Mainstream Economists Do Not Believe MMT

Journalists should at least acknowledge that mainstream economists strongly oppose the key assumptions of MMT.

P oliticians and journalists are abuzz with the new economic doctrine of “modern monetary theory” (MMT). As Jeanna Smialek, author of a recent New York Times piece on MMT, tweeted:

MMT is part of our national conversation, whether you find it valid of not. Lawmakers flirt with it. Prof. Kelton’s book was a bestseller. Journalists buzz about it, Chair Powell gets asked about it.

Whatever its role in “our national conversation,” it is important to note that MMT is widely rejected by mainstream economists because it is invalid, even incoherent, as a scientific theory.

Even moderate left-leaning economists oppose MMT. Lawrence Summers called it “a recipe for disaster.” Nobel Prize winner Paul Krugman described the theory as “just obviously infeasible.” Contrary to Smialek, Jason Furman argues that “MMT has actually had relatively little influence on the political system.”

No academic papers on MMT have been published in major economics journals. This is important because there is no systematically laid-out theory of MMT to criticize. Instead, defenders of MMT engage in repeated bait-and-switch arguments which, as Krugman explains, make the core propositions of MMT difficult to identify and impossible to refute.

Perhaps the most well-known exposition of MMT is Stephanie Kelton’s book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. Kelton lays out six supposed “myths” of standard economics. Similar claims can be found in other works on MMT such as the textbook by William Mitchell, Randall Wray, and Martin Watts.

While many of Kelton’s “myths” are supported by folksy stories or metaphors, most mainstream economists simply do not believe the main assumptions of MMT. Consider three key claims about MMT made in The Deficit Myth.

Claim 1: The U.S. Treasury creates new money

Standard economics makes a clear distinction between fiscal policy and monetary policy. Fiscal policy is what we usually think of as “government spending,” money that goes towards national defense, social security, and other programs.

Monetary policy is when the Federal Reserve creates new money and distributes it through the banking system. The Fed is the central bank of the United States. It does not finance regular government spending or programs. It simply manages the supply of money in the economy by creating new money, managing interest rates, and supporting the financial system.

MMTers intentionally ignore the important differences between the Fed and Treasury. They claim the Treasury can just create new money to spend on whatever it wants. But that’s not how it works, at least not in the United States. The Fed creates new money. The Treasury does not.

In The Deficit Myth, Kelton obscures the roles of the Fed and Treasury with statements like, “Both the US Treasury and its fiscal agent, the Federal Reserve, have the authority to issue dollars.” As an example, she notes that the Bureau of Engraving and Printing, which prints our paper currency, is part of the Department of the Treasury. But she fails to explain that those notes are actually distributed by the Fed through its network of regional reserve banks, not by Treasury spending.

She also claims that because the Treasury has an account at the Fed, it creates new money when it spends from that account. In truth, the Treasury account is like any other bank account: It makes payments by transferring funds from its account to the recipient account, not by creating new money. Plus, the Treasury account is very small relative to the federal budget, hardly useful for the large-scale spending envisioned by MMT.

In both of those cases, the Treasury is not creating new money. Kelton’s elegantly phrased but ultimately misleading descriptions might convince the average reader, but the characterization of the Treasury as a money issuer is soundly rejected by mainstream economists.

While it is possible in theory that a central bank like the Fed could print new money and spend it as directed by the Treasury, that is not how the system currently functions in the United States. Such policies have led to economic disasters in many countries, which is why advanced economies allow their central banks to be (mostly) independent in the first place.

Claim 2: Money does not cause inflation

Perhaps the most controversial and implausible claim from MMT is that inflation is caused by federal government deficit spending, not by monetary policy.

Standard economics teaches that inflation is ultimately a monetary phenomenon. The price level rises when the quantity of money grows faster than the public’s demand to hold it or when production slows but money growth does not, which is a partial cause of current U.S. inflation. In the long run, excessive money growth leads only to higher prices, not to increases in real economic activity.

In contrast, MMT predicts that only fiscal spending can lead to inflation. Even when fiscal spending is high, they argue, inflation only results when the economy is already at maximum capacity, which they describe as low (and sometimes zero!) unemployment.

Kelton tries to make this position sound reasonable to mainstream economists. “As we teach our first-year students,” she writes, “excessive spending manifests as inflation.”

That statement sounds like it’s consistent with standard economics, but actually, it’s not. Why? Because of the way MMTers define “overspending.”

In standard economics, inflation is the result of excessive total spending in the economy, including spending by households, businesses, and the government. But in MMT, “overspending” refers only to government deficit spending — when the government spends more than it brings in from taxes and is forced to borrow (or in some countries print) the difference.

Because MMT rejects the quantity theory of money and traditional public finance, Kelton makes a simple mistake about something that, as she notes, “we teach our first-year students.”

Kelton provides a few historical examples of Greece, Argentina, and Venezuela as countries that would have benefited from the MMT framework. In reality, each of these countries was formerly the victim of high inflation and economic collapse caused by MMT-style money creation. From 1973 to 1994, Greece’s annual inflation rate fluctuated between 11 and 27 percent as the country repeatedly inflated away its debts, which it ended only by joining the Euro and abdicating monetary sovereignty. Argentine inflation averaged in the hundreds of percent since 1975 but was brought down into the single digits in the 1990s, only to see it explode again since 2016 due to debt monetization. Venezuela’s annual inflation has been in the double digits for decades, more recently reaching the hundreds, in some years thousands, of percent. In each country, MMT-like policies were the cause of their economic problems, not the solution.

Claim 3: Government spending is not related to taxes or borrowing

In standard economics, fiscal spending from the Treasury must come from one of two sources: tax revenues or newly issued debt. This is known as the government’s “budget constraint.” The most the government can spend is what it can tax and borrow.

MMTers argue that the government is different because, unlike a household or business, it can print its own money; therefore, it can spend as much as it wants. No need to raise taxes to resolve budget deficits. The government can never default because it can just print dollars to cover its debts or to finance spending directly.

This strategy, however, has not worked well in the past and, in many cases as previously mentioned, has led to economic collapse. Even if the fiscal authority could print an infinite supply of dollars to cover its debts, such a vast monetary expansion would drive the economy and financial system to ruins.

Mainstream economists don’t believe that the printing press provides a means to avoid default. A group of economists from the IGM Forum was asked whether “countries that borrow in their own currency can finance as much real government spending as they want by creating money.” Not a single one agreed. Most strongly disagreed.

If the government can just print money when it needs it, why have taxes at all?

According to Kelton, taxes are needed “to create a demand for the government’s currency,” so people will be willing to use it. This idea is based on Chartalism — the state theory of money — that money is created by the government and used to direct economic activity.

Taxes can also be used to remove money from the economy in order to manage inflation. Kelton proposes that “maybe Congress could help fine-tune the economy with better real-time adjustments in government spending and taxation?”

While I, too, am critical of the Fed’s money-supply management, the idea that Congress would do better is inconsistent with economic theory and historical evidence. Research shows that countries with independent central banks tend to have better monetary policy than those in which the central bank is beholden to the fiscal authority.

Why are we talking about MMT?

Together, these three claims imply that, until we reach full employment, the government can spend without consequence. The government doesn’t need taxes or debt to increase spending. The Treasury can create new money and spend on whatever it wants. Doing so will not create inflation because money doesn’t cause inflation.

These key assumptions are the foundation of MMT. But they are contradicted by economic theory and history. They are claims that no mainstream economist would endorse.

Given the fact that mainstream economists do not believe MMT or its major propositions, why are we even talking about it?

The reason, of course, is that the political Left loves it. They love the idea that the government can spend without consequence. While politicians themselves have been less-vocal proponents of MMT, a few seem to be onboard. Senator Bernie Sanders (I., Vt.) hired Stephanie Kelton and became her “most prominent supporter.” Representative Alexandria Ocasio-Cortez (D., N.Y.) gave MMT a partial endorsement, saying it should be “a larger part of the conversation.” Such overtures keep MMT alive in its proponents’ imaginations, despite near universal criticism from the economics mainstream.

In fact, the popularity of MMT could have economic consequences, even if the theory itself is not officially adopted. Perhaps the MMTers’ goal is not to implement MMT in practice but simply to provide support, no matter how vague, for their big-spending ambitions. Many from the Left seem willing to promote an obscure economic theory, so long as it supports their preferred policies, because they know the public doesn’t know any better.

Journalists, however, should know better than to accept a story without question. It is their job to present both sides of the issue, not to lobby for their political favorites.

If journalists want to praise MMT and its newfound popularity, so be it. But they should at least acknowledge that mainstream economists strongly oppose the key assumptions of MMT and that even left-leaning economists think it’s a very bad idea.