Modern monetary theory

Definition

Modern monetary theory (MMT) is an economic framework that suggests that governments that control their own currency can spend freely to achieve full employment and ensure price stability, without the need for balancing budgets in the traditional sense. This approach emphasizes the role of government spending in driving economic activity and posits that inflation, rather than deficits, should be the primary concern when managing the economy.

5 Must Know Facts For Your Next Test

1. MMT asserts that a government with its own currency can never 'run out' of money in the same way businesses or individuals can, allowing for more flexible fiscal policy.
2. Under MMT, government spending is seen as a tool to create demand and reduce unemployment, making it a crucial component of economic health.
3. Proponents of MMT argue that fears of high public debt are overstated and that inflation becomes a concern only when full employment is reached.
4. The theory has gained attention during times of economic crisis, particularly when traditional monetary policy tools have been deemed insufficient.
5. Critics of MMT warn that excessive government spending could lead to runaway inflation if not managed carefully.

Review Questions

• How does modern monetary theory change our understanding of government spending and budget deficits?
  • Modern monetary theory shifts the perspective on government spending by asserting that governments with their own currency do not need to balance budgets like households or businesses. Instead, MMT argues that such governments can spend as needed to achieve full employment and economic stability. This challenges traditional views that prioritize reducing deficits and fosters a more proactive approach to fiscal policy.
• In what ways does modern monetary theory address concerns about inflation associated with increased government spending?
  • Modern monetary theory suggests that inflation should be the primary focus when discussing the implications of government spending rather than budget deficits. Proponents argue that as long as there is unused capacity in the economy—such as high unemployment—government spending can be increased without causing inflation. Only once resources are fully utilized does inflation become a risk, meaning careful monitoring is necessary to avoid overheating the economy.
• Evaluate the potential impacts of implementing modern monetary theory on both fiscal policy and overall economic health during a recession.
  • Implementing modern monetary theory during a recession could significantly alter fiscal policy by allowing governments to prioritize aggressive spending without the typical constraints of balancing budgets. This approach could enhance overall economic health by rapidly increasing demand, leading to job creation and economic recovery. However, it also raises concerns about long-term inflation if such spending is not carefully monitored once the economy stabilizes, highlighting the need for a balanced approach to managing growth.

Related terms

Fiscal Policy: Government actions regarding taxation and spending to influence the economy.

Inflation: The rate at which the general level of prices for goods and services rises, eroding purchasing power.

Central Bank: The institution responsible for managing a nation's currency, money supply, and interest rates.