This paper reveals the existence of poorly damped resonant modes in the modular multilevel converter (MMC) that can result in harmonic instability. A small-signal model based on dynamic phasors is introduced which takes into consideration the dynamics of internal variables, such as circulating arm currents, which have a tendency for a large second harmonic component and module capacitor voltage ripple, which has other harmonic components. The small-signal model is validated by comparison with the electromagnetic transient simulation of a detailed model. It is shown that the use of an active circulating current suppressing scheme can effectively improve the damping of internal harmonic modes in comparison with a passive filter used for the same purpose. The damping of internal harmonic modes has been shown to be significantly impacted by the gains of the MMC's outer-loop controller but is less sensitive to the ac system strength or the gain of the phase-locked loop. A larger arm resistance also increases the damping of these internal modes.