Fallacy of Fiscal Discipline: Spirit of MMT Through Mathematical Analysis

Abstract

According to the concept of "fiscal discipline" public finance must be balanced, at least in the long run. The school of thought known as MMT (Modern Monetary Theory), which has been gaining attention recently, rejects this idea. However, it is often pointed out that MMT lacks the mathematical analysis used in standard economics discussions. This study aims to provide a simple theoretical and mathematical basis for the skeleton of the MMT argument, while maintaining the basics of the neoclassical microeconomic framework, such as utility maximization of consumers by means of utility function and budget constraint, and equilibrium of supply and demand of good, under perfect competition with constant returns to scale technology. Using a simple overlapping generations (OLG) model with pay-as-you-go pension system that includes economic growth due to technological progress, we will show the following results. The budget deficit equals the increase in people's savings (net of pay-as-you-go pensions), and the accumulated amount of the budget deficit equals their savings. The budget deficit is the cause and the savings is the result, not the other way around. The budget deficit is created by the government, which in turn determines income, which in turn determines the savings. The budget deficit creates the savings, not that the savings finance the budget deficit. Reducing the budget deficit will reduce savings, income, and consumption.