Recently there have been many articles criticising Modern Monetary Theory (MMT), but there seems to be near universal agreement from MMT economists that these articles are attacking a strawman version of MMT, and that their true views are misrepresented — and this may be true. One difficulty in critiquing MMT is that there seems to be slightly different versions of MMT floating around online: MMT as exists in obscurer academic literature, including some older Post-Keynesian literature; MMT as it exists among various economics bloggers; and MMT as it exists on social media and on comments sections. In this article I will attempt (but probably fail) to critique MMT in good faith, but I will be targeting MMT as it is generally presented to the public — that is where I’ve digested most MMT content: mainly through MMT bloggers and on twitter. If this is at odds with some more academically pure version of MMT that exists in the literature, I can only suggest that modern monetary theorists could then work on their messaging somewhat. Perhaps the best way to start a good faith critique of MMT is to list its strong points of MMT:

The Good

· A positive vision. So much so called ‘heterodox’ economic literature simply consists of criticism of existing economic models and policies (which is easy to do — they are generalised simplifications by design), without offering an alternative framework or set of policy prescriptions. MMT on the other hand is a positive movement, in the sense that it doesn’t just critique orthodoxy but provides a new macroeconomic framework and a set of policy prescriptions that offer a positive vision for the future for progressives and centrists alike without the baggage and militant history associated with previous left wing movements. One might effectively argue that this mix of positive economic analysis and political activism is inherently compromising, but it is refreshing nonetheless.

· Politically effective. While this is by no means exclusive to them, MMT economists are effective at countering claims from austerians and hard money types and have reinforced important concepts from traditional macro like the aggregation fallacy of treating an entire economy and government budget like a single household that’s insulated from feedback effects. Furthermore, it is certainly true that for some countries, obsessing over how to pay for new investment and transformative policies can get you really stuck in a rut. Modern monetary theorists (MMTists) are right that for really important measures it’s often better to simply spend and invest the money now and figure out how to get funding later — they will point out for instance that nobody asked how we were meant to pay for a very costly and wasteful war in Iraq and yet that didn’t result in a budget crisis, so why should we obsess over it for important policies like tackling climate change? This resonates with me, things like government debt and interest rates are just numbers on a spreadsheet — in times of crisis we shouldn’t worry about spreadsheets holding us back, it’s the real resources we have available that matters.

· Not zero sum. So many previous progressive movements have been inherently austere by nature; demanding we reign in excess consumerism — or even going full Neo-Malthusian and insisting we embark on ‘degrowth’ and simply redistribute existing wealth to compensate. True to Keynes, and honestly modern economics in general, MMTists recognize that the idea that prosperity and social progress must compromise with growing the economy is a fallacy.

· Renewed interest in institutional detail. Again, while this is definitely not exclusive to MMTists , a lot of content has been produced by MMT economists detailing the monetary operations and institutional structure of ‘monetarily sovereign’ governments , much of it useful and illuminating — showing that some existing economic models contain implicit assumptions about monetary operations that may be wrong. Details such as these used to be dismissed as trivial or ‘netted out’ by some economists when in fact they can matter a lot, and it’s great to see renewed interest in methodically detailing how our economic institutions actually work in practice. However, I happen to think that MMT makes many wrong or dubious claims about the modern monetary systems and their operations too, which leads nicely onto the next section:

The Bad : Monetary crankery

MMTists often like to position themselves as the only ones to properly understand the ‘operational realities’ of modern monetary systems. Ironically, many of the claims made by MMTists on this topic are misleading at best. One common rhetorical tactic that I’ve noticed they employ, which often catches their critics out, is to use the term ‘government’ in a way that’s different typically from how it is used in mainstream economics. When they say ‘government’, they tend to include basically any institution that is an agent of the state, including the central bank — hence the ‘government’ here includes consolidating the treasury and the central bank into one entity, effectively ignoring or assuming away any independence the central bank may have.

This allows them to make assertions such as that money is created by government spending, or for instance, as Kelton claims, that government spending is “self-financing”. What’s even more confusing is that some supporters will often use the ‘treasury’ and ‘government’ interchangeably, despite the terms meaning very different things, and then essentially claim that even the treasury creates money when spending, which is definitely false, which I’ll get to later.

From these premise they are able to make further dubious semantic claims, such as that taxes and borrowing don’t actually “fund” government spending at all, and that the true purpose of taxation is to remove excess high powered money from the economy — in other words, taxes and borrowing are monetary policy operations. What’s interesting about this claim, I argue, is that it’s doubly wrong: it’s wrong both in a nominal operational sense and it’s wrong in a ‘real’ resource sense.

In a nominal sense, nominal funding simply means acquiring money before spending it. A general economic rule I propose is that for money users in a modern banking system, all credits require debits; the only entity that can credit without debiting is the one authorised to issue the money. What about the government? Since it can issue money, does this maxim still apply to it? Does the government need to nominally fund its expenditure still? Well, yes, in practice. Expenditure is carried out by the treasury, so let’s start there: typically the treasury is not authorised to issue the most common form of high powered money that is actually used for spending — bank reserves, and I believe in MMTists will agree with me so far. Thus in practice, the treasury has to secure this money in order to spend it, which it does by debiting its account at the central bank in order to credit other accounts. Technically, the treasury can issue physical currency, but government spending is practically never done this way in modern democracies (not that their haven’t been attempts, such as the ill fated mint the coin proposal).

Another important point is that the treasury cannot typically overdraw from its account at the central bank. In the United States JP Koning notes that it is currently illegal for the treasury to have an overdraft with the Federal Reserve. Thus, the treasury can only spend by first ensuring it has adequate funds in its account with the central bank. How does it do this? By collecting taxes receipts and selling bonds. Thus, taxing and borrowing does indeed fund treasury spending specifically. But what about the government in general? This is where the semantic headaches start; as stated earlier, typically in mainstream discourse when we talk about “government spending” we’re talking about spending from the treasury, not a consolidated treasury — central bank entity, which causes some of the confusion in the first place. But let’s define government in this way, for the sake of argument — does it then make sense to say that taxes/borrowing funds spending? After-all, this money is ultimately created by the government (the central bank) in the first place; it didn’t need taxes or borrowing to come into existence.

The answer is again: yes in practice. Whether MMTists want to admit it or not, while the central bank is an agent of the government (normally at least), it does still operate independently. When the government wishes to spend, it cannot simply demand funding from the central bank directly or even indirectly — it has to engage in borrowing and taxation without assuming any particular quantity of bonds will be purchased by the central bank. What MMTists will say here is that treasury and central bank will ‘coordinate’, setting up bond auctions and targeting a particular interest rate, with the CB purchasing bonds from the secondary market and expanding the money supply as needed, such that the treasury will always get the funding it needs. From here, they make the most bizarre claim in my opinion, which enables them to maintain the ‘taxes/borrowing not funding spending’ claim — they argue that the purpose of taxes and borrowing during this sequence of events is merely to ‘drain reserves’ from the system.

In other words, they claim, the purpose of taxation and borrowing is simply to remove the build-up of excess money from the economy that can occur when acquiring credit from the central bank, in order to maintain an interest rate target, or ultimately to stop inflation. To me this is manifestly absurd. To start with, intentions matter, if you ask any politician for what purpose they will approve any tax levied, I am confident exactly none of them will claim it’s in order to control the amount of reserves in the system as an anti-inflation measure (but I’m happy to be proven wrong). A more formal way that MMTists might put it is that taxes/net borrowing are simply a residual automatically adjusted to keep aggregate reserves in balance while the government acquires central bank credit to spend. The reality, of course, is that the central bank is the agency tasked with controlling the money supply, and will add or remove reserves via open market operations in order to target a particular interest rate, and hence it is commonly understood that it is central bank operations that act as the residual in controlling reserve balances, not taxing/borrowing.

As stated previously, central banks typically, including the federal reserve, are not legally allowed to directly finance the government, thus even if the government issues the money to begin with, as this money is issued by a separate independent agency to the agency that spends money (the treasury), the government must reclaim this money through taxes and borrowing before it can spend, which most people would regard as funding. So why do MMTists claim otherwise? The above linked Levy Institute paper dismisses such legal obstacles as “self imposed constraints”, but this is a red herring. Ultimately all economic institutions are largely composed of ‘self imposed constraints’, and it is by these constraints that we define how our economic institutions govern. One cannot assume away these constraints, assuming away the constraint that holds that spending must be tax and bond financed is in effect assuming the conclusion.

Additionally, in previous discussions I often see people try and substantiate these position by bringing up the ‘Treasury Tax & Loan Service’ (TTL), which is a system of distributing tax receipts across various select banks in the US banking sector as a buffer — they’ll point to how this system operates, whereby reserves are drawn from the TTL as needed when spending occurs, or otherwise, in order to ensure aggregate reserves remain in balance. But this is a highly obtuse argument: the TTLs are really just an internal mechanism employed by Fed to help with financial stability; when the Fed draws from these funds, this is not “taxation” in any meaningful sense — this money is already the government’s to begin with, as far as the public is concerned they were already taxed long ago. TTL operations should instead be considered a monetary policy operation, not taxation, and if an MMTist uses the TTL to argue that taxation is a monetary policy operation, you should consider this a fallacious rhetorical trick.

Now that we’ve hopefully established, in a long winded way, that government spending is in fact nominally funded by taxes and borrowing, we should move onto “real” funding. By this I mean providing the real resources necessary to purchase or deploy real goods and services. Both MMT and most of the mainstream essentially agree that governments have finite fiscal space — that is the ability to utilize idle resources to achieve its goals without competing with and bidding up already utilized resources. Here again many MMTists tend to argue then that government spending is simply the process of acquiring and utilizing resources — and that the purpose of taxation/borrowing is for when the government is close to an idle resource constraint but needs more resources. To claim that taxation or borrowing here should not be considered funding is again manifestly absurd. It is quite clear that in a real sense, a government’s “funds” is its fiscal space (defined as idle resources in real terms), and the only way to acquire more fiscal space than is already available, without reducing its own outlays, is to take it from others, in other words either by taxing them or borrowing from them — ergo in real terms taxing and borrowing unequivocally funds the government.

Monetary independence matters

Putting aside the question of whether the central bank really has any independence (MMTists will range from saying the idea of independence is a ‘sham’ to acknowledgement that the central bank at least has independence in ‘day-to-day’ operations), the question of how independent monetary policy decision making should be remains. To properly enact MMT policies, such as permanent zero interest rate policy, we could not have central bank independence (CBI), but most economists agree that at least some degree of CBI is very important. The reasons are fairly straightforward.

Some people argue that central bank independence is essentially a conspiracy to sabotage a progressive agenda and ensure money creation is unaccountable. But this is false, there are reasons why a degree of independence is desirable other than sinister ulterior motives, and independence does not imply non accountability: central bankers are still politically appointed, and have to adhere to a mandate set by politicians, which could change at any time. For a modern economy to properly function the currency needs to retain predictable value, if the value collapses or suffers extreme fluctuations then profound economic disruption and ruin can result. Both MMTists and the mainstream take inflation seriously as a problem. Most MMTists will tend to view inflation in a mechanical perspective: inflation occurs when demand (usually stimulated by government spending) is pushed beyond its resource constraint — while MMTists typically avoid models, this can essentially be reverse engineered to the economy having an L shaped AS curve in a typical AS-AD model — a standard Keynesian view and not particularly distinct from the mainstream. So far so good, but what does this have to do with CBI? What’s missing from this analysis so far is waste and credibility:

· Moral Hazard. Economists argue that the less independent monetary policy is, the more wasteful and non-credible economic policy can become. The most immediate cause under no CBI is moral hazard and conflicts of interest. If politicians can easily create money at will to fund any program they wish, such a responsibility may conflict with their responsibility (which they would have under scenarios where CBI is abolished) to ensure the currency doesn’t depreciate too much. Given that it can take a long time for inflation to occur, while the political payoffs from funding popular projects or tax cuts can be immediate, you have a classic moral hazard problem. When highly profligate spending and money creation does eventually cause inflation, it’s difficult to point to any particular project or tax cut as being a cause, hence an individual policymaker will tend to be shielded from the costs but gain privately from the individual projects they championed — this then approaches a tragedy of the commons problem.

· Soft Budget Constraints. But government investment isn’t necessarily inflationary if it increases productive capacity, could politicians theoretically just ensure all their spending is highly efficient? To make this claim, one would again, I argue, have to ignore modern economics — particularly the ground-breaking work by Janos Kornai on the “soft budget constraint” syndrome. Kornai observed this problem occurring particularly in highly planned economies such as in the Soviet Union — the simplest way to describe the problem is to note that the easier it is for a firm to acquire funding on demand, the less incentive they have to ensure their production is efficient, and the more incentive they have to engage in rent seeking. A clear moral hazard occurs when firms can be assured that the state will offer subsidies and financial assistance when needed. What MMT effectively does is make the government’s budget constraint as “soft” as possible — if a department, state firm or contractor knows that the politician they’re bargaining with for funds and pricing has effectively infinite funds, they can then “rip off” the government as much as possible, knowing full well that any claims, such as them having a limited budget or not having the cash available, would be a lie. The soft budget constraint syndrome will tend to cause ever rising costs, waste, inefficiencies and hence inflation.

Even before this happens, for smaller or less developed nations the public might fear that this might happen in the future, and hence avoid holding cash for fear of future inflation. If too many people have this same fear and dump the currency at the same time, the currency will depreciate straight away in what’s known as a self-fulfilling crisis. This is why economists take credibility seriously. If policymakers are in conflict with the central bank and are pushing through its abolition, this might signal to markets that the country is about to enter “tinpot” territory and cause participants to dump the currency, especially if enough of them believe that such a situation could result in the problems detailed in the above to paragraphs. This is what I call “psychological inflation”, it’s hard to impossible to predict the psychological response will be to economic policy — but it does matter, so governments should try to seem credible.

The purpose of monetary independence then is to avoid the moral hazard and ‘soft budget constraint syndrome’ issues that can arise when policy makers can both create and spend money at will. Entrusting a politically appointed separate agency with the task of adjusting the money supply and cost of borrowing ensures the conflict of interest described previously does not occur, and helps reassure economic participants that economic policy is credible and hence the currency safe. For what it’s worth, some MMTists appear to recognize the importance of separating responsibilities at least, such as Kelton who proposed separate agencies to evaluate new projects and ‘score inflation risk’ — but as I argued previously, it can take a while for inflation to materialize, and given that money is fungible it can be difficult to impossible to blame any specific government project on inflation. MMTists would need to demonstrate how such an agency would be superior to an agency that decides on the amount or cost of acquiring money (central bank) — and to date I have not seen fleshed out details on this hypothesised agency that could explain this. It would also need to resolve the problems associated with fiscal dominance, which I will go into further in the next section.

The theories behind abolishing CBI threatening monetary stability have empirical support too. There are many studies that attempt to construct an index of “central bank independence”, and use the values to predict the performance of various economic indicators such as inflation or growth. Two recent meta-analysis found the effect of CBI on inflation significant: Klomp, De Haan (2010) and Iwasaki (2017). Graphs such are these are common to show the relationship:

Is fiscal dominance stable?

In addition to opposing central bank independence, MMTists, like traditional Keynesians, are in general not too fond of using monetary policy to “fine tune” the economy in general. But MMTists go a step further in advocating that monetary policy in effect be permanently neutered, advocating for interest rates to remain permanently pegged at or near 0% (permanent zero interest rate policy: PZIRP) — in such a scenario this typically means the fiscal authorities are the ones responsible for controlling inflation, in the economics literature this is known as ‘fiscal dominance’.

One common criticism of high government deficits is to point to the build-up of debt that results. Economists usually respond by arguing that this doesn’t matter too much when interest rates are low. In economics, government debt is considered unsustainable when the interest paid on debt (‘r’) exceeds economic growth (‘g’): r > g. PZIRP is an attempt to deal with this potential problem by suppressing r permanently, and it has been observed that countries with very high debt levels will tend to be forced to adopt this policy. Given the higher deficits favoured by MMTists, it becomes more likely that we may be forced to adopt PZIRP too whether we want to or not. But is permanently suppressing rates, whether forced to or otherwise, a desirable situation? Economists argue that PZIRP (which can lead to financial repression) causes financial instability and that fiscal policy is ill suited to deal with inflation.

Post Keynesian economist Thomas Palley argues convincingly that setting rates to zero permanently would eventually force nominal appreciation of the dollar due to the covered interest parity — which would be in conflict with the money financed deficits and inflation associated with MMT’s full employment policy — which in turn would lead to financial instability. He notes that MMTists respond to this concern by advocating for exchange rate pegging — but such a peg would constrain the amount of new money that could be issued and would force foreign reserve holdings — this would effectively make the government less ‘sovereign’ in its money supply and undermine the core premise of MMT by introducing financial constraints on the government. He also cites other work from Aspromourgos showing that zero nominal rates can encourage financial speculation and asset price inflation, leading to financial crisis. There’s no guarantees, but one can’t deny the risks associated with PZIRP, so it does not seem to be a desirable policy in terms of financial stability.

The second issue is whether fiscal policy is an adequate way to control inflation — or more specifically: in this new scenario, under PZIRP, with no CBI, where the money supply is effectively expanded at will by politicians as needed for new spending, if or when inflation occurs will these same politicians be able to deal with it? There are several obvious issues that can arise here. As explored in the previous section — inflation policy becomes politically compromised; even under a situation of high inflation, fiscal policies required to deal with it — tax hikes, austerity — will still be highly unpopular, individual politicians may forego approving such measures in order to not upset their constituents. Passing legislation to deal with inflation and securing the votes needed then becomes very difficult and an undoubtedly slow and tedious process — for smaller counties this can be a recipe ripe for international speculators to attack the currency in the meantime. The core idea expressed by MMTists then, that fiscal authorities should continue to increase spending on social projects until we hit the ‘resource constraint’ (until inflation begins to spike), does not seem so straightforward after-all. The Job Guarantee is their method of ensuring, at least, that austerity does not lead to mass unemployment — putting aside whether this is politically feasible, and the political economy problems noted by Palley in the paper above — the guarantee of a minimum wage job would be little solace to most voters affected by austerity, so I cannot see how this would alleviate the above issues.

Studies, such as De Resende, Carlos

Rebei, Nooman (2008), find that countries with high degrees of fiscal dominance are associated with higher inflation, more severe business cycles and overall suffer significant welfare losses. MMTists often point to Japan as a counter-example, which effectively is constrained to PZIRP due to high debt levels, but still seems to be performing fine. I’m not sure this is an effective argument however: to start with, Japan has in fact suffered considerably over the last three decades — the lost decade saw serious stagnation and real wage decline. I’m not blaming this on fiscal dominance, my point here is that this, combined with the 2008 recession and demographic trends, acts as a strong deflationary countermeasure, reducing aggregate demand over decades which would surely have resulted in a large build-up of spare capacity. As such Japan has not yet had to grapple with inflation for a very long time, and ‘Abeonomics’ has much room to continue to stimulate the economy before inflation might arise. But if or when Japan does finally run out of spare capacity, and inflation becomes a threat, it’s not clear how effectively this will be dealt with. Given that Japan must import a considerable amount of energy, exchange rates are especially important, which might further complicate future anti-inflation policy by limiting the amount the currency can tolerably depreciate — as such one can’t yet consider Japan a true test of fiscal dominance, as we have not yet seen how it might react to an inflation problem.

Can countries avoid a fiscal dominance situation if the central bank or government owns much of its own debt? This is the argument Bill Mitchell implicitly tried to make towards the end of this article, arguing that we shouldn’t consider debt held by the BOJ as part of its debt burden, and hence Japan’s true debt ratio drops to 45%. But this may not stack up when considering fiscal dominance. To clarify, PZIRP is needed when the interest servicing costs to government from higher rates becomes too large a portion of government spending, or as Bill Mitchell puts it, takes up too much “fiscal space”. Does the government owning or monetizing the debt reduce this interest burden? Probably not, some like Ricardo Reis, argue that the scope for the central bank to lower the fiscal burden of debt is limited. Further, if a central bank buys up all or much of the debt, and the banking sector’s government bond holdings are replaced with excess reserves, this would have little effect on the interest burden — as to ensure a higher interest target is met, the same interest rate must be paid on excess reserves to act as the necessary price floor in the first place. In effect, replacing debt with central bank reserves is just replacing one liability with another — in terms of whether PZIRP is necessitated, it would make no difference.

Final thoughts, meeting half way?

The development of frameworks like MMT is understandable given the sway austerians and hard money enthusiasts have had over the media — but that does not excuse sloppy economics. Could there be a version of ‘MMT’ that achieves a progressive expansionary policy agenda without relying on dubious economic theory? I believe there a few things MMTists could do to start with:

First they should simply drop the confusing and misleading claims about whether taxes and borrowing fund government spending (framed as describing ‘operational realities’) — at best it’s speaking another language and stifling efforts to get other economists on board with the framework through semantic confusion, at worst it is simply flat out wrong.

Second, they should take more seriously the moral hazard issues associated with abolishing central bank independence and should consider instead allowing the central bank or another independent agency to control the amount of seigniorage revenue available to the government for spending. There should be no concern about this being undemocratic or compromising progressive policy, as politicians would be free to appoint who they like to run the agency. I myself proposed something like this back in 2012.

Lastly, they should revaluate whether PZIRP and fiscal dominance are healthy situations for a government to be in, and the inflation and financial instability that could result, and flesh out a detailed plan on how inflation might be controlled without relying solely on infrequent discretionary legislation passed by politicians. I have recently seen Rohan Grey propose a separate ‘credit policy’, whereby inflation is subdued by controlling the amount of credit that banks are allowed expand. This is a positive direction, although I would argue this is in actuality just reinventing monetary policy (and current interest rate policy serves the same purpose), and combined with PZIRP might just cause the private sector to continually shrink to make way for more government spending, but perhaps that topic is better left for a future article.