Where Modern Monetary Theory (MMT) goes awry

Reddit user BainCapitalist has a great explanation of why MMT doesn’t work in practice. The full comment is posted below.

I’m assuming you’re subtweeting my MMT comment. I’ve noticed that whenever MMTers brigade that post they only ever complain about “the economic is science” part and they never actually address the substance of the comment. I suspect they don’t read past the first couple sentences. Bear with me here, the thesis of this comment has nothing to do with philosophy of science (and to be clear I’m not accusing you of anything this is just a big annoyance I have with very online MMTers).

MMT says inflation is not a problem because you can tax excess money to control it. Why is this bad econ? Maybe its bad politics, but ASSUMING the government can do this, why is it bad?

This is the issue. What you’re describing is not a complete assumption, we need to know more.

Currently in the United States, our institutional arrangement is set up so that the Federal Reserve controls the costs of inflation and congress controls the costs of fiscal policy (crowding out).

It is absolutely possible for congress to take this responsibility away from the Fed, congress gave this responsibility to the Fed in the first place. But this isn’t a complete assumption because we need to know what the Fed does if they don’t control inflation. You need to specify an interest rate policy reaction function of some kind.

If you pin MMTers down on this they will either 1) just refuse to specify a reaction function or 2) make the Fed keep interest rates at 0% all the time. Standard macroeconomic theory says this will cause high inflation or deflation, there isn’t a stable equilibrium where nominal interest rates don’t change. MMTers get around this by saying interest rate policy does not do anything in the first place. Interest rates don’t affect the economy, or they only effect the economy through treasury remittances. In other words, they say the IS curve is vertical. This is what MMT is actually about, this is what makes MMT different than standard macro. They are rarely up front and honest about this, but if you don’t believe me then look at these quotes:


The problem with the mainstream credit channel is that it relies on the assumption that lower rates encourage borrowing to spend. At a micro level this seems plausible- people will borrow more to buy houses and cars, and business will borrow more to invest. But it breaks down at the macro level. For every dollar borrowed there is a dollar saved, so any reduction in interest costs for borrowers corresponds to an identical reduction for savers. The only way a rate cut would result in increased borrowing to spend would be if the propensity to spend of borrowers exceeded that of savers. The economy, however, is a large net saver, as government is an equally large net payer of interest on its outstanding debt. Therefore, rate cuts directly reduce government spending and the economy’s private sector’s net interest income.

Randall Wray:

We don’t really even know if raising interest rates slows the economy or speeds it up. We don’t know if lowering the interest rate to zero is gonna stimulate the economy or cause it to continue to crash, okay? I’ll just put out there and we can debate it later if you want. There is no empirical evidence to support this at all. There’s no empirical evidence to support the belief that raising interest rates fights inflation, OK. The correlation actually goes the other way. Raising rates is correlated with higher inflation.


The evidence suggests that interest rates don’t matter much at all when it comes to private investment… It is even possible, as MMT has shown, that cutting rates could further slow the economy because lowering rates cuts government expenditures (interest payments), thereby exacerbating contractionary fiscal policy.

These all pretty much say the same thing: the IS curve is either vertical or slightly upward sloping. This is just fundamentally inconsistent with the real world. See this inty comment for a simple regression and a laundry list of papers.

First published Jun 22, 2022