Modern Money Theory

Last year, government spending in the UK was around £840 billion. The Coronavirus episode means it’s going to be a lot higher in 2020. Where will the money come from? For Modern Monetary Theory (MMT), there isn’t a problem: the government can simply create new money. It’s as easy as that?

Let’s see.

According to the traditional (non-MMT) approach, there are three ways a government can finance expenditure: Taxation; Borrowing; ‘Printing’ Money. Each of these approaches carries economic and political risks. The political risk involved in increasing taxes is straightforward enough: higher taxes mean fewer votes. Furthermore, increasing taxes can put a dampener on the economy. For example, if people tighten their belts (to cover the higher taxes), there’s going to be a reduction in private sector spending.

Additionally, large companies may relocate to other countries. That would mean a significant reduction in demand and in tax revenues. For MMT economists, all of that is (at best) irrelevant. Why? Because, according to MMT, taxation isn’t used to fund government spending. In part one, I examined a fashionable claim about the origins of money.

Specifically, that money was invented from scratch by the state (rather than having organically emerged out of barter). To MMT economists, this claim is important: they believe it implies that all economic activity, and therefore everybody’s income, emanates from government. It is from this, they derive the slogan: “Taxpayers don’t fund government; the government funds taxpayers.”

So, for MMT, taxation isn’t a source of government funding. Does all this stand up? I don’t think so. Let me illustrate with an analogy: Nike supplies the footballs used in the Premier League. Does that mean Nike is, thereby, responsible for every goal scored during a season? Can we say: “The Premier League doesn’t fund Nike, Nike funds the Premier League.”?

No, it’s a preposterous claim. In part one, we showed that the state cannot have invented money. Here, we see that even if it had done, it implies nothing about the contemporary economy. MMT has fallen into a classic Genetic Fallacy. What about the second method of finance, borrowing? Well, it has to be paid back some time, doesn’t it? Surely, debt places an unfair burden on future taxpayers; the young and the as yet unborn? “Not at all,” says MMT. Government debt can simply be paid off by creating new money with a few keystrokes.

It’s that easy? I’ll come back to that in a later article.

“Should we use money creation to get us through the COVID crisis? I think we should, but not for the reasons put forward in MMT”

Let’s look at the final government finance option: the creation of money. In the MMT literature, the idea of creating money to pay for government expenditure is treated as revolutionary. This is baffling, it’s nothing of the sort; it’s been a hotly debated policy option for decades. In fact, in 1914 a famous and catastrophic cycle began when the German government decided to finance its war effort through money creation.

There’s nothing new in the idea of a government creating money to fund expenditure. The question is, what happens when it does?

The major concern is inflation or even hyperinflation. In the case of Germany, by 1923 inflation was a terrifying 29,500%. Thereby preparing the ground for National Socialism. There’s an ambivalence in MMT: “Of course we’ve thought about inflation!” they shout indignantly. However, Randall Wray, one of MMT’s leading apologists, claims the inflation battle was won twenty years ago.

Unfortunately, history is littered with economists proclaiming the death of a problem just before it goes nuclear. Irving Fisher’s: “Stock prices have reached a permanently high plateau,” written immediately before the 1929 crash, is perhaps the most notorious example. Randall Wray also claims that even if inflation rose from the dead, rates of up to 40% wouldn’t present much of an issue. Dangerous talk.

Disappointingly, MMT is a cacophony of logical errors; the economic equivalent of a “Get Rich Quick’ scheme, or an “Eat What You Like and Lose Weight” product. MMT’s policy recommendations don’t follow from its analysis. However, that doesn’t mean these recommendations are necessarily wrong; just that if they are right, they are right by accident.

So, should we use money creation to get us through the COVID-crisis? I think we should, but not for the reasons put forward in MMT. The measures designed to combat the virus have created huge excess capacity in the economy. In the short term at least, an increase in monetary demand is a sensible option. However, extreme vigilance is essential. Inflation destroys societies. 40% isn’t a sane limit; 5% is the outer limit of tolerance.

Peter Lawlor is a trustee of the John Hicks Foundation in Oxford, he was the chief economist at the German Stock Exchange, and continues to act as an economics adviser to senior Wall St figures and political leaders.