Putting Modern Monetary Theory To The Test

An unconventional approach called Modern Monetary Theory (MMT) that suggests governments don’t have to worry about debt is gaining traction. Its basic starting point is that a government that can borrow in its own currency can take on much more debt than orthodox economics says is prudent. If you want to spend more on government programs, just print more money with a few key strokes on the Federal Reserve computer.

Governments can manage their economies though spending and taxes instead of relying on a quasi-independent central bank to do it via interest rates. If spending much more than it collects in tax revenue creates inflation, the government can deal with inflation by raising taxes.

MMT is the economic rationale coming from potential Democratic candidates for president and rising political stars like Rep. Alexandria Ocasio-Cortez (D-N.Y.), who argue that the nation can afford large-scale social projects such as the recently proposed Green New Deal, Medicare for All, free college tuition, massive public infrastructure projects, and a job guarantee program with the federal government becoming the employer of last resort.

The MMT enthusiasts acknowledge that ballooning deficits risk triggering inflation, but claim the low inflation of the past decade leaves plenty of room to increase the budget deficit. Advocates of MMT suggest using taxes to pull money out of the economy before it overheats.

Voters punish politicians for tax hikes. Do you really trust them to raise taxes to pull money out of the economy? The theory says government should stop trying to balance the budget because policies aimed at doing it hurt the economy, which forces cuts to social programs. They believe a budget surplus should be avoided at all costs.

This perspective is contrary to the conventional economic thinking that when government spends more than it collects, it either has to borrow or raise taxes. Critics such as Warren Buffet say “We don’t need to get into danger zones and we don’t know precisely where they are.” Other detractors jokingly refer to MMT as magical monetary thinking. They believe you cannot borrow endlessly without risking real economic harm, especially if the return on government investments is below the interest rate on borrowing.

And such policies may undermine the United States’ standing as the world’s reserve currency. When countries reject the dollar as a world currency and foreign buyers such as China do not want to buy U.S. debt, increased government borrowing could eventually cause interest rates to rise as investors demand a better return on treasury bonds. MMT advocates respond that U.S. borrowing costs and inflation have remained low despite our being waist deep in deficits and debt.

Yes, the federal government could print more dollars to pay off the debt if it ever came to that, but is the dollar in danger of no longer being the world’s primary reserve currency and enjoying the lower interest rates and ability to fund budget deficits in perpetuity that goes along with it? Will rising debt and deficits cause foreign investors such as foreign central banks, sovereign wealth funds, and institutional investors to turn away from the dollar because they see increased risks from holding dollars as the government ratchets up borrowing to unprecedented levels?

The real world is much more complicated than ideological simplifications and abstractions. True to form, progressive politicians reveal good intentions, outsize ambitions, and a deficit of humility. Good intentions and grand ideas are frequently blind to the bothersome trivia of execution and to unintended consequences.

Whether you agree with MMT or not, it represents an important heterodox challenge to mainstream economic orthodoxy. Hedge fund king Ray Dalio has said the United States will adopt this economic philosophy to finance big government spending for more widespread growth.

After all, economic growth is the religion of the modern world.

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