Economics Working Paper 20122
Abstract: This paper assesses what has become known as Modern Monetary Theory, or MMT, using Stephanie Kelton’s influential book, The Deficit Myth, as its point of reference. Building on the idea of functional finance, developed by Abba Lerner in the 1940s, the basic premise of MMT is that the size of a nation’s fiscal deficit does not matter for countries that issue their own currency; those countries are able to print money to finance their deficits and backstop their debts. However, the situation is different for countries that have adopted another country’s currency or a regional currency, like the euro. The latter countries, which Kelton calls “currency users” do not have access to a national central bank to backstop their debts. Consequently, these countries are susceptible to financial crises. This circumstance, Kelton argues, was responsible for the recent financial crisis in Greece; that country’s adoption of the euro meant that it was unable to rely on the printing press to backstop its debt. I show that Kelton’s appraisal of the Greek financial crisis is an inaccurate depiction of recent monetary history. I also show that Kelton’s description of functional finance is an inaccurate depiction of Lerner’s presentation of that concept. Finally, I show that Kelton’s scheme does not provide limits on money creation and inflation, assumes unlimited fiscal space, does not account for monetary uncertainty or the destabilizing effects of lags under discretionary policy, assumes that there is always spare capacity such that the aggregate supply curve is flat, and would increase both the size and the administrative role of government in economic affairs.