Modern Monetary Theory (MMT) has been gaining attention in recent months - some positive and some not so positive.
Over the next few years, investors can expect to hear a lot more about MMT. So what is it, and why should they care?
MMT is not a policy
First and foremost, MMT is not a policy or a theory - in many ways, its name is its biggest weakness. It is a fact-based, empirically supported framework of the modern (post gold standard era) monetary system.
At its core, MMT is a framework and detailed description on how the monetary system actually works across most developed countries. Indeed, those of us living in Australia (and the US, UK, Canada, Japan or New Zealand) are already living in an MMT world.
So if MMT is nothing more than a description of the system, how is it different to mainstream economics?
Currency issuer vs currency user
Distinguishing between a currency issuer and a currency user may sound like a fairly esoteric concept, but in fact it goes to the heart of MMT - and explains issues that have otherwise baffled mainstream economists.
For instance, in 2011 economist Paul Krugman famously asked why there was such a difference between Japanese and Italian interest rates. He noted Japan's government debt dwarfed that of Italy - yet Japanese interest rates were always zero, while Italy (and most of Europe) was suffering from a sovereign debt crisis.
MMT recognises countries that issue their own currency - such as the governments of Australia, US, Japan and the UK - cannot inadvertently become insolvent. Of course, that doesn't mean they will never go broke. But insolvency is a political choice, not economic. For example, the debt ceiling in the USA is a political constraint, not an economic constraint.
Likewise, whether Australia's deficit is $10 billion or $100 billion, the debt will never force interest rates higher or condemn Australia to an economy similar to Greece. There will always be a buyer of its bonds.
However, currency users - including countries such as Italy, Portugal and Greece, as well as businesses and state and local government - are no different to a household. Like a household, Italy does not have its own currency-issuing central bank, and therefore can 'go broke'.
Recognising that money is not a constraint for government, many critics jump to the conclusion that adherents of MMT believe deficits don't matter, and therefore the entire framework is garbage. Yet there are many papers over the years in which MMT academics clearly acknowledge deficits have always mattered - just not the way people traditionally think.
The MMT framework understands that while money may buy any good or service in an economy, it doesn't guarantee that good or service will be available. That is, the constraint on unlimited net government spending isn't financial, but rather the availability of real resources in the economy. And while a country like Australia or the USA can never run out of its own currency, it can run out of labour, energy, food or water.