Thursday, September 30, 2021

The Deficit Myth - Modern Monetary Theory

Before U.S. President Nixon abandoned the gold standard in 1971, anyone with U.S. dollars could exchange them for gold at a fixed price.  Now that the U.S. government (as well as other governments including Canada) can issue new money at will, we call it “fiat money.”  Stephanie Kelton, former chief economist on the U.S. Senate Budget Committee, claims that this ability to create money at will has profound implications that she explains in her book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.  Modern Monetary Theory is certainly a different way to think about government finances, but whether it really has profound implications is less clear.

Under the gold standard, government finances resembled a family’s finances.  To run a deficit, the government had to borrow.  However, today the government can just create new money.  Governments typically choose to issue bonds (treasuries) to cover deficit spending, but such bonds are really just a different kind of money conjured out of thin air.  The government could just create as many dollars as it needs, but it chooses to create bonds that pay some interest.

When we understand fiat money, we see that the government can’t go broke because it can create new money at will.  This means the government could wipe out the national debt in seconds, and U.S. Social Security (or CPP and OAS in Canada) can’t run out of money as long as the government chooses to keep paying these benefits.

According to Kelton, it’s a myth that “deficits are evidence of overspending.”  In reality, it’s inflation that we should look to as evidence that governments are overspending.  When deciding what projects the government should take on, financial constraints and deficits aren’t the real concern; it’s resource constraints in the economy.  There have to be enough workers and other resources in the economy to do the work the government wants done.

Kelton explains that our real constraints come from trying to control inflation.  However, she doesn’t address these constraints in any more detail.  She lists many projects governments could take on, including providing jobs guarantees, providing health care, improving education, fixing infrastructure, and addressing global warming.  She says we can ignore deficits in these pursuits, but how do we know we won’t end up with high inflation?

Kelton needs to make a case that we can pursue ambitious programs without causing inflation, but she leaves this unaddressed.  If it turns out that inflation is closely linked to deficits (perhaps with time lags), then our current focus on controlling deficits would be little different from Modern Monetary Theory’s focus on inflation.  They would be saying the same thing with different words.  I suspect they’re not saying entirely the same thing, but the degree to which they differ is hard to say.

Modern Monetary Theory (MMT) calls for a federal jobs guarantee.  The idea is that any unemployed person should be able to get a job with the government at a rate of pay slightly below the lowest pay in the private sector.  I see some challenges.  How do you deal with people who want to be paid but don’t want to work much?  How do you deal with aspiring workers who have physical or mental problems that prevent them from getting much work done?  If you employ such people, how do you prevent others from pretending to have such problems?  How do you avoid corruption among those who run such programs (e.g., no-show jobs)?  How do you avoid having some young people give up on their education and take a guaranteed job?  Maybe none of these concerns is a show-stopper, but I’d be interested in seeing solutions.

The best parts of this book explained the implications of fiat money.  While many people understand that governments can just create new money, the full implications of this fact aren’t obvious.  However, it’s not clear to what extent MMT is really a new financial theory, and to what extent it’s just a different way to express conventional ideas.


  1. Michael, thank you for the summary.
    I do not comprehend several points made by the author though, wonder if you could express your opinion on these:
    1. "This means the government could wipe out the national debt in seconds". Imho, this can be achieved by manufacturing more money and transferring it to lenders. Such move will create a hyper-inflation and immediately cause a need for a bigger debt.

    2. "Governments typically choose to issue bonds (treasuries) to cover deficit spending, but such bonds are really just a different kind of money conjured out of thin air." Imho, bond is an IOU, modern money has nothing behind it; how are these the same?

    1. Hi AnatoliN,

      To be clear, the author wasn't advocating for the government to wipe out its debt by creating more dollars. Her point is that the government could easily do this if it wanted to. We sometimes hear that the government is "broke" but this is impossible for an entity that can create new money at will. I don't know what would happen if the government were to pay off all its debts (bonds, treasuries, etc.) with newly created dollars, but inflation is certainly a possibility.

      Both dollars and government bonds are just conjured out of thin air. The only difference between one and the other is that bonds pay interest and come with the promise to replace the bond with dollars when it matures.