The Modern Monetary Theory Vs. Traditional Policy

The Modern Monetary Theory Vs. Traditional Policy
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The Modern Monetary Theory Vs. Traditional Policy
Economists have different theoretical explanations regarding the functioning of the economy. Various models have been put across to control economic activities in the world. Governments play a major role in controlling the economy through fiscal policy. As well, monetary policy determines the inflation rates that could grow or negatively affect an economy. Among the theories used to elaborate more about the economy are the traditional policy and the Modern Monetary Theory (MMT). These two theories have different perspectives regarding the growth of an economy. Therefore, this paper will compare and contrast the MMT and the traditional policy. It will also outline the pros and cons presented by both theories.
The MMT theory describes the currency as a monopoly whose use is controlled by the government. The theory supports the role played by fiscal policy in controlling the economy. The unemployment rate in a country is evidence that governments are restricting the finances and assets that could be used to satisfy needs and pay taxes. If the currency were not a monopoly being controlled by the government, then economies would be able to reach full employment. According to the theory, government plays a huge role in the creation of new money. In turn, this gives money its value (Mankiw, 2020). The government has the ability to increase the amount of money in circulation and reduce it through tax collection. Whenever the economy is having a high rate of inflation, the government reduces the amount of money in circulation. This is achieved by increasing tax rates and cutting on government expenditure. Once the amount of money in circulation has been reduced, the inflation rates reduce, thus leading to normalcy in the economy. However, reducing the level of inflation to the desired levels is not always possible. Through the MMT, governments can use the power they have over money to control economies. If money were not a monopoly, then it would be challenging to control economic growth. This is an indication of how beneficial the theory is in terms of economic growth. Another example of how governments' power over money is beneficial to the economy is during recession periods. During this time, the government has the ability to increase the amount of money in circulation. This is achieved by increasing public spending and cutting a tax rate (Mankiw, 2020). When people have more disposable income to spend, the demand for products will increase. In turn, this would stimulate economic growth. This contrasts with the traditional policy, which relies on the management of short-term interest rates and fails to rely on new tools of stimulating economic growth. The economy structure keeps on changing, which makes the traditional policy an ineffective way of stimulating economic growth. Money, being a monopoly, turns out to the ideal way of stimulating economic growth. The MMT has been adopted by many governments such as the US and Japan. The theory has proven to be an effective tool for stimulating economic growth and controlling unemployment rates within the countries (Dell'Ariccia, Rabanal & Sandri, (2018).
The MMT points out that federal deficits are a good thing for the economy because they facilitate economic growth. It also claims that surpluses are not always good, as claimed by the traditional policy. The traditional policy claims that deficits are bad, and whenever a country is in a deficit, it should implement fiscal policies to reduce the deficit (Furman & Summers, 2019). A deficit means that the country's expenses have exceeded its revenues. It is an indication that the country is spending more on imports than exports. Traditional policy believes that a deficit is bad for the economy because it indicates the economy is not maintaining a trade balance. However, the MMT points out that such deficits are not always bad. In most cases, governments deliberately allow such deficits to occur for the purpose of stimulating an economy to exit recession. The deficits are also made to stimulate the economy's future growth. Therefore, if the deficits were not a good thing, some economies might not be able to recover from recessions. The surpluses are not always a good thing for the economy. A surplus occurs in a situation where the country's exports exceed imports. This is an indication that the country has a high domestic saving level. The bad thing about such surpluses is that they might be achieved at the expense of the economy's future growth. If a country has more money than it invests in the domestic market, it will be required to venture into international markets. Failure to which, the economy might not grow in the long-run due to a reduction in the number of investments in the domestic country. The traditional policy considers surplus as a good thing, but MMT po...