Does the National Debt Matter? A Look at Modern Monetary Theory, or MMT
Modern Monetary Theory, or MMT, has been a hot topic of late. This heterodox theory, which proposes a rethinking of how public finance works, has few fans among academic economists. But this wonky debate has now spilled over into the policy world, and there are politicians who seem to be falling under the lure that deficits don’t matter. Meanwhile, some prominent economists are walking a fine line—rejecting MMT but simultaneously making the case that deficits don’t always matter as much we thought they did.
In an attempt to cut through all this noise, here are six key, simple takeaways for policymakers:
1. Deficits do have a role to play in public finance
Some mainstream economists, such as former Treasury Secretary Larry Summers, are arguing that “traditional fiscal-policy taboos need to be rethought in an era of low real interest rates,” a view echoed by Olivier Blanchard and Jason Furman.
When interest rates are low, it is relatively inexpensive for the government to borrow. Economists mostly care about debt as a percentage of total gross domestic product—if real interest rates are lower than GDP growth, then in theory, a country without deficits will see its debt to GDP ratio shrink to zero over time.
This implies that some temporary deficits can be a good thing. In certain cases, taking on debt to finance a one-time, specific societal investment—additional funding for unemployment insurance during recessions, for example—may make sense.
2. But there’s still no free lunch
Of course, the United States is not running temporary deficits—our deficits are chronic and growing. Alan Auerbach and Bill Gale find that even if interest rates remain at today’s low levels for the next 30 years, the debt-to-GDP ratio in 2049 would rise to 156%.
Additionally, as Blanchard points out, even with a lower cost of borrowing, debt has some real economic costs through “crowding out.” Put simply, government borrowing increases the demand for loanable funds, thus increasing interest rates. As interest rates rise, some private-sector projects no longer make financial sense and are forgone. Crowding out private investment ultimately leads to a misallocation of resources away from their most economically productive use, hampering economic growth.
At the moment, evidence for crowd-out is sparse due to historically low interest rates. While certain factors—an aging population and loose monetary policy—have been keeping the cost of borrowing low, trying to exploit this environment with additional deficits and debt will put pressure on interest rates to rise. What can’t last forever, won’t. The more we borrow today, the more expensive it will be to continue borrowing in the future. At some point, debt has to be paid back. There is no free lunch.
3. MMT underestimates other downside risks of debt
The central tenet of MMT is that a government borrowing in its own sovereign currency cannot default on its debts. MMT advocates note that inflation is the only restraint on debt-financed spending. This leads some to conclude that under the theory of MMT, debt is not a concern, as governments can simply print more money to pay off debt. Such a theory is roundly rejected by academic economists on both sides of the political spectrum, as noted in a recent survey of prominent economists.
It is technically true that, no matter how large the federal debt gets, the United States could always print money to pay it off. But doing so has costs:
- Loss of credibility for the government—printing money to pay off debts cannot be a systematic solution, because at some point, investors will lose confidence and no longer be willing to lend to us.
- Inflation risk—numerous historical examples show that hyperinflation is a real concern when governments let loose with debt-financed spending.
- Exchange rates—MMT has not rigorously dealt with implications of the open economy. Debt-financed spending might drive down exchange rates, exacerbating the issues with inflation and credibility.
Finally, it’s worth considering that macroeconomic policy is messy. The economy is a complex system—often driven by fickle market expectations and unpredictable animal spirits. Some care and risk-aversion are warranted.
4. MMT assumes away politics
MMT proponents have argued that inflation risk should be controlled with fiscal policy. Here is Stephanie Kelton, a leading advocate of MMT and former advisor to Sen. Bernie Sanders (I-VT), in an interview earlier this year:
[W]hat we would say is: Look, if you are Congress and if you are considering a new spending bill, instead of thinking about the ways in which that new spending will add to the deficit or add to the debt, you should be thinking about the ways in which that new spending has the risk of accelerating inflation. And then avoid doing that.
Generally speaking, however, to avoid the risk of inflation with increased spending, Congress would have to increase taxes or reduce spending someplace else. In other words, this is putting the onus of inflation control on Congress, the institution that lately seems worst-equipped to handle it. The Federal Reserve—which has spent a long time building extensive credibility in its commitment to fight inflation—would be largely sidelined.
5. Even MMT admits that deficits and debt matter
It’s worth noting that the United States currently owes over $23 trillion. Why doesn’t the federal government just print money to pay off the debt? Or why even bother to borrow money in the first place? Because what politicians seem to be taking away from MMT—that they can finance huge spending increases with debt—doesn’t work in the real world.
Even MMT’s disciples recognize this. In a podcast debate, Kelton said that “I would never take the position that we ought to move forward, passing legislation with no offsets, to do Green New Deals, and Jobs Guarantees, and Medicare for All.” In the end, MMT’s arguments largely boil down to a disagreement over how much room there is to borrow without accelerating inflation.
6. It’s hard to pin MMT down on anything at all
The discussion over MMT has become confusing for both policymakers and economists. In large part, this is because prominent supporters of MMT have taken vague, sometimes contradictory positions: When politicians make claims about paying for the Green New Deal through MMT, stay silent, and when economists criticize this view, claim you are being misunderstood.
As Nobel-prize-winning economist Paul Krugman wrote, “…arguing with the MMTers generally feels like playing Calvinball, with the rules constantly changing: every time you think you’ve pinned them down on some proposition, they insist that you haven’t grasped their meaning.”
This should not be surprising, as MMT’s political ascension stems from politicians seeking to justify spending more without raising taxes. It is not in the interest of MMT’s thought leaders to clear up this fundamental misunderstanding that deficit spending can continue without negative economic consequences. As Krugman succinctly put it: “MMT is an attitude, not a model.” But an attitude cannot be your basis for setting good, fiscally sound public policy.
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