What Is Modern Monetary Theory All About

It is a variety of Keynesianism -- nominally centered at the University of Missouri, K.C., with its most notable exponent, James Galbraith, a Cambridge trained economist and son of John Kenneth Galbraith -- that focuses more on the money supply, the importance of large deficits and their impact, the extent of use of productive resources and less on interest rates, the dangers of high public debt and the threat of inflation during recessionary times. It challenges the view that during recessionary times -- when resources are not fully employed -- deficit spending should be restrained out of fear of inflation or rising public debt. The argument is that deficit spending should be even more aggressive during depressed times because as long as there is unemployment and plants are not at capacity, inflation is not a realistic prospect. Neither is concern about a high debt to GDP ratio as long as we commit to not default and retain flexible exchange rates.

Conventional Keynesians, like Krugman and others, worry that if deficits are too large, even during recessionary or high unemployment times, inflation lurks in the wings and imposes a curb. Nonsense, say the MMT theorists. Demand driven inflation, the only type to worry about, can only come about when as we approach full employment and plants are running near full capacity. Until then, we can run deficits as large as we want and need with the interest expense being the only issue and a marginal one at that. In short, we constrain badly needed deficit spending because of our fear of inflation which is a false boogy man, except at full employment, and high public debt, which is also not a problem, if we have flexible exchange rates and commit not to default.

The heart of the matter is this: according to Modern Monetary Theory, the Fed buying up Treasuries is just, in Galbraith’s words, a “bookkeeping operation” that does not add income to American households and therefore is not really inflationary (a continuous rise in prices generally).

“It seemed clear to me that ... flooding the economy with money by buying up government bonds ... is not going to change anybody’s behavior,” Galbraith says. “They would just end up with cash reserves which would sit idle in the banking system [with few borrowing], and that is exactly what in fact happened [with quantitative easing in 2009 and 2010].” Sitting on cash instead of bonds, as near cash.

Deficit spending adds directly to national income. Buying bonds to increase the money supply doesn't. The idea that the government can never run out of money -- central to MMT -- has different implications for different economists. The MMT thinkers contend hyperinflation and prospect of default which bother others isn't possible absent full resource employment, and, unless of course, a nation chooses to default, which is a problem.

Orthodox Keynesians are also baffled by another claim of MMT: namely, that budget surpluses in and of themselves are usually bad for the economy. According to MMT, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is, in effect, “taking money from private pockets and forcing them to make that up by going deeper into debt,” Galbraith claims. I think he is correct although this claim leaves conventional Keynesians shaking their heads. But that is because they don't distinguish between the private sector being forced to become a net debtor, on one hand, and being induced to reduce consumption expenditures in an overheated economy, on the other.

An implication, that constant deficits are usually preferable where there remain idle resources bothers orthodox Keynesians even more. Conservatives orbit. The implications of ever growing public debt seem not well addressed by either group, beyond the growing interest burden, and a great sense of unease by the orthodox Keynesians. Perhaps the failure to understand MMT, is what creates that unease. After all, what magic attends any particular Debt/GDP ratio, as long as a nation commits not to default, in whole or part, and maintains flexible exchange rates to permit it to make that commitment.