Modern Monetary Theory- theoretical or practical?

posted in: Economic ideas | 0

Recently, while browsing through BBC’s Business Daily (link at the bottom of the page), I came across an interesting topic – Modern Monetary Theory or MMT for short. I thought I will share my thoughts on my understanding of the same.

In essence, it describes a situation where a country can print currency to meet its public debt. This theory maintains that since the currency used in today’s world is fiat money (currency issued by the government that does not have a value on its own) and not full bodied money (like gold, where the value of currency is the value of the commodity itself), the government has absolute control over how much currency can be  printed. In other words, since the Government is free to print its money, it need not worry as much about its public debt, which is an interesting proposition.

It is a widely accepted and followed rule that governments should try to keep their fiscal deficit at a minimum to: 

  1. Prevent inflationary spirals due to high money supply in the economy,
  2. Prevent low GDP growth due to tax revenue being used to finance debts instead of being used to boost infrastructure and spur GDP growth, and
  3. Cause an erosion of government credibility.

For these reasons, governments try to avoid creating a high fiscal deficit by lowering expenditure during the year.

However, advocates of the MMT are saying that such an approach is incorrect and has led to years of unneeded government austerity with their fiscal deficit. The idea being put forward here is that government spending is what creates money in the economy, and it can always repay its debts by simply creating the money to do so.

Following this approach has many implications. It could lead to hyperinflation taking place because of simply printing currency to meet public debts. History is replete with cases of hyperinflation that have been caused by an attempt to print money to the tune of their fiscal deficit, which subsequently lead to the value of the currency tanking due to excess money supply in the economy.  

MMT might also lead to central banks losing their sovereignty to a large extent because they would not be controlling the monetary policy anymore. Central banks take measures to regulate money supply in the economy by controlling interest rates and open market operations (such as selling securities to soak up liquidity). Under MMT, the government would oversee how much currency is printed and the current measures taken by central banks to regulate supply would not matter as much. This is countered by supporters of MMT, who opine that the steps taken by the central banks are ineffective anyway in controlling inflation, and therefore by giving the power to control monetary policy to the government, augurs well for the economy. To my mind, it is best that  the responsibility for managing the monetary policy lies with the economists at the central bank rather than the government.

However, in my opinion, the biggest disadvantage of MMT lies in its exclusivity. Only established and dominant economies can implement such a radical idea, such as the USA. The economy of the USA is independent, which is not the case when you look at many developing economies including India, which import in other currencies. In this case, the fiscal deficit, which also includes foreign borrowings, cannot be merely met by printing more of the Indian Rupee. Increasing debts and expecting excess currency to cover the new fiscal deficit created as a result could be hugely detrimental, as it may cause foreign investors to withdraw their investments and lead to hyperinflation if not regulated. Therefore regulation, is the key to its proper implementation and control.

The concept of MMT, while interesting, poses some problems, which is why most economies with a strong central bank do not advocate it. However, the idea of just printing currency to finance debts is a tantalising one, and it could probably stick around for present or future governments to implement.

The views expressed in the blog are based on my understanding of the topic. Kindly excuse any fallacies and feel free to leave feedback and corrections in the comments below.

You can hear the BBC Business Daily being discussed here via this link:

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