Study Notes:

MMT inherits a substantial body of ‘theory’ from past scholars and integrates it into a coherent framework. Many people who first become aware of MMT fail to understand the importance its theoretical aspects. This misunderstanding manifests in the oft-stated claim is that MMT is really just description of how the world works or that it is just a set of accounting relationships.

If this was true, then there would not be much substance to MMT.

While this is not a lesson in philosophy of science, we can say some things about theorising.

When we talk about theory, we are talking about a process that starts with conjecture or a proposition that we consider, in advance, will help us understand and explain reality. These conjectures transcend to theoretical status when they are confronted with that reality using data and empirical techniques and prove to be what we call 'congruent'.

Note that congruency does not equate to 'truth'. There is no way of knowing whether we have discovered the truth. Congruency means that our explanation is the tentatively most adequate in terms of helping us understand the dynamics of real-world data.

Research and theorising in the social sciences must involve empirical confrontation, but this process is quite different to the natural or physical sciences because we study humans in uncontrollable situations. That means the way we proceed and the types of conclusions we draw are quite different. There are no ‘laws’ in economics as there are in physics, for example.

A theory is typically comprised of certain interlinked components including: (a) Definitions of the key components of the theory - national income, unemployment, etc; and (b) Behavioural or functional relationships which specify how key variables are determined and interact with each other.

Here we make assumptions to structure and control the scope of the analysis and design hypotheses. Our aim is to see whether this structure has 'empirical congruency', which is a fancy way of saying that the theory is consistent with reality and provides a better explanation of the facts than any other competing ideas. Now why is there a T in MMT?

Take the basic macroeconomic proposition that total spending equals total output equals total income. At one level this is an accounting statement, which has to be true by dint of the way we measure these aggregates within the national accounts.

Assume, we are at a point in time and the government wants to increase employment and reduce unemployment. It knows that increased spending will increase output and employment.

But how much extra spending is required to meet the employment policy target?

And how does the economy adjust to the increased spending to deliver the target?

What happens to ensure that our above accounting statement holds?

How does the economy adjust to the new spending?

To explain what happens, rather than just describe after the fact what happens, we need have to theorise about human behaviour to understand what variables respond to the initial increase in government spending and how they respond. In turn, we need to be able to explain what other variables might then respond and how.

Once the adjustments are completed, we will see the accounting relationship reasserted. But theory is crucial to understand how it is reasserted.

We theorise that firms respond to expected extra spending and sales by hiring extra workers, who then earn extra income overall. Part of that extra income is taxed by government and the households then spend a proportion of each extra dollar - we need behavioural theories to understand the direction and magnitude of the response.

We also theorise that some proportion of extra income is spent on imports.

Moreover, we need theories of investment spending by firms and government spending.

By bringing all these notions together, we are able to provide narratives and quantify the way the economy responds to extra spending, which then allows government, in this case, to work out what employment growth they will produce for each dollar of extra spending.

A congruent theory is thus one that captures the real-world adjustments accurately.

Without this theoretical scope, we would be groping in the dark.

As we proceed in the course, we will encounter many examples of how ‘theory’ is a core part of what we call MMT.

MMT is much more than a descriptive lens. It is a coherent body of propositions that allow us to understand how the monetary system works. Understanding comes with explanation.

Explanation requires, in part, theory.

MMT is appropriately named.