What is modern monetary theory - and what does it mean for business?

The economics behind the Green New Deal is a significant departure from traditional monetarism.

by Paul Simpson
Last Updated: 31 Jul 2019

Modern monetary theory is the idea that if the government injects £50 into the economy, it will probably get £40 back in taxes and the other £10 will be recorded as a surplus on someone else’s books.

This theory, as expounded by US economist Stephanie Kelton, is a rebuke to politicians who become obsessed by the government deficit because they are, as she puts it, "looking at this picture with one eye shut". In Kelton’s view, government spending is self-financing – providing it only incurs debts in its own currency.

Multi-billionaire Warren Buffett agrees with this approach, which justifies the massive public sector investment in the Green New Deal, proposed by Democratic congresswoman Alexandria Ocasio-Cortez, to turn the US into a carbon-neutral economy. 

This doesn’t sound like Milton Friedman’s monetarism

It isn’t. Modern monetary theory is founded on the belief that fiscal policy (what the government decides to tax and spend) is the key driver of a country’s economy rather than monetary policy (what the central bank decides to do about interest rates and its balance sheet).

The only problem with this argument is that few prominent economists agree. Even if a government issues debt in its own currency, they counter, slow revenue growth and increase spending on an ageing population could expand the deficit, affect savings, drive up interest rates and squeeze national income.

Does that mean modern monetary theory is rubbish?

No, the debate is a useful reminder that the knee-jerk political reflex – we must balance the budget now – is not an economic panacea.

Politicians often draw analogies with household economics, suggesting you can’t pay out more than you’re bringing in. It’s a great soundbite but it ignores the fact that the biggest single investment most families make is to incur a large, long-term debt to buy a house. 

So what does this mean for business?

On a macro-economic level, modern monetary theory represents a rejection of austerity and a splurge in infrastructure and R&D spending – good news for the construction and high-tech sectors. More importantly, the theory’s proponents argue its implementation will spur higher long-term economic growth - and a rising tide raises all boats.  

It may also provide a lesson of sorts. Fiscal policies say as much about a government’s vision of society as its financial prowess. That is also true for companies. CEOs must keep a close eye on debt but there may be times when deficits are not just necessary but advisable. Stable and sustainable debt is nothing to be scared of.

Image credit: Senate Democrats/Wikipedia (Creative Commons)

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