Modern Monetary Theory: A Paradigm Shift or Drift?
Modern Monetary Theory is a post-Keynesian heterodox theory postulating that an economy holding a sovereign currency can never run out of money.
Everyone — from individuals at home to economists at the Central Banks — prepares a budget — personal or national — once in a while — weekly, monthly, or annually. The exercise involves balancing the incomes and expenditures, such that the former is greater than the latter. As individuals, our income streams remain limited to wages, returns on past investments, and loans. For the Central Banks, these sources are taxation and borrowing unless they unveil the power of printing money. This distinction is one of the tenets on which the post-Keynesian thinkers have built the Modern Monetary Policy (MMT).
Now and then, we have heard governments resorting to their printing presses to finance deficits and paying off debts. In times of deep financial crisis, it is a necessary evil. It took the Fed USD 29 trillion to bail out Wall Street during the 2008 Financial Crisis.
Although these Central Banks have deep pockets (and they decide the depth), there is a theoretical limit to the extent of the money supply in an economy. The currency issued cannot surpass the value of resources, from natural resources to human capital and technological productivity, in an economy. In some way, even the printing press, or balancing money supply digitally, has limits that make our budgets a little more like government budgets. Even individuals and corporations have financial verges, though the amounts differ. Lending opportunities for a person applying for a housing loan will be much less than a new start-up idea funded by venture capitalists, which, in turn, will be much less than what Central Banks can provide to governments.
And if the modern financial system were so simple, this is where the similarities would end. Yet, we live in a complex world where individuals and not some Central Bank created a brand-new digital currency — the Bitcoin. There is still one area where individuals and corporations differ from national governments — the former can go bankrupt while the latter cannot.
For Modern Monetary Theory to work, the economy should not only show a growing trend of domestic output, but this growth should be sustainable as well. An economy operating at its full-employment level provides an ideal condition to exercising the MMT policy framework. Job Guarantee Programs, thus, form a fundamental policy prescription for MMT. It would inevitably follow a minimum wage guarantee by national and state governments.
India’s MGNREGA forms a case in point for such employment guarantee programs. While it has its share of issues, ranging from implementation to governance, it does not restrict the impact of such schemes in different contexts. Unemployment insurance in the United States is a proxy for such programs as both categorize as automatic stabilizers.
In addition to fiscal policy, automatic stabilizers like these help control inflation without doing anything further. When unemployment increases in an economy, the spending on such programs goes up. When unemployment reduces, spending declines. Monetary policy, adjusting interest rates, reserve ratios, and quantitative reasoning, does little, according to MMTers.
The origins of Modern Monetary Theory go back to 1947 when Abba Lerner, a Russian-born British economist, drawing on Chartism, conceptualized ‘functional finance.’ The term suggests that states with fiat currency (modern-day financial sovereignty) can pay off their debts by printing more money and, thus, do not face any debt constraints. Inflation was the only constraint these states faced, but it was a consequence of excessive government spending and not monetary policy.
Growing deficits and high debts do not pose a problem until they exceed the value of the physical assets in an economy. Even advanced countries carry a high debt to GDP ratio. The national debt to GDP ratio for the United States stands at 105% in 2019. The same indicator values at 235% for Japan and 74% for India. While the United States and Japan have seen tremendous economic growth and development in the past decades, India is not growing at its full potential due to material and financial constraints. The story is not much different for other low and middle incomes countries as well.
One of the criticisms of MMT is that it does not apply to developing countries due to their underutilized natural resources and human capital and, most importantly, little monetary sovereignty. But, these countries neither satisfy the prerequisites that the MMTers have laid out for their policy prescriptions to work.
In practice, the Modern Monetary Theory restricts its working to financial sovereigns like the US Dollar, British Pound Sterling, Australian Dollar, Chinese Renminbi, and Japanese Yen that issue bonds and deficits in their currencies. It leaves out the European Union due to its dependence on the Euro, the African continent, and most Latin American and South Asian countries.
History has taught us that while deficit spending may be inevitable in times of crisis and to support massive infrastructural investments, governments must, in due time, focus on fiscal responsibility throughout the business cycle to protect themselves from falling. Hyperinflation in Venezuela and the Greece crisis are examples not unknown. Deficits do matter. So do debts. Though MMTers claim that economies like the United States will not end up like that, a series of 2008-like crises and pandemics, which will not be inevitable owing to climate change, could turn the tables sooner than realized.
The Modern Monetary Theory moved one step ahead and two steps back. It presents insights into how the economy functions, much similar to Lerner’s observations. Having a magic wand that adds to the money supply can have serious consequences. The knowledge of its existence (has, in the past, and) will let the financial capitalists exploit vulnerabilities of the financial system as they can always land on generous bailouts from the Central Banks.
