What is the Modern Monetary Theory? (III)

This is a third summary of the course "Modern Monetary Theory" given by Bill Mitchell on EDX . #MMT #FiscalPolicy #Functionalfinance

Dec 05, 2023

Are you curious about the Modern Monetary Theory (MMT) and its impact on fiscal policy? Look no further! In this third article, we will delve into the essentials of MMT, shedding light on its principles and potential implications. As policy-makers and economists continue to debate its validity, understanding the basics of MMT is crucial. With a focus on functional finance, MMT challenges traditional notions of government spending and deficits. By emphasizing the role of a sovereign currency issuer, MMT suggests that fiscal policy can be used to achieve full employment and economic stability.

Join us as we explore the depths of this theory and unravel its potential impact on our economy.

In general, when monetary and fiscal policies are compared, MMT is said to favour fiscal policy.

Why not monetary policy?

The effects of monetary policy are uncertain. The use of the interest rate instrument to increase interest rates is more in favour of lenders. Moreover, the effects of monetary policy on income distribution are uncertain. They emphasise that fiscal policy is a more effective tool to improve income distribution.

For example, they state that QEs only increase banks' reserves but do not increase banks' propensity to lend. For a bank to lend, it needs customers to come to the bank and ask for a loan.

At the same time, here again they question why governments issue bonds to spend? Remember, sovereign states have no financial constraints. What MMT is getting at, my friends, is that the law says that the amount of taxation and borrowing must cover state expenditure. But since the sovereign state has no financial constraints, this should not be an obligation. It is not necessary!

MMT economists emphasize that the central bank cannot be independent of the treasury and, due to operational realities, they need to work together. Ultimately, the short-term interest rates set by the central bank serve as a leading indicator for long-term interest rates.

Simultaneously, they argue that if government spending exceeds the amount of taxes collected in the same period, excess reserves will accumulate in banks. Due to the potential effects of these reserves, it could limit central bank policy. Therefore, they strongly emphasize the need for collaboration between the treasury and the central bank.

They suggest that for the interest rate, a crucial element of monetary policy, to effectively impact spending, spending must be sensitive to interest rates. For example, if you are unemployed and interest rates drop, would you borrow and spend? They also point out that the impact of interest rates on inflation is uncertain.

Fiscal policy is the best.

They criticize the idea within neoliberal economics that states should run budget surpluses. They argue against austerity policies, stating that tightening the belt of countries traps them in a vicious cycle and leads to a worse balance.

The proposed solutions are as follows:

When citizens' spending increases significantly, government spending should decrease, and vice versa, following Lerner's functional finance principles.