There’s a relatively new theory of how the government should manage the economy called Modern Monetary Theory. Over the weekend, I read a bit about it. With the impact of the COVID crisis, there are open questions about the best way forward. Should we continue managing the economy as we have since 1940 or change it?
The US government has two primary economic goals: maximize employment and minimize inflation. The more employed Americans, the greater the GDP, the wealthier the country. Too much inflation means your money’s purchasing power decreases with time, which means you need more dollars to buy the same thing.
In the past 80 or so years, the government has used the Kenyesian economic policy. There are two big ideas from this mental model you’ll recognize.
First, the government should use interest rates to influence the economy. When the economy is doing well, increase interest rates to slow lending, and cut rates to stimulate the economy.
Second, the government should fund itself from taxes. Keep the deficit in check by not spending too much. If the government prints money to fund expenses, inflation will balloon.
The MMT has the same goals but achieves them differently.
First, rather than influencing the economy through interest rates, change taxes dynamically. When the economy is doing well, tax more. During recessions, tax less.
Second, the government guarantees everyone a job. That ensures the maximum employment rate. Empower the Executive Branch of the government to decide the projects these employees should pursue.
Third, finance these jobs by making new money: grow the deficit.
Fourth, tax the wealthy to pay for some of the difference, but maintain a significant deficit. MMT argues the deficit is the way governments create wealth for its citizens.
These are complex issues and will be debated for many years to come. There are proponents of MMT and opponents. Stephanie Kelton has written a book on the MMT, which I read and it offers an in-depth explanation of the theory. On the other side, many classical economists have critiqued the theory. The most colorful critique is from Paul Krugman who calls MMT “Calvinball” a game from the comic Calvin & Hobbes in which you can change the rules as you go.
If you’d like to read more on the topic here are some places to start. If you like being an armchair economist as I do, it’s a fun rabbithole to explore.
- The Deficit Myth: Stephanie Kelton, an MMT proponent, lays out the argument in great detail.
- Wikipedia article: check out the table at the end that compares two philosophies
- Ray Dalio’s overview of MMT: a review of the pros and cons of MMT from the founder of one of the world’s largest hedge funds
- Paul Krugman’s Critique of MMT