Modern Monetary Theory

As you may know, among Economists there are two schools. The J.M.Keynes school thinks big stimulus, infrastructure programs, guidance by Govt are all good to manage and grow the economy. The F. A. Hayak followers believe that letting market do whatever it wants, running a laissez-faire system is the more robust approach to manage the economy. In case you haven't seen it, there is a pretty cool/humorous video on YouTube that explains these two schools of thought: https://www.youtube.com/watch?v=d0nERTFo-Sk. There is even a Round 2 video available now. 😀

From Keynes Vs. Hayak discussions, when you come down to nation level monetary policies, what is practiced/understood in the world now is the quantity theory of money where we watch & manage the actual amount of money that is in circulation. Since the focus is on the "quantity", economists and politicians often talk about the size of the nation's deficit. The general understanding in this picture is a nation is just like an individual that is earning and spending money. If the nation earns (i.e. gathered revenue through taxes) less than what it proposes to spend in its budget outlays, it runs a deficit. If it continues to run deficits year after year, the total national debt keeps increasing. Except for a handful of tiny nations, pretty much every country of some reasonable size runs annual deficit. With our cumulative deficit running around 36 trillion dollars, US is pretty much on top of the world in numbers (though there are other toppers when you normalize it to GDP). Since the world's thinking is shaped by this quantity theory of money, this sounds ominous and is nicely dramatized by websites like https://usdebtclock.org/. 

In the US, state governments are required to balance the annual budget and so if they want to spend money on some new program, they need to find the money (quantity) by either cutting down some other program or raising the revenue (usually through taxes/bonds). But the federal government is not bound by this rule and so it can keep spending whatever it wants as long as the congress and the president agree. There is this (jocular) US notion called national debt ceiling beyond which the federal govt supposedly can't increase the debt. But it is a ceiling set by the congress itself and so routinely that limit gets increased by whatever number needed, after politicians get to grandstand for a while giving speeches about how we are stealing from our children. Whichever party is running the government at any given time usually will not talk about the raising deficit since it will limit their ability to spend money on their pet projects. But the opposition party will keep talking about how irresponsible the governing party is to let the deficit climb so high under their watch. Once the parties switch shoes, they will switch their tunes as well. These grandstanding speeches and heads turning the other way can all be seen all over the world in other countries also. If a politician proposes any new program (say free child day care for all working parents), even journalists who consider themselves responsible will promptly ask them as to how they will pay for it. This is based on the quantity theory of money understanding. We understand that an individual can borrow money at times to some extent (to buy a home or to go to college) to improve their lives but need to pay it back and so can't keep borrowing year after year ruining their credit. Along the same line, we think a national government also can borrow money for a while but if it keeps running deficit perpetually, country will be ruined.

In the past few decades, a group of economists have been developing an alternative descriptive (not prescriptive) model called Modern Monetary Theory (MMT). This school claims that the deficit number in itself doesn't really matter as long as the economy is strong enough to handle it. They point out that a national government is not the same as an individual earning and spending money. The way I see it, MMT can be said to focus on three areas:

1. Whether a country has a sovereign currency or not: If a country is part of a monetary union (like the Euro Zone) or peg their currency against another currency like the US dollar, they can't print as much money as they want. 

2. Inflation rate: Even if the currency is sovereign, if the country recklessly prints money (referred to as quantitative easing), inflation may shoot up ruining the economy. Ridiculous examples of this scenario can be seen in countries like Zimbabwe and Venezuela, where inflation runs at several thousand or million percent making the currency just useless.

3. Capacity of the national economy to absorb new money coming in: In case of a recession or high unemployment scenario, the economy can absorb the stimulus. But if the economy is at full capacity (i.e. everyone who wants a good job has one and so production/consumption is already at its max), attempting to stimulate the economy with more money or public sector projects will not yield good results but will result in inflation.

There may be other factors. But I'd like to keep it simple with focus on these three areas. MMT proponents say that as long as these three areas are managed carefully, you can stimulate the economy as much as you want to grow a country. So, when someone proposes free healthcare or college education or childcare for the whole country, you shouldn't ask how will you pay for it because we may be paying for it already in an indirect way by not having enough healthy people or college graduates or worry-free parents working away. Presuming that the country has its own sovereign currency, we should instead ask what level of inflation this will lead us to, and is the system/population/economy big enough to absorb the stimulus to become more productive in the long run. 

In the US, traditional economists like Larry Summers think MMT is some fad voodoo economics that won't work. You can find interesting lectures by people like Stephanie Kelton on YouTube that describes the MMT idea. Since unlike QMT, where you can simply focus on one number, MMT needs to focus on inflation, interest rates, total effect on the economy, etc. its proponents so far don't want to call it prescriptive. But as the descriptive theory evolves, clear prescriptions may start rolling out. Recent run up in inflation may be worrisome. But MMT proponents saying that this is one out of the three items I listed above that just need to be managed and brought down. Now that it is close to 2% again, as per MMT, we can continue spending!

In the country where you live, is national debt and annual budgetary deficit discussed and understood by people in general or by your friends' circle? PLMK what you think.

(Minor clean up/update on 10/03/2024)