In the field of economic policy, debates between different schools of thought often shape the direction of government actions. Two prominent perspectives—Modern Monetary Theory (MMT) and mainstream, conventional economics—represent contrasting approaches to managing fiscal policy, inflation, and growth.
Historically, these two frameworks have often been viewed as competing forces, each with its own set of assumptions and prescriptions. However, viewing them solely as opposites oversimplifies the conversation. In fact, their relationship can be seen as more complementary than conflicting, especially when examining how fiscal policies are implemented in different economic contexts.
Let’s explore how these two approaches can work together to form a more holistic, adaptive economic framework.
The Foundations of MMT and Conventional Economics
Modern Monetary Theory emerged in the late 20th century as an alternative to mainstream economic thought. Developed by economists such as Warren Mosler, L. Randall Wray, and Stephanie Kelton, MMT challenges the traditional view that governments must balance their budgets like households, arguing instead that governments issuing their own currency have greater flexibility in managing deficits. MMT suggests that such governments can spend as much as necessary, so long as inflation remains under control. Proponents believe that focusing too heavily on debt and deficits undermines the government’s ability to address unemployment, public investment, and social welfare needs.
Conventional economics, on the other hand, emphasizes a more cautious approach. Rooted in the work of economists like Milton Friedman and John Maynard Keynes, it maintains that unchecked government spending can lead to inflationary pressures that destabilize the economy. The central tenet is that governments should aim for a balanced or manageable deficit, as excessive borrowing and spending can devalue the currency and erode public confidence. In this view, inflation is a constant threat that should be mitigated through restrained fiscal policy and effective monetary interventions, such as adjusting interest rates or tightening the money supply.
At first glance, the core principles of MMT and conventional economics seem irreconcilable. Where MMT calls for expansive fiscal policy, conventional theory preaches prudence. Where MMT sees inflation as a controllable outcome, conventional economics warns of its disastrous potential. Yet, the two schools of thought are not as mutually exclusive as they appear. Instead, the key lies in understanding when and how to apply the lessons of each framework.
Fiscal Policy as a Tool for Economic Growth
The concept of fiscal policy as a means to stimulate growth is central to both MMT and conventional economics. However, the extent to which each approach advocates government intervention differs. MMT encourages government spending to bridge gaps in demand, especially in times of economic downturn. The logic behind this is clear: when private sector demand is weak, the government can step in, creating jobs and increasing consumption, thereby driving growth.
In contrast, conventional economics advises a more measured approach. It acknowledges the role of government in counteracting recessions but cautions against overreach. For example, conventional theory advocates for counter-cyclical spending, where governments increase spending during downturns but pull back during periods of growth to prevent overheating the economy. This approach seeks to balance the short-term benefits of stimulus with the long-term risks of inflation and debt accumulation.
The reality is that both approaches are useful, depending on the specific economic context. During a deep recession or a period of low inflation and high unemployment, MMT’s emphasis on aggressive fiscal policy can be a powerful tool. In such scenarios, the risk of inflation is low, and government spending can help stimulate demand. However, during periods of economic stability or rising inflation, conventional wisdom takes precedence. In these times, tightening fiscal policy becomes necessary to prevent runaway inflation, ensuring long-term economic stability.
The Role of Inflation: A Common Concern
Inflation is a central concern for both MMT and conventional economics, but the two theories approach the issue differently. For MMT proponents, inflation is the only real constraint on government spending. They argue that as long as inflation is under control, the government can continue to spend without worrying about deficits or debt. In this view, taxation and monetary policy should be used primarily to manage inflation, rather than to fund government spending directly.
Conventional economists, on the other hand, see inflation as a more immediate threat. They argue that excessive government spending—especially if it outstrips the economy’s productive capacity—can quickly lead to inflation. Once inflation takes hold, it can spiral out of control, eroding savings, reducing purchasing power, and destabilizing financial markets. From this perspective, keeping inflation in check should be the primary goal of fiscal and monetary policy.
What both perspectives agree on is that inflation is not a trivial issue. However, while MMT tends to focus on controlling inflation after the fact, conventional economics emphasizes preemptive measures to avoid inflation altogether. This divergence in approach suggests that the two theories can complement each other, rather than compete. MMT’s insights can inform how governments respond to low inflation environments, while conventional economics provides a framework for managing the risks of inflationary pressure in stronger economies.
Germany and Zimbabwe: Hyperinflation and Diverging Interpretations
The cases of post-World War I Germany and Zimbabwe in the 2000s are often used as examples in discussions about the dangers of inflation and the risks associated with government spending. Both instances represent extreme cases of hyperinflation, and both are frequently invoked by conventional economists to argue against excessive fiscal expansion. However, MMT proponents interpret these cases differently, focusing on the role of supply constraints and external pressures rather than merely excessive money printing.
After World War I, Germany faced enormous reparations and a devastated economy. In response, the German government resorted to printing money to meet its obligations, leading to runaway inflation. Prices skyrocketed to the point where citizens needed wheelbarrows full of banknotes to purchase basic goods. At its peak in November 1923, inflation in Germany reached a staggering 29,500% per month. Conventional economists view this as a clear warning about the perils of unchecked government spending and excessive money supply. For them, Germany’s case demonstrates that fiscal policy without regard to inflation can lead to economic collapse.
MMT scholars, however, argue that the situation in Germany was not just about money printing. They emphasize the structural damage to the German economy from the war and the harsh external constraints of the Treaty of Versailles. Germany’s productive capacity was severely weakened, and the burden of reparations in foreign currency created a mismatch that exacerbated inflationary pressures. From the MMT perspective, Germany’s hyperinflation was driven by a supply-side collapse and external obligations, suggesting that government spending was not the sole culprit.
Similarly, Zimbabwe’s hyperinflation in the early 2000s is frequently cited as another example of fiscal irresponsibility. After land reforms that devastated agricultural production, the government turned to money printing to finance its deficits. The result was one of the worst cases of hyperinflation in history, where prices doubled daily, and the economy fell into chaos. At its peak in November 2008, Zimbabwe’s inflation rate reached an unfathomable 79.6 billion percent month-on-month. Conventional economists point to Zimbabwe as a clear example of how reckless fiscal policies can destroy an economy.
However, MMT proponents argue that Zimbabwe’s hyperinflation was primarily a result of the collapse of its productive sector. The land reforms decimated agricultural output, which had been the backbone of the economy. With supply severely constrained, any increase in demand from government spending or money printing inevitably led to inflation. In this interpretation, the lesson is not that government spending always causes inflation, but that spending must be aligned with the economy’s ability to produce goods and services.
These historical cases show that hyperinflation is often more complex than a simple result of government spending. External factors, such as reparations or the collapse of key economic sectors, can play a critical role in driving inflation. While conventional economists focus on the risks of overspending, MMT reminds us that supply constraints and structural issues must also be addressed to manage inflation effectively.
The Japanese Example: Fiscal Stimulus Without Inflation
Japan offers a compelling case study for examining the interaction between fiscal policy and inflation. For decades, Japan has pursued expansive fiscal policies to combat deflation and stagnation, with its government debt reaching one of the highest levels among developed nations. As of 2021, Japan’s government debt stood at a staggering 259% of its GDP, far exceeding that of other major economies. Yet, despite years of large deficits, Japan has not experienced significant inflation. In fact, the country has struggled with low inflation and deflationary pressures for much of the past 30 years, with inflation rates often hovering below 1% annually.
This scenario aligns with MMT’s argument that government spending does not automatically lead to inflation, especially in an economy with weak demand. Japan’s aging population, high savings rates, and low consumer spending have kept inflation in check, despite the government’s large deficits. In this context, MMT’s prescription for fiscal expansion to stimulate growth seems appropriate. Japan’s experience suggests that in environments where demand is subdued, governments can afford to run large deficits without triggering inflation.
However, conventional economics also plays a role in understanding Japan’s situation. While Japan’s government has been able to avoid inflation, its long-term debt sustainability remains a concern. Conventional theory warns that high levels of debt, even if they don’t cause inflation immediately, can become a burden over time. Interest payments on debt can crowd out other government spending, limiting the government’s ability to respond to future crises. In Japan’s case, a careful balance between fiscal stimulus and debt management is essential.
The United States: Inflation and the Limits of Fiscal Stimulus
In contrast to Japan, the United States has faced rising inflation in the wake of the COVID-19 pandemic, despite similarly aggressive fiscal measures. The U.S. government implemented massive stimulus packages to support households and businesses during the pandemic, with trillions of dollars in direct payments, unemployment benefits, and loans. The American Rescue Plan Act of 2021 alone injected $1.9 trillion into the economy. While these measures helped to stabilize the economy in the short term, they also contributed to a surge in demand that outpaced supply, leading to inflationary pressures.
This experience highlights the limits of MMT’s approach. While fiscal stimulus was necessary to prevent a deeper recession, the U.S. case demonstrates how excess demand, when coupled with supply chain disruptions and other external shocks, can lead to inflation. Here, conventional economic thinking—focused on balancing demand with supply and controlling inflation—becomes crucial. The United States Federal Reserve’s decision to raise interest rates in response to rising inflation reflects this conventional wisdom. In 2022, the Federal Reserve embarked on one of its most aggressive rate-hiking cycles in decades, raising the federal funds rate from near zero to over 5% in just over a year.
The U.S. case also shows that MMT and conventional economics need not be mutually exclusive. The initial fiscal response to the pandemic was necessary to avert economic collapse, but as inflationary pressures began to mount, conventional measures like monetary tightening became essential. This balance between fiscal stimulus and inflation control illustrates the potential for the two frameworks to complement each other.
Switzerland: Stability Through Fiscal Prudence
Switzerland, with its highly developed economy and stable financial system, provides another useful example for understanding the relationship between fiscal policy and inflation. Switzerland has long maintained conservative fiscal policies, with relatively low levels of public debt and cautious government spending. As of 2021, Switzerland’s government debt-to-GDP ratio stood at around 42%, significantly lower than most developed economies. This approach aligns closely with conventional economic theory, which emphasizes fiscal restraint to avoid inflation and maintain long-term stability.
Despite this cautious approach, Switzerland has not suffered from the economic stagnation seen in Japan. Instead, it has maintained steady growth and low inflation. One key factor is Switzerland’s focus on maintaining a high level of productivity and innovation, particularly in industries like pharmaceuticals, finance, and technology. By investing in areas that drive economic growth without overextending its fiscal commitments, Switzerland has been able to achieve stability without resorting to aggressive government spending.
Switzerland’s case suggests that for highly developed economies with strong supply-side fundamentals, conventional economics provides a solid framework for maintaining stability. In such economies, the risks of inflation may outweigh the benefits of expansive fiscal policy, and prudence in government spending becomes essential. However, Switzerland’s experience does not invalidate the insights of MMT; instead, it shows that different economic contexts require different approaches. In Switzerland’s case, the focus is on maintaining productivity and innovation, rather than relying on fiscal stimulus to drive demand.
The Philippines: A Developing Economy in Need of Investment
The Philippines presents yet another contrasting case. As a developing economy with a young and growing population, the country faces challenges that are different from those in Japan, the United States, or Switzerland. The Philippines has significant infrastructure and social welfare needs, and its government has been working to address these gaps through public investment. In this context, MMT’s emphasis on fiscal expansion is particularly relevant.
For developing economies like the Philippines, government spending on infrastructure, education, and healthcare is critical for long-term growth. MMT’s argument that such spending should not be constrained by concerns over deficits is compelling, especially in a country where investment in these areas is sorely needed. The Philippine government’s “Build, Build, Build” program, launched in 2017, aimed to increase infrastructure spending to 7% of GDP by 2022, a significant increase from historical levels. However, the Philippines also faces significant inflation risks, driven by factors like energy prices, food supply shocks, and currency fluctuations.
Here, conventional economic thinking provides important guidance. While fiscal expansion is necessary to address the country’s developmental needs, the government must also be mindful of the inflationary risks associated with increased spending. In this context, a balanced approach that incorporates both MMT’s emphasis on investment and conventional economics’ concern for inflation control is essential for ensuring long-term growth and stability in the Philippines.
A Balanced Approach for Varied Economic Contexts
The examples of Germany, Zimbabwe, Japan, the United States, Switzerland, and the Philippines reveal the diverse economic conditions that shape the outcomes of fiscal policies. MMT and conventional economics, though often viewed as opposing theories, offer valuable insights that can be applied depending on a country’s specific economic circumstances.
In times of economic crisis, such as in the aftermath of war or during a global pandemic, MMT’s emphasis on fiscal expansion can be a crucial tool for stimulating growth and avoiding deeper recessions. However, as economies recover and inflationary pressures begin to mount, conventional economic wisdom provides essential guidance on managing those risks, ensuring long-term stability and sustainability.
The cases of hyperinflation in Germany and Zimbabwe highlight the dangers of ignoring supply-side constraints and the role of external pressures, reinforcing the importance of tailoring fiscal policies to a nation’s economic capacity. Meanwhile, Japan’s deflationary experience and Switzerland’s steady growth show that expansive government spending is not always necessary, especially when economies are already strong or face demographic challenges.
The most effective economic policies are those that recognize the complexity of real-world economies. Governments should not rigidly adhere to one economic theory at the expense of another. Instead, a flexible, adaptive approach that incorporates the strengths of both MMT and conventional economics offers the best chance for fostering sustainable growth, controlling inflation, and addressing the unique challenges of each country.
Image by Barta IV
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