Modern Monetary Theory: What’s Missing from the Narrative

Introduction

What Modern Monetary Theory gets right — and what it leaves open.

In my previous post, The MMT Case for Governments Funding Open Source Software, I argued that once you accept the MMT framing — that governments spending in their own currency face real, not financial constraints — entirely new categories of public investment become possible. Instead of asking “How will we pay for it?”, MMT invites us to ask “Do we have the real resources to do it, and is it worth doing?”

I find MMT convincing. As far as I can tell, MMT correctly describes how modern monetary systems operate in practice and, more importantly, reframes public finance in a way that’s empirically and morally coherent. However, I feel some questions are underexplored. Below are seven points I think deserve more attention.

The Historical Path from Gold to Fiat

MMT often explains its logic through hypothetical examples: a village or island community invents a currency, imposes a tax payable only in that currency, and builds public infrastructure through spending. It’s a clean parable for how a fiat system operates, but it skips the messy historical reality. Real economies evolved out of the gold standard, colonial systems, and centuries of credit and debt relationships.

This historical trajectory matters because it shaped institutions and mental models. For centuries, money was tied to commodities or convertibility. Even after fiat currencies became the norm in the 1970s, policymakers and the public continued to think in gold-standard terms: budgets must balance, debt is dangerous, deficits crowd out investment. The idea of a currency-issuing government running sustained deficits for public purpose still feels wrong to many because it contradicts this inherited narrative.

In other words, path dependence matters. Countries that transitioned smoothly from gold to fiat (like the US) developed deep bond markets and fiscal flexibility. Others, like the GCC countries, kept fixed pegs to maintain credibility. The eurozone created a multi-sovereign system without a true fiscal authority, effectively reintroducing gold-standard constraints by design.

MMT describes the mechanics of the current system correctly, but the psychology and politics of money remain haunted by its metallic past. Understanding that history — including why governments voluntarily re-imposes constraints — is important to understanding why MMT truths are not yet widely acted upon.

MMT and Taxation in Low- or Non-Tax Economies

A central tenet of MMT is that taxes drive money. In the chartalist view, the reason people accept a state’s currency is because they must use it to pay taxes to that state. Taxes, in other words, create a continuous, annual demand for the currency and give it value. Without that legal obligation, the story goes, people could just as well trade in shells, gold, or dollars.

This logic works well for modern democracies with extensive taxing, but what about countries like the UAE, Saudi Arabia, or Qatar — states that have their own currencies, central banks, and issue money freely, yet collect little or no income tax from their citizens? People still use the Dirham, Riyal, or Dinar as their medium of exchange, even though there’s no tax liability forcing them to do so!

The answer, I think, lies deeper than taxation. What really underpins the value of money is the state’s capacity to impose and enforce obligations, and taxation is only one form of that power. In low-tax states, coercion and dependency take other forms: citizens and residents must use the local currency to pay for licenses, fines, utilities, and government services; companies must settle wages and rents in it; and the state maintains a monopoly on critical resources, like oil, which it prices and distributes in its own currency. The currency’s demand thus stems from state authority and control over the domestic economy, not necessarily from the need to pay income taxes.

In that sense, MMT’s story about taxation is conceptually correct but incomplete. The core insight — that money derives value from the state’s ability to compel its use — still holds. But taxation is just one mechanism among others that bind the public to the currency. The deeper chartalist foundation is not “we pay taxes in this currency” but “we live under the rule of this currency.”

In MMT, Does the Central Bank Need to Be Independent?

Modern macroeconomics treats central bank independence as sacred. The logic is that politicians are too tempted to overspend; therefore, monetary policy must be delegated to technocrats with a narrow mandate for price stability. This separation between “monetary” and “fiscal” policy is one of the most defining features of late-20th-century economic governance.

MMT, as far as I can tell, rejects this separation. It views the Treasury and the central bank as two arms of the same sovereign entity: the currency issuer. Operationally, when the government spends, the central bank marks up bank reserves; when it taxes, reserves are marked down. Whether the two institutions sit under one roof or two seems irrelevant — the monetary operations are consolidated. From this perspective, independence is not an economic necessity but a political construct. The payment system would function just as well if the central bank acted under Treasury coordination. Independence serves a different purpose: to constrain fiscal policy and to depoliticize money creation.

The deeper issue is thus political, not technical. A fully MMT-aligned state would require the Treasury and central bank to coordinate closely, implying a shift from “monetary dominance” (central banks controlling the macro agenda) to “fiscal dominance” (spending and taxation steering demand). Whether societies trust elected governments to wield that power responsibly — or prefer to outsource it to unelected technocrats — is a question of political philosophy, not macroeconomics.

How Does the Government Know How Much to Spend?

A common criticism of MMT is that it implies unlimited government spending, leading inevitably to inflation. MMT proponents counter that the real constraint is not financial but resource-based: governments should spend until they reach real capacity (full employment, full utilization) and stop before inflation emerges. That’s sound in theory, but it leaves an operational gap: how does a government know where that limit is in real time?

Traditional macroeconomics uses metrics like the output gap and fiscal rules (such as the EU’s 3% deficit cap) to guide spending. MMT, by contrast, offers principles rather than formulas. It calls for active fiscal management guided by real resource conditions (unemployment, productivity) but provides few tools for measurement or calibration. This is where MMT’s strength as a descriptive theory meets its weakness as a policy framework. It explains how sovereign finance works, but it doesn’t yet supply a rulebook for day-to-day decision-making. In practice, an MMT-informed government would need institutions capable of dynamically modeling unemployment, productivity, inflation, and interest rates.

The next frontier of MMT should be developing operational framework for fiscal balance. Knowing that governments can spend is only half the story; knowing how much they should spend is the other half.

What Is The Functional Relationship Between Spending, Employment, and Productivity?

MMT weaves together spending, unemployment, and inflation into a coherent story: government deficits create private surpluses, unemployment is evidence of insufficient public spending, and inflation signals real resource limits. But what’s missing is a functional model, a way to connect these variables dynamically and operationally.

For example: how does incremental public spending translate into employment gains? How quickly do those gains raise productivity? How does that interact with inflation expectations and private investment? To govern by MMT principles, policymakers need to think in systems, not identities: if we increase spending here, what happens to capacity utilization there? How long do supply elasticities take to respond? At what point do we reallocate rather than expand? These are questions of operational modeling, not ideology.

MMT has succeeded in redefining what governments can do. The next step is defining how they should manage feedback loops between fiscal stimulus, employment, and real productivity. In other words, the theory has liberated policy from false financial constraints; now it needs a control system to keep it stable.

What Is the Right Level of Inflation in MMT?

MMT treats inflation not as a monetary phenomenon but as a real-resource constraint. Prices rise when nominal demand outstrips real capacity. But MMT stops short of articulating what level of inflation is desirable, if any. Most central banks today target around 1-2%. That number is arbitrary but politically convenient: it avoids deflation while gradually eroding debt burdens. MMT, however, could take a more explicit stance. If governments are to use fiscal power to manage the economy directly, then inflation becomes a distributional choice. Moderate inflation benefits debtors over creditors, young over old, public borrowers over private lenders.

So what is the MMT inflation target? Zero? Two? Enough to sustain full employment but low enough to maintain real wages? The literature doesn’t say. Inflation, like unemployment, is a policy variable. If MMT is about aligning fiscal power with public purpose, then it should also define what a socially optimal inflation rate looks like. In short, inflation is not just an operational risk in MMT; it’s a political instrument. The question is not whether inflation should be low, but whose interests low inflation serves.

The Many Kinds of Money

MMT distinguishes between two primary layers of money: government money (reserves, cash, Treasury liabilities) and bank money (deposits created through lending). That’s a useful distinction, but it leaves out the explosion of “money-like” assets that dominate modern finance — equities, crypto, derivatives, and shadow bank liabilities.

When a company’s stock price goes from \$10 to \$100, its market capitalization may rise by billions, but no new government money is created. The valuation increase is not “new money”; to turn that paper wealth into purchasing power, someone else must part with actual money — bank deposits. MMT recognizes this distinction in theory, but rarely explores its macro consequences.

The financialization of the global economy has created vast asset-money ecosystems — markets where wealth can seemingly multiply without corresponding production. MMT’s sectoral balances still hold, but the behavioral dynamics of asset money deserve much more study. An expanded MMT framework would incorporate these parallel systems explicitly: not all “money” is state money, but all financial claims eventually settle in it. Understanding how liquidity, valuation, and leverage interact with real-resource spending could make MMT not just a theory of the state, but a theory of the entire monetary ecosystem.

Conclusion

In my view, Modern Monetary Theory is one of the most important intellectual developments in economics. It reframes public finance in real, not imaginary, terms, and opens the door to purposeful investment in social and digital infrastructure. But as it moves from the textbook to the policy arena, it faces new challenges: institutional design, operational control, and the complexity of a globalized financial system. None of these questions undermine the core of MMT, they simply show that the conversation is not over. If anything, they point to what comes next: monetary sovereignty is understood not just as a technical fact, but as a tool of democratic choice, historical evolution, and social design.