Does modern monetary theory (MMT) apply outside the US?

Modern Monetary Theory (MMT) argues the true constraint is inflation, not debt levels.

Any government issuing debt in its own currency can self-fund in recessions by having the central bank purchase government treasuries, effectively lending to itself.

MMT is not limited to the U.S.; countries like Japan, the UK, and Canada have successfully used domestic debt monetization during recessions without sparking inflation.

MMT principles can stabilize recessions globally, provided inflation is controlled and monetary-fiscal coordination remains intact.

What is modern monetary theory (MMT) ?

Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that reinterprets conventional understandings of fiscal and monetary policy for nations with full monetary sovereignty (Kelton, 2020).

MMT principles:

1. Monetarily sovereign governments (those issuing their own fiat currency) cannot go bankrupt in their own currency.

2. Taxes do not fund spending but instead create demand for currency and control inflation.

3. The primary constraint is inflation, not budget deficits or debt-to-GDP ratios (Mitchell et al., 2019).

   
   

Do We Owe to Ourselves?

MMT argues that governments issuing debt in their own currency can effectively self-fund to close a negative output gap during recessions. This mechanism relies on the understanding that a country’s public debt is debt to itself: the government issues treasuries, and the central bank purchases them to expand the money supply (Kelton, 2020).

Historical data show that most recessions are deflationary. For example, during the 2008 global financial crisis, U.S. core inflation fell to 0.6% in 2010, well below the Federal Reserve’s 2% target (Federal Reserve Bank of St. Louis, 2023). In such periods, output falls below its potential, prompting firms to cut prices to sell unused capacity. According to MMT, this is precisely when self-funding fiscal expansion is both feasible and necessary.

Importantly, MMT principles are not exclusive to the U.S. The mechanism operates in any country issuing debt in its own currency, provided inflation remains below target. For instance, Japan has maintained a public debt-to-GDP ratio exceeding 250% without triggering inflation because actual output remained below potential (IMF, 2022). Similarly, the UK and Canada successfully expanded public spending during COVID-19 recessions without destabilizing inflation in the initial phase, highlighting that the key constraint is productive capacity, not nominal debt.

Why MMT Can Work Globally

The success of the self-funding mechanism relies on coordination between fiscal and monetary policy:

1. Fiscal Expansion: Governments issue treasuries to finance spending, stimulating aggregate demand.

2. Monetary Accommodation: Central banks purchase treasuries, lowering yields and creating bank reserves.

3. Closing the Output Gap: Spending restores actual output toward potential output without causing runaway inflation.

If either side fails, the mechanism falters. For example:

• Without monetary accommodation, higher government borrowing costs can crowd out spending.

• Without fiscal stimulus, monetary expansion through asset purchases (QE) may only inflate financial assets, as observed in post-2008 U.S. QE programs, where M2 velocity fell from ~1.9 in 2007 to ~1.1 in 2015 (Federal Reserve Bank of St. Louis, 2023).

Stagflation and MMT Limitations

A key limitation of MMT is stagflation—simultaneous high inflation and negative growth. Countries like Turkey in 2021-2022 and Argentina historically illustrate this challenge. Expanding spending in such conditions risks inflation spirals, as supply-side constraints prevent additional output.

MMT can still apply conditionally in stagflation if the negative output gap is wide enough to absorb additional demand without surpassing potential output. For instance, a country can maintain the current inflation rate while restoring production, then gradually tighten policy to reduce inflation after recovery.

Central Bank Independence and Hyperinflation Concerns

Critics of MMT often cite Weimar Germany and Zimbabwe, warning that monetized deficits lead to hyperinflation. However, these episodes involved loss of central bank independence and foreign-denominated obligations, not controlled domestic monetary expansion.

Modern frameworks mitigate this risk:

• Central bank independence ensures governments cannot perpetually overspend without restraint.

• Inflation targeting regimes (e.g., ECB, Fed, BoE) allow monetary tightening via treasury sales or policy rate hikes once inflation rises.

• Empirical studies suggest that advanced economies with independent central banks rarely experience inflation from moderate debt monetization if output remains below potential (Blanchard, 2019).

From Debt Taboos to Accounting Solutions

Despite its logic, MMT faces psychological and political barriers. Voters and markets often perceive rising public debt-to-GDP ratios as fiscal deterioration, even if the debt is domestically held. For instance, after COVID-19 stimulus packages, U.S. debt-to-GDP surged to 128% in 2020, sparking political debates despite historically low borrowing costs (CBO, 2021).

A practical adaptation is changing central bank accounting to enable “transfers”:

• The central bank debits a “transfers account” when issuing money directly to households or in coordination with fiscal authorities.

• This avoids the optical surge in public debt, supporting MMT principles without triggering public debt anxiety.

Conclusion

Modern Monetary Theory applies globally to countries issuing debt in their own currency, not only the U.S. The true constraint is inflation, not arbitrary debt thresholds.

In recessions:

• Governments can lend to themselves via treasury issuance.

• Central banks can purchase these treasuries to monetize spending.

• Inflation signals when to stop.

However, stagflation and political perceptions of debt remain practical challenges. Adjustments in central bank accounting and communication can make MMT-based strategies more politically viable while ensuring that spending fills the output gap without risking hyperinflation.

References

• Blanchard, O. (2019). Public Debt and Low Interest Rates. American Economic Review, 109(4), 1197-1229.

• Congressional Budget Office (CBO). (2021). The 2021 Long-Term Budget Outlook.

• Federal Reserve Bank of St. Louis. (2023). FRED Economic Data. https://fred.stlouisfed.org

• International Monetary Fund (IMF). (2022). Fiscal Monitor: Managing Public Wealth.

• Kelton, S. (2020). The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. PublicAffairs.

• Mitchell, W., Wray, L. R., & Watts, M. (2019). Macroeconomics. Red Globe Press.

• Wray, L. R. (2015). Modern money theory: A primer on macroeconomics for sovereign monetary systems (2nd ed.). Palgrave Macmillan.