Modern Monetary Theory and the Temptation of Limitless Spending: A Dangerous Illusion
Modern Monetary Theory (MMT) is built on two fundamental propositions: that a government issuing its own currency can never default on its debt and that it can achieve full employment simply by hiring workers. While these claims are not necessarily false, they are far from universally desirable. If taken at face value, they suggest that governments should engage in unchecked spending or that citizens should embrace such policies without scrutiny.
At its core, MMT’s reasoning hinges on the concept of currency. While some may conflate this with money, the distinction is crucial. Currency is always a form of money, but money is not necessarily currency. Whether issued by governments or as cryptocurrencies, modern currency is inherently an intrinsically worthless instrument—whether a piece of paper or a digital token. However, this characterization does not fully define it. As I outline in my book, an intrinsically worthless currency is best understood as a claim that promises payment in units of itself. In practical terms, this means that an issuer—such as a central bank—can create a note valued at one dollar, which represents a liability for the issuer. The holder of this claim can return it to the issuer and receive another identical note valued one dollar in return. Importantly, because the issuer controls the supply of these claims, it can always fulfill this obligation, rendering it immune to default.
While this self-referential definition may seem counterintuitive, a persuasive illustration lies in the British pound. A five-pound note, as shown below, explicitly states that the Bank of England “promises to pay the bearer on demand the sum of five pounds.” This highlights the circular nature of currency issuance—one in which the obligation of the issuer is simply to provide more of the same.
The Role of Governments in Currency Issuance
Modern Monetary Theorists would likely accept this definition but go further in asserting that only governments can issue currency. Here, however, their position is questionable. The rapid rise of cryptocurrencies demonstrates that private entities, too, can create currency aligned with the definition given. Moreover, issuance does not necessarily require a single, centralized authority. Bitcoin, for example, is a decentralized system in which new currency units—ledger entries recorded as liabilities in the Bitcoin network—are distributed to miners.
MMT proponents further argue that government spending must precede the circulation of currency. According to their view, public expenditure is necessary to introduce money into the economy, allowing transactions to take place. Yet this claim is misleading. Currency could just as easily enter circulation through alternative mechanisms, including random distribution, as seen in various cryptocurrency models. There is no inherent reason why government spending must be the primary source of money creation.
The Fallacy of Default Immunity
A key implication of the intrinsically worthless currency is that currency issuers are immune to default, as they can always meet obligations in the unit they issue. However, this does not apply to all government entities equally. The central bank, as the issuer of government currency, may indeed be protected from default. The same cannot be said for the treasury, which must meet obligations in a currency it does not control.
For instance, bank deposits are claims to dollars, but those dollars are issued by the Federal Reserve, making them a finite resource for commercial banks when customers demand withdrawals. Similarly, treasuries issuing bonds are fundamentally distinct from central banks creating currency. While credit rating agencies do not assess the solvency of central banks, they do evaluate the creditworthiness of treasuries, banks, and other institutions precisely because these entities face solvency constraints.
Thus, the first MMT proposition—that governments cannot default—is not universally true. It applies only when the central bank and treasury are so closely intertwined that treasury bonds are effectively indistinguishable from central bank liabilities. While such an arrangement is often assumed to be the case, even in advanced economies, it is not an inherent feature of currency. Rather, it represents a political and institutional distortion—one designed to exploit the benefits of currency issuance. This is a long-standing practice, but one that perhaps deserves greater scrutiny.
A case in point is the European Central Bank (ECB), which was explicitly designed to operate independently from national treasuries. However, the sovereign debt crisis of the past decade has steadily eroded this separation, leading to a partial reversion that resembles implicit monetary financing—an outcome many had hoped to avoid.
Full Employment Without Inflation?
If governments indeed face no borrowing constraints, it follows logically that they could spend freely to achieve full employment by directly hiring workers. The second core MMT proposition is therefore a natural extension of the first. But does this approach truly create jobs without inflationary consequences?
MMT advocates argue that most economies operate below full employment, meaning additional government hiring could expand output without generating inflation. This view relies on a Keynesian framework in which the aggregate supply (AS) curve remains flat until full employment is reached, only then becoming vertical. In theory, fiscal spending moves aggregate demand (AD) from a point of underemployment (point A in the above graph) to full employment (point B in the above graph), with no inflationary effects.
However, this assumption is fraught with risks. It presumes that governments can precisely calibrate their spending, stopping at full employment without exceeding it (like in point C in the above graph). In practice, historical experience suggests that governments struggle to resist the temptation to overspend. Excessive unbacked fiscal expansion fuels inflation, raises inflation expectations, and distorts income distribution—ultimately depressing consumption, investment, and overall economic stability. Rather than fostering sustainable growth, such dynamics often trigger economic contractions, prompting even more government intervention and perpetuating inflationary spirals.
Even in the unlikely scenario where a government halts spending precisely at full employment, the strategy remains problematic. The state lacks the ability to efficiently allocate resources across sectors. If fiscal expansion directs labor into unproductive industries, employment may rise, but productivity growth stagnates. Misallocating human capital in this manner distorts incentives, discourages careers in high-value fields such as engineering, weakens innovation, and dampens long-term economic growth.
While inflation is a disease, a low-productivity trap is arguably an even greater threat. Many economies that engaged in large-scale public employment programs have found themselves struggling with stagnation for years afterward. The notion that government planners, unrestricted by budgetary discipline, can act as efficient allocators of labor is a frequently repeated but rarely validated claim.
Unfortunately, the myth of unlimited government spending remains pervasive on both sides of the Atlantic. In Europe, proposals for expanded joint borrowing rarely mention the tax increases that will eventually be required to finance such spending. The implicit assumption is that debt will either be rolled over indefinitely or monetized outright.
This mindset reflects a broader political tendency to defer financial discipline in favor of short-term policy objectives. The ability to print money does not equate to the ability to create real wealth without limits. As history has repeatedly shown, sound economic management requires recognizing constraints, not disregarding them. The allure of costless government spending is a dangerous illusion—one that prudent policymakers should approach with the utmost caution.
Pierpaolo Benigno. 2025. Monetary Economics and Policy: A Foundation of Modern Currency Systems. Princeton University Press.