What is Modern Monetary Theory?

Modern Monetary Theory (MMT) is a framework for thinking about the relationship between the issuer of a fiat currency and the economy it denominates.

It has two basic premises:

1: People need money

More formally, the fundamental value of a dollar is non-zero because the market for dollars is propped up on the demand side by taxes.

Within the United States, support for the dollar also extends to debts:

United States coins and currency [including Federal Reserve notes and circulating notes of Federal Reserve Banks and national banks] are legal tender for all debts, public charges, taxes, and dues. – §31 U.S.C. 5103

In normal conditions¹ this creates a virtuous cycle for the currency issuer; since everyone needs dollars for their debts and taxes, employers are incentivised to pay their workers in dollars, which in turn encourages them to accept dollars for their goods and services. The ubiquity of the dollar in the economy—or, put another way, people’s faith that it will be useful for settling transactions—is what gives it value beyond the baseline set by taxes.

This calculus also provides a concrete answer to why the dollar is more valuable to an American than a decentralized currency—a cryptocurrency’s fundamental value can be calculated in terms of the payments for which it is the only option², which is vanishingly small compared to the dollar. It also explains why the euro isn’t worth very much to most Americans³.

2: Money is a tool, not an asset

Dollars are created and destroyed by the government; the amount (and manner) in which they are distributed or recovered is the government’s most important economic (and social) policy tool.

A key point here is that governments don’t have bank accounts. The central bank settles debts by creating money. Likewise, money collected by the government is magicked out of existence. A currency issuer’s purpose is not to have money, it’s to manage the economy by exerting control over money.

This turns common budgeting sense on its head—a household’s financial health may be determined by its bank account’s balance, but a currency issuer’s financial health is measured by its economy, which it can influence by adding or removing money.

The government has many options for increasing the money supply, including spending, forgiving debt, or mailing everyone a check. It mostly decreases the dollar supply by raising taxes, which—as with spending—can be used to accomplish social goals; in the same way that spending money on single-payer insurance adds dollars to the market in service of public health, a wealth tax takes dollars out of the market while reducing inequality.

This premise puts the lie to the most common complaint against public spending: “how will you pay for it?” Through the lens of MMT, the government’s budget doesn’t need to balance. Running a deficit is not the same as overspending unless it sparks…

Inflation

At its core, MMT is about replacing an artificial (revenue) constraint with a real (inflation) constraint – The Deficit Myth, p72

In an otherwise static system, we can view inflation as the result of a government spending more than it collects in taxes. From the perspective of a “dollar market”, excess spending by the government creates a glut on the supply side, diluting the currency’s value.

Inflation isn’t necessarily bad when it’s well-controlled. A small and consistent amount⁴ gradually reduces the real cost of long term debt and gently incentivizes people to maintain the economy’s velocity by moving their idle cash into investments or durable goods.

That said, the economy isn’t a static system. Oversimplifying, the economy “likes” a stable velocity of money, but transactions that don’t involve the government can vary wildly for reasons as capricious as the parties involved. In aggregate, these transactions form trends—oscillations in the market.

Through the lens of MMT, these booms and busts are opportunities for a savvy government to improve life for their citizens by spending into downturns and levelling the playing field during booms. One MMT-derived policy that accomplishes this naturally is a federal job guarantee.

A new New Deal

“Relief”, the “first R” of Roosevelt’s New Deal, hired the unemployed to build infrastructure for the nation. In the same way that the government is the “lender of last resort” to distressed banks, the government made itself the employer of last resort to distressed citizens. From an MMT perspective, programs like this work well for a few reasons:

Automatic budgeting

Instead of becoming unemployed, workers could take a job with the government during a recession, their new salary naturally causing an increase in government spending. During a healthy market, private companies would reduce the cost of the program by poaching people from public employment with more lucrative offers.

Stabilize the economy

Obviously being employed is good for the worker, but for the economy at large a job guarantee puts money directly where it’s needed most: stabilizing people’s income stabilizes their spending, which in turn stabilizes inflation.

Minimum wage and conditions

Because the government participates in the same labour market as private industry, a public job guarantee effectively sets the minimum wage and working conditions for its citizens. This helps eliminate “bad jobs”—unsafe, exploitative work—from the market without harming workers.

Anyway

This post is mostly written in terms of US dollars, but the framework applies just as well to any government that issues their own currency. Governments that don’t control their economy’s currency—whether a small country or state/local governments—suffer the zero-sum rules of household budgeting, and entities like the EU live in a weird middle ground where a single distressed country has to petition the coalition to deploy monetary controls to their benefit.

If you found this interesting, check out this talk by Stephanie Kelton. She also wrote The Deficit Myth, which includes this closing quote:

As long as there is plenty, poverty is evil. Government belongs wherever evil needs an adversary and there are people in distress. – John F. Kennedy