Modern Monetary Theory, an unconventional take on economic strategy
By Dylan Matthews
ABOUT 11 YEARS ago, James K. “Jamie” Galbraith recalls, hundreds of
his fellow economists laughed at him. To his face. In the White House.
It was April 2000, and Galbraith had been invited by President Bill
Clinton to speak on a panel about the budget surplus. Galbraith was a
logical choice. A public policy professor at the University of Texas
and former head economist for the Joint Economic Committee, he wrote
frequently for the press and testified before Congress.
What’s more, his father, John Kenneth Galbraith, was the most famous
economist of his generation: a Harvard professor, best-selling author
and confidante of the Kennedy family. Jamie has embraced a role as
protector and promoter of the elder’s legacy.
But if Galbraith stood out on the panel, it was because of his offbeat
message. Most viewed the budget surplus as opportune: a chance to pay
down the national debt, cut taxes, shore up entitlements or pursue new
He viewed it as a danger: If the government is running a surplus,
money is accruing in government coffers rather than in the hands of
ordinary people and companies, where it might be spent and help the
“I said economists used to understand that the running of a surplus
was fiscal (economic) drag,” he said, “and with 250 economists, they
Galbraith says the 2001 recession — which followed a few years of
surpluses — proves he was right.
A decade later, as the soaring federal budget deficit has sharpened
political and economic differences in Washington, Galbraith is mostly
concerned about the dangers of keeping it too small. He’s a key figure
in a core debate among economists about whether deficits are important
and in what way. The issue has divided the nation’s best-known
economists and inspired pockets of passion in academic circles. Any
embrace by policymakers of one view or the other could affect
everything from employment to the price of goods to the tax code.
In contrast to “deficit hawks” who want spending cuts and revenue
increases now in order to temper the deficit, and “deficit doves” who
want to hold off on austerity measures until the economy has
recovered, Galbraith is a deficit owl. Owls certainly don’t think we
need to balance the budget soon. Indeed, they don’t concede we need to
balance it at all. Owls see government spending that leads to deficits
as integral to economic growth, even in good times.
The term isn’t Galbraith’s. It was coined by Stephanie Kelton, a
professor at the University of Missouri at Kansas City, who with
Galbraith is part of a small group of economists who have concluded
that everyone — members of Congress, think tank denizens, the entire
mainstream of the economics profession — has misunderstood how the
government interacts with the economy. If their theory — dubbed
“Modern Monetary Theory” or MMT — is right, then everything we thought
we knew about the budget, taxes and the Federal Reserve is wrong.
“Modern Monetary Theory” was coined by Bill Mitchell, an Australian
economist and prominent proponent, but its roots are much older. The
term is a reference to John Maynard Keynes, the founder of modern
macroeconomics. In “A Treatise on Money,” Keynes asserted that “all
modern States” have had the ability to decide what is money and what
is not for at least 4,000 years.
This claim, that money is a “creature of the state,” is central to the
theory. In a “fiat money” system like the one in place in the United
States, all money is ultimately created by the government, which
prints it and puts it into circulation. Consequently, the thinking
goes, the government can never run out of money. It can always make
This doesn’t mean that taxes are unnecessary. Taxes, in fact, are key
to making the whole system work. The need to pay taxes compels people
to use the currency printed by the government. Taxes are also
sometimes necessary to prevent the economy from overheating. If
consumer demand outpaces the supply of available goods, prices will
jump, resulting in inflation (where prices rise even as buying power
falls). In this case, taxes can tamp down spending and keep prices
But if the theory is correct, there is no reason the amount of money
the government takes in needs to match up with the amount it spends.
Indeed, its followers call for massive tax cuts and deficit spending
Warren Mosler, a hedge fund manager who lives in Saint Croix in the
U.S. Virgin Islands — in part because of the tax benefits — is one
proponent. He’s perhaps better know for his sports car company and his
frequent gadfly political campaigns (he earned a little less than one
percent of the vote as an independent in Connecticut’s 2010 Senate
race). He supports suspending the payroll tax that finances the Social
Security trust fund and providing an $8 an hour government job to
anyone who wants one to combat the current downturn.
The theory’s followers come mainly from a couple of institutions: the
University of Missouri-Kansas City’s economics department and the Levy
Economics Institute of Bard College, both of which have received money
from Mosler. But the movement is gaining followers quickly, largely
through an explosion of economics blogs. Naked Capitalism, an
irreverent and passionately written blog on finance and economics with
nearly a million monthly readers, features proponents such as Kelton,
fellow Missouri professor L. Randall Wray and Wartberg College
professor Scott Fullwiler. So does New Deal 2.0, a wonky economics
blog based at the liberal Roosevelt Institute think tank.
Their followers have taken to the theory with great enthusiasm and
pile into the comment sections of mainstream economics bloggers when
they take on the theory. Wray’s work has been picked up by
Firedoglake, a major liberal blog, and the New York Times op-ed page.
“The crisis helped, but the thing that did it was the blogosphere,”
Wray says. “Because, for one thing, we could get it published. It’s
very hard to publish anything that sounds outside the mainstream in
Most notably, Galbraith has spread the message everywhere from the
Daily Beast to Congress. He advised lawmakers including then-House
Speaker Nancy Pelosi (D-Calif.) when the financial crisis hit in 2008.
Last summer he consulted with a group of House members on the debt
ceiling negotiations. He was one of the handful of economists
consulted by the Obama administration as it was designing the stimulus
package. “I think Jamie has the most to lose by taking this position,”
Kelton says. “It was, I think, a really brave thing to do, because he
has such a big name, and he’s so well-respected.”
Wray and others say they, too, have consulted with policymakers, and
there is a definite sense among the group that the theory’s time is
now. “Our Web presence, every few months or so it goes up another
notch,” Fullwiler says.
A divisive theory
The idea that deficit spending can help to bring an economy out of
recession is an old one. It was a key point in Keynes’s “The General
Theory of Employment, Interest and Money.” It was the chief rationale
for the 2009 stimulus package, and many self-identified Keynesians,
such as former White House adviser Christina Romer and economist Paul
Krugman, have argued that more is in order. There are, of course,
A key split among Keynesians dates to the 1930s. One set of
economists, including the Nobel laureates John Hicks and Paul
Samuelson, sought to incorporate Keynes’s insights into classical
economics. Hicks built a mathematical model summarizing Keynes’s
theory, and Samuelson sought to wed Keynesian macroeconomics (which
studies the behavior of the economy as a whole) to conventional
microeconomics (which looks at how people and businesses allocate
resources). This set the stage for most macroeconomic theory since.
Even today, “New Keynesians,” such as Greg Mankiw, a Harvard economist
who served as chief economic adviser to George W. Bush, and Romer’s
husband, David, are seeking ways to ground Keynesian macroeconomic
theory in the micro-level behavior of businesses and consumers.
Modern Monetary theorists hold fast to the tradition established by
“post-Keynesians” such as Joan Robinson, Nicholas Kaldor and Hyman
Minsky, who insisted Samuelson’s theory failed because its models
acted as if, in Galbraith’s words, “the banking sector doesn’t exist.”
The connections are personal as well. Wray’s doctoral dissertation was
advised by Minsky, and Galbraith studied with Robinson and Kaldor at
the University of Cambridge. He argues that the theory is part of an
“alternative tradition, which runs through Keynes and my father and
And while Modern Monetary Theory’s proponents take Keynes as their
starting point and advocate aggressive deficit spending during
recessions, they’re not that type of Keynesians. Even mainstream
economists who argue for more deficit spending are reluctant to accept
the central tenets of Modern Monetary Theory. Take Krugman, who
regularly engages economists across the spectrum in spirited debate.
He has argued that pursuing large budget deficits during boom times
can lead to hyperinflation. Mankiw concedes the theory’s point that
the government can never run out of money but doesn’t think this means
what its proponents think it does.
Technically it’s true, he says, that the government could print
streams of money and never default. The risk is that it could trigger
a very high rate of inflation. This would “bankrupt much of the
banking system,” he says. “Default, painful as it would be, might be a
Mankiw’s critique goes to the heart of the debate about Modern
Monetary Theory — and about how, when and even whether to eliminate
our current deficits.
When the government deficit spends, it issues bonds to be bought on
the open market. If its debt load grows too large, mainstream
economists say, bond purchasers will demand higher interest rates, and
the government will have to pay more in interest payments, which in
turn adds to the debt load.
To get out of this cycle, the Fed — which manages the nation’s money
supply and credit and sits at the center of its financial system —
could buy the bonds at lower rates, bypassing the private market. The
Fed is prohibited from buying bonds directly from the Treasury — a
legal rather than economic constraint. But the Fed would buy the bonds
with money it prints, which means the money supply would increase.
With it, inflation would rise, and so would the prospects of
“You can’t just fund any level of government that you want from
spending money, because you’ll get runaway inflation and eventually
the rate of inflation will increase faster than the rate that you’re
extracting resources from the economy,” says Karl Smith, an economist
at the University of North Carolina. “This is the classic
hyperinflation problem that happened in Zimbabwe and the Weimar
The risk of inflation keeps most mainstream economists and
policymakers on the same page about deficits: In the medium term — all
else being equal — it’s critical to keep them small.
Economists in the Modern Monetary camp concede that deficits can
sometimes lead to inflation. But they argue that this can only happen
when the economy is at full employment — when all who are able and
willing to work are employed and no resources (labor, capital, etc.)
are idle. No modern example of this problem comes to mind, Galbraith
“The last time we had what could be plausibly called a demand-driven,
serious inflation problem was probably World War I,” Galbraith says.
“It’s been a long time since this hypothetical possibility has
actually been observed, and it was observed only under conditions that
will never be repeated.”
According to Galbraith and the others, monetary policy as currently
conducted by the Fed does not work. The Fed generally uses one of two
levers to increase growth and employment. It can lower short-term
interest rates by buying up short-term government bonds on the open
market. If short-term rates are near-zero, as they are now, the Fed
can try “quantitative easing,” or large-scale purchases of assets
(such as bonds) from the private sector including longer-term
Treasuries using money the Fed creates. This is what the Fed did in
2008 and 2010, in an emergency effort to boost the economy.
According to Modern Monetary Theory, the Fed buying up Treasuries is
just, in Galbraith’s words, a “bookkeeping operation” that does not
add income to American households and thus cannot be inflationary.
“It seemed clear to me that . . . flooding the economy with money by
buying up government bonds . . . is not going to change anybody’s
behavior,” Galbraith says. “They would just end up with cash reserves
which would sit idle in the banking system, and that is exactly what
in fact happened.”
The theorists just “have no idea how quantitative easing works,” says
Joe Gagnon, an economist at the Peterson Institute who managed the
Fed’s first round of quantitative easing in 2008. Even if the money
the Fed uses to buy bonds stays in bank reserves — or money that’s
held in reserve — increasing those reserves should still lead to
increased borrowing and ripple throughout the system.
Mainstreamers are equally baffled by another claim of the theory: that
budget surpluses in and of themselves are bad for the economy.
According to Modern Monetary Theory, when the government runs a
surplus, it is a net saver, which means that the private sector is a
net debtor. The government is, in effect, “taking money
from private pockets and forcing them to make that up by going deeper
into debt,” Galbraith says, reiterating his White House comments.
The mainstream crowd finds this argument as funny now as they did when
Galbraith presented it to Clinton. “I have two words to answer that:
Australia and Canada,” Gagnon says. “If Jamie Galbraith would look
them up, he would see immediate proof he’s wrong. Australia has had a
long-running budget surplus now, they actually have no national debt
whatsoever, they’re the fastest-growing, healthiest economy in the
world.” Canada, similarly, has run consistent surpluses while
achieving high growth.
To even care about such questions, Galbraith says, marked him as “a
considerable eccentric” when he arrived from Cambridge to get a PhD at
Yale, which had a more conventionally Keynesian economics department.
Galbraith credits Samuelson and his allies’ success to a
“mass-marketing of economic doctrine, of which Samuelson was the great
master . . . which is something the Cambridge school could never have
The mainstream economists are loath to give up any ground, even in
cases such as the so-called “Cambridge capital controversy” of the
1960s. Samuelson debated post-Keynesians and, by his own admission,
lost. Such matters have been, in Galbraith’s words, “airbrushed, like
Trotsky” from the history of economics.
But MMT’s own relationship to real-world cases can be a little
hit-or-miss. Mosler, the hedge fund manager, credits his role in the
movement to an epiphany in the early 1990s, when markets grew
concerned that Italy was about to default. Mosler figured that Italy,
which at that time still issued its own currency, the lira, could not
default as long as it had the ability to print more liras. He bet
accordingly, and when Italy did not default, he made a tidy sum.
“There was an enormous amount of money to be made if you could bring
yourself around to the idea that they couldn’t default,” he says.
Later that decade, he learned there was also a lot of money to be
lost. When similar fears surfaced about Russia, he again bet against
default. Despite having its own currency, Russia defaulted, forcing
Mosler to liquidate one of his funds and wiping out much of his $850
million in investments in the country. Mosler credits this to Russia’s
fixed exchange rate policy of the time and insists that if it had only
acted like a country with its own currency, default could have been
But the case could also prove what critics insist: Default, while
technically always avoidable, is sometimes the best available option.
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