Modern Monetary Theory (MMT): A Brave New World

MMT, an Introduction

Modern Monetary Theory, or MMT as it is commonly known, is a contemporary economic theory that implies that governments – under certain conditions – can simply create as much money as they like, without fear of consequences. The rise of MMT runs as a direct counter to traditional fears of rising public debt, which have long been used as a means of arguing against large scale government spending. “The essential message of MMT is that there is no financial constraint on government spending as long as a country is a sovereign issuer of currency and does not tie the value of its currency to another currency” (Globerman, 2021).

Figure 1: MMT as a policy suggests that for sovereign currency producers, printing vast sums of money needn't come with a downside

The key point here is that a country must be the issuer of its own currency. Naturally, this greatly narrows down the number of countries that could feasibly attempt such a policy. Amongst those who could are the US, Canada, Japan, China and the UK. MMT as a principle thus relies upon a given economy having a monopoly on its own money supply. Effectively meaning its own central bank that prints its own currency. Economic tradition dictates that if a government wishes to increase spending, it must do so by increasing taxation, or by borrowing. In the latter instance, largely through the sale of government bonds. (Sumner, 2021). Essentially a government issued I.O.U. to be repaid with interest at a future date. Under an MMT model taxes are employed for the purpose of fighting inflation, rather than funding expenditure as has traditionally been the case (Lockert, 2021).

Inflation as a phenomenon generally arises when an economy’s real and nominal resources are out of sync which means too much money has been printed, or supplied, and there are not enough goods and services available to meet the existing levels of demand. Taxes in this instance serve the purpose of extracting money from the economy. Thus reducing the level of money available and in turn, reducing the level of inflation (Matthews, 2019), at least in theory. Inflation is a after all a complicated beast.

Social Consequences, The Future is Now

The upside, and potential socio economic consequences of an MMT oriented policy model are frankly enormous. MMT has been mooted as a potential cure all for everything from the development of renewable energy infrastructure, to the resolving of income inequality in society (Baker and Murphy, 2020). The logic being that a country that fits the relevant MMT criteria can effectively borrow from, and in turn pay itself back by simply printing more of its own domestic currency. Under this framework, there is no obvious need for previously held concerns about rising budget deficits, or the raising of greater tax revenue in advance of large scale public investment.

Figure 2: US Politician Alexandria Ocasio-Cortez has been a strong proponent of MMT as a potential funding solution for a US Green New Deal

On a political footing, MMT has gained significant recent traction as a potential means of paying for a “Green New Deal” in the US – an ambitious proposed overhaul of US energy infrastructure which would see 100% of US energy being produced “through clean, renewable, and zero-emission energy sources” (Kurtzleben, 2019). Rather than raising taxes immediately, in order to fund the proposed infrastructural investment some years or even decades from now, the money required to fund the project could simply be printed right away. In effect hyper-accelerating the progression toward a zero carbon emissions status for the US economy (Horsley, 2019).

MMT does not so much advocate conjuring money out of thin air, as it does a reversal of the established order with regard to government spending and how it is funded. In a paper for the Social Policy & Society Journal, authors Andrew Baker and Richard Murphy propose a direct overhaul of the established governmental directive with regard to Tax Policy, “a reversal of the tax-spend cycle, by identifying a spend-tax cycle” (Baker and Murphy, 2020). Spend now, tax later. The benefits of the future, realised today.

Sovereign Currency an Essential Requirement

MMT as a concept has attracted a great deal of criticism from traditional mainstream economists. One of the foundational tenets of which is the perceived inapplicability of MMT to developing nations. The logic behind an MMT oriented policy as applied to a USA or Canada is that the governments of these countries can simply ask their central bank to print more US and Canadian dollars as needed, in order to pay off their debt.

Figure 3: The USA as the sole producer of the world's dominant currency serves as a prototypical example of a nation that could attempt an MMT oriented policy

A developing nation is much more likely to borrow in foreign currency – specifically US dollars, under the current global economic hegemony – and therefore lacks the ability to print the currency required to meet their debt obligations. This raises the cost of borrowing for developing nations in both a nominal, and very real sense. If, for instance, said country’s currency were to fall in value against the dollar, then it would be all but impossible for them to pay off their debt (Lockert, 2021). In this instance, printing more money doesn’t help, but is rather much more likely to add to the country’s woes. Raising once more the spectre of rising inflation with no tangible gain on the other side of the scale.

MMT and The Inflation Problem

If everything were as simple as implied by MMT advocates, why would MMT have not been employed en masse long ago? As has already been mentioned, one of the more immediate responses from any mainstream economist would be the prospect of rising, or even hyper-inflation. History offers many practical demonstrations of the treacheries of trying to simply print one’s way out of economic difficulties. In such a scenario, a country’s money supply is increased to the point where its currency effectively loses its value, and becomes basically unusable. The Weimar Republic (1923) serves as one of history's most memorable examples of this principle in effect, with Zimbabwe (2008) and Venezuela (2016 – present) offering more recent ones (McKibbin, 2019).

MMT in Practice

To that unfortunate list we can now add Sri Lanka, whose economy is currently in a widely documented state of crisis. Sri Lanka in many ways demonstrates the dangers of a smaller or developing nation attempting something akin to an MMT policy. While Sri Lanka’s current economic hardships are a result of a confluence of unfortunate circumstance, a heavy excess of domestic currency supply is very high on that list. Over the past three years Sri Lanka's government have attempted to break from the well worn tropes of economic history with regard to inflation. During this time they have continued to dramatically increase the country's money supply, in effort to deal with the simultaneous onset of a host of Economic difficulties. “From December 2019 to August 2021, Sri Lanka's money supply increased by 2.8 trillion rupees -- a massive 42%.”, of which 130 billion rupees – approximately $640 billion US dollars were printed in October of 2021 alone (Mushtaq, 2021).

The causes of Sri Lanka’s inflationary crisis are not so simple as having printed too much domestic currency. With global inflation already rampant in the aftermath of the Covid-19 Pandemic and the extensive Covid relief financing supplied by governments worldwide, rising oil prices have in turn led directly to significantly increased fuel and freight costs. These price increases have had a knock on effect on pricing in Sri Lanka for everything from milk-powder to medicine (Ethirajan, 2022). As an island nation Sri Lanka is heavily reliant on imports in order to sustain itself. Vital commodities such as oil and gas are traditionally paid for using foreign reserve currency – usually bolstered by Sri Lanka’s popular tourism sector. Unfortunately, the Covid-19 Pandemic has had a devastating impact on Sri Lanka’s tourism market, with revenues having fallen by an extraordinary 90 percent since 2019 (Ethirajan, 2022).

Figure 5: The Sri Lankan MMT experiment represents the potential perils of an MMT oriented Economic Policy

A Word of Warning

Sri Lanka’s former Deputy Governor of its Central Bank, W. A. Wijewardene had previously warned of the perils of employing an MMT oriented policy, likening it to the summoning of a Demon; “the present Government’s reliance on MMT is like getting a demon to work for it. If it does not play the game within limits, the demon will turn back and swallow it.” (Sri Lanka Modern Monetary Theory Experiment Could Be an Untamed Demon: Economist, 2021).

Those chickens would very much appear to have come home to roost. Though Sri Lankan citizens are currently facing much more immediate concerns such as electricity and food shortages (Yeung, 2022), chronic inflation makes for an unfortunate and persistent foe in any attempt to address such concerns. Sri Lanka’s annual inflation rate for the month of March 2022 was a brutal 18.7 percent, up from 15.1 percent the month prior, and the highest it has been since October 2008 (Sri Lanka Inflation Rate, 2022).

MMT advocates may point to the fact that Sri Lanka is not an exact fit for the MMT template. The Sri Lankan rupee for example, is pegged – or set – against the US dollar at an approximate fixed rate of 200 Rupees to 1 US Dollar. Thus limiting the autonomy of the Sri Lankan government with regard to its own currency. This semi-fixed exchange rate has had to prove more than a little flexible of late in light of rapidly changing economic conditions (Karunungan and Ondaatjie, 2022). There are however, more than enough parallels to demonstrate the potential risks of an MMT oriented policy, certainly for countries lacking the economic and political gravitas of a USA, UK or Japan. The Sri Lankan Government's decision to create vast sums of money out of thin air over the past several years has quickly led the country to an economic precipice. In the aftermath of their failed MMT Policy experiment, the Sri Lankan Rupee really isn't worth very much right now. This in turn makes the funding of such transactions a very tricky proposition indeed.

Conclusion

The MMT debate is unlikely to go away any time soon. Advocates on both sides tend to enter discussions on the subject with an almost religious zeal. Critics will argue the well-trodden economic aphorism, “there is no such thing as a free lunch”, and point to the many well documented instances of rising inflation running in parallel with expansionary monetary policy. Advocates will point to the potential for a true paradigm shift in the field of economic governance, and the startling infrastructural benefits that an MMT oriented policy could bring with almost immediate effect. There is much historic, and present day precedence to indicate that freely excessive government spending is not something which should be taken lightly. If the potential gains include saving the very planet itself however, is it worth the risk?

References

Baker, A. and Murphy, R. (2020). Modern Monetary Theory and the Changing Role of Tax in Society. Social Policy & Society: 19:3, 454–469, Cambridge University Press. Retrieved from https://www.cambridge.org/core/journals/social-policy-and-society/article/modern-monetary-theory-and-the-changing-role-of-tax-in-society/B7A8B0C7C80C8F7E38D20BE4F5099C83

Ethirajan, A., (2022). How the soaring cost of living is hitting Sri Lankans hard. BBC. Retrieved from https://www.bbc.com/news/business-59952980

Globerman, S., (2021). A Primer on Modern Monetary Theory. Fraser Institute. Retrieved from https://www.fraserinstitute.org/studies/primer-on-modern-monetary-theory

Horsley, S. (2019). This Economic Theory Could Be Used To Pay For The Green New Deal. NPR. Retrieved from https://www.npr.org/2019/07/17/742255158/this-economic-theory-could-be-used-to-pay-for-the-green-new-deal?t=1650451639501

Karunungan, L. and Ondaatjie, A., (2022). Sri Lankan Rupee Tumbles Most in More Than Four Decades. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2022-03-08/sri-lankan-rupee-tumbles-most-in-more-than-four-decades

Kurtzleben, D. (2019). Rep. Alexandria Ocasio-Cortez Releases Green New Deal Outline. NPR. Retrieved from https://www.npr.org/2019/02/07/691997301/rep-alexandria-ocasio-cortez-releases-green-new-deal-outline

Lockert, M., (2021). What is Modern Monetary Theory? Understanding the alternative economic theory that's becoming more mainstream. Business Insider. Retrieved from https://www.businessinsider.com/modern-monetary-theory

Matthews, D. (2019). Modern Monetary Theory, explained A very detailed walkthrough of the big new left economic idea. Vox. Retrieved from https://www.vox.com/future-perfect/2019/4/16/18251646/modern-monetary-theory-new-moment-explained

McKibbin, W. J., Is modern monetary theory too good to be true? The Brookings Institution. Retrieved from https://www.brookings.edu/opinions/is-modern-monetary-theory-too-good-to-be-true/

Mushtaq, M., (2021). Sri Lanka's economy seen as a 'ticking time bomb'. Nikkei Asia. Retrieved from https://asia.nikkei.com/Economy/Sri-Lanka-s-economy-seen-as-a-ticking-time-bomb

Sri Lanka Inflation Rate, (2022). Trading Economics. Retrieved from https://tradingeconomics.com/sri-lanka/inflation-cpi

Sri Lanka Modern Monetary Theory experiment could be an untamed demon: economist. (2021, January 10). EconomyNext. https://economynext.com/sri-lanka-modern-monetary-theory-experiment-could-be-an-untamed-demon-economist-77719/

Sumner, S. (2021). Understanding Modern Monetary Theory: Part 1. Econ Lib. Retrieved from https://www.econlib.org/library/Columns/y2021/SumnermodernmonetarytheoryPartI.html

Yeung, J., (2022). Sri Lanka is facing an economic and political crisis. Here's what you need to know. CNN. Retrieved from https://edition.cnn.com/2022/04/05/asia/sri-lanka-economic-crisis-explainer-intl-hnk/index.html

Image Sources

Figure 1: Mendelson, R., (2021). According to the MMT theory, deficits don't matter as much as we think they do and aren't necessarily a signal of a shaky economy. [Illustration]. Retrieved from https://www.businessinsider.com/modern-monetary-theory

Figure 2: Marovich, P., (2019). Representative Alexandria Ocasio-Cortez of New York and Senator Edward J. Markey of Massachusetts, right, announcing the resolution on Feb. 7. [Photograph]. Retrieved from https://www.nytimes.com/2019/02/21/climate/green-new-deal-questions-answers.html

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Figure 4: Animashaun, C. MMT in Practice. [Illustration]. https://cdn.vox-cdn.com/thumbor/6uuUDjV650qAE5GFEyk0uggJ9Ac=/0x0:1800x1013/1920x0/filters:focal(0x0:1800x1013):format(webp):no_upscale()/cdn.vox-cdn.com/uploads/chorus_asset/file/16125094/mmt_in_practice.jpg

Figure 5: Kodikara, I. S., (2022). An activist shouts and holds up burning bread as he protests rising living costs at the entrance of the president’s office in Colombo, Sri Lanka, on Tuesday. [Photograph]. Retrieved from https://www.nbcnews.com/news/world/sri-lanka-economic-crisis-imf-rcna20220