Modern monetary policy

Persistent puzzles or “anomalies” are leading to questions about the validity of the economic current paradigm. More than 10 years after the financial crisis, economics is increasingly afflicted by issues such as enduring low inflation, climate change, socio-economic inequality and the difficulty of stimulating economic growth in the face of structural headwinds. As such, a new economic paradigm is emerging about debt, and the role of monetary and fiscal policy by policymakers. More so, political discussion and events will amplify this debate in the coming years.


  • The U.S. annual budget deficit will hit $1 trillion this year, grew 39% in the first eight months of this fiscal year, and will increase to $1.1 trillion for the fiscal year 2020. As a result of running persistent deficits, the Congressional Budget Office estimated in January of this year that U.S. national debt is expected to grow from the current 78% of GDP to 105% of GDP by the end of the next decade and to about of 150% of GDP in the coming three decades. This would be an all-time high and unprecedented episode debt build-up during a boom of the business cycle.
  • At the beginning of this decade, then-President Obama instated the bipartisan “National Commission on Fiscal Responsibility and Reform” (often called “Simpson-Bowles” for the co-chairs of Alan Simpson and Erskine Bowles). In November 2010, the commission released its plan to improve the U.S. fiscal situation and achieve fiscal sustainability in the long-term. However, debt has actually been growing in the U.S. this decade, even before Trump. We have written before that debt is on the rise globally, meaning that central banks and governments have fewer means to fight the next recession.
  • In 2009, economists Reinhart and Rogoff wrote an influential paper on the growth prospects given nominal debt level. There is an “exact” level of bad debt. The credit-to-GDP gap captures the build-up of excessive credit, defined as the difference between the credit-to-GDP ratio and its long-run trend and it has been found to be a useful early warning indicator of financial crises. A growth of 10 percentage points is generally considered cause for concern. Furthermore, high private debt is usually more worrying than high public debt, especially with high debt levels among middle- and lower income groups causing economic growth to stagnate, as governments have more alternatives to pay off their debt (e.g. issuing more of their own currency or increasing taxation). Lastly, the trajectory of debt development is much more important than its nominal level, and budget deficits are the causal mechanism that make debtors vulnerable to financial instability.
  • The new Democratic Congresswoman Alexandria Ocasio-Cortez issued a resolution revolving active measures to combat climate change and socio-economic inequality named the Green New Deal. To finance this huge stimulus package, she stated that governments don’t need to balance their budgets and that budget surpluses actually hurt the economy. Referring to Modern Monetary Theory (MMT), she stated that it should be “part of a larger conversation”. Bernie Sanders, a Democratic presidential nominee, is also a proponent of MMT, while opposing Democratic Presidential nominee Elisabeth Warren has stated that “we need to rethink our system in a way that is genuinely about investments that pay off over time”.
  • In January of this year, Oliver Blanchard, former Chief Economist of the IMF, stated that there were many reasons to doubt the supposed costs of running U.S. budget deficits, as interest rates are below economic growth rates, such that net interest payments are still around their historical averages. The fact that a former IMF Chief Economist made these remarks gained widespread attention in economics, as the IMF has long been an advocate of austerity and balanced budgets to deal with economic problems (the IMF was considered an important institution advocating the neoliberal or “Washington consensus”, which informed economic policymaking in the last decades).
  • Ray Dalio, the best-paid hedge fund manager of this year, has said the U.S. eventually will have to adopt a new monetary policy and economic philosophy that uses zero interest rates to finance its government spending. We have written before that despite massive quantitative easing programs, inflation in the developed world remains far below its historical average due to structural issues such as technological developments and demographic transitions. This becomes even more puzzling considering the fact that there is record-low unemployment and economies are nearing full employment (thus falsifying one of the key decision-making tools of central banks, the “Philips curve”).


Support for Modern Monetary Theory (MMT) is on the rise, as economists are reconsidering their assessments of the risks of debt, as well as speculating about future ways to deal with persistent economic problems such as inequality, low inflation despite record-low unemployment (i.e. a broken Philips curve), and even climate change. The theory, in brief, holds that debt-to-GDP ratios are irrelevant to countries that issue their own currency, as they can always print extra money, and their only constraint on spending is inflation. As such, proponents of MMT argue that fiscal policy is the most important tool to achieve full employment (i.e. keeping up demand) and economic growth. The key idea of MMT is that the balance of spending in the public sector is mirrored by a balance in the private sector: a government surplus leads to private sector deficits and vice versa. Governments could then cause economic downturns as they lead to private sector deficits, which should be solved by deficits and government spending. Furthermore, taxation should be used to keep inflation in check, as it takes money out of the economy, thus keeping private parties from spending and pushing up prices. Additionally, inflation is not caused by excessive growth in which aggregate demand outstrips aggregate supply, but by large companies with market power that tighten supply and artificially drive up prices. As such, MMT holds that fiscal deficits are irrelevant as long as unemployment and inflation are low, and that the economy and inflation should be managed by fiscal instead of monetary policy.

With neoliberalism in retreat after the 2008 financial crisis and Eurozone crises, Modern Monetary Theory could deliver building blocks for thinking about a new economic paradigm.

But more importantly than the question whether MMT is fully correct or whether it will eventually overtake mainstream economic thinking, MMT corresponds to the current Zeitgeist. First, it can explain some of the most pressing problems that economists have had to deal with since the 2008 financial crisis, such as simultaneous low inflation and unemployment: they claim that the low current inflation is caused by too low aggregate demand, which should be solved by running larger deficits. Second, it criticizes the neoliberal idea that budgets should always be balanced and austerity is the solution to economic problems. An example might clarify this. Although many point to budget deficits as the cause of the Eurozone crisis in 2010, the episode could also be explained from a rise in risk premiums and a corresponding sudden stop in cross-border lending because of the 2008 financial crisis. This endangered the financial solvency of banks and governments dependent upon lending, as they run current-account deficits. As such, a balance-of-payments crisis turned into a public debt crisis, worsened by prolonged austerity, which held back investments to boost the productive capacity of crisis-struck economies (following neoliberal advice by the European “troika”). With neoliberalism in retreat after the 2008 financial crisis and Eurozone crises, MMT could deliver building blocks for thinking about a new economic paradigm.

More importantly, the idea that our economies need structural reform to deal with future challenges (i.e. unemployment caused by automation, higher risk premiums and costs caused by climate change) in the face of persistent problems (i.e. socio-economic inequality and environmental degradation) has made the idea of more active governments more fashionable. Indeed, the deep political transition that is needed is reflected in the active role of governments (e.g. some MMT proponents suggest that governments should provide “job guarantees”) and the use of fiscal policy to create sustainable and socially responsible investments (e.g. the Green Deal). Indeed, many Democratic presidential nominees have made MMT an integral part of their economic election agenda. Lastly, our age of returning Great Power competition asks for governments that take a more pro-active stance in designing a future-proof industrial agenda. MMT, with its focus on fiscal instead of monetary policy, could become a tool for politicizing economic policy of leaving it in the hands of “technocratic” central bankers.


  • The MMT view that inflation is often the effect of artificially tightened supply by monopolies could provide additional ammunition in the debate about breaking up Big Tech companies. However, we have written before that it is questionable whether current anti-trust regulation (with its focus on consumer welfare and prices) is suitable for dealing with these companies, which actually lower prices of many goods and services (in nominal currency terms).
  • We have written before that money always has a political side, and that this must be carefully managed or else currencies might become (literally) worthless. Although MMT holds that small budget deficits and surpluses actually hurt inflation, there is a big danger of inflation spinning out of control, beyond the reach of government taxation, as regulation can often take long to be decided upon and come into effect. Money that comes from governments printing it and increasing inflation could therefore lead to lower trust in “fiat money” and spur the move towards new sources of money that are less susceptible to politization (e.g. cryptocurrencies).