Anthony J. Pennings, PhD


Modern Monetary “Practice” and the Fear of Inflation in a Low-Supply Economy

Posted on | August 1, 2021 | No Comments

One of America’s most potent political myths is that you, as a citizen, pay for government spending. People talk about paying for this or that program, but what really happens is that Congress appropriates the money for spending. Then the Treasury instructs the Federal Reserve Bank to credit the spending accounts. Taxes and borrowing are separate entries. The issue is gaining scrutiny as the US economy reconciles 2020’s economic output slowdown due to COVID-19 in the context of record government spending.

A relatively new area of economic analysis, called Modern Monetary Theory (MMT), emerged from practitioners in the finance industry telling a different story about government spending. It is worth examining as it is based more on financial traders’ practices, particularly those who work with government bonds. Warren Mosler was critical in formulating and shedding light on the actual processes involved in government spending. Thus my emphasis on Modern Monetary “Practice” as it starts with this description of the spending process that allows us to reframe its dynamics.

Spending should not be seen as a panacea for the economy. Spending can be wasteful and lead to inflation. Spending needs to be productive. The $28 trillion debt accumulated by May 2021 is worthy of monitoring, but what does it really mean? What are its implications?

Taxes are registered by government, yes, but it’s not like household economics. A household needs a breadwinner, someone to bring home the bacon, to load up the metaphors. Someone needs to have money to pay the bills. Governments operate under a different set of rules and responsibilities. They can print or mint minor amounts of money and use the Fed for larger quantities. Government provides the money for the economy to operate, and the incentive – taxes – to make people want to own it. Mosler argues that governments have a monopoly on their currency and the responsibility to get it into the economy, by spending, to enable markets to work.

Central banks can make purchases of bonds and quite frankly, whatever it wants to buy. The Fed traditionally only bought government treasuries but now regularly buys mortgage-backed securities in a process called quantitative easing. Ideally, they can sell these treasuries and securities to absorb money from the economy if it smells inflation. The banking sector also creates money when it loans money to consumers.

The Treasury auctions bonds. But to pay for spending? They essentially provide:

  • Time deposits for investors;
  • Hedge instruments for traders;
  • Opportunities for foreign countries to keep their currencies cheap versus the dollar;
  • A vehicle for the Fed to influence the money supply and coordinate interest rates.

Borrowing should be seen as a political strategy to keep the financial system secure, provide a stable hedge, and manage the dollar’s value.

So, rather than worrying about “paying” for something, US citizens should be active in deciding how taxes should be used in public policy. The US policy should be designed to tax what it doesn’t want. Well, that isn’t going to be easy. But it is what democracy is about. Spending should also be determined on what will keep the US safe and secure. It should keep the economy productive while providing opportunities and avoid excessive inflation.

This last point is important. Inflation is the primary limiting factor when it comes to spending and is a calculus between supply and “effective” demand. “Too many dollars chasing too few goods” is the standard explanation by economists. Spending is easier for a government to coordinate. A good example occurred during the COVID-19 when the US government passed several emergency spending packages to support businesses and families, especially airlines hurt by the shutdown in travel. While the economy skyrocketed due to the fiscal and monetary stimulus, the slowdowns in production, disruptions of supply chains, and people staying at home caused a significant spike in inflation during early 2021.

Inflation in the US had been largely absent since Nixon took us off the gold standard in the early 1970s. At that time, the dollar deflated, and OPEC countries restricted oil production. So they wanted to drive up prices to make up for the diminishing value of the US greenback. Meanwhile, lacking banking systems due to Islamic restrictions on credit, they recycled US dollars through a global euro-dollar system. Called “petrodollars,” banks worldwide coordinated syndicated loans with these funds for countries needing dollars for energy purchases and development projects. “Economic hit men” scoured the world and pressured countries around the world to borrow the money, eventually creating what was called the “Third World Debt Crisis” in the early 1980s.

Since the 1980s, financialization and the commercialization of Cold War technologies created sufficient competition and disruption to keep prices down. Primarily information technologies, they increased productivity, reducing labor and resource costs. Also, globalization created new forms of interstate competition and cooperation, as supply chains supported innovation and higher quality products. The US government also floated bonds internationally to countries like England and Japan that strengthened the dollar and kept it as the world’s reserve currency.

The COVID-19 pandemic presents unprecedented economic challenges, particularly with its 2021 resurgence as the delta variant. A rising stock market that saw the DJIA hit 35,000 and S&P hitting 4,395.26 with a market capitalization of US$38.2 trillion. But concerns about inflation grew as commodities such as copper, lumber, and oil increased. A computer chip shortage also raised concerns about the production and pricing of cars, computers, and other commodities based on microprocessing capability. But the Fed and others saw this phenomenon as “transitory,” citing disruption, demographics, debt, and productivity as factors that would reduce inflationary pressures.

So the economy looks to be at risk in late 2021. Will the practical application of MMT provide operational guidance for a new era of prosperity? Can infrastructure and climate change solutions provide sufficient returns on these investments? The big question is whether government spending for such programs can avoid significant inflationary pressures? With COVID, we are struggling with how to spend in a low-output economy.


AnthonybwAnthony J. Pennings, PhD is Professor at the Department of Technology and Society, State University of New York, Korea. Originally from New York, he started his academic career Victoria University in Wellington, New Zealand before returning to New York to teach at Marist College and spending most of his career at New York University. He has also spent time at the East-West Center in Honolulu, Hawaii. When not in the Republic of Korea, he lives in Austin, Texas.


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