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MODERN MONETARY THEORY: THE END OF POLICY NORMS AS WE KNOW THEM?
Modern Monetary
Theory: The End of
Policy Norms As We
Know Them?
ERIC M. LEEPER
CONTRIBUTING AUTHOR FOR THE
PROGRESSIVE POLICY INSTITUTE
FEBRUARY 2022
@ppi | @progressivepolicyinstitute | /progressive-policy-institute
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MODERN MONETARY THEORY: THE END OF POLICY NORMS AS WE KNOW THEM?
Modern Monetary Theory: ERIC M. LEEPER
CONTRIBUTING
The End of Policy Norms AUTHOR FOR THE
PROGRESSIVE
As We Know Them? POLICY INSTITUTE
JANUARY 2022
ABOUT THE AUTHOR
Eric Leeper is a contributing scholar for the of the Virginia Center for Economic Policy at the
Progressive Policy Institute. He is also the Paul University of Virginia, and a visiting scholar and
Goodloe McIntire Professor in Economics at the member of the Advisory Council of the Center for
University of Virginia, a research associate at the Quantitative Economic Research at the Federal
National Bureau of Economic Research, director Reserve Bank of Atlanta.*
EXECUTIVE SUMMARY
Modern Monetary Theory (MMT) gained bromides and much to gain by replacing historic
popularity at a time when U.S. inflation was policy norms with fresh ideas. MMT explicitly
benign, income and wealth inequality was ties itself to populist policies, self-labeling their
on the rise, and progressive politicians saw a plans “the birth of the people’s economy” [subtitle
political opportunity to pass big-ticket spending of Kelton (2021)]. Any sensible elected leader,
programs. To the nagging perennial question, whose vision is not impaired by conventional
“How do we pay for it?,” MMT serves up a tasty economic thought, would happily gobble up such
answer. You don’t need to raise taxes or reduce a fiscal banquet.
other spending. You don’t need to secure low- MMT is the progressive counterpoint to supply-
cost borrowing. A monetarily sovereign nation, side economics. It supplants the claim that tax
like the United States, can create more currency cuts pay for themselves with the claim that
to buy the goods and services that the programs “…[federal] spending is self-financing” [Kelton
require. (2021, p. 87), emphasis in original]. Both claims
Large new spending programs often invoke in contain a germ of economic substance. Both
U.S. voters fears of persistent budget deficits claims are carefully crafted to provide elected
and rising inflation. MMT delivers the reassuring officials seemingly plausible economic grounds
message that those fears are grounded in to support their preferred fiscal policies (though at
defunct “orthodox” economic reasoning that opposite ends of the political spectrum). Both offer
limits the federal government’s capabilities: we policymakers an ideology freed of trade-offs.
have nothing to lose but our outmoded fiscal
* The author thanks Joe Anderson for many helpful discussions and insights and Campbell Leith, Jim Nason, and PPI staff for detailed comments.
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MODERN MONETARY THEORY: THE END OF POLICY NORMS AS WE KNOW THEM?
Because economic policy is too important 4. MMT does not acknowledge that even well-
to be reduced to catchy phrases and clever intentioned policymakers face incentives
marketing, this essay analyzes MMT economics to use inflation to achieve employment
dispassionately. It does not assess the or fiscal financing goals. Because those
worthiness of MMT’s goals. Instead, it asks if incentives to inflate are especially powerful
MMT can achieve its goals without doing grave for elected officials, many countries,
damage to America’s fiscal standing and, quite including the United States, have adopted
possibly, its economy. The answer: probably not. the norms of (i) independent central
MMT suffers from several flaws: banks tasked with inflation control and
macroeconomic stabilization and (ii) fiscal
policies that largely pay for government
1. It denies a fundamental concept in spending with current and future taxes.
economics: in a society with finite Those policy norms have improved inflation
resources but unlimited wants, market performance and social welfare. MMT
prices adjust to induce individuals and overthrows those norms to move inflation
policymakers to make trade-offs that control and countercyclical policies from
ultimately align supply and demand. the Federal Reserve to Congress, to finance
Economics quantifies the costs and federal spending by creating new currency,
benefits of those trade-offs to inform and to subjugate monetary policy to fiscal
policymakers. needs.
2. That denial leads MMT to see no need to 5. It does not appreciate the central role that
offer a comprehensive theory of inflation. safe and liquid U.S. Treasurys perform
It maintains that inflation gets triggered in the global financial system. Neither
when economy-wide demand for resources does it apprehend the extent to which its
exceeds the economy’s resource limit, policy proposals may destabilize financial
but has little to say about inflation and its markets and undermine the special status
determinants when, as it usually does, the of Treasurys and the dollar in the world
economy operates below that limit. economy, a status that strengthens the U.S.
economy.
3. MMT’s solution to inflation from high The problems begin with the basic assumptions
resource utilization is to raise “taxes,” that underpin MMT. Its advocates attribute
without specifying which taxes. all unemployment to insufficient demand for
Governments have many tax instruments workers and believe unemployment should be
at their disposal — labor, sales, capital, alleviated through a federal guaranteed jobs
wealth, and inflation — and each tax program. Weak demand frequently underlies
affects individuals and the macro economy unemployment, particularly during economic
differently. Generic advice to control downturns. But workers themselves have a say
inflation with higher taxes is vacuous until in their employment status. During the COVID-19
MMTers provide far more detail.
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MODERN MONETARY THEORY: THE END OF POLICY NORMS AS WE KNOW THEM?
pandemic, a broad cross section of workers infrastructure, climate, and democracy. MMT
left the labor market and voluntarily have not promises to address each of these deficiencies
re-entered. From March 2020 to October 2021, by first altering policymakers’ understandings of
labor force participation rates were depressed fiscal financing matters.
relative to the previous year: 2.5% for men, MMT abandons two long-standing policy norms.
2.6% for women, and 3.8% for workers 55 The first came from Alexander Hamilton in 1790
and older. Employers across the country have and can be summarized as “federal budget
positions that remain unfilled. COVID is surely an deficits beget budget surpluses,” meaning that
unusual situation, but it serves to illustrate that debt-financed spending is backed by future
employment outcomes are not always driven by taxes. This norm has contributed to less costly
insufficient demand. financing and bestowed on U.S. Treasurys status
MMT is at its weakest when addressing inflation, as the world’s go-to safe and liquid assets,
how it gets determined and how policies can enabling their critical role in global financial
control it. Its most common argument reduces markets. The second norm evolved from the
to: inflation control is not a problem until it is. 1951 Treasury-Fed Accord to make monetary
Problems arise when resource utilization reaches policy operationally independent. Legislation
some limit, at which point higher taxes can keep houses countercyclical policy primarily in the
inflation in check. But resource utilization is not Federal Reserve with the mandate that the Fed
the only factor that affects inflation. In late 2021, achieve price stability, maximum sustainable
consumer price inflation hit a 40-year high of employment, and low long-term interest rates,
over 6%, yet compared to their pre-COVID levels, and facilitate financial stability.
employment, capacity utilization, and industrial MMT instead posits that a dollar of new
production are lower, while the unemployment government debt need not carry any assurance
rate is higher. Inflation is not rising because of tax backing. It regards Treasury securities
the overall economy has hit its resource limit. solely as a means for the central bank to achieve
To be sure, supply-chain issues have driven up its interest rate target. MMT shifts responsibility
some prices relative to others, but these issues for achieving full employment and controlling
are not what anyone means by economy-wide inflation from monetary policy to fiscal policy.
resource limits. MMT’s weak theory of inflation The central bank’s primary tasks are to serve as
is stunning because the potential of the MMT the Treasury’s bank and to maintain zero interest
agenda to trigger inflation is the most frequently rates. Despite MMT claims to the contrary,
voiced criticism of the theory [Summers (2019), monetary policy is completely subservient to
Cochrane (2020), Hartley (2020), Mankiw (2020)]. fiscal policy, tossing aside Federal Reserve
The guaranteed jobs program points to a more independence and the social benefits that accrue
general theme of MMT: the federal government from it.
can solve big problems once policymakers Full embrace of MMT’s policy proposals and
grasp the key tenets of MMT. Kelton (2021) new norms — whatever they may be — carries
identifies seven “deficits,” defined in terms of significant risks. Those risks include higher and
both quantity and quality, that MMT can help to more volatile inflation and interest rates and
close: good jobs, saving, health care, education,
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