Modern monetary theory or MMT is a popular theory that gives an apparent blank check to the government for printing money, making it appealing to some economists and lawmakers on both sides of the aisle.
Proponents of MMT insist that as long as a government’s debt is denominated in its own currency, there is no limit on monetary borrowing. Public debt is irrelevant and a country’s central bank can always avoid default by printing more money. Such printing, MMT proponents argue, can go on without any inflationary consequences. They call for economists to stop being superstitious and fearful of debt and for policymakers to embrace unlimited, risk-free government spending.
The proposition that trillion-dollar deficits are OK — that the U.S. federal government can and should freely print money to finance massive spending with no concern about debt and deficits — has been embraced by both the Donald Trump and Joe Biden administrations.
Here are two reasons why the Federal Reserve can’t print as many dollars as it wants.
1. U.S. ability to borrow depends on its credit rating
MMT’s claim that deficits, debt, and massive money printing are harmless “are not only flatly false, they are deeply dangerous,” Jonathan Hartley wrote in a fall, 2020 article for National Affairs, a quarterly journal of essays about domestic policy, political economy and political thought. Hartley was a visiting fellow at the Foundation for Research on Equal Opportunity and a master’s in public policy candidate at the Harvard Kennedy School at the time.
Although Fitch Ratings reaffirmed the U.S.’s AAA credit rating on July 13, it said that could change due, in part, to rising debt levels in the world’s largest economy. Fitch said debt dynamics point to a stabilization in the debt ratio at a level at which a “further meaningful increase” in borrowing could lead to a downgrade, CNN reported on July 14.
People buy the debt and accept the U.S. dollar based on credit and faith in the strength of the system. A drop in the U.S. credit rating could boost interest rates on Treasurys, increasing government borrowing costs and further swell the federal debt.
“The U.S. Treasury has a unique ability to borrow at lower rates, which arises in part because of the safety and liquidity benefits that come from its debt being issued in the world’s reserve currency,” Hartley wrote.
“Yet this special quality does not eliminate the fact that, sooner or later, one does run out of other people’s money. Eventually, interest costs on government debt become as large as the state’s revenue, at which point investors, no longer believing the government to be solvent, will refuse to buy bonds or lend to the government at manageable interest rates … interest costs will eventually subsume all other government revenues. Interest rates being close to zero certainly slows down this process (and negative interest rates reverse it slightly), but once inflation eventually rises, so too will interest rates and the interest costs of public debt.”
2. MMT and inflation risks
MMT proponents argue that money printing can go on without any inflationary consequences. In a March 2019 commentary for the Mercatus Center at George Mason University, Patrick Horan and Scott Sumner criticized the main claims of MMT and identified five weaknesses. All of them involve inflation:
MMT has a flawed model of inflation that overestimates the importance of economic slack: MMT argues that slack — the amount of resources not being used at a given time — determines inflation. There is a tradeoff between inflation and unemployment, with more of one leading to less of the other. However, history — simultaneously high inflation and unemployment in the 1970s — showed that this model was flawed, the authors wrote. Instead, they identified monetary policy, not slack, as determining the path of inflation.
MMT overestimates the revenue that can be earned from creating money: A government can earn revenue from printing money if it costs less to print it than the money is worth. So if a $100 bill costs $0.06 to print, there’s a $99.94 profit. But if the government does not pay interest on that money, it will be spent fast by the public. The result is high inflation for not much added revenue, the authors wrote. One study found that the maximum sustainable amount of revenue from money creation is roughly 4 percent of GDP, which would generate annual inflation at 266 percent.
MMT overestimates the power of fiscal policy and underestimates the effectiveness of monetary policy in determining inflation, so raising taxes is the solution to high inflation. However, this is not what has happened in U.S. economic history. In the 1960s, President Lyndon Johnson used this logic to raise taxes and balance the budget. High inflation persisted and only fell in the early ’80s when Fed Chair Paul Volcker cut the growth of the money supply. Budget deficits were high at the time under President Ronald Reagan.
MMT overestimates the ability of fiscal authorities to control inflation: Fiscal policy in most countries is determined by politicians, who respond to the interests of their constituents. “How likely does it seem that Congress and the president would be likely to raise taxes during a period of high inflation when the public is already upset at rising prices? Not very,” the authors wrote.
MMT has too few safeguards against the risks of excessive public debt: As Greece learned during the Great Recession, debt might look manageable in one economic environment but be unsustainable in another. “While the U.S. is unlikely to default on its debt, high debt can cause other problems, including either higher taxation or higher inflation in the future. Either of these problems can stifle future growth and prosperity,” the authors wrote.
There is no guarantee that the U.S. will always be able to pay off massive amounts of debt with ease, Horan and Sumner concluded. “History tells us that circumstances change.”
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