In a world of rapidly rising government debt, Modern Monetary Theory (MMT) is attracting attention. That is not surprising, given that the theory purports that a government that controls its own currency should not worry about balancing the public budget, as it can always issue debt and create more money to pay it back – as long as the debt is issued in its own currency. The only constraint on public spending is the total productive capacity of the economy. As long as there is spare capacity (unemployment) governments can spend freely without creating inflationary pressures or other adverse effects. Taxes do not serve to finance public spending, but are simply a tool to withdraw purchasing power from the private sector or to redistribute wealth in society. Now, as lockdowns have pushed government indebtedness to new highs, some earlier sceptics are cautiously embracing MMT as a means of avoiding a showdown with economic reality.
There are many problems with MMT, but let us leave aside the theoretical problems with how MMT defines money, taxes, savings and debt (we discuss some of the problems here). Even if one was to concede that the theory was correct regarding such accounting identities, the practical implementation raises serious issues.
First of all, the claim that monetary expansion will not cause price inflation while output is below capacity is wrong. MMT’ers will point out that neo-Keynesian policies like Quantitative Easing (QE), specifically enacted to drive up price inflation via an increase in aggregate demand, has failed to spark consumer price inflation. However, other prices have not remained stable; equity markets, housing and other real assets have skyrocketed. This is exactly why Austrian economic theory defines inflation as an increase in the money supply and not a rise in consumer price levels; where in the economy inflation manifests is irrelevant. If more currency is created, the holders of that currency are poorer and the party who received the new currency (the government) is richer. Resources are transferred from the private to the public sector. This is why inflation is sometimes described as stealth taxation.
Second, MMT relies on the notion that idle resources can be utilized by the public sector without adverse effects on the private sector. It even claims to provide a benefit, as by employing those who would otherwise be unemployed, the state ‘maintains’ the stockpile of excess labour, leaving them easier to reemploy back into the private sector once labour demand increases. While this sounds alluring, in reality large scale government work programmes will inevitably compete for resources that are in demand in the private sector. Moreover, Austrian economists point out that there is a reason why there are idle resources in the economy – it stems from a recession caused by an unsustainable credit expansion and these resources cannot just be employed at random in some public bureaucrat’s pet projects but need to be guided into industries and professions that are in real demand. Employing unemployed construction workers to build more housing from the public purse does not solve the structural problem of excess housing stock and too many workers being skilled in construction. Only a free market can guide idle resources to achieve the optimal capital allocation. Deficit spending can (at least temporarily) increase GDP but GDP is not wealth. Wealth is created when production meets actual, not artificial, demand.
Third, the efficacy as an economic policy relies on politicians being willing to rein in spending or increase taxation to withdraw resources from the private sector once output approaches total capacity in the economy. But anyone who have followed the evolutions of the Western welfare states, where spending always begets more spending, will know that this is unrealistic – much like the current reign of Keynesian economists has not seen high economic growth being met with contractionary fiscal policy as the theory prescribes. Political expediency trumps economic theory. There is no reason to think that MMT economists would have more luck enforcing the prescriptions of their theory on elected politicians.
Even if MMT worked in theory, the real-life consequences of implementing it would not just be ballooning public borrowing but inflation, competition for resources between the private and public sector, misallocation of capital and lower long-term economic growth. That is why politicians must fight the urge to adopt MMT, no matter the allure in a post-Covid19 world of astronomical deficits. Excess capacity does not occur at random but is the result of capital misallocation, and employing idle hands at random does nothing to rectify the problem. Resources spent in the public sector cannot be spent in the private sector. Deficits are not just accounting identities to be squared off against borrowing, they represent borrowed consumption and will have to be squared off against less consumption in the future. There is no magic money tree. The reality is that debts need to be paid back, no matter who is borrowing the money.