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Understanding The Strengths and Limitations of Modern Monetary Theory

Updated: Dec 16, 2023

Section One: A brief introduction


The Modern Monetary Theory has grown in popularity over recent years. The theory suggests that governments operating a fiat currency (a currency not backed by any physical commodity such as Gold) can print as much money as required to fund their business activities, without suffering any potential consequences. The theory also strongly supports the notion of taxation being removed as the primary source of government revenue, and instead offers it the managerial role of controlling the economy's inflation rate and aiding in income redistribution. In this article, I will discuss the strengths and limitations of this theory and provide examples of the recent applications of this expansionary form of monetary policy.



Section Two: Strengths and Advantages


Modern Monetary Theory implies that the level of government expenditure isn't limited to the revenue earned from taxation and that printed money can also be used to supplement their spending. With the government essentially taking control over the source of the budget, they retain more flexibility when it comes to deciding on the areas where they can concentrate their spending. As they aren't financially constrained to just their tax revenue, they gain the ability to finance more advanced projects and infrastructure developments for the economy, and become more responsive in implementing suitable policies used to tackle potential economic crises.


Another common belief within the Modern Monetary Theory is that full employment is a desirable and achievable goal for the economy, and the extra money in circulation can help reach this target. The theory suggests that the extra money available to the government can be used to provide enhanced education, healthcare, training and other public services that can improve the welfare and quality of the population. In the long term, this can help reduce unemployment within the economy, as more individuals gain the required ability and skillset to join the labour force and actively contribute to the economy's output production. Furthermore, strong advocates of the Modern Monetary Theory propose 'job guarantee programs' as another way of dealing with unemployment. These government-funded schemes would aim to eliminate involuntary unemployment, with the primary objective being to target those who are unable to find work in the private sector, and provide them with the opportunity to work for the government and earn a stable stream of income.


Section Three: Limitations and Drawbacks


Despite all the potential strengths that the theory holds, rapidly raising the money supply poses many risks to the state of an economy. One of the more dangerous risks is the likelihood of hyperinflation. Recent examples of this situation occurring include the 1923 Weimar Republic Crisis and the 2008 Zimbabwe hyperinflation case, with both scenarios eventually resulting in a replacement of the former currency. Raising the money supply and increasing the level of government expenditure will significantly increase the level of aggregate demand and, if not matched with sufficient growth in the aggregate supply, can lead to massive levels of demand-pull inflation, reducing the real wealth of consumers and diminishing the purchasing power of money.


Internationally, hyperinflation will affect the value of the currency on the foreign exchange market. With the value of domestically produced goods and services rising at a high and increasing rate, the demand for these goods and services falls. Demand for the currency will suffer as a result, as its demand is originally derived from the demand for the economy's goods and services. Falling demand for the currency will result in its depreciation, increasing the relative price of imported goods, and reducing the relative price of exported goods. In theory, this should make exports more price-competitive and imports less price-competitive. However unless Marshall Lerner's Conditions - where the sum of the Price Elasticity of Demand for exports and imports is greater than 1 - are satisfied, this will likely worsen the country's trade balance on the current account of the balance of payments.


Section Four: Recent Application Of This Theory


In the United States, a proposal titled 'Green New Deal' has been brought forward by democrats Alexandria Ocasio-Cortez and Edward J. Markey, formulated with the intention of tackling the issue of climate change. Though the proposal is believed to cost about $100 trillion, Ocasio-Cortez claims that the program can be funded off the basis of Modern Monetary Theory and that deficit spending can be used to finance its operations. She argues that the government's spending shouldn't be limited to solely its tax revenue and printing money will help facilitate the development of the project. Economist Stephanie Kelton also suggests that the lingering fears over hyperinflation should not persist, with the belief that the spare capacity available in the economy will reduce the upward pressure on prices and avoid triggering inflation.


Section Five: Summary and Final Remarks


All in all, Modern Monetary Theory attempts to provide valid support for the implementation of intense expansionary monetary policy. We have discussed its benefits, drawbacks and even seen how it has been applied in the real world, but ultimately the theory has only been recently developed and will need time to be fully accepted and well-recognised in the business world. Past cases of applying Modern Monetary Theory have produced disastrous results, but with rapid financial innovation and the discovery of renovated forms of technology and production methods over the years, we can look forward to a bright future with this theory, a future that is more responsive to these concerns about hyperinflation and is able to boost to the efficiency and productivity of the economy.


Sources:

  1. First picture from - Lawlor, P., 2019. Modern monetary theory – panacea or pie-in-the-sky?. [Online] Available at: https://www.investec.com/en_za/focus/economy/mmt-panacea-pie-in-sky.html [Accessed 27 June 2023].

  2. Hans, R., 2023. What is Modern Monetary Theory?. [Online] Available at: https://www.deskera.com/blog/modern-monetary-theory/#what-is-modern-monetary-theory [Accessed 27 June 2023].

  3. Llewellyn, J. & Thompson, S., 2019. The hyperinflation of 1923. [Online] Available at: https://alphahistory.com/weimarrepublic/1923-hyperinflation/ [Accessed 15 June 2023].

  4. Friedman, L., 2019. What Is the Green New Deal? A Climate Proposal, Explained. [Online] Available at: https://www.nytimes.com/2019/02/21/climate/green-new-deal-questions-answers.html [Accessed 30 June 2023].

  5. Horsley, S., 2019. This Economic Theory Could Be Used To Pay For The Green New Deal. [Online] Available at: https://www.npr.org/2019/07/17/742255158/this-economic-theory-could-be-used-to-pay-for-the-green-new-deal [Accessed 30 June 2023].

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