shortage occurs and they must offer hirer wages in order to attract qualified staff. Demand is so great that shortages occur and people would rather pay a hirer price than have to wait.
However, it should be obvious where the problem is with this logic. It assumes rising costs and full employment. In order words, higher inflation would only occur if businesses do not benefit from economies of scale and cannot easily expand. However, in a recession businesses are running far below full capacity and there are hordes of skilled workers desperate for a job. In these conditions, businesses can easily expand without incurring rising costs. MMT believes the government should spend money until we reach full employment and price stability. In order words keep printing money until everyone who wants a job has one and then stop. Western European economies have not been in a position of full employment since the 1960s and America only experienced it during the Second World War. Therefore MMT argues there is always room for expansion and to view the economy as at full capacity is unrealistic. MMT also believes people aren’t stupid and will have enough sense to stop the printing presses once inflation starts rising.
So instead of worrying about the deficit or the risk of default, MMT believes that governments should focus on ending unemployment. To do so they propose a “Job Guarantee” and that the government should act as an “Employer Of Last Resort”. They believe the government should do everything to encourage private businesses to hire people through massive spending and major tax cuts, but if this still leaves people looking for work, then the government should hire people itself. This should be done in a literal manner, as in advertising jobs at say $10 an hour and hiring everyone who shows up. People will spend these wages on local businesses giving them a boost, allowing them to hire more people who in turn will spend and help businesses, sparking a virtuous cycle. Without the threat of unemployment, employers would have to treat their employees better and be less able to crush unions and encroach on workers’ rights.
But what will these new hires do? Does the government need extra employees or are they just pointless make-work jobs? Actually the government needs more police officers, schools and hospitals are overcrowded and public transport is in a dire state. This is to say nothing of what will probably be the greatest issue of the 21st century, Global Warming. Developed economies need to entirely overhaul their energy sectors, dismantle fossil fuel plants and build wind turbines, solar panels etc. All of which will create jobs and reduce the social welfare bill. It may seem strange that everyone in the economy would have a job, but how can it make sense for one tenth of everyone who wants to work to be kept in forced idleness?
MMT also has radical view of taxes, believing that contrary to popular opinion, they do not fund the government. Let me repeat that in case you missed that. Taxes do not fund the government. Instead printing money does. MMT views taxes as money taken out of the economy and spending as money pumped in. For example imagine that at the end of every year the government took all the coins it received in taxes and melted them down and then forged new coins to be used as government spending. So budget deficits are seen as creating money and budget surpluses are destroying money. So contrary to the rest of the country, MMT does not panic over deficits nor get excited over surpluses. MMT claims the Clinton budget surpluses were not the positive everyone claimed but were taking money out of the economy and contributing to the 2001 recession. I warned you MMT would be a bit mind blowing.
But then what are taxes for? MMT argues they are just to control inflation and to make people use the currency. MMT views the economy as operating at a certain level. If it drops below this level we have a recession, the solution to which is to print money and cut taxes. If we rise above this level, we have an inflationary boom, the solution to which is to raise taxes to stop the economy from overheating. The historical record shows that taxes are the main reason why societies started using currency in the first place.
MMT also swims against the tide of bank theory. Textbooks usually present a simple case where people deposit money in a bank which then keeps some of it (say 10%) and then lends out the rest. Hence lending is based on saving. MMT flips this story on its head. Instead it argues that banks lend out money and then go looking for savings to cover themselves. Crucially, the lending also creates the saving. If a bank lends you some money, it has effectively created money out of thin air (an important point that opponents of printing money forget). When you spend that money, the recipient either saves it or spends it. The money either goes right back into the banking system or to someone else who will eventually put it back in. The banks can always get an inter-bank loan or borrow from the central bank who cannot refuse as doing so would risk destroying the bank and with it the system.
Trying to understand Modern Monetary Theory is a bit like the first people trying to understand flying. No matter how many logical arguments are made, something in your gut tells you it can’t be true. How could an aeroplane possibly stay in the air despite weighing so much? How could it not crash despite going at such speed? Can we really trust the pilot not to make a mistake? How can the government print all the money it needs? Are taxes really that irrelevant in funding the government? Can we really trust the government not to mess up? In many ways MMT seems too good to be true. However, if it does work then it would be the miracle theory we have all been searching for. It’s so crazy, it might just work.