Submitted by Taps Coogan on the 7th of April 2020 to The Sounding Line.

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Modern Monetary Theory (MMT) is less of a new theory of monetary policy and more of a re-statement of facts that most market participants already implicitly accept as true. Get beyond the chicken-and-egg semantics of whether or not the federal government spends first and borrows later and get beyond whether central banks aught to be merged with fiscal authorities. The punchline of MMT is three fairly ‘vanilla’ statements:

• The federal government can spend as much money as it wants without affecting interest rates, so long as the spending is monetized (MMTers may argue that spending doesn’t need to be monetized to have no effect on rates, but few economists agree with that point).
• The monetary authority can set interest rates at whatever level they want, so long as the money supply is adjusted accordingly.
• Neither of those two actions necessarily causes inflation. Only if the increase in spending creates excess demand for goods and services will inflation ensue.

If the points above seem obvious, it’s because we been living them, to a degree, for the last decade. Governments have been spending as much money as they want. Central banks have been setting interest rates at whatever level they want. Hyper-inflation has not ensued yet (if one forgets about healthcare, schooling, etc…).

The argument against MMT is not that it is wrong about the prior points (though in this author’s opinion it is wrong about deficits not needing to be monetized by the central bank in order to prevent a reduction in the money available outside the treasury market). The argument against MMT is that it is not good policy.

If you accept that the government can spend as much as it wants without effecting interest rates, it becomes hard to argue against any spending discipline until problematic inflation shows up.

If you accept that the central bank can and should manipulate interest rates, two things happen. First, it becomes harder and harder to imagine any reason why interest rates should be raised other than to fight a problematic rise in inflation. Second, persistently low borrowing costs lead to more and more borrowing, which can only be supported by lower and lower interest rates, pushing down the threshold at which inflation becomes problematic.

Before you know it, you have a wildly over-indebted economy, dominated by government spending, with rampant capital misallocation, and populated with companies and financial asset prices that cannot survive even a modest rise in borrowing costs or inflation. In attempt to keep that increasingly fragile economic structure growing, policy makers turn to ever more ‘creative’ ways to inject liquidity into the economy. Maybe the central bank starts directly lending to companies. Maybe the government starts sending people direct cash payments (helicopter money). We are now doing both.

Just as the Fed rolled at QE2, and QE3 long after the Global Financial Crisis has passed, it is going to be very hard for policy makers to resist more corporate bailouts, helicopter money, and extreme QE whenever the economy looks ‘soft’ in coming years.

Eventually, such a system runs into its kryptonite, inflation, at which point the brakes simply aren’t going to work.

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