January 29, 2021 glacierinvest

Modern Monetary Theory (“MMT”) has become increasingly popular over the past several years. I recently listened to Stephanie Kelton’s The Deficit Myth to learn more about the rationale for MMT. Modern Monetary Theory claims that currency issuers (e.g., United States, Japan, Eurozone, etc…) don’t have to operate under the same restrictions as households operate. Households are required to focus on generating enough revenue first and then they can spend. The governments of currency issuing nations don’t have the same constraint. They can spend first and generate the revenues to cover their expenditures afterwards. In other words, the conventional wisdom of having enough money before you incur expenditures need not apply to currency issuing nations. For many, this sounds ludicrous as it’s contrary to what most of us have been taught about sound financial management throughout our lives. Professor Kelton acknowledges such in her book but goes on to provide an informative explanation of how MMT actually works.

One of the first things Professor Kelton addresses in the book is the perception versus reality of how the government spends and funds those expenses. While most of us believe our government taxes and borrows first and then spends, the government actually spends first and then taxes and borrows, which is what MMT proposes.

Another main point of The Deficit Myth is that fiscal deficits aren’t nearly as important as we make them out to be. Per Professor Kelton, we shouldn’t be making spending decisions exclusively on the basis of fiscal deficit impacts. In reality, fiscal deficits aren’t as detrimental to a currency as inflation is. The key to maintaining a healthy currency is keeping inflation in check. This is accomplished by achieving the appropriate ratio between revenue sources (taxes and borrowing). Inflation will begin to rise as debt levels get too high and can only be offset by raising taxes to bring stability back to the currency. Maintaining the proper equilibrium between tax revenue and debt levels is the key to a stable currency in an MMT framework.

While Professor Kelton claims we can’t allow fiscal deficits to hold us hostage, she highlights other deficits we should be focusing on such as the jobs, healthcare and infrastructure deficits among others. In an MMT framework, sufficient money could be created to address these deficits.

On the surface, MMT makes a lot of sense to me. Determine what your spending priorities are and create enough money to fund them while finding the optimal balance between taxes and borrowing. This really resonates with me. However, my biggest objection to MMT is not the theory itself but the fact that people would be making decisions within the MMT framework. As should be obvious, it’s incredibly difficult, if not impossible, to exercise fiscal prudence and discipline if there’s a perception that we have unlimited resources. Most people when they have a financial windfall end up feeling wealthier and loosen the purse strings and end up spending more, often on things that might not be necessary. It’s basically the wealth effect, which states that when the value of our assets rise we feel more financially secure and thus more willing to spend money, perhaps unnecessarily or recklessly.

Congress has repeatedly demonstrated it is willing to spend money on things that aren’t necessary at certain points in time. In any necessary spending bill or package, such as the 2020 stimulus packages, there are always pet projects of certain senators, or senators’ constituents, that get included in these packages in order to get the senators’ approval for the bill. I’m sure the thought process is something along the lines of: “What’s another $25m in a $1 trillion bill?” Over time the seemingly insignificant pork adds up financially and can build resentment among citizens, especially in areas that aren’t getting their pet projects funded. Additionally, it reflects the lack of fiscal discipline that already exists in our government. The political party doesn’t matter. If it’s a priority for senators and/or their constituents then it often is used as leverage to get the senators’ votes. I realize this is how the political system works but it results in an inefficient allocation of resources, potentially at the expense of higher priorities in the future.

Ultimately, my fear about MMT is that it would create a mindset of unlimited resources in which continued, and increasingly, imprudent spending decisions would be made. While Professor Kelton may be correct in claiming fiscal deficits aren’t important, operating out of concern of fiscal deficits does help to hold Congress somewhat accountable in the decisions it makes. As with any system, MMT would only be as strong as its weakest link, which would be us in this case.

The main takeaway for me from The Deficit Myth is that MMT is not a theory that advocates for reckless spending and debt levels. It simply takes a different perspective on deficits, how to fund them and how to maintain balance in a currency-issuing system all in the name of meeting the needs of our country and its citizens. Additionally, it has led me to reflect on the potentially more important topic of what are our priorities as a country and how do we achieve them?

(Note: I don’t believe there was any mention of the interplay between higher government debt levels and economic growth. I would like to understand the MMT view on that relationship.)