Explainer: what is modern monetary theory?
- Written by Steven Hail, Lecturer in Economics, University of Adelaide
There is a school of thought among economists who aren’t worried about the so called “budget black hole”, where tough choices have been called for to reduce government spending. Proponents of modern monetary theory, like Bernie Sanders’ chief economic adviser Professor Stephanie Kelton, claim the Australian government need not balance its budget and are instead calling for the government to balance the economy, which they argue is a different thing entirely.
Modern monetary theory is an approach to economic management developed since the 1990s by Professor Bill Mitchell, alongside American academics like Professor Randall Wray, Stephanie Kelton, and investment bankers and fund managers like Warren Mosler. It builds on the ideas of a previous generation of economists, such as Hyman Minsky, Wynne Godley and Abba Lerner, whose interpretation of the work of the famous economist J.M.Keynes was very different from that which became dominant by the 1980s.
By the 1980s, most people saw Keynes as an advocate of budget deficits only during periods of high unemployment. Lerner, as early as 1943, in a paper entitled Functional Finance and the Federal Debt, had argued that Keynesian economics involved running whatever government deficit was necessary to maintain full employment, and that deficits should be seen as the norm. Keynes, in a letter to fellow economist James Meade written in April 1943, said of Lerner, “His argument is impeccable. But heaven help anyone who tries to put it across”.
While the theory has attracted its own interpretations and criticism it’s also gaining traction in a global economic environment that continues to defy the efforts of policymakers to restore sustained economic growth.
There are three core statements at the heart of modern monetary theory. The first two are:
1) Monetary sovereign governments face no purely financial budget constraints.
2) All economies, and all governments, face real and ecological limits relating to what can be produced and consumed.
The first statement is the one which is widely misunderstood. A monetary sovereign government is one with its own currency and central bank, a floating exchange rate, and no significant foreign currency debt. Australia has a monetary sovereign government. So does the UK, the US and Japan. The Eurozone countries are not monetary sovereigns, as they do not have their own currencies.
The second of these statements confirms the obvious fact that governments can cause inflation, if they choose, by spending too much themselves, or not taxing enough. When this happens, the total level of spending in the economy exceeds what can be produced by all the labour, skills, physical capital, technology and natural resources which are available. We can also destroy our natural ecosystem if produce too many of the wrong things, or use the wrong processes to produce what we want to consume.
The Australian government is a currency-issuing central government. It cannot run out of Australian dollars. It’s never forced to borrow Australian dollars, although it can and does choose to do so, and its debt securities play a useful role in our financial system.
It doesn’t exactly need to tax us to pay for its spending either. Taxes exist to limit inflation. It’s necessary for us to pay taxes to keep total spending – government and private – at a level which will not be inflationary.
This doesn’t mean government spending and taxation have to equal each other, and in countries like Australia this rarely happens in practice. This leads to the third principle of modern monetary theory:
3) The government’s financial deficit is everybody else’s financial surplus.
For every lender, there must be a borrower. That means that across our financial system, surpluses and deficits always add up to zero.
This is clear in the following chart, which shows the financial balances of the Australian private sector, the rest of the world, and the Australian government sector, since 1994.
Authors: Steven Hail, Lecturer in Economics, University of Adelaide
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