Modern Monetary Theory and Inflation

Modern Monetary Theory (MMT) offers a description of monetary operations which has drawn increased national attention over the past two decades. The proponents of MMT are often maligned and badly misrepresented by the press, orthodox economists, financial analysts, and others.

MMT puts forth the idea that monetary sovereign nations: nations which create their own free floating currencies, are not budget constrained in their spending practices. Monetarily sovereign nations, such as the U.S., cannot possibly be constrained by funding issues because they create their own currency.   There is no operational limit on the amount of currency which they can produce. There are practical inflationary constraints on a sovereign monetary authority’s production of money, but funding constraints are self-imposed and do not reflect the ability of a nation, which creates its own currency, to spend as appropriate on a nation’s needs.

The mechanics for MMT go like this. When the federal government spends, money enters into a checking account. This spending action, has, in effect, and in reality, based on definitional categories of money, actually produced new money. When the federal government collects taxes, or borrows, it destroys money: it takes money out of the economy. There is no natural law which states that federal expenditures must equal taxation and borrowing.  In other words, the Federal government need not fund deficit spending with debt. This is a policy choice. Households must match that which comes in with that which goes out, but governments which create their own currencies are not likewise constrained. The truth of these statements is readily demonstrated through an examination of the U.S. colonial period during which colonial governments spent currencies into existence and taxed at a level meant to control inflationary pressure. The North’s use of Greenbacks during the Civil War provides another example of this practice.

Tax and debt issuance are necessary to absorb excessive money out of particular markets in order to prevent inflationary build-ups in these markets, and also for other public purposes. These markets include goods and services markets, and also include asset markets such as stocks, bonds, real estate, and other investment vehicles. The goal is to control the amount of money which flows into these markets so that the prices of the various goods, services, and assets reflect real and stable values.

Excessive money creation without adequate money destruction, i.e., taxation and borrowing, will create inflation in the goods, services, and asset markets. MMTers readily acknowledge this point. Inflation occurs, in the goods and services sectors when expenditures exceed productive capacity, or in MMT words when the economy bumps up against real resource restraints. This makes perfect sense. This is also where MMT is badly misrepresented in the press as economists, financial analysts, and others make the outrageous claim that MMT promotes the view that the federal government can endlessly spend without inflationary consequences. A recent opinion piece in The Hill (March 30, 2021) stated:  “For those unaccustomed with MMT, in essence it states that the U.S. government can print and spend money limitlessly.” This is not the MMT view and the promoters of such a view generally either reveal a lack of exploration of MMT thought, or worse,  MMT views are misrepresented in an effort to impose discipline on federal government spending.

While on this topic, we should not allow the current system to escape criticism on the inflation front. The system’s dependence on unemployment, underemployment, and low wages, in order to preserve price stability,  create other inflationary forces which generally go unrecognized. These unrecognized inflationary forces include police, courts, prisons, the U.S. military,  and other unproductive activities which do not directly add to the production of goods and services. Much of the need, or perceived need, for domestic security services such as police, courts, and prisons can be directly  linked to low income conditions in large segments of the U.S. population. Also, the U.S. military likely finds greater social acceptance due to its offering of employment in a less than full employment economy. Low wage and no wage conditions spur growth in these non-productive and therefore inflationary activities.

The unemployed require state support, and it is right to provide this support. But unemployed  labor earnings  combined with earnings paid to both domestic security labor force and those employed in the U.S. military puts upward pressure on prices in the goods and  services sectors. To date, countervailing deflationary forces have hidden these inflationary costs. Without consideration of these inflationary forces, we immediately go to wage gains as the source of inflationary pressure. As nice as it would be to see a military budget of zero, one has to wonder about  the deflationary impact of such a budget. Nonetheless a demilitarized world is a worthy goal and it would be better to direct soldiers into productive rather than destructive activities. 

Part of MMT’s theoretical framework is a full employment federal jobs program which guarantees employment to any willing participant at a respectable minimum wage along with healthcare and childcare services. MMT correctly perceives that one of the major problems with the free market economy is there is a constant pool of unemployed, underemployed, and low paid labor which damages both the individual and the broader national economy. Under the MMT scheme, the wage in the job guarantee program would effectively set the national minimum wage. During expansionary times the private sector would bid labor out of the job program and during recessionary times labor would fall back into the job program. The job guarantee would moderate economic cycles and build a productive national workforce.

MMTers generally believe there is much available space for federal spending before real resource capacity is fully utilized–the point at which inflationary pressures begin to build. There are examples which back their view. Japan has  struggled with deflationary pressures since the 1990s. During the past decade Japan has gone on a money creation binge which has resulted in a national debt to GDP ratio which approaches 240%, more than double the U.S. ratio of debt to GDP. Yet Japan’s inflation rate still hovers around zero. In the U.S., despite vigorous efforts to the contrary, the nation’s central bank, the Federal Reserve, has been unable to achieve a 2% inflation  target. Both of these examples demonstrate the strong deflationary forces present in the global economy: this provides space for expanded money creation. 

Would a federal full employment jobs program have a long term inflationary impact? It is difficult to say. MMTers say no. To me the answer is not so clear. What is clear, however, is that if a “healthy”,  non-inflationary economy is dependent, as it has been during previous decades, on a pool of unemployed, underemployed,  and low wage workers,  then the economy is either flawed in its design,  or we are using a wrong set of measurements. 

Current accounting measures facilitate private sector measurements of profits and losses but fail to  account for the broader social gains and losses associated with such activity. We all know that full employment is better than non full employment. Yet inflation measures, which are important for money supply management purposes,  have dictated a near constant state of unemployment. The possible exception to this general rule is WWII, which essentially amounted to a full employment federal jobs program.

If inflation measures and private firm accounting practices which prevent full employment violate that which we know to be true, i.e., full employment is better than unemployment, then it is time to create new measurements and accounting practices which better reflect the reality of what is happening in the broader national economy.

MMT offers  accommodation to capitalist national economies with free floating sovereign currencies. Capitalists ought to embrace MMT ideas because capitalism  will not survive its current form. If capitalism does not embrace necessary reform, one variant of which MMT represents, the other direction involves increasing social discontent, oppression and violence.  Few people, capitalist or non capitalist, want to wander down this path.

If the MMT plan were put into place and it were to prove unworkable due to inflationary pressures, then either a new set of measurements and accounting practices should be developed which reflect the broader gains achieved through a guaranteed full employment program, or the economy would need other radical restructuring which ensures a decent standard of living for all people.

#MonetaryPolicy #mmt #inflation