Definition
Modern Monetary Theory (MMT) is an economic theory that emphasizes the control a government has over its own currency. It suggests that governments can’t run out of money since they control its creation, therefore they can spend freely to stimulate economic growth and enhance public services. However, it also highlight the risks of inflation if the spending exceeds the economy’s capacity to respond to such inputs.
Key Takeaways
- Modern Monetary Theory (MMT) suggests that countries that have full control over their sovereign currency can never run out of money, just like a homeowner who owns a money printer can never run out of money.
- According to the MMT, such nations don’t have to worry about accumulating too much debt because they can print more money to pay off their debts. However, it also recognizes that excessive money printing can result in inflation and thus advocates the use of taxes and government spending as tools to control inflation.
- MMT is often associated with policies promoting government programs requiring significant spending, such as universal healthcare or basic income, since it argues that the government has much more capacity to spend than traditional models suggest.
Importance
Modern Monetary Theory (MMT) is a crucial concept in finance as it fundamentally challenges traditional views about fiscal policy and monetary sovereignty.
It posits that countries that produce and control their currency (i.e., fiat money), such as the U.S., can issue unlimited amounts of money virtually, without necessarily leading to hyperinflation.
It argues that such countries are capable of funding any deficits by creating more currency and are not reliant on taxation or borrowing to finance public expenditure.
Thus, it provides a framework for understanding the full potential of fiscal policy in managing economic fluctuations and achieving macroeconomic objectives, such as full employment and price stability.
The importance of MMT lies in its direct impact on policy debates around issues like debt sustainability and the role of fiscal policy in stimulating economic growth.
Explanation
Modern Monetary Theory (MMT) is an economic framework that suggests that countries with complete control over their own currencies, like the USA or the UK, can print more money as it is needed, without the fear of ending up in debt. Its purpose is to address deficits and surges in spending, such as those witnessed in times of economic recession or downturn.
Proponents argue that such nations can spend freely to stimulate economic growth and full employment, as they can never run out of money and can repay any debt they owe, as they control the currency in which the debt is denominated. Instead of considering the traditional concepts where the budget surplus or deficit is given primary importance, MMT emphasizes on a balance between inflation and unemployment, and the country’s capacity to realize its social programs or goals.
In fact, it is often used as a justification for government spending on public programs or services. According to MMT, inflation is the only true barrier to limitless spending.
Thus, if a country produces too much money and inflation rises, the government can implement policies such as raising taxes or cutting public spending, to remove excess cash from the economy and prevent inflation from spiraling out control.
Examples of Modern Monetary Theory
The United States in the Aftermath of the 2008 Financial Crisis: After the 2008 financial crisis, the United States government and the Federal Reserve took on substantial amounts of debt to help stabilize the economy. Many critics argued this would lead to inflation and even bankruptcy, but these scenarios didn’t happen. Instead, the US economy recovered, and the increase in debt had no significant adverse effects. This example supports Modern Monetary Theory (MMT) as it highlights that countries with sovereign currencies could take on more significant debt without dire consequences.
Japan’s “Lost Decade”: In the 1990s, Japan experienced a period of economic stagnation, despite low debt and fiscal responsibility. To revive the economy, the Japanese government launched aggressive fiscal stimulus programs, increasing public debt significantly. Even with the high debt, Japan did not experience any economic implosion nor did it face any significant inflation, lending some credence to the tenets of MMT.
The Covid-19 Pandemic Economic Response: Many governments worldwide, including the U.S, U.K, and Canada, have been taking on vast amounts of debt to support businesses and individuals during the economic fallout caused by the Covid-19 pandemic. Despite predictions of inflation or economic catastrophe, these countries have largely managed these debts without immediate economic ruin. Through this, they have indirectly demonstrated one of the MMT’s core arguments—that states with their sovereign currency can generate more money to cover significant public debts.
FAQ: Modern Monetary Theory
What is Modern Monetary Theory?
Modern Monetary Theory (MMT) is a macroeconomic theory that describes and analyses modern economies in which the national currency is fiat money, established and created by the government. In such a system, the government has a very high degree of freedom to undertake fiscal and monetary policy actions.
What are the primary principles of Modern Monetary Theory?
According to MMT, since governments issue their own currencies, they can never run out and can therefore spend freely, since they can always create more. This is used as an argument against austerity. MMT proposes that the main constraint for government spending is inflation, which occurs when an economy surpasses its real productive capacity.
What are the criticisms of Modern Monetary Theory?
Critics argue that MMT is overly optimistic about the government’s capacity to control inflation. They also argue that it overstays the importance of budget deficits and national debt. Critics also say that implementing policy based on MMT could lead to hyperinflation.
Who are the main proponents of Modern Monetary Theory?
Modern Monetary Theory is brought forth by economists such as Warren Mosler, Randall Wray, Stephanie Kelton, and Bill Mitchell. It has also been taken up by some politicians and political movements, particularly within the progressive left wing in the US.
What is the relationship between Modern Monetary Theory and fiscal policy?
MMT argues that fiscal policy, not monetary policy, should be the primary tool of macroeconomic management. It proposes that governments should use their budget to achieve full employment, creating new money to fund government purchases. The central bank’s role is then to manage interest rates to control inflation.
Related Entrepreneurship Terms
- Fiat Currency
- Sovereign Currency
- Mandatory Government Spending
- Inflation Control
- Full Employment
Sources for More Information
- Investopedia: It is a comprehensive online source dedicated to investing and finance, and it provides detailed analysis and explaination of Modern Monetary Theory (MMT).
- Encyclopedia Britannica: This encyclopedic platform would provide a reliable, accurate, historical perspective and understanding of Modern Monetary Theory.
- Brookings Institution: This nonprofit public policy organization based in Washington, D.C., conducts high-quality, independent research and, based on that research, provides innovative, practical recommendations. You can find various discussions and perspectives on Modern Monetary Theory here.
- The Guardian: As a leading global news organization, The Guardian provides various articles, analysis and opinion pieces on Modern Monetary Theory.
