Modern Monetary Theory – What do SAIS faculty make of it?

By Leif Olson

March 5, 2020

WASHINGTON, DC – In 2016, Stephanie Kelton, an economist at Stony Brook University, joined the Bernie Sanders campaign. With Kelton came a new economic idea: Modern Monetary Theory (MMT). MMTers claim that governments need not worry about deficit spending or debt, a belief that spawned policies like the Green New Deal, Medicare for All and universal student loan forgiveness. Thus far, Sanders, Alexandria Ocasio-Cortez and Elizabeth Warren have adopted some of MMT’s ideas while proposing policies with unprecedented levels of public spending.

So, what does MMT propose—and what do SAIS professors think about it?

MMT’s central tenet—as described by Jason Fichtner, SAIS professor and Senior Lecturer of International Economics—is: “a government can spend and print its own currency […] and basically expand the money supply and deficits– so long as they’re not increasing the level of inflation.” Fichtner continued, “MMTers tend to think that there is a lot more fiscal bandwidth to borrow money or print money… and that you can continue to do that ad infinitum, so long as you don’t go above the rate of economic growth.”

The five principles of MMT are: 1) the government need not raise taxes to spend, 2) it cannot default on debt in its own currency, 3) its spending is only limited by inflation, 4) it can combat ‘too much money chasing too few goods’ through taxes and bonds which reduce money supply and 5) it does not need to compete with the private sector for investment or savings by selling government bonds.

Both Fichtner and Professor Cristino Arroyo believe some of these points are supported by economic theory. For example, when asked about the viability of increasing government spending without raising taxes, Fichtner said, “this is where the MMTers have a point in theory, but only to a certain extent.”

Problems in the economic logic of MMT appear in the 5th point. “There are a certain amount of loanable funds that are in the economy […] in a closed US type model you put money in the bank as cash, and the bank loans it out. So there are loanable funds,” Fichtner said, “If the government comes in and says ‘oh, I want this amount of money’, and they siphon off ⅓ of loanable funds, that means there’s still ⅔ left, but the public demand has stayed the same. That leads to an increase in interest rates due to supply and demand.” This increase, Fichtner claims, will lead to a ‘crowding out’ effect, where people are less likely to invest in projects at the higher interest rate.

Professor Arroyo—Associate Director of International Economics—agreed, saying, “The view here might be that you don’t have to compete with the private sector for savings. But, whatever it is that the private sector saves, if your view is that they optimally allocate it across a menu of assets that comprise a portfolio, how do you get them to hold more of a government asset: like money, like debt– without changing the relative prices of these things against other assets?” Arroyo explained that if you want optimized portfolio holders to hold more government bonds, the government has to compete with those other assets.

Inflation, according to both professors, is another issue. “You might say that inflation doesn’t matter across a certain range of indebtedness,” Arroyo said, “‘it could be a long time until this will be a problem in practice’– or not,” in which case, Arroyo claimed that overzealous spending would lead to “hyperinflation.”

As SAIS students learn in their economics courses: there is no free lunch. This is what Fichtner thinks is most unnerving about MMT. “Instead of saying this is going to cost us 32 trillion dollars over 10 years and this is how we pay for it; they say, I won’t raise taxes, I’ll just print money and pay for it, hence it is a free lunch.’ I think that’s faulty,” Fichtner said, “and that’s what scares me.”

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