Modern Monetary Theory and the Deficit

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Jun 14, 2019 3:43:54 PM

and tagged Politics and the Economy

Leave a comment

modern monetary theoryA controversial topic currently exciting economists goes by the name of Modern Monetary Theory (MMT). While there are many ways to interpret it (as you can see from its name, it doesn’t actually describe anything), the key tenet is that deficits don’t matter. Governments that control their own currencies, like the U.S., can spend whatever they want simply by printing more money. The controversy doesn’t come from this assertion—it’s a simple fact—but from the different interpretations of what, exactly, this means.

If the controversy surrounding MMT stayed in the world of economics, you probably wouldn’t need to know much about it. The reason you should know about it, though, is because MMT is being touted as the next big thing in the Democratic Party’s policy arsenal. And with the presidential election coming next year, MMT could have a real impact on the economy after 2020. So, now’s a good time to take a look.

Why deficits don’t matter

Let’s start with the base idea: deficits don’t matter. From an economic standpoint, there is actually a good reason to agree with this. If we use deficit spending so the government can finance public investments that will more than pay for themselves, then it makes sense. It is estimated, for example, that every dollar spent on the interstate highway system returned $6 in additional economic growth over a 40-year period. This investment made sense, and any borrowing was certainly justified. When we look at proposed infrastructure spending today, with interest rates at historic lows, we can make the same argument for many projects. Economists all along the political spectrum accept this. So far so good.

The problem comes when we try to define a “productive investment” worth borrowing for. In theory, we could make the case for pretty much anything, so this becomes more of a political argument than an economic one. If anything and everything can be a productive investment, at least for a certain level of plausibility, then how do we decide where to focus? Are there any limits?

The limit, historically, has been the amount of available resources. In recent decades, however, deficit spending (i.e., borrowing from the future) has allowed us to exceed current available resources. And once you start deficit spending, there are no obvious limits except for the ability to pay the accrued debt. This is what has driven the political conversation in the U.S. for the past 20 years or so: how to limit deficit spending to what the economy can afford to pay.

Which brings us to today. MMT, put in its simplest form, is the idea that we do not need to limit our spending, or our deficits, as long as we spend the money on productive things. We have gone from a spending limit of current resources, to one of how much debt we can pay, to potentially no limit at all on spending, as long as we spend on good things. Which brings us back to politics—because it’s the politicians who will determine what those good things are.

A political discussion, not an economic one

What gives MMT its potential power today is that both parties have essentially abandoned the idea that the deficit needs to be constrained. Republicans have decided that more private saving and investment, driven by lower taxes, will generate enough growth to pay for the deficit, while Democrats believe more spending will create enough general welfare to do the same. Both parties have essentially adopted the core tenet of MMT, which is why we have seen the deficit spike again.

The MMT discussion is therefore not really about economics. The discussion is really about politics and what we should be spending all that extra money on. The discussion, which I expect you will be hearing much more of over the next year or so, is therefore not about whether we run up the deficit but what we will get for running it up.  

So, pay attention to MMT, but realize it is not about some new and untried economic model, but—like every other political discussion—about who benefits from the existing model.

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®