[This blog post is a modified excerpt from a TSI commentary published about a month ago]
Modern Monetary Theory, or MMT for short, is gaining popularity in the US. It is based on the idea that under the current monetary system the government doesn’t have to borrow. Instead, it simply can print all the money it needs to fill the gap between its spending and its income. The only limitation is “inflation”. As long as “inflation” is not a problem the government can spend — using newly-created money to finance any deficit — as much as required to ensure that almost everyone is gainfully employed and to provide all desired services and infrastructure. It sounds great! Why hasn’t anyone come up with such an effective and easy-to-implement prosperity scheme in the past?
Of course it has been tried in the past. It has been tried countless times over literally thousands of years. The fact is that there is nothing modern about Modern Monetary Theory. It is just another version of the same old attempt to get something for nothing.
Most recently, MMT was put into effect in Venezuela. For all intents and purposes, the government of Venezuela printed whatever money it needed to pay for the extensive ‘free’ social services it promised to the country’s citizens. The MMT apologists undoubtedly would argue that the money-printing experiment didn’t work in Venezuela because the government didn’t pay attention to the “inflation” rate. It kept on printing money at a rapid pace after “inflation” became a problem. Our retort would be: “Great point! Who would have thought that a government with the power to print money couldn’t be trusted to stop printing as soon as an index of prices moved above an arbitrary level.”
In essence, MMT is based on the fiction that the government can facilitate an increase in overall economic well-being by exchanging nothing (money created ‘out of thin air’) for something, or by enabling the recipients of the government’s largesse to exchange nothing for something. It is total nonsense, although there is an obvious reason that it appeals to certain politicians. Its appeal to the political class is that it superficially provides an easy answer to the question that arises when politicians promise widespread access to valuable services free of charge. The question is: “Who will pay?” According to MMT, nobody pays until/unless “inflation” gets too high.
And what happens when inflation gets too high? Well, according to MMT the government simply ramps up direct taxation to reduce the spending power of the private sector, which supposedly quells the upward pressure on prices.
Therefore, MMT can be viewed as a case of heads the government wins, tails the private sector loses. As long as “inflation” is below an arbitrary level the government can extract whatever wealth it wants from the private sector indirectly by printing money, and if “inflation” gets too high the government can extract whatever wealth it wants from the private sector via direct taxation.
The crux of the issue is that new wealth can’t be created by printing money, but existing wealth will be redistributed. It’s like when a private counterfeiter prints new money for himself. When he spends that money he diverts real wealth to himself while contributing nothing to the economy. MMT is the same principle applied on a gigantic scale.
That being said, MMT does have its good points, just not the good points that its proponents claim.
As happens when money is loaned into existence under the current system, the application of MMT will affect relative prices as well as the so-called “general price level”. The reason is that the new money won’t be injected uniformly across the economy. However, it’s likely that the price increases stemming from the monetary inflation will be more uniform and direct under MMT than under the current system. In other words, under MMT the effects of monetary inflation should be reflected much sooner and to a far greater extent in the CPI than is the case with the current system.
That the application of MMT would lead quickly to what most people think of as “inflation” is a benefit, because the link between cause (monetary inflation) and effect (rising prices) would be obvious to almost everyone. A related benefit is that MMT would short-circuit the boom-bust cycle.
Booms happen when the Fractional Reserve Banking (FRB) system (with or without a central bank) expands credit and in doing so creates the impression that the quantity of real savings is much greater than is actually so. This prompts excessive investment in long-term business ventures that would not look viable in the absence of misleading interest-rate signals.
We assume that under MMT the commercial banks still would be lending new money into existence, but the temporary downward pressure on interest rates from the surreptitious money creation of the banks would be more than offset by the upward pressure on interest rates from the blatant money-printing of the government. The boom phase therefore would be very short, perhaps even barely noticeable. In effect, MMT would bypass the boom and go straight to the bust. Again, this would be beneficial because it would expose the link between cause (the application of a crackpot monetary theory) and effect (economic hardship for most people).
MMT is such an obviously silly idea that any economist, politician, journalist or financial-market commentator who advocates it should not be taken seriously. However, that they are being taken seriously opens up the possibility that MMT will be implemented in the not-too-distant future, with the ‘benefits’ outlined above.
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