A new economic theory is challenging all that we know about deficits, tax and the nature of money. Alex Katsomitros spoke to economist Stephanie Kelton, a leading advocate of the Modern Monetary Theory, to discuss its relevance in an era of pandemics, soaring debt and dysfunctional politics 

In a busy corner of Manhattan, a glowing, ominous billboard reminds passers-by that two things never stop running in this life or the next one: debt and time. The idiosyncratic clock tracks in real-time the amount of debt carried by US government, ever increasing and endlessly touted by American politicians as a big, threatening monkey on the nation’s shoulder.

But what if the billboard was displaying savings rather than debt? What if inflation was the only constraint to a government’s ability to print its own currency? Fanciful as these claims may sound, they form the basis of a new school of thought in economics, aptly called Modern Monetary Theory (MMT) – or, to its many critics, Magic Money Tree theory.

Despite the ridicule, MMT is gaining ground in academic circles and beyond, due to a mix of originality and good timing: it is bizarre, radical and innovative enough for our weird times. And it is no coincidence that The Deficit Myth, a book which summarises its proposals, has become a best-seller in the midst of the pandemic. Its author, Stephanie Kelton, an economist who teaches at Stony Brook University, has emerged as the high priestess of a heresy that threatens to unseat economic orthodoxy from its throne. “Economists are guilty of reinforcing many bad ideas, which are very pervasive. They are in all the textbooks undergraduates are taught,” Kelton says.

A radical theory

Despite its fanciful name, at the core of MMT lies a simple idea. Unlike households and businesses, governments are currency issuers, rather than users. They can print as much money as they want – these days by pushing a button – without having to worry about deficits and accumulating debt. Inflation, the theory goes, should be their only concern. Sure, overspending would make the money in our pockets less valuable. But that is hardly the problem in today’s developed economies, which are plagued by low inflation; current deficits may be too small, rather than too big, Kelton suggests in the book. Nor do they burden next generations, an accusation often levelled at fiscally imprudent governments. A fiscal surplus is not proof of good management, but of unnecessary frugality, sucking much-needed money out of the economy, Kelton warns: “Government surplus is a drawdown of the financial balance in the non-governmental sector, which can make future generations materially poorer.” 

Based on a school of thought known as “chartalism”, Kelton and other advocates of MMT question the mainstream version of the history of money, according to which coins were invented as a means of exchange. Most economists believe that governments tax their citizens to raise money that can be later spent on infrastructure and services, such as education. For MMT, it’s the other way round; governments use tax as a way to create demand for their currency. Without taxation, few people would bother to join the army or build schools to earn the money needed to pay their taxes. “The government doesn’t need our money. We need their money. We’ve got the whole thing backward!” Kelton claims in the book. 

What follows is that countries that enjoy monetary sovereignty, such as the US and the UK, can never go bankrupt or run out of money to fund welfare programmes. As Kelton claims, the important question politicians should be asking themselves is not “How will you pay for it?” but “How will you resource it?” In the book, she goes as far as claiming that we should find another term for government debt: “The national debt is nothing like household debt, so using the word debt just leads to confusion and unnecessary angst. We could just refer to it as part of our net money supply.”

So what makes “the deficit myth” so appealing, not just to elites but also to the broader public? Kelton ascribes the success of the myth to worldly motives. For many lawmakers, presenting the deficit as something similar to household debt allows them to push their agenda of welfare and tax cuts; for the rest, it’s a good story they don’t want to contest. “Even politicians who don’t give two hoots about the deficit will speak as if it is a threat to our national security. Not because they believe it, but because they believe they can move the public,” Kelton argues.

Cranking up the printing press 

Until recently, MMT was treated as a fringe theory, the equivalent of 5G phobia in economics. And yet, in the wake of the shutdown of the US economy last spring, Congress committed more than $2tn to tackle the ensuing economic crisis, possibly tripling the country’s deficit over the current decade and increasing federal debt by an estimated 7.5%. Does Kelton feel vindicated? “Yes,” she tersely replies. “It’s like you cook dinner in the oven every night and sometimes you set the temperature at 300°F and sometimes at 400°F. Nobody goes to the oven and says ‘I can’t put the temperature where I need it tonight because I ran it hot last night!’ So deficits that were run in the past will not limit what future governments can do.”

For most economists however, and even more politicians, deficits and debts do matter. According to mainstream economics, high deficits push governments to borrow, leading to higher interest rates that can hurt private investment and eventually growth. MMT’s solution is to stick to an interest rate of zero and, more controversially, pass the mantle of controlling inflation and tackling unemployment to governments, rather than independent central banks. 

Inevitably, critics of MMT revert to well-known horror stories of modern economic history to discredit it: Zimbabwe, whose inflation rate this July reached a record of 837.53%; Argentina, whose endless debt restructuring saga has crippled the country’s economy; and a host of other countries that print their own money, and yet are plagued by skyrocketing inflation, bankruptcies and soaring debt. The story invariably ends in disaster, although for different reasons (Argentina, for ™  example, famously made the mistake of pegging its currency to the dollar, thus undermining its monetary sovereignty). Cranking up the printing press hits the currency’s exchange rate; government bonds become unattractive for international investors; inflation spikes in a vicious cycle of doom and gloom. Sooner or later, the interest rates governments need to pay to finance their deficits become astronomical. 

Kelton acknowledges the limits of monetary sovereignty for developing nations that rely on dollar-denominated imports, such as oil: “What we are trying to do with these smaller countries is to help them understand how important it is to move along the spectrum of monetary sovereignty. To take full advantage of it, the ideal would be a floating exchange rate and a fiat currency where the government spends and taxes in a unit of account that it defines and in a currency it controls.” 

From a European perspective, The Deficit Myth can be read as an indictment of the euro. What were the nineteen eurozone countries thinking when they relinquished their coveted monetary sovereignty? Kelton, who was an early eurosceptic, foresaw the debt crisis that gripped the eurozone: “Markets would eventually figure out that they were lending to currency users, rather than issuers, and that there was no fiscal analogue to the monetary union.” However, she warns that it’s too late to go back to a future of national currencies: “It [the eurozone’s future] depends on whether this is a true union; whether countries are going to treat one another as if their interests are aligned and their commitment to the project is strong, instead of pointing fingers. The critical point is that the ECB has to guarantee solvency of member states.”

Kelton’s most radical proposal is also the most topical one in an era of massive layoffs, unprecedented furlough schemes and structural unemployment due to automation: a national job guarantee programme. Kelton argues that local communities should be deciding what jobs are necessary to build what she calls “a care economy”– an exercise that could eventually be implemented globally. Wouldn’t that turn millions of unemployed workers into slackers who wouldn’t have a reason to seek employment in the private sector ever again? Kelton begs to differ: “Their wage would be the national minimum wage. People would want to leave because wages would be higher outside the programme. The job guarantee ensures a highly liquid labour market, so it’s a pro-business policy.”  

A broken science 

Courtesy of The Deficit Myth and her fiery disposition, Kelton has gained the status of an academic celebrity. Passionate and down-to-earth, the 51-year-old economist tours universities and US media to promote the merits of MMT. Unusually for an academic, she does not hide her political preferences. In 2008, she unsuccessfully ran as a Democrat for a seat in the Kansas legislature, while in 2015 she served as the Chief Economist for the Democrats on the US Senate Budget Committee and as an adviser to Bernie Sanders’ presidential campaign. It is no surprise that The Deficit Myth is more of a polemic than an economic textbook pretending to be neutral. Void of technical jargon, it may serve as the ultra-liberal’s bible for the coming US election – or, more likely, the next ones.

If Kelton has harsh words for someone, it’s for her fellow economists: “Mainstream economists have done incredible damage to communities the world over – it’s unforgivable. Economics is broken, it has evolved into a defence of neoliberalism.” 

Part of the problem is an illusion about the infallibility of its tools, she says: “Many economists don’t like the label of ‘social science’; they like to think they are above other social sciences because they use maths. But policymakers turn to them, so economists have an outsized voice in shaping policy.” 

Could female economists, like the recent Nobel Laureate Esther Duflo and herself, bring some sanity to the profession? Kelton is hopeful, but acknowledges the difficulty of the task: “Men automatically enjoy a higher degree of presumed prestige. It’s a steeper hill to climb for women.”

Purchase Stephanie Kelton’s ‘The Deficit Myth’ here.