Capitalism is in soul-searching mode (see ‘1968’ in January), social anger and populism are threatening democracy (‘Democratic Indulgence’, October ’18), economists have lost credibility (‘Behind The Curtain’, February ’18), the economic cycle is naturally ageing whilst central banks have little to no ammunition to save the world from a global recession… The cocktail is explosive and its detonator is called Modern Monetary Theory (or ‘MMT’).
MMT, or neo-chartalism, is a seductive economic model. It argues rather elegantly that the main constraints to economic policy should not be money, since the monetary system is a totally artificial construct, but physical resources available to an economy. As long as such resources are not fully exploited, any government in its right mind should be prepared to run a fiscal deficit. For that deficit is not real. What is real is that some valuable economic assets are underutilized. What is real is unemployment and the poverty it engenders. Therefore the government should be ‘overspending’ to compensate for the private sector’s ‘underspending’ – as long as inflation is under control. Importantly, government expenditures (net of taxes) would be financed with new money through the direct credit of employees’ and suppliers’ bank accounts.
Recent history suggests that monetary policy (including low interest rates) have not proven to be highly effective to exploit such untapped potential. According to the MMT proponents, fiscal policy is the most effective tool to manage an economy, for example through a job guarantee program. If perfectly implemented, MMT would secure full employment at all times and reduce economic cyclicality whilst keeping inflation under check.1 Finally, printing money to finance a fiscal expansion ensures that private investment is not crowded out by government spending through the issuances of bonds and, with them, upward pressure on interest rates.
MMT is supported by sophisticated economists which gives it some credibility. To appreciate this, it suffices to read the heated exchange between Stephanie Kelton and Paul Krugman in the NYT and on Bloomberg last month or to read various pieces of research, including a great article entitled ‘MMT for Austrians’ published in New Economic Perspectives. Yet I would still pick three practical arguments against MMT: (1) Technocrats at central banks must be preferred over politicians to drive economic growth to its potential; (2) Governments tend to be quick to boost deficits to support the economy, but they are not known to be willing or able to reduce it when required; (3) Governments able to print their money may never become insolvent, but their finance would not be deemed to be sustainable by the outside world, with dire implications for economic stability.
But if Paul Krugman, supported by Larry Summers and Kenneth Rogoff, cannot decisively win a public debate with Stephanie Kelton, who can convincingly challenge MMT in the eyes of voters? The temptation to experiment with MMT will be strong. MMT will be espoused by a growing number of politicians: Promising job guarantee and other goodies to save the world such as a Green New Deal by running a budget deficit based on an economic theory supported by credible economists is a winning proposition in today’s environment.
Unfortunately, MMT in its original form, however robust, will be hijacked by governments once in power with only one certain outcome: the uncontrolled expansion of budget deficits.2
MMT is much more than a flash in the pan. It is an irresistible economic theory which will give apparent legitimacy to irresponsible government behavior. It will have dramatic implications for macro-economics, micro-economics and the financial markets. The short term implications may well be positive for any economy adopting the concept. There is little doubt that MMT could boost growth, as it did on the back of President Trump’s expansive fiscal policy last year. Until inflation kicks in, because it will. Eventually, the harsh budget deficit reduction measures could well break the camel’s capitalistic and democratic back… and boom.
Not too soon, hopefully.
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