March 11, 2021
Modern Monetary Theory has Real-world Pitfalls
- In this paper, Farah Omran and Mark Zelmer examine Modern Monetary Theory, and find that while the MMT actually accepts that government deficits matter, and acknowledges the need to contain inflation, it overstates the degree of monetary sovereignty that governments like Canada, with a small and open economy, enjoy in a world where capital is mobile.
- MMT argues that a monetary sovereign government – one that issues its own currency, borrows mainly in that currency, and operates a floating exchange rate – does not face financial constraints. However, the authors expressed concern that additional spending that seeks to maintain current consumption could erode investor confidence, leading to lower levels of investment and an exchange rate depreciation.
- MMT also prescribes fiscal measures – raising taxes or cutting spending, for instance – to deal with inflationary pressures, placing the onus on governments rather than central banks. The authors argue that having an independent central bank tasked with an explicit inflation control mandate is essential for a well-functioning economy to anchor market perceptions about inflation.