MMT Is A Cool, Dangerous Idea

    • MMT is attracting a lot of attention due to the proximity of the 2020 Presidential election
    • At its core, MMT assumes a different money origin, which has repercussions in the way we interpret budget deficits and debt.
    • The theory is an interesting exercise, but the risk of turning sour should make it unfit to be tested in big economies like the US.

Modern Monetary Theory (aka MMT) is now in vogue as some democratic candidates line up for the Presidential election.

Graph 1 – MMT interest over time



MMT is a simple idea. Basically, instead of assuming that money began with barter, as a way of easing transactions, it assumes that taxes were the real origin. Governments would incur in paper debt, and taxpayers had to cancel those debts, through taxes, by buying the paper from the holder of those debts and deliver it to the treasury.

It seems innocuous, but it has some complex ramifications. In the contemporary world, that would mean that when the government spends more than it taxes, it would be crediting the banking system reserves. On the other hand, when it taxes more than it spends, it would be withdrawing money from the banking reserves. Interestingly, when governments incur in huge deficits, the bank’s reserves will get flooded with money, and they will start competing for the short term instruments to deploy that money. Basically, pressuring lower interest rates.

If the MMT holds, we might have increased budget deficits and no consequences. In other words, MMT uses the government budget as a tool to keep unemployment near its natural rate (very Keynesian). That’s possible because, according to the MMT, a high unemployment rate is a symptom that the economy needs more money in circulation. That’s definitely an interesting debate to have with friends over a cup of wine. But, I fear that, during this late cycle, it might be just fuel to the next recession (or depression, I might add).

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