Modern Monetary Theory

Definition

Modern Monetary Theory (MMT) is an economic framework that argues that governments that control their own currency can create money to finance public spending without the risk of default. This theory suggests that budget deficits are not inherently problematic, as long as there are real resources available in the economy to utilize, linking public debt and budget deficits to the overall capacity of the economy to absorb additional spending.

5 Must Know Facts For Your Next Test

1. Modern Monetary Theory posits that a sovereign government can never 'run out' of money in the same way a business or individual can, as it has the authority to issue currency.
2. Under MMT, budget deficits are viewed as a tool for achieving full employment and utilizing idle resources rather than as a burden to future generations.
3. The theory emphasizes that inflation becomes a limiting factor when an economy is at full capacity, thus influencing how much money a government can create without negative consequences.
4. Critics argue that MMT could lead to hyperinflation if not managed properly, especially if the money supply grows faster than the economy's productive capacity.
5. MMT encourages the use of fiscal policy over monetary policy, suggesting that direct government spending can be more effective in stimulating economic growth.

Review Questions

• How does Modern Monetary Theory redefine our understanding of budget deficits in relation to government spending?
  • Modern Monetary Theory redefines budget deficits by suggesting they are not inherently harmful but rather necessary for achieving economic goals like full employment. MMT argues that a government with its own currency can sustain higher levels of debt without fear of insolvency, as it can always create more money. This perspective shifts the conversation from concerns about debt levels to discussions about resource utilization and inflation management.
• Evaluate the implications of Modern Monetary Theory on public debt and fiscal policy strategies.
  • Modern Monetary Theory has significant implications for how we view public debt and fiscal policy. It suggests that governments should focus on maximizing resources and employment rather than worrying excessively about balancing budgets. This could lead to increased public investment during economic downturns, but it also raises questions about long-term inflation risks and how to manage them effectively within this framework.
• Synthesize the arguments for and against Modern Monetary Theory in the context of current economic challenges faced by governments today.
  • The arguments for Modern Monetary Theory center around its potential to address economic challenges by allowing governments to finance large-scale projects without fearing default, thereby stimulating growth and reducing unemployment. Critics raise concerns about the potential for runaway inflation if too much money is injected into the economy without corresponding increases in production. In today's context, especially after crises like COVID-19, governments face pressure to balance immediate fiscal needs with long-term economic stability, making MMT a relevant yet contentious topic in contemporary economic policy discussions.

Related terms

Fiscal Policy: Government actions regarding taxation and spending, which can influence economic activity and manage budget deficits.

Inflation: A general increase in prices and fall in the purchasing value of money, which can be a concern in discussions of excessive government spending.

Public Debt: The total amount of money that a government owes to creditors, often increased through borrowing to fund deficits.