MMT: A Highway to Hyperinflation

M odern Monetary Theory (MMT), a fringe framework for understanding our money system, is on a charm offensive. The government spent trillions of dollars over the past two years, real bond yields are negative, and inflation is running hot, but MMT’s proponents are apparently taking “something of a victory lap,” according to a glowing new profile of the face of this theory, Professor Stephanie Kelton, in the New York Times.

In response to the victory-less victory lap, the economic problems with MMT have been spelled out over the last few days by eminently qualified academics (for a good summary of the objections to MMT, it’s well worth reading this piece by Noah Smith). The first among its problems is that MMT has no rigorous economic models or schematics attached to it. To say that it is ill-defined is an understatement. Advocates of MMT, for example, use a different definition of “savings” than all other economic schools (not counting investment), and they play games with the notion of the “natural” rate of interest. They make large claims about the long-run non-neutrality of money. Economists from Michael Strain to Paul Krugman have been scratching their heads trying to figure out what exactly it is the MMT crowd believes.

But layered atop the eccentric economic views contained within MMT (to the extent that one can coherently express them) are some equally implausible assumptions about political behavior. The disastrous consequences of these errant assumptions are utterly predictable, and yet MMT advocates assume them anyway.

First, MMT advocates a permanent zero interest rate and elimination of the bond market. Today, if the Fed wants to increase the money supply to spur lending, it can buy treasuries from banks in exchange for loanable funds. To put it simply, the banks, awash in new reserves, are then able to lend more, thereby increasing the supply of money in the real economy and lowering the interest rate. That result is a matter of basic supply and demand. By the same token, if the Fed wishes to reduce the money supply to control inflationary pressures, it can sell treasuries and take those bank reserves out of the market, restricting the supply and raising the interest rate. This policy tool would be eliminated under an MMT regime.

How, then, could the government fight inflation? MMT leaves only one tool to reduce the money supply: taxes. According to MMT, the government doesn’t collect taxes to pay for things; rather, it collects taxes to reduce the money supply and to create a demand for dollars in the first place.

Imagine, then, how the MMT scenario plays out. Inflation burns hot and prices begin rising faster and faster. People watch as the dollars in their bank accounts buy fewer and fewer groceries, gallons of gas, or other necessities of life. Voters ask government to do something to restore their evaporating purchasing power. In response, Congress decides to . . . raise taxes? Take more of their money?

This is beyond implausible: It is the opposite of what would happen. We know the playbook that the party in power uses to avoid blame for inflation. Every week for the last several months, President Biden or Press Secretary Psaki have blamed “corporate greed” and “price gouging” for Americans’ rising expenses on everything from gasoline to meat. Just last week, in the face of the highest inflation rate in 40 years, Representative Pramila Jayapal (D., Wash.) launched an attack on Starbucks for “price gouging,” as though anyone were forced to buy a Frappuccino. Senators Mark Kelly (D., Ariz.) and Maggie Hassan (D., N.H.) have called for suspending the tax on gasoline. Between price controls, subsidies, and tax cuts, the measures that elected officials most commonly propose in response to higher prices would all result in more money being poured into the economy, which, without monetary tools to curtail it, is an invitation to hyperinflation.

That leads to MMT’s second disastrous idea: directly monetizing government debt. The great institutional change that MMT would implement is an effective merger between the Fed and the Treasury. In technical terms, it would turn the Fed’s liabilities into legal tender, which is currently illegal under the Federal Reserve Act. In other words: money printing.

Currently, all the government’s spending, excessive and bloated as it seems, is debt-financed, not monetized. The Treasury sells bonds at auction and uses the money from those sales to fund its programs. In this arrangement, no new money is created by government spending since purchasers have to pay for the bonds with existing money. Quantitative easing, for example, is when the Federal Reserve purchases bonds or mortgage-backed securities from primary-dealer banks (banks that have an account directly with the Fed) that purchased those assets elsewhere. Fed purchases are more accurately referred to as “asset swaps,” since the bank reserves they swap for bonds are not legal tender. The Federal Reserve cannot spend money directly into the economy. You and I cannot take out a mortgage from the Fed. The Fed can, in essence, sell bank reserves to a bank. Those reserves must be converted into loans and lent into the real economy in order to become new money.

But MMT has no objection to a different arrangement: The Federal Reserve, rather than commercial banks or private citizens, could simply print new money as directed by Congress, and use it to “buy” zero-interest “treasury bonds,” effectively selling money to itself. The government would then spend the newly printed dollars directly into the economy, whether to finance a federal jobs guarantee, a Green New Deal, or take your pick, although under the logic of MMT you really wouldn’t have to. In Kelton’s words: “We can run fiscal deficits without increasing the debt, if we don’t issue the Treasuries.”

This is, to put it mildly, unwise. There is a very good reason that fiscal and monetary policy should be kept separate. Monetizing the debt so that the government can put (allegedly) “idle resources” to use would quickly lead to hyperinflation, which (as mentioned above) the MMT crowd would “solve” with the only tool at hand: raising taxes. This entails the government, which created the inflation by overspending, having to seize an even greater percentage of control over the economy by taking money away from citizens.

MMT’s vision assumes that Congress would, once granted the ability to monetize debt and effectively spend unlimited amounts of newly printed money, spend right up until the economy reaches full employment. At that point, the same political body currently blaming corporate greed rather than itself for increased coffee prices would turn off the money spigot, with no concern for the interest groups reliant on newly created government programs.

What would really happen, as business economist Lacy Hunt says, is that Gresham’s law would be triggered, and bad money would chase out the good. “In very short order,” he warns, “everyone would be totally miserable.”

The end result of this is obvious: a massive increase in the government’s command and control of economic decision-making in the United States.

There are many problems with MMT, even strictly within the scientific discipline of economics. But politically, it ought to be a nonstarter. The policy recommendations of those who advocate it are among the most predictably destructive to come out of any school of economic thought since the time of Karl Marx. MMT should remain on the fringe where it belongs.