Modular Multilevel Converter Virtual Synchronous Generator (MMC-VSG) technology is gaining widespread attention for its ability to enhance the inertia and frequency stability of the power grid integrated with converter-interfaced renewable energy sources. However, the excitation voltage regulation in the MMC-VSG can generate equivalent negative damping torque and cause low-frequency oscillation problems similar to those in synchronous machines. This article aims to improve the system’s damping torque and minimize low-frequency oscillations by introducing a Virtual Power System Stabilizer (VPSS) into the power control loop. Building on the study of dynamic interactions between various control links of the MMC, this research establishes a reduced-order model (ROM) and a Phillips–Heffron state equation for the MMC-VSG single machine infinite bus system, using a hybrid modeling approach and a zero-pole truncation method. It also analyzes the mechanism of low-frequency oscillations in the MMC-VSG system through the damping torque method. The analysis reveals that the negative damping torque produced during the excitation voltage regulation process causes changes in the virtual power angle, which in turn increases the risk of low-frequency oscillation in the MMC-VSG. To address this issue, the article proposes an optimized control method for the MMC-VSG dual power loop architecture (power-angle/excitation) VPSS. This strategy compensates for the inadequate damping torque of a single loop VPSS and effectively suppresses low-frequency oscillations in the system.