Explainer: Five questions about Modern Monetary Theory

WASHINGTON (Reuters) - What are the key ideas?

Like famed economist John Maynard Keynes, Modern Monetary Theory advocates think government has an important role in offsetting what happens when demand falls short of what’s needed to keep everyone who wants a job employed. They draw also on the ideas of Hyman Minsky, who was best known for his work on financial bubbles but also noted what he felt was the inherent tendency of market systems to fall short of full employment. MMT proponents also have a distinct view about the demand for money drawn from the work of a Keynes contemporary, Abba Lerner. They see it as rooted in government’s power to order that taxes be paid in a currency which it alone issues, and which it can also spend on goods and services. In their view, that means government spending can be used for core policies including a universal job guarantee that stabilize demand through the business cycle.

Isn’t that inflationary?

MMT advocates contend governments that have their own national currencies do not have a “budget constraint” — in other words they can’t run out of money because they can always issue more. Since they also see fiscal policy as the main tool to stabilize the economy, they would trust elected officials to make the spending decisions needed to ensure goals like universal employment. Some argue that’s a recipe for inflation, and the reason an independent central bank is needed to check excessive spending. MMT advocates do acknowledge the risk of inflation and see it as the constraint that would keep politicians honest. Under this framework, inflation is seen as a product of real resource limits, and it would fall to Congress to set spending, tax and industry-specific regulatory policies to keep inflation under control.

What about jobs?

Labor is a chief resource MMT advocates think about. A central idea is that the underuse of labor is a chronic problem for the U.S. economy and a key reason the Fed has struggled to raise inflation in recent years. They argue that government should guarantee a job to anyone who wants one. As the economy does better or worse through the business cycle, the number of people relying on those guaranteed government jobs versus private-sector jobs would expand or contract, with people during an expansion lured by the higher wages that the private sector would have to offer to attract workers.

What’s left for the Fed to do?

MMT sees the Fed as largely ineffectual. Under the framework MMT advocates describe, Congress would set a reference interest rate — it could even be zero — and the Fed could administer that. But the Fed’s employment mandate would be moot since there would be a guaranteed job for everyone, and inflation would be handled through fiscal tools as well. Financial supervision would remain with the U.S. central bank, as would its traditional role as lender of last resort in a crisis.

Could it backfire?

A lot of faith is put in elected officials and government regulatory agencies to get it right and show both a high degree of foresight in budgeting and a high degree of precision in managing inflation. Critics say it also overlooks how financial markets and global financial flows could create a backlash. Exchange rates float in the MMT framework. A loss of trust in U.S. finances could erode the dollar’s standing and create inflation through rising import prices, or a worse sort of financial crisis.

Reporting by Howard Schneider; Editing by Paul Simao