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The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy
Stephanie Kelton
John Murray 2020

Macroeconomics
William Mitchell, L Randall Wray & Martin Watts
Red Globe Press 2019

Modern Monetary Theory (MMT), which began as a fringe school of economic thought two decades ago, has gained in popularity in the past couple of years.

Since the COVID-19 pandemic and huge global government deficit spending began, it has even gained mainstream media attention. Two recent books provide excellent guides as to what MMT is about.

MMT is a cluster of economic theories and policies, the main practical upshot of which is that governments that issue their own currency cannot run out of money and therefore budget deficits and the resulting debt are not necessarily a concern.

In fact, a rational policy for capitalist governments would be to aim for a budget deficit in all but exceptional circumstances.

Economist Stephanie Kelton, a former adviser to progressive United States Senator Bernie Sanders, explains the ideas of MMT in The Deficit Myth.

Its chapters open with an economic myth and an MMT response which provides a succinct outline of what MMT is.

“MYTH #1: The federal government should budget like a household.

“REALITY: Unlike a household, the government issues the currency it spends.”

It is a common mantra of politicians and economists that a government has to “balance the budget”. If it decides to spend money on something it has to make cuts somewhere else or increase taxes to pay for it.

This is frequently accompanied by a relatable tale about how families or businesses have to do the same with their budgets, or they will run out of money.

The MMT response is that this is a false comparison, as governments, unlike families or businesses, are able to create their own currency. They are currency issuers rather than simply currency users.

“MYTH #2: One way or another, we are all on the hook [for the national debt].

“REALITY: The national debt poses no financial burden whatsoever.”

Politicians tell us that running continuing budget deficits will build up a debt which we, or future generations, will have to make sacrifices to pay back.

However, a currency issuer can always create the money to pay off debt.

Due to self-imposed rules, in countries like the US and Australia, there is a separation between the treasury, which funds budget deficits by selling interest-bearing bonds, and the central bank, which is actually given the power to create money. Treasury builds up a debt by selling bonds to fund its deficits.

But the central bank has the ability, firstly, to control the interest rates on government bonds and, secondly, to buy those bonds up again with money it creates merely by electronically entering credits into the bond sellers’ bank account.

The most heavily indebted developed country is Japan, with government debt at 240% of GDP, or US$96,000 per person. But half of these bonds have already been bought up by the Bank of Japan, meaning that debt effectively has been retired and the rest could easily be retired with a few computer keystrokes.

“MYTH #3: Deficits are evidence of overspending.

“REALITY: For evidence of overspending, look to inflation.”

While deficits are not necessarily a problem, governments can’t spend limitless amounts without running into any problem.

The limit, however, is not posed by the need to balance the budget but by the real resources of society.

Capitalist economies, as a matter of course, have unused, excess capacity, most clearly represented by persistent unemployment.

MMT proposes that governments ought to spend to put this excess capacity to use.

The key policy here is a jobs guarantee. With its ability to create money, government can afford to offer everyone a job at a liveable minimum wage, expanding the economy and providing socially useful goods and services.

However, once an economy is operating at, or near, its capacity, for a government to spend more would only put more money into the economy without producing more and thus lead to inflation.

Inflation, therefore, is an indicator that the economy has reached its real limits. Governments should worry about this limit, not its financial limit.

Further aspects of MMT are indicated by other myths that Kelton addresses.

“MYTH #4: Government deficits crowd out private investment, making us poorer.

“REALITY: Fiscal deficits increase our wealth and collective savings.”

“MYTH #5: The trade deficit means America is losing.

“REALITY: America’s trade deficit is its ‘stuff’ surplus.”

“MYTH #6: “Entitlement programs like Social Security and Medicare are financially unsustainable. We can’t afford them anymore.

“REALITY: As long as the federal government commits to making the payments, it can always afford to support these programs. What matters is our economy’s long-run capacity to produce the real goods and services people will need.”

A more thorough and detailed account of MMT can be found in Macroeconomics, written by three prominent MMT economists. It is actually written as a macroeconomics text book, but from an MMT perspective. As such it not only covers MMT, but outlines and critiques the prevailing mainstream economic theories that are generally taught as “macroeconomics” with little regard to their flaws or the existence of alternative theories.

Macroeconomics provides a more thorough treatment of MMT theories than Kelton’s book does. It includes significant use of graphs and mathematics, although nothing beyond high school level. However, Kelton’s very readable book may be preferable to those who find that unappealing.

Something that often gets lost in discussions around MMT is that traditional taxing and spending will still be necessary.

In OECD countries, government spending ranges from 25–56% of GDP while revenue ranges from 23–58%.

By comparison, the excess economic capacity that MMT proposes to engage, as represented by the unemployment rate, is generally in the single digits. If MMT funding was used as an alternative to taxing and spending, public services like health and education would have to be practically eliminated.

So while MMT illustrates why deficits are not necessarily a concern, the need to tax the ability to command society’s resources away from the private sector and put it towards public spending remains. Hence, the question of who is going to pay for public services cannot be dodged.

Yet, Kelton writes that “building a better economy isn’t contingent upon raising enough revenue to pay for the things we want. We can, and must, tax the rich. But not because we can't afford to do anything without them.”

True, we could do some things without such taxes, but it would mean bulldozing public services.

Kelton and the Macroeconomics authors are not unaware of this and don’t propose that tax and spend policies should be abandoned. However, MMT’s emphasis on the role of taxation is overwhelmingly as an anti-inflationary measure, often downplaying its necessity for providing public services.

Kelton recognises that MMT “can be used to defend policies that are traditionally more liberal … or more conservative (for example, military spending and corporate tax cuts).”

Even though MMT advocates are very largely in the liberal camp, by emphasising taxation as a counter-inflation measure rather than its necessity in providing public services, it can license a sidestepping of the question of who is going to pay.

If MMT continues to gain a more mainstream following, its conservative potential may become increasingly evident.

Another problematic aspect of MMT, supported by Kelton and the Macroeconomics authors, is its revival of the early 20th century ideas of chartalism. This can be summed up by the claim from original Chartalist Georg Knapp that money “is a creation of the legislative activity of the state”.

MMT essentially describes an economy based on a fiat currency. Prior to 1971, currencies were based on the gold standard.

Governments secured confidence in the value of their currencies by guaranteeing that they could be exchanged at a fixed rate for gold. This system restricted the ability of governments to create money at will if they did not have the gold reserves to back it up.

The government ability to relatively freely create money that MMT describes is only applicable to a post gold-standard world.

The MMT revival of chartalism appears to be an attempt to elevate (a mistaken analysis of) fiat currency, created by government and not backed by any particular commodity, into a fundamental and universal account of money.

However, the fact that, historically, money existed in the form of commodities, such as cowrie shells, salt and even as metallic coins, long, before the state took on the role of issuing it, makes the MMT theory of money implausible.

Nonetheless, a system of fiat money is what our economy is based on today, so much of what MMT has to say still stands, even if we set aside its unnecessary and unhelpful commitment to neo-chartalism.