What is modern monetary theory? An economist explains how it could help Canada

Yahoo

26-05-2025

Few words spark more anxiety in public debate than 'national debt' and 'government deficit.' National debt is the total amount of money the government owes, accumulated over years of running deficits. Government deficit is when the government spends more money than it collects in taxes and other revenues.
Dating back at least to the 1930s, the idea that government budgets should mimic household finances continues to dominate public discourse.
Politicians, pundits and even some economists routinely warn that deficits are inherently dangerous and must be minimized — arguing that, like households, governments must ensure their spending does not exceed their income, or else bankruptcy looms.
But what if this analogy is completely wrong? According to a dissenting school of economic thought known as modern monetary theory (MMT), governments that issue their own currency aren't like households at all.
MMT argues that a government with full monetary sovereignty — meaning it issues its own currency, does not peg it to another currency or commodity and does not borrow in foreign currency — faces no hard financial limits on its spending.
Unlike individuals, who must earn or borrow money before they can spend, a government with currency sovereignty creates money as it spends, meaning it can always meet its financial obligations. This theory has significant implications for how Canadians understand public debt and deficit spending.
MMT draws on a diverse range of intellectual traditions, including Chartalism, functional finance and the post-Keynesian school.
Its foundational ideas were first articulated by figures such as Warren Mosler, a financial practitioner whose writings sparked early debates, and later developed by academic economists including L. Randall Wray, Stephanie Kelton and Bill Mitchell.
Once dismissed as 'voodoo economics,' MMT has in recent years moved from the margins of economic thought into the public arena, gaining increasing attention.
As Kelton has noted, ideas that challenge conventional wisdom follow a predictable trajectory: they are first ignored, then ridiculed and eventually met with fierce opposition. MMT is now firmly in the 'resistance' phase.
The question of how governments finance public spending is not just an academic dispute, but also one that shapes the future of economic policy, democratic governance and social priorities.
Economic frameworks are debated and contested in the public arena. The way they are framed determines public understanding, political support and ultimately, real-world policy directions.
Canada's federal government, through its partnership with the the Bank of Canada, has the authority to issue Canadian dollars 'as needed.'
MMT emphasizes that a country like Canada doesn't need to collect dollars before it can spend them. Instead, it creates money by effectively 'marking up' or crediting bank accounts — essentially through keystrokes — when making payments.
This process underpins government spending for procurement of goods and services, public transfers (pensions and employment insurance), interest payments on government debt, Bank of Canada asset purchases (quantitative easing) and emergency responses.
However, this does not mean governments can spend without limits or consequences. Nor does it eliminate the need for taxes.
Instead, MMT shifts the focus from arbitrary fiscal rules to real economic constraints. The key limitation on government spending is not whether it has enough money — because it can always create more — but whether the economy has the capacity to absorb that spending without causing inflation.
While the government does not need tax revenue to 'pay for' spending, taxes play a crucial role in controlling inflation by removing money from circulation, managing inequality and affecting how people work, invest, spend money and innovate.
Critics of MMT often argue that expansionary fiscal policies — such as large-scale government spending or stimulus packages — inevitably lead to inflation. A common explanation for the recent inflationary surge in Canada and elsewhere is that government programs injected excess purchasing power into the economy.
However, MMT argues that inflation only becomes a problem when government spending pushes the economy beyond its capacity — when there are not enough workers, materials or resources to meet rising demand.
Until that point, government spending can be used to invest in public goods, create jobs and ensure economic stability.
From an MMT viewpoint, the main constraint is not where to get money but whether those newly created dollars can be absorbed by unused capacity without creating unsustainable price pressures. Government spending can work if it's well-timed and directed toward productivity-enhancing projects.
By targeting idle resources and improving the supply side, government spending can increase output, boost employment and promote stable economic growth.
One of MMT's key contributions is democratizing money itself by demystifying the idea that money is inherently scarce. It emphasizes that government spending is constrained by the availability of real resources, not finances.
If more people understood this, it could shift the terms of public debate from questions like, 'How will we pay for it?' to more practical and meaningful ones like: 'Do we have the people, materials and technology to make this happen without sparking inflation?' and 'Is this socially beneficial?'
For example, when large-scale investments in green energy, health care, child care or affordable housing are dismissed as 'too expensive,' MMT reframes the issue around real-world capacity and social benefit.
Do we have the people, skills and infrastructure to carry them out effectively and sustainably?
By shifting the focus from financial constraints and the government's bank account to real economic potential and democratic priorities, MMT opens new pathways for policy discussions that are grounded in material reality rather than outdated fiscal dogma.
Canada is well-positioned to benefit from an MMT-informed approach to fiscal policy, which offers a valuable lens for rethinking and prioritizing economic policy.
As a country with currency sovereignty and substantial natural and human resources, Canada has the ability to use targeted public spending to address pressing challenges such as housing affordability, health-care and child-care expansion, and climate change mitigation.
MMT encourages us to shift the conversation from artificial fiscal constraints to real-world economic possibilities. Instead of asking, 'Can we afford it?' we should be asking, 'What do we need, and how can we mobilize our resources to achieve it?'
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As economic challenges from climate change to growing inequality mount, Canada cannot afford to be held back by outdated myths about government finances.
By embracing a more flexible and realistic approach to fiscal policy, Canada can create an economy that works for everyone, not just the wealthiest few.
MMT is not a one-size-fits-all policy directive, but a framework that emphasizes how governments with currency sovereignty operate. It highlights that real constraints lie in available resources, not in arbitrary budget limits, offering the government new way to think about economic possibilities.
This article is republished from The Conversation, a nonprofit, independent news organisation bringing you facts and trustworthy analysis to help you make sense of our complex world. It was written by: Mohsen Javdani, Simon Fraser University
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Mohsen Javdani does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.