An assessment of modern monetary theory

Modern monetary theory (MMT) is a so-called heterodox economic school of thought which argues that elected governments should raise funds by issuing money to the maximum extent to implement the policies they deem necessary. Over the last few years, it has been supported by political representatives, for whom MMT has provided a rationale for their calls for Green New Deals and other large public spending programmes. Most recently, it has also found an echo in calls for bold post-COVID-19 recovery plans. But it also came under increased scrutiny and fire from the mainstream economic world.

This article seeks to understand modern monetary theory (MMT) using six frequently asked questions.

What exactly is MMT all about? The MMT doctrine suggests shifting to a regime where the government finances its spending programmes by issuing base money, to achieve full employment. Should inflationary risks emerge, it is expected to raise taxes. The job of the central bank (if any) boils down to accommodating the needs of the government.

How do MMT’s theoretical foundations compare with the consensus approach? The MMT doctrine relies on an unconventional approach for its assignment of macroeconomic policies to the macroeconomic stabilisation targets: the government (through fiscal policy) must tackle the joint full employment price stability objective, while the central bank (through monetary policy) deals with debt sustainability. Under the consensus approach, it is the other way around: monetary dominance prevails. In theory and assuming both these policy‑makers deliver on their mandates by appropriately deploying their respective instruments, both approaches should put the macroeconomy on track to equilibrium.

Is MMT workable in practice? There is some indication that the MMT doctrine may face practical limitations. Elected governments are typically associated with commitment problems, because they have incentives to push the economy beyond its productive capacity/full employment. And as the government commitment to the joint objective of full employment and price stability can be perceived not to be credible, it is more likely that people's inflation expectations are not well anchored.

Why has MMT been so popular in recent years? The low inflation context of the last few years might suggest that the inflationary risks induced by expansionary fiscal policies are limited. And the low interest rate environment points to contained servicing costs for the sovereign debt. But MMT’s appeal might rely too much on the persistence of such low inflation and low interest rates.

How does MMT compare with the Eurosystem’s asset purchase programmes (APP and PEPP)?

Asset purchase programmes and MMT both aim at stabilising the economy. But their approaches differ. While the asset purchase programmes seek to lower longer-term rates to ensure easy funding conditions for the whole economy until the economy takes off again, MMT concentrates solely on providing the government with ample and cheap financing on a permanent basis.

Is a temporary switch to MMT principles realistic in the euro area in the COVID-19 crisis context? The recent increased need for further fiscal support in the midst of the COVID-19 crisis justifies an in-depth reflection about the appropriate monetary-fiscal policy mix to support a fast and sound economic recovery. Doing so does not mean that monetary dominance should be abandoned, and MMT recipes taken on board. Avoiding being perceived as opening the MMT Pandora’s box is key: that will minimise the risk of having to make a painful choice between high inflation and severe fiscal consolidation in the (distant) future.