Why MMT can’t work

Using a stock-flow consistent ISLM open-economy model, this article shows that, unless very specific country circumstances hold, modern money theory (MMT) cannot work as an effective and sustainable macroeconomic policy program aimed to achieve and maintain full-employment output through persistent money-financed fiscal deficits in economies suffering from Keynesian unemployment or underemployment. Specific country circumstances include cases where the economy enjoys very high policy credibility in the eyes of the international financial markets or issues an international reserve currency; under such circumstances, the adverse outcomes of MMT policy can be prevented and expansionary demand shocks can be effective. Short of such features, an open and internationally highly financially integrated economy that implements MMT policy would either see its money stock grow unsustainably large or would have to set domestic interest rates to levels that would be inconsistent with the policy objective of resource full employment and that would cause instead economic and financial instability. The article explains why ISLM analysis is used to support the arguments developed in it.