The Modern Monetary Theory perspective on the external economy

Many economists conflate (a) financial; (b) real resource; and (c) political constraints governments face, producing erroneous analyses as a result. Modern Monetary Theory (MMT) provides a clear framework for distinguishing and disentangling these constraints in an open economy setting. Criticisms mounted against MMT reflect the fact that much of the open economy analysis in mainstream macroeconomics is predicated on understandings based on fixed exchange rates. Once exchange rate flexibility freed monetary and fiscal policy to pursue domestic policy goals, those ‘constraints’ became inapplicable. However, both mainstream and heterodox economists still consider currency vulnerability the greatest challenge facing any government. While mainstream economists rely on a raft of fictions about both the domestic and external economies to mount their case against MMT, heterodox economists focus on a balance-of-payments constraint on fiscal policy. The chapter analyses the ‘balance-of-payments-constrained-growth’ (BPCG) theory, concluding that if there is a binding constraint, it is political rather than real resource or financial.