Counter arguments to the critics of modern monetary theory (MMT)

MMT works best in jurisdictions where central bank money creation is exclusively government-backed, with the U.S. Fed being the clearest example today.

Modern Monetary Theory (MMT) asserts that a government can self-fund in its own currency as long as its central bank finances spending through public debt only.

This “self-funding loop” relies on central banks accepting only government treasuries as collateral for money creation.

To fully apply MMT principles, central banks would need to limit monetary issuance to public assets, preventing private credit risk from entering central bank balance sheets.

1. Federal Reserve Act requires the Fed to finance government

   
   

Critics dispute MMT’s assertion that a country can self-fund in a recession. Yet, the Federal Reserve Act effectively leaves the Fed with no option but to finance government spending. The Fed can only lend in return for U.S. Treasuries or government-sponsored mortgage-backed securities (Fannie Mae, Freddie Mac). In recessions, the Fed purchases Treasuries until its dual mandate of price stability and full employment is threatened by inflation. In practice, the U.S. lends to itself through this mechanism (Federal Reserve, 2022).

Under MMT, this “self-funding” loop works as long as central banks accept only public treasuries as collateral for money creation. If central banks begin accepting private commercial papers or corporate bonds, the monetary base is split between public and private credit creation, weakening the MMT logic.

2. Private debt proves fragile, while public debt does not

   
   

High private leverage has historically driven financial crises, while high public leverage has not. Since 1980, U.S. private sector debt has risen sharply, with household debt-to-GDP peaking near 100% in 2008 (BIS, 2023). The Global Financial Crisis (2008) demonstrated that private debt amplifies downturns as households and firms cut spending to service loans (Mian & Sufi, 2014).

Current monetary policy has been piling on private debt via QE, purchasing trillions in corporate bonds and mortgage-backed securities. By contrast, public debt can be monetized without immediate fragility, as governments cannot be forced into insolvency in their own currency.A sustainable system would limit private leverage while creating new income via central bank transfers—debt-free spending that aligns with MMT principles.

3. Raising public debt is the most efficient way to boost demand

   
   

Monetization of public debt ensures direct spending. QE, in contrast, expands central bank balance sheets by purchasing financial assets—but much of the liquidity is trapped in markets, inflating asset prices rather than consumption (Gagnon et al., 2011).

A public debt-financed stimulus or central bank income transfers delivers a 100% pass-through to spending, requiring a smaller balance sheet expansion than trillions in QE aimed at corporate assets.

4. Would inflation pose a threat?

   
   

Critics worry that unconstrained public spending leads to inflation or even hyperinflation. Indeed, political incentives can encourage over-spending before elections. However, these risks already exist under current debt issuance frameworks.

Modern economies mitigate this with central bank independence: the central bank can raise rates or tighten capital requirements to restrain credit creation if inflation exceeds target.

5. Global Central Bank Capacity for MMT

   
   

The capacity for MMT depends on collateral rules:

• Federal Reserve (U.S.) – Accepts only public Treasuries and GSE-backed securities, except for temporary emergency programs. Strong MMT alignment.

• ECB & Bank of England – Accept both public and private collateral (bank bonds, corporate debt, ABS). This dilutes MMT’s pure self-funding logic.

• RBA (Australia) – Similar to the ECB; accepts private collateral in routine operations.

Only the U.S. maintains a clean public-only model, which allows near-complete self-funding under MMT during recessions.

Central Bank	Public-Only Collateral?	Private Collateral Accepted?	MMT Self‑Funding Integrity
Federal Reserve (US)	✅ Yes	❌ Only temporary emergency facilities	Strong alignment with MMT
ECB (Eurozone)	✅ Yes	✅ Yes (bank and corporate debt, ABS)	Weak – monetary creation split
Bank of England (UK)	❌ No	✅ Yes (public and private securities)	Weak alignment
Bank of Japan (Japan)	❌ No	✅ Yes (JGBs, commercial paper, trust interests, ABS)	Mixed – core is public, significant private
Reserve Bank of Australia (RBA)	❌ No	✅ Yes (bank-issued & corporate bonds, securitised assets)	Weak alignment
Swiss National Bank (SNB)	❌ No	✅ Yes (primarily mortgages, moving to Lombard & commercial loans)	Weak – emergency-only public bias but expanding private exposure

Conclusion

Modern Monetary Theory does not invent a new mechanism; it formalizes the self-funding reality of governments operating with sovereign currency. As long as central banks restrict collateral to public debt, money creation finances the government without default risk. Once private collateral dominates, central bank funding is split, and MMT’s clean logic weakens.

Limiting private leverage, sustaining income via central bank transfers, and maintaining a public-collateral framework could render the monetary system more resilient to crises while avoiding the repeated buildup of fragile private debt.

References

• Bank for International Settlements (BIS). 2023. Credit to the Non-financial Sector.

• Federal Reserve. 2022. Federal Reserve Act: Section 14.

• Gagnon, J., Raskin, M., Remache, J., & Sack, B. 2011. The Financial Market Effects of the Federal Reserve’s Large-Scale Asset Purchases.

• Mian, A., & Sufi, A. 2014. House of Debt. University of Chicago Press.

• European Central Bank. 2024. Collateral Framework Guidelines.

• Reserve Bank of Australia. 2017. Collateral Eligibility and Operations.