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Monetary Policy Simplified, Or Simply Wrong?

Some ideas are crazy enough to work; others are just crazy. It is worth taking the time to consider where Modern Monetary Theory falls on this spectrum.

In its simplest form, MMT argues that countries – like the United States – that issue their own currencies in a fiat system cannot run out of money the way individuals or businesses might. This means that the country issuing its own currency can never default on its debt. Therefore, the theory goes, governments can massively expand spending without damaging the broader economy. The government can address any unintended consequences, such as an overheating economy, by adjusting tax rates. Spiking inflation? No problem – just raise taxes.

A simple explanation of MMT, like the one above and those I have seen in most mainstream media coverage, makes it sound like an obviously flawed, dangerous idea. However, while researching this topic I was surprised to learn that the details of MMT get significantly more complex up close. Some of the theory’s advocates argue that critics are attacking their own perception of MMT, rather than the reality. For instance, while the claim that MMT supporters think deficits never matter is commonly repeated, most of them readily acknowledge that extreme deficits can cause hyperinflation. MMT generally also includes the idea of a job guarantee, which would theoretically ensure full employment without requiring the central bank to manipulate interest rates. This mechanism is mainly meant to keep wages from rising too fast, not to inflate them, as some critics claim. Certain MMT-supporting economists have expressed frustration at the media or various politicians’ failed attempts to accurately describe their positions. MMT is also a school of thought with many contributors, some of whom depart from one another in the particulars, further complicating matters.

MMT is not new, but for a long time it remained outside the mainstream, largely dismissed by most economists. MMT recently entered the national conversation, however, largely due to a boost from a few prominent supporters. Rep. Alexandria Ocasio-Cortez, D-N.Y., proposed increasing deficit spending in order to fund proposed actions designed to address climate change concerns. Rep. Bernie Sanders of Vermont has invoked MMT in discussions of Medicare for All. Other politicians, largely on the left, have avoided embracing MMT fully but have expressed approval for certain components of the theory. (President Donald Trump, while by no means an MMT booster, has said in the past that the U.S. government can never default on its debt.) Some prominent money managers and business analysts, of varying political affiliations, also have said they find the framework useful.

For each MMT fan, many critics wait in the wings. Warren Buffet, Carl Icahn, Paul Krugman and Federal Reserve Chairman Jerome Powell are among the prominent investors and economists who have expressed skepticism or incredulity about this theory. Other observers concede that MMT – or at least some aspects of the theory – may represent a useful outlook when a country is stuck in deep recession, but not under normal economic circumstances.

Critics have identified several serious issues with MMT. It relies on the assumption that politicians will rapidly institute unpopular policy when necessary, which many observers find a shaky proposition at best. Raising taxes on constituents is a hard sell for most politicians at the best of times, much less in a moment when inflation is rising sharply. Some MMT proponents, acknowledging this problem, suggest that fiscal policy and monetary policy should be coordinated, ideally with automated controls based on economic conditions. That would be a radical change to the way our government functions.

Just because inflation has not been a problem for many years doesn’t mean it could never come back. What happens in the MMT advocates’ worldview if the country experiences a major inflation spike? Would the government need to abandon infrastructure, social support programs and other programs mid-stream? Abrupt major spending cuts are unlikely to be much more popular with voters than sudden and significant tax hikes.

In a worst-case scenario where inflation is not checked fast enough, the world could lose confidence in the dollar, and the currency’s value would collapse. A plummeting exchange rate could cause a variety of serious problems, from further increasing inflation, to capital flowing out of the country, to lower real wages as imports become much more expensive.

Most economists agree that there is some upper limit to how much money we could introduce into the economy before the system falls apart, but we do not know what that limit is. In this sense, MMT reminds me of the Laffer Curve. Developed by economist Arthur Laffer in the mid-1970s, the Laffer Curve illustrates the relationship between the tax rates citizens pay and the total tax revenue the government collects. As tax rates rise from zero, revenue increases – to an optimal point. After that point, the tax rate becomes too high, discouraging workers; revenue begins to decline. Revenue is zero at both a 0% and 100% tax rate, and it is maximized somewhere in the middle.

In real life, no one knows exactly where the Laffer Curve’s peak is, which is why policymakers differ on the ideal amount of tax to levy. Similarly, there is likely some amount of optimal government debt; both too much and too little hinders economic growth. Unfortunately, we do not know what that optimal level is, either. Erring on the conservative side could restrict growth, but borrowing too aggressively introduces the risk of a system meltdown.

I think MMT has intoxicated certain liberals the same way that the idea that tax cuts are always beneficial and self-funding intoxicates some conservatives. Much like the most extreme application of supply-side economics, MMT takes some valid ideas and inflates them into an unsustainable extreme. Both ideas are, in their broadest sense, easy to understand. But neither allows for sufficient real-world complexity.

Reasonable people can disagree about the levels of government debt – or taxation – that best serve our society. But just as families need to spend responsibly, so do governments. There is no magic wand that can fix all of our problems painlessly. MMT ultimately serves as one more reminder that we need to stay grounded in reality when we discuss our nation’s finances.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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