Modern Monetary Confusion (a.k.a. Modern Monetary Theory)
Modern Monetary Theory claims that Governments which control their own currency do not face a ‘fiscal or financial’ limit to their ability to spend, they can always borrow more (issue more debt). We go in search of the new ‘Theory’ behind this claim and find that the only new theory is the Modern Monetary Confusion.
The Modern Monetary Confusion: always being able to issue debt does not equate to being able to have an ever increasing debt.
Ninety-nine percent of Modern Monetary Theory is in no way different from standard economic theory. A Government wishing to increase spending can fund this by issuing debt. And as long as the Government controls a currency, it can always do this. Either people will be willing to buy this debt –to lend the Government the money– or the Government can simply print money to make up the difference. So far, so good.
Where is the new ‘Theory’ in Modern Monetary Theory? If the claim is simply that Government could spend more this can always be achieved by increasing taxes in tandem. With both Government revenue and spending going up there would be no need for any Modern Monetary Theory to make this possible; whether or not this would be desirable is for another day. Clearly then Modern Monetary Theory must be about more than just increased Government spending. For some reason this spending should be paid for by increased Government debt. Nor can Modern Monetary Theory be about increased Government spending during major recessions that is paid for by debt with a view to paying off the debt during future good times. This would just be standard economics of a Keynesian variety. Our search for the new ‘Theory’ in Modern Monetary Theory continues.
Modern Monetary Theory is left arguing that the Government should increase spending paid for by issuing Government debt on the ground that it can just continue issuing debt forever. In the lingo of Modern Monetary Theory the idea of an ever increasing debt is described as that the Government faces no ‘fiscal or financial constraint’ to Government spending. At this point Modern Monetary Theory finds a ‘Theory’! But in doing so loses all grasp of reality and wanders off into La La Land.
The problems begin with observing that either the increase in spending paid for by debt is going to be a one-trick pony –in which case we can all yawn and move on– or the Government is going to do this repeatedly/permanently, leading to ever increasing Government debt levels. Modern Monetary Theory’s divorce from reality comes from confusing the fact that a Government that controls a currency can always issue more debt –either someone buys the debt or can print money– with the idea that a Government can therefore have an ever increasing debt. This is the Modern Monetary Confusion: always being able to issue debt does not equate to being able to have an ever increasing debt!
A Government that issues its own currency can always issue more debt. It cannot have an ever increasing debt. Why? Let’s return to why the ‘issuing own currency’ is an important part of this argument in the first place. Any Government can increase debt if someone is willing to buy the debt (i.e., to lend them the money). But as the Government debt continues to pile up at some point there will be no-one willing to lend more money, because they don’t think the Government will be able to afford to pay them back and so it would be a losing proposition to lend. Or in a logically possible but unrealistic scenario, simply because the Government has already borrowed all the savings of everyone in the economy and there is nothing left to lend. This is where the Government controlling a currency comes into play. If the Government wants to borrow by issuing debt and no-one wants to lend them money then they can print money to pay for the debt instead. When a government does this it is not really issuing debt at all, and so debt stops going up. Of course, the flip-side is that the Government is now paying for things by printing money. This is money-financing of the Government and we are just back to standard economics. A Government can finance itself by printing money. The printing of money sooner or later generates inflation, this raises revenue for Government in the form of an ‘inflation-tax’; it works by redistributing income from people holding money to the Government by making the money those people hold worth less, while the Government now holds more money.
So Governments cannot have an ever increasing debt: the Theory of Modern Monetary Theory is divorced from all reality. Either people will stop lending to the Government, or the Government will switch to money-financing of Government spending. Money-financing of Government spending is not a new Modern Monetary Theory. At low levels –printing money valued at one-or-two percent of GDP per year– it is largely benign simply acting as another form of taxation, albeit one that is highly regressive (poor people hold more cash relative to income). But used as a major source of revenue as Governments have occasionally done in the past it has often ended badly. In its most extreme form money-financing is how countries get hyperinflation. In fact the cause of every hyperinflation, from Germany between the World Wars, to Zimbabwe’s which peaked in 2008-9, is Government printing money to finance itself. Again though, money-financing of Government spending is just standard economics.
So what Theory is left for Modern Monetary Theory? Naught but a Modern Monetary Confusion.
- What is Modern Monetary Theory? Here are links to two short pieces, and two long ones:
Explainer: what is Modern Monetary Theory?
The Rock-Star Appeal of Modern Monetary Theory (mostly on the political side in US context)
Modern Monetary Theory and Practice – An Introductory Text
- That sooner or later people will simply refuse to lend to the Government is evidenced by two observations. First, that some Governments end up borrowing from the IMF: why would you borrow from the IMF, with all the harsh conditions that imposes on the borrowing country, if there was any alternative person to borrow from? Second, that some Governments that do control their own currency end up borrowing money in foreign currencies. If there was always someone who would lend you money in your own currency why would you ever want to borrow in a currency you don’t control?
- There are two other options for how the Government might pay for debt that I ignore above for expositional purposes. First, the Government might (partially) default on the debt. While default will sometimes be a sensible option for countries that find themselves in unforeseen bad situations it hardly seems like a good idea to run a Government that borrows with the deliberate intention of defaulting on the debt. This would be a one-way street to becoming an economic backwater. Second, the Government can force, or strongly incentivize, people and firms to hold Government debt. This is called Financial Repression and it is common practice. At root though Financial Repression is just a more hidden, and typically more distortionary, way of paying for the debt than just taxing; e.g., forcing the financial sector to hold lots of Government debt at low interest rates is just a way of redistributing income from the finance sector to the Government, and this could just as easily be done with a tax on the finance sector. Financial Repression, like default, is something that countries finding themselves struggling with high levels of debt might find is a least-bad option. Or Financial Repression may sometimes represent an appealing alternative to taxation. But again while Financial Repression will sometimes be a good idea for countries already struggling with high levels of debt, it is not a reason to start borrowing in the first place.
- Another option would be to increase taxes in the (near) future. But this is just a delayed version of increasing taxes to pay for increased spending. So we will ignore this here as again it doesn’t leave any ‘Theory’ in Modern Monetary Theory.
- Technically modern Governments would be unlikely to ‘physically print’ money. They simple credit it to bank accounts; the Treasury has an account at the Central Bank. For present argument though the effect is essentially the same.
- In practice/history another reason countries often embark on major increases in Government spending paid for by debt is to fund wars. I ignore this here.
- Not all countries issue their own currency and so have this ability to always issue more Government debt that either someone will buy or that the Government can pay for by printing money. The obvious exceptions are Eurozone countries. These share a currency and so an individual country, be it Greece or Germany, cannot unilaterally decide to print more money. The Government can therefore only issue debt if someone will buy it. The Eurozone debt crisis that started in 2009 reflects what happens when a country wants to issue debt but struggles to find someone to buy it.
- Fiat currencies is a technical economics term for a currency issued by the Government and which is ‘enforced’ with legal backing. One example is the US dollar which is issued/printed by the US Government and which the US government says that you must accept as ‘legal tender’ for transactions, and is the only currency in which you can pay your taxes. It is closely related to the idea of a currency which is controlled by the Government, but not quite the same as the Euro illustrates. The Euro is a fiat currency in that it is legally mandated and accepted by the various Eurozone Governments, but those same Eurozone Governments cannot unilaterally print more Euros, this can only be done as a joint action of the Eurozone Governments.
- Modern Monetary Theory is often also linked to the idea that because of the erroneous claims about Government borrowing it follows that the Government should promote full employment. Were a country to decide that it wished to create full employment through a program of the Government of hiring everyone who wanted a job it could do this without any need for Modern Monetary Theory, just raise taxes to pay for all the people the Government employs. Modern Monetary Theory brings nothing new to the discussion of whether or not a policy of full employment by Government employment is desirable.