What is MMT and how does it work?

I have been replying to some questions on Quora, some on Modern Monetary Theory (MMT). Here is my answer to the question in the title:

There are two questions here.

What is MMT?

Modern Monetary Theory (not the most descriptive or accurate name, in my view) is a combination of key ideas and concepts in the empirical macroeconomics field known as Post-Keynesianism.

There are a number of dimensions, including:

A) Both Knapp’s State Theory of Money (explaining bank reserves, coins, notes and Treasury Securities -“high powered money” or “tax credits”) and Mitchell’s Credit Theory of Money (ATM money/liability accounts – “bank credits”) are combined and MMT shows how they relate – that whilst bank issued bank credits trade at par with state issued tax credits in the private sector, they cannot be used to extinguish outstanding tax liabilities to the state – which has significant implications for fiscal and monetary policy.

B) Keynes/Kalecki’s monetary production economy, showing that there can be macroeconomic equilibrium at less than full capacity with involuntary unemployment and that any economy needs to be understood in terms of monetary flows and stocks as well as real exchanges. This justifies fiscal activism as the Government therefore needs to be pro-active in handling private sector labour underutilisation, if it is a Government for the people.

(C) Godley’s Stock-Flow Consistent (SFC) accounting and balance sheet based models of such economies showing the actual relations between monetary and real exchanges. This shows that many accepted ideas are incorrect since, for example, it shows that Government/Public Sector Debts are actually Private Sector Assets.

D) It incorporates Lerner’s functional finance approach to fiscal and monetary policy. In combination with (A) and (F) it argues that fiscal policy is more effective than monetary policy in macroeconomic management and at all times, not just under some specific scenarios such as the “Liquidity Trap” – the mostly post GFC conditions.

E) It incorporates Minsky’s Instability Hypothesis and others, examining the actual and possible finance operations of states and banks and their effectiveness. This can guide bank reform and help show how to avoid or minimise financially caused recessions.

F) It identifies a macroeconomic policy tool to achieve both loose full employment and price level (inflation) stability called the Job Guarantee. This is derived from Minsky’s Employment of Last Resort, Mitchell’s Buffer Stock Employment and Molser’s Transition Jobs. This is a path not taken compared to the typical (Mitchell) “unemployment buffer stock” or (Marx) “reserve army of the unemployed” and one that specifically rejects Phillips Curve derived models that argue that there is an unavoidable tradeoff between employment and inflation. Whilst Phillips Curve derived models dominate (in the background) employment and inflation policies, the Job Guarantee is always a policy option, even though it is mostly ignored or misunderstood.

Overall it provides a coherent descriptive macro-economic framework, within which to examine current and past differing currency regimes – to identify their strengths and weakness and the actual (even if unrecognised or denied) scope of fiscal and monetary tools available. It can be used to evaluate the implications of existing and alternate fiscal and monetary policies, in any currency regime, on key macroeconomic factors such as unemployment, productivity, growth and inflation.

Being empirically based it rejects many foundational assumptions in various other economic theories such as neoclassical/New Keynesian/Austrian/Marxists including : that banks are originators of credit and are not intermediaries; that deposits do not create loans, it is loans that create deposits; that focusing on government deficits/debt is concern with the wrong form of debt – the real issue is private debt, its type, distribution, stability and sustainability; that government net financial liabilities are nothing more than private sector net financial assets – state spending in the private sector and saved there; that both the labour theory and marginalist theories of value are wrong; that whilst Hayek correctly saw that economies are complicated and so limited in top-down planning but that they are also complex and so capable of being modelled and understood and can be better managed with feedback mechanisms through enhanced automatic stabilisers (tax/benefit fiscal flows and bottom-up localised tools such as job guarantees) to handle unemployment and inflation; that is such automated fiscal policy is superior to ineffective “independent” monetary policy; that one cannot model the economy by ignoring money, banks and private debt; that trade and markets do not work the way that mainstream economists assume; it rejects “sound” government finance as being dysfunctional and irresponsible; that government finance is radically different to household finance; that recognising and exercising these policy tools would enhance the business, employment, productivity, inflation and growth prospects for everyone compared to the status quo.

If you think there is a lot of information above, you are correct. There is much to this that the various simplistic straw man caricatures in some answers to various Quora questions completely misrepresent and misunderstand. In short this is a realistic heliocentric framework overturning the dominant geocentric and ptolemaic fantasies. (But is it more like Galileo or Copernicus?) Still this is just a very high-level description of some of the key aspects and implications of MMT.

There is no argument for any of the above, you asked what it is, not whether it is correct. This leads to the second question:

How does it work?

This is simpler to state, although much needs to be done to understand and implement its insights.

It works because it is a more accurate, empirically based description of our world than conventional macroeconomic frameworks which rely assumptions of a fictional or fantasy world that does not exist and without the use of out of date, mis-stated, flawed mathematical models that are inadequately curve fitted and adapted on an ad hoc and post hoc basis to mis-describe the real world.

I made the contrast large but note that MMT is no panacea. Reality is too complex for any simplifying model to successfully capture.

There are a handful of economists who have developed this framework to date. If some of the many thousands of professional economists in industry, finance, academia, governments, treasuries and institutions gave up their fantasies and started to use this framework this could have a remarkable benefit in providing better identification, evaluation and implementation of national and international policies across the world.


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