The bus stop by my office has a huge debt counter that ominously ticks up and calculates the share of the national debt that each American ‘owes’. With the recent passage of the $1.9 trillion American Rescue Plan, the national debt has come under substantial scrutiny. One of the emerging schools of thought around the national debt is Modern Monetary Theory (MMT). The Deficit Myth by Stephanie Kelton is the “MMT for babies” introduction that I’ve been looking for, and maybe it would answer a personal question: should I be scared of that bus stop ad?
MMT is two things: a description of how the US funds its operations through debt and a prescription of policy proposals that follow from those descriptions.
The primary insight of MMT is that as the creator of the dollar, the US government can spend money before it collects taxes. In a stylized example, the US government can buy an airplane and the Federal Reserve can literally just add new money to Boeing’s bank account. For the federal government, taxes don’t actually fund anything because Uncle Sam can create money with the press of a keyboard. In this worldview, the federal government doesn’t need to tax the rich or cut spending in order to pay for programs, the government can just create whatever money they need.
This line of thinking begs a few questions.
Question 1: If we can just create money, why don’t we just fund everything?
This question is at the heart of MMT. If the government has the ability to create money and fund whatever programs we can dream of, why not do it? The obvious answer is that the amount of money can actually outpace the real supply of goods and resources. When too many dollars chase too few goods, prices go up as a matter of supply and demand. This is inflation. MMT argues that instead of worrying about the dollar amount of our debt, we should actually worry about causing excessive inflation.
What is not clear is how much money we can create without causing a huge amount of inflation. From 2008-2018, the Federal Reserve created over $3.8 trillion1and inflation was at a record low and well below the Federal Reserve’s goal of 2% inflation. Advocates of MMT will look at this data and say that the US government could’ve spent more money on big, bold policy initiatives like Medicare for all without worrying too much about inflation.
This line of thinking has actually become quite commonplace in our national debates. During the debate over the $1.9 trillion American Rescue Plan, much of the debate was centered around whether the bill would cause too much inflation, not whether we could ‘afford it.’ To some degree, politicians have come to the realization that we can create the money out of this air - this is MMT at work.
Question 2: Okay, so what’s the point of taxes?
Taxes play a two-fold role in MMT. First, taxes are a mechanism for creating demand for US dollars by legally requiring payment to the government in US dollars. Second, taxes are used as a way to take money out of circulation and slow down inflation.
Okay, but what about Social Security and Medicare? Politicians are constantly talking about how we are running out of funding for Social Security and we see FICA taken out of our paychecks every pay period. I learned that Social Security is only allowed to pay out funds from a specific pool, the Social Security trust, because Franklin Roosevelt structured the program to only pay benefits from the trust. The US government could pass a bill that fully guarantees Social Security and Medicare benefits and, the US government could use its money creation powers to fund those benefits. In fact, Medicare Parts B and D (Supplementary Medical Insurance) has been fully guaranteed by the US government and is at no risk of a benefits shortfall.
Policy Proposals
The second part of the Deficit Myth describes a federal job program that guarantees work and would act as a shock absorber for workers in bad parts of the business cycle. I don’t want to get into too much depth about this because it was a little too pie in the sky for me. The details on how a program like this could work were hand-wavey at best. MMT advocates also rely on automatic stabilizers that, while reasonable in theory, would just be too politically infeasible. The main automatic stabilizer is having a tax rate that changes along with inflation projections from the Congressional Budget Office. Broad changes in the tax code imposed by technocrats wouldn’t last long even if that proposal somehow got passed in the first place.
Overall, I think the MMT point of view on government debt is indisputably true and that we should frame inflation as the main constraint on government spending. I tend to side with critics that say MMT downplays the risks of inflation. Notable critics argue that runaway inflation could cause the US dollar to no longer the most in-demand currency in the world. The unlimited demand for the US dollar is an essential assumption of MMT itself. For a more educated critique of MMT, I would recommend Greg Mankiw’s short paper A Skeptic’s Guide to Modern Monetary Theory.
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I’m being more than a bit hand-wavey here when I say the Federal Reserve “created over 3.8 trillion.” This number is simply the amount that the Federal Reserve’s balance sheet increased, and is certainly not the only way money gets created. ↩︎