The illusion of inflation control
in Modern Monetary Theory

Modern Monetary Theory (MMT) has shifted from academic margins into policy conversations because it presents a straightforward proposition: If a country issues its own currency, it need not fear deficits; the only binding constraint is inflation. For governments facing aging populations while preparing for strategic rearmament, green investment and industrial policy, this message is politically attractive. It promises room to spend without the specter of insolvency, as long as prices stay “under control.”

The past decade lent credence to this view. After the 2008 financial crisis and during the Covid-19 pandemic, large deficits coexisted with subdued consumer price inflation for some time. Many concluded that governments could spend more than previously thought, and that monetary financing and closer coordination between central banks and fiscal policies could be used more assertively. The global inflation spike of 2022-2023 challenged that complacency, but it did not resolve the fundamental question that matters for investors and policymakers: Can inflation, as measured and managed in practice, serve as a reliable brake on expansive fiscal policy?

The Austrian School of Monetary Economics argues that the MMT “inflation constraint” is an unreliable anchor. It contends that the notion of an inflation constraint is flawed methodologically, operationally and politically.

Methodologically, headline price indices are constructed from changing baskets, involving arbitrary quality adjustments and contentious weighting schemes. They reflect a narrow slice of economic reality and often overlook where new money bites first: in asset markets such as stocks and housing. This distorts relative prices and the structure of production.

Operationally, inflation data arrives with lags, while fiscal and regulatory responses are slow, blunt and contested.

Politically, tightening policy when prices rise requires imposing visible costs on voters; the incentives to delay action or redefine the problem are powerful.

For market participants, the risk is not only a rise in consumer prices. It is a prolonged phase of asset inflation, misallocated capital and increasing inequality that can coexist with seemingly contained consumer price indices (CPIs). If inflation is treated as the only red line, and if that line is both unclear and flexible, government spending and central bank support for deficits can persist longer and to a greater extent than what the fundamentals support. Fiscal policy may shift from potentially helpful stimulus to reckless overspending. When the adjustment finally comes, it is often hurried and burdensome.

Why inflation fails as a policy anchor

MMT’s operational rule is deceptively straightforward: Sovereign governments can finance spending until inflation picks up, at which point they must tighten policy, primarily through fiscal means. This makes inflation the single most important signal in the system. If that signal is reliable, timely and comprehensive, the framework could, in principle, be workable without causing much harm. The Austrian critique emphasizes that it is none of these.

Measurement is inherently imprecise: Inflation, as conventionally measured, is not an objective physical fact. It is an index built on choices about which goods and services to include, how to weight them and how to account for changing quality. These decisions are not purely technical; they reflect political and institutional priorities. Altering the index’s components or methods can all affect the reported figure without changing the underlying experience of households.

From an Austrian perspective, the problem is fundamental: There is no single accurate inflation rate that can be measured for the entire economy. Preferences and consumption patterns change, product quality evolves and new goods emerge. Even under ideal conditions, the most that price indices can offer is a range of estimates, not an exact figure.

Consumer price indices overlook crucial channels: Headline inflation targets are tied to CPIs, which by design exclude many of the sectors where monetary and fiscal expansion first have an impact. The biggest blind spot is asset prices, including real estate, equities and other capital markets, where price inflation can be much more aggressive than in the consumer basket.

New money enters the economy unevenly, benefiting early recipients, often governments, banks and asset holders, before prices adjust elsewhere. This dynamic can drive asset booms and alter the structure of production long before CPI data signals a problem. The result is a mismatch between the policy trigger (consumer price inflation) and the actual buildup of systemic risk and fragility, which is often channeled through asset markets.

Inflation is a lagging indicator: Monetary and fiscal expansions take time to filter through the economy. By the time inflation becomes visible in official statistics, asset misallocations and structural imbalances may already be entrenched. Trying to steer fiscal policy by this delayed feedback loop is like trying to regain control of a car after it has already begun to skid.

The operational consequence: If policymakers rely on CPI as their compass, they risk allowing expansionary policy to go far beyond sustainable limits, especially in environments where consumer price pressures are initially muted. For investors, this means that a stable headline inflation rate should not be mistaken for macroeconomic stability. Under an MMT-style regime, a suppressed CPI can coexist with overheating in credit markets, real estate and equities – conditions that set the stage for sudden corrections.

Political barriers to fiscal restraint

Even if inflation could be measured perfectly and in real time, the MMT framework assumes that governments will act quickly to tighten fiscal policy once prices rise. In practice, this is unlikely. Fiscal restraint – whether through higher taxes, spending cuts or new regulations – is slow to implement, politically costly and often postponed until market pressures leave no alternative. Policymakers have strong incentives to prioritize unsustainable short-term growth and employment through monetary and fiscal expansion over preemptive inflation control, especially near elections. They prefer short-term stimulus over long-term stability.

Inflation, being widespread and contested in its causes, is also easily reframed or downplayed. Methodological changes, selective emphasis on core measures or optimistic forecasts can all be used to justify continued expansion. Historical precedents, from wage-and-price controls in the United States in the 1970s to recent reassurances that inflation was transitory, show how political considerations delay corrective action.

In an MMT-style regime, the boundary between fiscal and monetary policy becomes even more blurred, with central banks accommodating deficits. This coordination makes it more difficult to tighten policy once inflation surfaces, raising the likelihood that policy will overshoot. For investors, this means that inflation will not act as a strict limit in practice, and that policy tightening, when it happens, will be abrupt, disruptive and more damaging to markets.

Implications for investors and policymakers

When inflation is viewed as the only limitation on fiscal expansion, but is difficult to measure, subject to political manipulation and slow to trigger action, the risks for investors and policymakers multiply. Under an MMT-style approach, governments can sustain large deficits for longer than fundamentals justify, especially when consumer price indices remain subdued. This creates fertile ground for asset bubbles, misdirected investments and growing wealth disparities: conditions that can persist with apparently stable inflation data.

For investors, this means headline CPI alone is not a sufficient indicator of macroeconomic stability. Monitoring asset prices, credit growth and capital allocation patterns becomes essential. The eventual policy turn, once political tolerance for inflation breaks or markets force adjustment, is likely to be sudden, affecting interest rates, currencies and asset valuations simultaneously.

For policymakers, the lesson is that credible fiscal discipline cannot rely solely on a single, politically sensitive indicator like the CPI. Broader metrics, institutional safeguards and recognition of asset-market inflation are needed to avoid the boom-bust cycles and economic distortions that result when the inflation constraint proves illusory.