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Modern Monetary Theory: A New Paradigm for Money and Fiscal Policy



What is Modern Monetary Theory and why does it matter?

Modern Monetary Theory (MMT) is a macroeconomic theory that puts the functioning of the monetary system at the center of its analysis. It has post-Keynesian roots and has gained popularity in recent years with its core claim that a state that issues its own currency does not have to fear insolvency1.

The basics of MMT

According to MMT, money is not a scarce commodity that the state has to collect from the private sector through taxes or borrowing before it can spend. Rather, money is a legal and social institution that the state creates and regulates through its monopoly power2. The state can use its currency-issuing capacity to finance its spending and achieve public policy goals, such as full employment, social welfare, and environmental sustainability3.

The main constraint on the state’s spending is not the budget deficit or the public debt, but the availability of real resources (labor, capital, and natural resources) in the economy. If the state spends more than what the economy can produce, it will cause inflation, which erodes the purchasing power of money. To prevent inflation, the state can use fiscal policy (taxes and spending) and monetary policy (interest rates and bond issuance) to manage the aggregate demand and supply in the economy2.

The implications of MMT

MMT challenges some of the conventional wisdoms in mainstream economics, such as:

  • The state should balance its budget over the business cycle or achieve a primary surplus to stabilize its debt-to-GDP ratio.
  • The state should borrow from the private sector or foreign creditors to finance its deficit spending.
  • The state should maintain a positive interest rate to attract investors and savers.
  • The state should avoid printing money to finance its spending, as it will lead to hyperinflation.

MMT argues that these are not universal or natural laws, but rather self-imposed or institutional constraints that can be changed or removed by the state. For example:

  • The state does not need to balance its budget or achieve a primary surplus, as it can always service its debt denominated in its own currency. The appropriate fiscal stance depends on the economic conditions and the policy objectives of the state.
  • The state does not need to borrow from the private sector or foreign creditors, as it can create money through its spending. The purpose of bond issuance is not to finance the deficit, but to provide a safe and liquid asset for the private sector and to conduct monetary policy.
  • The state does not need to maintain a positive interest rate, as it can set the interest rate at any level it desires. A low or zero interest rate can reduce the cost of public debt and stimulate private investment and consumption.
  • The state does not need to avoid printing money, as long as it does not exceed the productive capacity of the economy. Creating money can enable the state to mobilize idle resources and achieve full employment.

The relevance of MMT

MMT offers a new perspective on how we think about money, fiscal policy, and macroeconomic stability. It also provides a framework for designing alternative policies that can address some of the pressing issues of our time, such as:

  • How to deal with the economic and social consequences of the COVID-19 pandemic?
  • How to finance a green transition to combat climate change?
  • How to reduce inequality and poverty in a globalized world?
  • How to reform the international monetary system to promote cooperation and development?

MMT is not a panacea or a magic bullet, but rather a lens that helps us see more clearly the possibilities and limitations of our monetary system. It invites us to question some of the assumptions and myths that have shaped our economic thinking and policymaking for decades. It also challenges us to imagine and create a more just and sustainable world.

I hope you enjoyed this blog post. If you want to learn more about MMT, you can check out these sources:

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