“The debt isn't the reason we can't have nice things. Our broken thinking is.” In her
book, The Deficit Myth, Professor Stephanie Kelton advocates for an unorthodox
approach to solving the biggest economic problems of our day. Her prescription is
simple: print more money and spend it. This idea, known as Modern Monetary Theory
(MMT), argues that a government that controls its own currency can print money to
fund its expenditures with no repercussions. 1 This thinking has inspired politicians
such as Bernie Sanders, Elizabeth Warren, and Alexandria Ocasio-Cortez to release
ambitious spending plans for infrastructure, pollution reduction, health care, education,
and crisis response, promising to improve all these areas without raising taxes.2,3,4 Is
this a fairy tale come true? Despite the rosy predictions, this “modern” theory is nothing
but a repeat of old fantasies that threaten to upend decades of monetary discipline that
generations of central bankers have built and which should not be hastily embraced by
governments.
It’s the Inflation
The MMT approach of massively increasing money printing would result in dangerous
degrees of inflation. Funding government expenditures using unlimited quantities of
newly created money leads to a super-charged version of the expansion of the monetary
base, which will create hyperinflation, significantly destabilizing the economy.
Traditionally, when central banks try to increase the money supply, they have to inject
money into banks and hope that the banks will then lend the money out to the market.5
Under that system, the money supply will not increase unless additional lending takes
place. But if such money were placed in the hands of the government for spending, it
would go to the market directly, increasing the money supply with no delay. Even if
such money eventually went back to banks, to slow its circulation in the economy the
central bank would have to increase interest rates 6 . The central banks then must
continually print more money to cover the interest payments, leading to a potential
spiral effect of escalating inflation.
The history of monetary policy is littered with disastrous attempts to fund governments
through money printing. After World War I, the Weimar Republic was saddled by
massive war debt and reparation payments. Facing the possibility of sanction for failing
to pay, its central bank resorted to printing money to buy foreign currencies to satisfy
payment obligations. 7 Within six months, the general price level rose by 1700%. 8
Hyperinflation led to the rapid depreciation of the German Mark to such an extent that
the exchange rate between the Mark and the US dollar reached an alarming ratio of four
trillion Marks to one dollar.9 Since then, this horrific scenario has repeated itself in
Zimbabwe, Argentina, and most recently Venezuela.10
Proponents of MMT reject these well-known precedents and argue that using money
printing as a source of government revenue does not inevitably lead to inflation. They
highlight Japan and the United States as compelling examples.11 In Japan, despite loose
monetary policy with persistently low-interest rates falling below one percent for
1
years, 12 the country experienced consistently low inflation rates since 1990, with
figures mostly below two percent and occasionally even entering negative territory.13
Furthermore, the money supply in Japan has continuously increased, nearly tripling by
2021.14 The United States witnessed a similar phenomenon from 2008 to 2019, with
the money supply more than doubling, 15 while the Consumer Price Index (CPI)
remained relatively stable at around two percent. 16 These prominent examples
challenge conventional understandings of inflation and strengthen the claim that public
expenditure funded by money creation does not necessarily result in significant
inflation.
Inflation is a multifaceted outcome influenced by various factors. Low inflation that
occurs despite a constant expansionary monetary policy regime can be attributed to
technological progress, an aging population, and low inflation expectations. 17
Technological advancements have boosted worker productivity, lowered average costs,
and subsequently reduced overall price levels.18 Additionally, in Japan’s case, its labor
market is characterized by firm-specific skills developed through long-term
employment practices. 19 The increasing proportion of unemployed older workers,
competing in entry-level positions without firm-specific skills, exerts downward
pressure on wages, leading to long-term deflationary effects.20
Inflation expectations also play a paramount role in the recent success of taming
inflation. A central bank that can act independently from the government’s fiscal
authorities strongly influences inflation expectations.21 Notably, greater central bank
independence correlates with lower expected inflation rates.22 The United States, for
example, has maintained low inflation due in part to public trust in the Federal Reserve.
During the 1970s, the Federal Reserve’s policies exemplified its commitment to
maintaining price stability. This period, referred to as the great inflation, was marked
by a decline in aggregate supply triggered by the oil crisis.23 Despite the risk of a
recession, the Federal Reserve made the deliberate decision to raise interest rates as
much as 20% to counter the escalating inflationary pressures. 24 , 25 More recently,
Chairman Jerome Powell pledged that Federal Reserve would keep raising interest rates
to tame the current supply shock-induced inflation even if that meant sparking a
recession.26,27 This strategic approach showcased the central bank’s unwavering focus
on curbing inflation and safeguarding the overall stability of the economy. As a result,
professional forecasters and financial analysts anticipate that price inflation will align
with the Federal Reserve’s target in the medium term.28 This sentiment fosters reduced
public sensitivity to economic fluctuations, as confidence in the Fed’s commitment to
the two percent inflation target reduces the likelihood of abrupt price level swings.29
However, the reliance on the central bank for government spending severely
undermines central bank independence. In this framework, fiscal authorities gain the
power to control the decisions of the central bank, blurring the boundaries between
monetary and fiscal policies. As a result, government spending becomes synonymous
with expansionary monetary policy, leading to an increase in the money supply.
2
However, this approach diminishes the central bank’s ability to effectively adjust
interest rates, which historically served as a tool for addressing inflationary pressures.
Consequently, public trust in the central bank erodes, and the economy becomes more
sensitive to economic fluctuations, jeopardizing price stability.30 The loss of trust in
the central bank undermines its capacity to implement effective measures to control
inflation, creating a challenging environment for economic stability.
Hurt Growth Potential
Even setting aside the inflation issue, printing money to fund the government can still
destabilize the economy and stymie growth. Continuous expansionary monetary policy
necessitates a zero-interest rate environment, which, in turn, encourages borrowing and
speculative behavior. With cheap credit amply supplied, individuals will invest in
various assets as a means of increasing their wealth, leading to an asset price bubble.31,32
This was seen, for example, from 2008 to the days before the pandemic, as Bitcoin’s
price jumped from a fraction of a penny to $19,345. 33 Additionally, when the
government injects money into the economy, particularly through the central bank, it
can also contribute to the formation of asset price bubbles. As the injected funds
circulate through expenditure and income flows, a portion finds its way into the
financial circuit through saving activities.34 This surplus liquidity, in turn, drives up
asset prices due to increased demand.
Simultaneously, “zombie firms” thrive due to the prevailing low borrowing costs in the
economy, trapping productive workers in unproductive firms. Such firms are
characterized by a lack of profitability over consecutive years, rendering them unable
to meet their debt obligations.35 But when the interest rate is low, zombie firms can
survive by borrowing. Specifically, the number of zombie firms correlates negatively
with the nominal interest rate.36 This relationship was further evidenced during the
Covid-19 pandemic in Japan when a zero-interest pandemic loan program was
introduced in 2020 to provide financial aid to businesses. 37 This low-interest rate
program resulted in a significant increase of 20,000 zombie firms from 2019 to 2020.38
The presence of zombie firms presents a significant menace to overall economic
performance due to their inherent inefficiency, leading to ineffective resource allocation.
These companies typically exhibit lower levels of productivity and have the potential
to impede the growth of more efficient firms by locking up resources, leading to what
is commonly known as “congestion effects.”39 By competing for resources, zombie
firms drive down prices of other products in the market while simultaneously inflating
wages and funding costs.
In addition, adopting zero interest rates as a consequence of continuous expansionary
monetary policy will inevitably result in a significant depreciation of the domestic
currency. The principle of covered interest parity dictates that for people to hold a
currency with a low interest rate, the exchange rate would have to appreciate to
compensate for the absence of interest income associated with holding the domestic
3
currency. 40 However, the persistent disparity between domestic and foreign interest
rates in the above scenario would trigger a steady outflow of capital and result in
currency depreciation.41 Such depreciation means people would have less reason to
hold the domestic currency, leading to further depreciation. The foreign exchange rate
thus collapses, rendering international trade unsustainable due to the extreme
devaluation of the currency. This severe depreciation adversely affects people’s living
standards and exacerbates the economic challenges faced by the country.
The above scenario spells doom, especially for developing countries. Developing
countries are more likely to rely on imports for critical resources such as food and
medicine42,43. A devalued currency means fewer imports, but to stop the devaluation,
such countries also face unpleasant choices. Under the concept of the impossible trinity,
also known as the trilemma, a country cannot achieve the following objectives
simultaneously but only two: “autonomous monetary policy,” “free capital movement,”
and a “stable foreign exchange rate.44.” With the interest rate staying at zero and an
urgent need to stabilize the currency, developing countries would have to close their
capital market to stop money from flowing out. This is problematic because the free
movement of capital facilitates efficient investment allocation, leading to increased
investment levels, improved living standards, and overall economic development. 45
Without it, investors would be hesitant to invest in a country, causing that country to
further lose growth potential.
A compelling example of the importance of attracting foreign investment and a stable
exchange rate for developing countries is observed in China's post-liberalization
policy. 46 From 1979 to 1994, annual capital inflows experienced a significant rise,
increasing from less than 1 percent of total fixed investment to 18 percent.47 These
foreign capital inflows have led to the establishment of factories, job creation,
integration into global markets, and technology transfers. Furthermore, China's
strategic decision to maintain a stable (while undervalued) exchange rate between 2002
and 2008 resulted in impressive export growth, averaging 27.3% and contributing
significantly to its GDP expansion.48 Approximately 30% of China's economic growth
during that period can be directly attributed to the outstanding performance of its export
sector.49 Inflation due to money printing would have hindered this progress.
Conclusion
While Keynes advocated for government intervention in a world filled with
uncertainties, his argument was often misconstrued in order to justify big government.
Our predicament today is brought by this very hubris: unrestrained spending, even in
normal times, leads to mounting debt, and when true needs for government intervention
arise, there is no money for them. The last thing that should be done now is to look for
some other defunct theory in the air. Instead of solely relying on increased tax revenue
and direct government intervention in the market, an alternative approach can be
pursued by employing policies that redirect existing market funds toward specific
4
industries. Such tried-and-true market-based solutions have worked well in the pursuit
of environmental sustainability, for example, as carbon taxes have proven to be the most
cost-effective way of removing CO2 emissions.50 Moreover, governments can keep
incentivizing private sector participation in renewable energy ventures by removing
market barriers and creating a business-friendly environment, without further
burdening their budgets. This approach harnesses market forces and encourages
private-sector engagement, allowing for efficient resource allocation and greater
economic growth.
Notes
N. Gregory Mankiw. "A Skeptic’s Guide to Modern Monetary Theory." 12 December 2019, pp. 2 3.
Ocasio-Cortez, Markey Reintroduce Green New Deal Resolution. 20 April 2021. https://ocasiocortez.house.gov/media/press-releases/ocasio-cortez-markey-reintroduce-green-new-deal-resolution-0
3
See Bernie Sander’s version of the green new deal, https://berniesanders.com/issues/green-new-deal/
4
Warren version. https://elizabethwarren.com/plans/climatechange#:~:text=Elizabeth%20will%20require%20the%20Pentagon,microgrids%20and%20advanced%
20energy%20storage.
5
N. Gregory Mankiw. Macroeconomics, 10th edition, New York: Worth Publishers. 2019
6
N. Gregory Mankiw. "A Skeptic’s Guide to Modern Monetary Theory." 12 December 2019, pp. 2 3.
7
Evans, Richard J. The Coming of the Third Reich. New York City: Penguin Press. 2003
8
Ibid.
9
Coffin. Western Civilizations: Their History & Their Culture. W. W. Norton & Company; 14th
edition. January 1, 2002
10
These three countries, historically exhibiting bad fiscal judgments, currently top the global inflation
chart,
https://www.imf.org/external/datamapper/PCPIEPCH@WEO/VEN?zoom=VEN&highlight=VEN
11
Only recently, both countries are beginning to experience inflation, mild compared to other
examples we mentioned. And more importantly, economists agree that the current inflation is caused by
supply shocks, not monetary policies.
12
The World Bank. Deposit interest rate (%) - Japan.
<https://data.worldbank.org/indicator/FR.INR.DPST?locations=JP>.
13
International Monetary Fund. Inflation rate, average consumer prices, Annual percent change.
<https://www.imf.org/external/datamapper/PCPIPCH@WEO/JPN?zoom=JPN&highlight=JPN>.
14
CEIC. Japan Money Supply M2. <https://www.ceicdata.com/en/indicator/japan/money-supplym2#:~:text=What%20was%20Japan's%20Money%20Supply,table%20below%20for%20more%20data
>.
15
Board of Governors of the Federal Reserve System (US), M2 [M2SL], retrieved from FRED,
Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M2SL, June 25, 2023.
16
The World Bank. Inflation, consumer prices (annual %) - United States.
<https://data.worldbank.org/indicator/FP.CPI.TOTL.ZG?end=2022&locations=US&start=2009>.
17
Juan M. Sánchez , Hee Sung Kim. Why Is Inflation So Low?. 02 February 2018.
<https://www.stlouisfed.org/publications/regional-economist/first-quarter-2018/why-inflation-so-low>.
18
Ibid.
19
Higuchi, Naoto, and Kiyoto Tanno. “What’s Driving Brazil-Japan Migration? The Making and
Remaking of the Brazilian Niche in Japan.” International Journal of Japanese Sociology, vol. 12, no. 1,
Nov. 2003, pp. 33 47. DOI.org (Crossref), https://doi.org/10.1111/j.1475-6781.2003.00041.x.
20
Shigeru Fujita & Ippei Fujiwara, 2021. Aging and the Real Interest Rate in Japan: A Labor Market
Channel. Working Papers 21-23, Federal Reserve Bank of Philadelphia.
21
Lee, James, et al. What Are Inflation Expectations? Why Do They Matter?
22
Jácome, Luis, and Samuel Pienknagura. Central Bank Independence and Inflation in Latin
America—Through the Lens of History. IMF Working Papers, vol. 2022, no. 186, Sept. 2022, p. 1.
DOI.org (Crossref), https://doi.org/10.5089/9798400219030.001.
1
2
5
Meltzer, Allan H., “Origins of the Great Inflation,” Federal Reserve Bank of St. Louis Review 87,
no. 2, part 2 (March/April 2005), pp. 145 75.
24
History of Federal Funds Rate, https://www.thebalancemoney.com/fed-funds-rate-history-highslows3306135#:~:text=The%20Fed%20increased%20the%20benchmark,stop%2Dgo%E2%80%9D%20mon
etary%20policy.
25
See also the history of the Great Inflation, told by the Federal Reserve,
https://www.federalreservehistory.org/essays/great-inflation
26
NPR Report, https://www.npr.org/2022/08/26/1119604922/federal-reserve-jerome-powell-inflationinterest-rates-recession
27
See also PBS’s documentary The Age of Easy Money.
28
Belz, Sage, and David Wessel. Explaining the Inflation Puzzle. p. 2.
29
The 2% target rate was first practiced by the central banks in New Zealand and now is followed by
most advanced economies.
30
In the three countries with the highest inflation we mentioned, none has independent monetary
authority.
31
Palley, Thomas I. Modern Money Theory (MMT): The Emperor Still Has No Clothes. p. 17.
32
See also the asset price bubble in Japan in the 80s, which was accompanied by monetary growth.
Shiratsuka, Shigenori. n.d. The Asset Price Bubble in Japan in the 1980s: Lessons for Financial and
Macroeconomic Stability. no. 21.
33
“A history of Bitcoin price,” https://www.investopedia.com/articles/forex/121815/bitcoins-pricehistory.asp
34
Palley, Thomas I. What’s Wrong with Modern Money Theory (MMT): A Critical Primer. p. 14.
35
Banerjee, Ryan, and Boris Hofmann. The Rise of Zombie Firms: Causes and Consequences. 2018.
36
Ibid.
37
JIJI. “Japan sees 'zombie' firms rise 30% after zero-interest pandemic loan program.” 03 May 2023.
<https://www.japantimes.co.jp/news/2023/05/03/business/pandemic-zombie-companies/>.
38
“Zombie Firms Rise Again in Japan with Aid of Pandemic Loans.” 09 August 2022.
<https://www.nippon.com/en/japan-data/h01399/>.
39
Banerjee, Ryan, and Boris Hofmann. The Rise of Zombie Firms: Causes and Consequences. 2018
40
Palley, Thomas I. Modern Money Theory (MMT): The Emperor Still Has No Clothes. p. 16.
41
Schmidt, Johannes. The Open (Economy) Flank of Modern Monetary Theory (MMT). p. 8.
42
Sri Lanka has just experienced such a crisis. And countries in Africa are also suffering as Russia’s
invasion of Ukraine has propelled food price to rise.
43
Zanna, Luis-Felipe. Fighting Against Currency Depreciation, Macroeconomic Instability and
Sudden Stops. Board of Governors of the Federal Reserve System International Finance Discussion
Papers. 2005
44
Mankiw, N. Gregory. Macroeconomics, 10th edition, New York: Worth Publishers. 2019
45
Guitián, Manuel. The Challenge of Managing Global Capital Flows.
46
While China does not exactly have an open capital market, it does give special privileges to FDI that
other developing countries may not be able to copy. See this analysis
https://www.minneapolisfed.org/article/2016/chinas-foreigninvestment#:~:text=From%201990%20to%201994%2C%20total,82%20percent%20from%20other%2
0nations.
47
Zuliu Hu, Mohsin S. Khan. Why Is China Growing So Fast? April 1997, International Monetary
Fund ed.: 5.
48
Yang Yao. "The Chinese Growth Miracle." Handbook of Economic Growth. Ed. Philippe Aghion,
Steven N. Durlauf. Vol. II. 2014. 943-1031. <https://doi.org/10.1016/B978-0-444-53540-5.00007-0.>.
49
Ibid.
50
OECD Report on Effective Carbon Prices, 2013, https://read.oecdilibrary.org/environment/effective-carbon-prices_9789264196964-en
23
6