A while ago, I was asked to add an entry to this blog's glossary explaining what a theory is, the goal being to clarify why modern monetary theory is considered a theory. It was a good suggestion, but I did nothing about it because I was just too busy at the time.
Yesterday, as I began to feel flickers of life return and the grip of my cold/flu on my brain eased, I addressed a number of comments on the blog that had been waiting for attention for some time, and this was one of them.
The resulting glossary entry is as follows. And why give it attention now? That's because I am working on a Guide to MMT, to be available as a free download in the PDF Shop of this blog, hopefully in time for Christmas (to help you avoid all that mindless television). This might feature in it, but it's touch-and-go whether there is enough time to achieve this goal now. We'll see....
A theory is not a guess. Nor is it an ideology, a hope, or a political preference. As the philosopher Wilfrid Sellars once put it, a theory is a structured attempt to “explain how things hang together.”
In economics, that means offering a coherent account of how money, markets, governments and real resources interact; one that can be stated clearly, tested against observable facts, and used to make sense of what otherwise appears opaque.
A good theory does three things.
First, it provides a framework for understanding: a set of concepts that describe the relationships between actors in the economy. Without such a framework, facts sit in isolation, and policy becomes guesswork.
Second, a theory must fit the evidence. It must describe the world as it actually is, not as some would like it to be. Its assumptions must be explicit and open to challenge. If the data show that the theory does not correspond to reality, it is the theory that must change, not the world.
Third, a theory should generate insight. It should illuminate consequences, identify constraints, and highlight choices. Its purpose is not prediction in the sense of fortune-telling, but understanding in the sense of explanation.
It is on these grounds that Modern Monetary Theory (MMT) qualifies as a theory, and why claims that it is “not a theory” are simply wrong.
Why MMT is a theory
MMT offers a coherent explanatory framework for how money works in a modern, sovereign, fiat-currency economy. It begins from observable realities:
- Governments that issue their own currency cannot involuntarily run out of it.
- Taxes do not fund spending but create demand for the currency and manage inflationary pressure.
- Bank lending creates deposits; it does not lend out pre-existing savings.
- The real constraints on public spending are resource availability and inflation, not the state of the government's bank balance.
From these premises, MMT explains how fiscal policy, monetary operations, bond issuance, taxation, savings instruments and employment interact. It does so without appealing to fictional constructs such as “loanable funds,” “crowding out,” “government as household,” or “bond vigilantes controlling fiscal space,” all of which persist in mainstream commentary despite lacking empirical foundation.
Crucially, MMT's insights are testable against observable institutional reality. The operations it describes, such as how the central bank settles payments, how reserves are created, how gilt issuance functions, and how banks create credit, are all matters of fact. They can be inspected in government accounts, central-bank operating procedures and actual market behaviour.
This is why central banks around the world increasingly produce explanations of money creation that align, often unintentionally, with the MMT description. The Bank of England's 2014 paper stating that “loans create deposits” is a case in point: it confirms, rather than contradicts, the core MMT framework.
Finally, MMT is a theory because it provides insight into policy choices. It clarifies:
- that the constraint on government spending is inflation, not solvency;
- that unemployment is a political choice, not an inevitability;
- that fiscal policy, not interest-rate manipulation, is the effective stabilising tool;
- that public deficits correspond to private surpluses, and so cannot be understood in isolation.
This illuminates what governments can do, not what they must do. It does not tell politicians what values to hold or what outcomes to prioritise. That remains a matter of political economy. What MMT does is provide the theoretical scaffolding that makes reasoning about those choices possible.
Why this matters
Too often, economic debate is dominated by ideologies pretending to be theories. The claim that “government spending must be funded by taxes” is not an empirically grounded theory; it is a political assertion. So too is the idea that financial markets ration public spending. These claims persist because they serve powerful interests and because they have become embedded in public discourse. They are not grounded in how modern monetary systems actually work.
By contrast, MMT starts from operational reality and builds a coherent explanatory framework from there. That is what makes it a theory, and an indispensable one for any society that wishes to use its collective resources to deliver well-being, resilience and care.
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During my MBA I had a enthusiastic lecturer who always used to say that ‘there was nothing as good as a good theory’.
To underline this, he defined himself as a Prac-ademic’ someone who applied good theories to managerial issues both to solve problems and improve the theories, even help us find out the bad theory from the good theory – by using theory in a practical way. I suppose it was his way of making theory real and trying to rid academia of its ivory tower status.
This concept does not exist in politics – which is a tragedy. Nor economics. I mean, if it did, things might have changed by now?
Great post – in support of expertise – not blind faith or snake oil – the usual fare.
Thanks
Prac-ademic – handy term, thank you PSR for introducing it. Could this describe an aspect of the polymath Richard Murphy? A man for all Reason.
🙂
I’m looking forward to your guide. The best analogy I think re MMT is with Copernicus. He saw beyond the obvious and his proposition that the earth orbited the sun became a theory (or even a theorem) once it was proved. In fact, MMT as an explanation of how money works in a modern sovereign state with its own fiat currency is, in fact, a theorem, a proven statement.
The problem I find with the word ‘theory’ is that the ‘folk understanding’ of it is that it’s just an unproven idea which is probably impractical and has little to do with ‘real life’.
I find that the response to MMT from many people is that ‘it’s *only* a theory’, with the implication that it’s not to be seriously considered. Of course, most of these respondents are perfectly happy with the Theory of Evolution, or the Theory of Gravity but ‘that’s different’… hmm
So, that needs to be pointed out
I believe it was me who made the request for this, so thank you! Worth waiting for.
To follow on from Maggie Downie’s comment, a couple of other everyday examples against the “only a theory” argument, which I think I mentioned before, are music and driving theory tests. People wouldn’t be sitting these every day if music or driving were just “unproven ideas”!
Nevertheless, I quite like that you now seem to be trying out alternative formulations like “modern money system” or just “modern money”. That may well be the best way forward.
Very good. And it was you.
I’m struggling a little bit here. I just seem to be nipping at your posts recently! Please bare with me – I intend only to clarify to improve.
Since MMT seems to describe the practice of how fiat currency creation and cancellation occur, I quite like Monetary Practice, or Fiat Currency Monetary Practice. I’m not sure that there is much ‘theoretical’ or ‘abstract’ needed to be put into a theoretical monetary framework (which I’d expect with a theory). The abstract part is the promise to honour payments?
Like Maggie D above, I get concerned that some people think that theories are not yet proven ‘suggestions’ and can therefore be ignored (as used by many to dismiss or diminish evolutionary theory). The thing about Monetary Practice is that it is simply a description of the practical process that is followed.
I know that in your article you clarified what you meant by theory — I asked google to distinguish between theory, model and practice and it gave me these:
“Theory: Provides a comprehensive, testable explanation of a phenomenon, detailing how and why specific relationships lead to specific outcomes. Theories are broad in scope and supported by substantial scientific evidence from multiple studies… It aims for a deep, fundamental understanding of underlying principles. ”
“Practice: The actual application of theories and models in real-world, operational, or experimental settings. Practice involves the day-to-day work and experiences that test and use theoretical knowledge to solve concrete problems. Tangible and experiential”.
This is a fair question, but I think your conclusion goes a step too far.
Once properly understood, MMT is not just a description of operational practice, even though it starts there. It can do more than say what happens: it also explains why it happens, what follows from it, and what constraints actually apply. That is exactly what makes it a theory rather than a mere account of procedure.
So, yes, MMT begins with the observable monetary practices of a fiat currency system: how governments spend, tax, issue bonds when they wish to do so, and interact with central banks. But it then derives testable propositions from those practice; for example, that a currency-issuing government cannot run out of its own money, that taxation does not fund spending, and that inflation, not solvency, is the binding constraint. Those claims can be, and are, assessed against real-world evidence.
Calling this “Monetary Practice” understates what is going on. Practice describes operations. Theory explains their meaning, limits and consequences. Evolutionary biology is not just the observation that species change; it is the explanatory framework that makes sense of those observations. MMT plays the same role for modern money.
The problem is not that MMT is “only a theory”. It is that many people misunderstand what a theory actually is.
I was introduced to the idea of ‘positive economics’ by an excellent text book of that title by Richard Lipsey. It was a standard text book written in 1975, which I used during the 80s. It would be well out of date now, but he did have your approach to theories, as I recall. I don’t think MMT had ‘arrived’ at that time, but if he were writing today, he would be forced to acknowledge it as very much positive economics.
That book is neoliberal to its core.
I hate it. I still have a copy.
Standard text for A level in the 70’s and 1st year undergraduate. I revisited in the summer. Simply awful. 200 pages on supply and demand, 5 sufficient. Very little about role of govt and the explanation of money largely wrong and very confusing. I hope they are not still using it.
I agree with you.
‘Positive Economics was _the _ economics textbook (a textbook that every student could ‘really understand’) when I started teaching in Durham university circa 1965 and I still saw students clutching copies in my last year before retirement from Liverpool (2001). Some time after I retired I was buying a book in the very large bookshop of a ‘top’ university. It was near the beginning of the academic year, I saw a whole shelf of shiny new copies of Lipsey. I’m sure there must have been many books suitable for undergraduate economics students written during 26 years, why did this one persist? It was a textbook of neoliberal ideology – perhaps that’s why it lasted. My wife had to do a compulsory optional course in economics and to this day she says she finds it hard to get Lipsey out of her mind. The last advert I saw was for the seventh edition.
Richard, thinking about the predictive power of a good theory has Prof Steve Keen’s Ravel programme been used to model the UK economy and to check out the economic forecasts of the Treasury/OBR?
Not as far as I know.
Ask Steve, I suggest.
Steve Keen’s Ravel does a good job of demonstrating certain relationships within the economy and is based on sound principles of double entry. However, it’s too simple. Models like The Treasury and EY (I worked on it for a while) are incredibly complex. It would be good if Steve could get involved and improve one of them.