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  • Writer's pictureOlivia Ru

Modern Monetary Theory: Is public debt as bad as it sounds?

A radical school of Economic thought suggests that budget deficits have been excessively villainised in traditional fiscal policy. Brought out of obscurity by Democratic representative Alexandria Ocasio-Cortez back in 2019, Modern Monetary Theory (MMT) suggests that it is possible to fund important social and environmental reforms, by printing money.

On the surface printing money to fund budget deficits may seem to contradict basic economic principles, as rising debt has the potential to cause a string of issues later on. However, MMT suggests that this notion that debt is bad does not apply to governments and makes an important distinction between how household and government debt functions in an economy.

Unlike in orthodox economic schools of thought, currency is not a scarce resource that public and private sectors compete to obtain. As Stephanie Kelton, Bernie Sander’s former Economic advisor wrote in ‘The Deficit Myth: Modern Monetary Theory and the Births of Peoples Economy’, in nations who hold a fiat currency and primarily borrow in its currency, the government is a currency issuer who is not restrained by budgets like a household. In other words, governments such as the US, with a public monopoly on their currency cannot default on loans, because they can fund their budget deficits by printing more money.

Professor Kelton further argues that government deficits are private sector surplus and thus support growth while continuous government surpluses are a private sector deficit. MMT proponents argue that there is an ideal level of debt and governments should aim to take on as much debt as needed to utilise its resources at full potential.

However, a major limitation that MMT faces is excessive inflation. The creation of new money devalues existing currency while also causing demand-pull inflation if real production does not increase. When there are high levels of inflation, MMT supporters suggest that governments should increase taxes and decrease the deficit to decrease the demand for goods and services.

Several developed countries across the globe have seen an increased acceptance towards public debt, with few immediate consequences. For example, Australia’s gross debt to GDP ratio will grow from 20.4% in 2010 to a predicted 51.6% by the end of 2021, while the US has printed 3 trillion dollars’ worth of USD in response to COVID-19 and continues to experience steady levels of annual inflation at 1.4%. MMT proponents often point to Japan – the unwilling poster child of MMT, has experienced very little inflation to negative inflation in the last decade despite a public debt to GDP ratio rising sharply to 240%.

However, critics often question the legitimacy of its theories, stating that there is a lack of precision as it is difficult to determine what an acceptable amount of debt is and that MMT has difficulty accounting for global trade and financial flows.

While several factors are left unclear and there is a lack of consensus among experts, MMT leaves us questioning whether an obsession with fiscal surpluses and balanced budgets is as appropriate as previously thought.

By Olivia Ru - 2nd Year Bachelor of Economics and Bachelor of Advanced Studies

(Financial Economics and Psychological Science)

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