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Is Modern Monetary Theory Relevant?

Updated: Sep 4, 2021

Ishaan Gupta

BSc Economics, UCL

MMT or Modern Monetary Theorem is a heterodox macroeconomic framework.This basically means that it goes against the conventions of the established macroeconomic theorems, in proposing that sovereign countries with a fiat currency can print money to finance deficits. In so doing, they can stop worrying about borrowings and interest payments, and expand their balance sheets without any hackles!

This theory was first proposed by Warren Mosler and supported by Bill Mitchell. It lingered and stayed alive at the margins of economic literature for long, before the internet and politicians like Alexandria Ocasio-Cortez and Bernie Sanders brought it to the fore. MMT has gained particular traction in the testing times of Covid-19.

In theory then, MMT is a more technical term for what we call a free lunch. No wonder then that it’s a darling of left-leaning politicians, who just got a treasure trove for their expansive welfare programs. But nothing in the world comes for free. MMT too has its own cost; costs that are often too big to be ignored lightly.

An economic cycle can be broadly divided into two parts. The first being the so-called ‘normal times’, when the economy is growing and everything is just fine. The second are abnormal times, such as these, where economies are either in the midst of a recession or are about to slide into one.

In abnormal times, one has to consider the amount of currency the public is willing to hold. A slew of money printing and an over-flushed money supply might just end up in bank accounts. If the public can not hold the excess cash, it would just go and deposit it in their accounts. Unlike in normal times, when the deposits could be turned into loans by expanding the banks’ balance sheets, in abnormal times the appetite for loans is very low. Thus all this extra money will land with the Federal Reserve, through the reverse repo facility, with the Fed having to foot the bill for the money. Is it then a free lunch?

As the reverse repo rate is lower than the coupon rate, the banks lose on money as compared to when they bought treasuries. It may all seem good in the short run, with the government having to pay less for their deficits, but the deeper implications can not and should not be missed. Banks are naturally hungry for alpha (returns). With the reverse repo rate being low as it is, and the more conventional ways of generating alpha being saturated, the banks will be forced to turn towards more unconventional ways. This would mean taking on more beta (risk) in order to create excess alpha. When banks take on more risk, the repercussions are to be felt by the entire economy, uncannily similar to what happened prior to 2008.

Using MMT in normal times is what is more hazardous. No matter how strongly some proponents of MMT call it a policy for crisis management, once implemented, there is nothing stopping it from lingering on. We have seen it with Quantitative Easing(QE), that once an economy gets habitual of steroids, it is very difficult getting it off them. The first big ticket measure to reverse QE resulted in the taper tantrum of 2013, devastating emerging markets and destabilizing the world economy.

With the appetite for loans back on track, and banks happily willing to lend, an increased money supply will greatly increase loans, expanding consumption and investment spending. This will then definitely lead to hyper-inflation. Inflation is not good for anyone. Not only does it make the future very uncertain, but a rapidly decreasing value of the currency can spin the country into a crisis, much like what happened in Argentina. Inflation results in an appreciation in the real exchange rate of the country. That increases the price of exports and reduces their competitiveness. Given that the USA already runs a current account deficit, inflation would just worsen it, also adding to the political woes of the country.

MMT defendants argue that no such thing will happen. They suggest taxes as a way to limit inflation. But there are limits to what a deflationary fiscal policy can achieve, which is precisely why the world moved towards a deflationary monetary policy. What taxes will you increase to reduce inflation? Would they be corporate taxes? But, wouldn’t that lead to an exodus of companies, or at least an exodus of the assets of companies towards low tax regimes? Or, will income taxes be increased? If so, would the rich foot the bill or the poor? If the rich do it, wouldn’t that act as a disincentive to work? And if the poor do so, what happens to achieving greater equality, the chief reason many socialists support it in the first place!

Some MMT theorists assert that fiscal deficits are essential to promote saving. Therefore deficits must be encouraged as they have a positive economic impact. This could not be further from the truth.

Japan and Germany both have surplus private savings of 8% and 6% respectively. Yet Germany has a fiscal surplus of almost 2% of GDP.

  • I+G+X=S+T+M

  • I-S= (T-G) + ( M-X )

The above equations show that it is not necessary for a fiscal deficit to induce a savings surplus. It is very much possible for a savings and fiscal deficit to exist side by side, with foreign savings helping to finance the fiscal account deficit.

Finally, there is the question of the dollar. The dollar has been the reserve currency of the world from a long time. Recently though, there has been pressure from rival countries like China and even Russia, who aim to counter the dollar’s dominance. MMT might just ease their path. Inflation will reduce the trust in the currency, rendering its tag as a fiat currency useless. One of the major reasons the greenback still holds its sway is because of the treasury bills. They have been for long the go to safe asset of the world, making every country reliant on the dollar. With MMT proponents espousing a bond free financing, one of the major reasons to hold the dollar will be gone.

MMT is surely an unmitigated disaster, which will accelerate the dismantling of the West led global economic order.

Additional Info

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