FRANKFURT – Many people are now proclaiming that the COVID-19 pandemic has provided proof positive that Modern Monetary Theory (MMT) is the only way forward for governments. To the uninitiated, MMT probably sounds extremely sophisticated – even scientific. Its representatives speak as though they have developed a new economic paradigm comparable to the Copernican Revolution in astronomy. Yet behind the sleek title and confident policy pronouncements lies a message that is as simple as it is dangerous, particularly now that governments around the world are spending freely to keep their economies afloat during the pandemic.
According to MMT, governments can spend what they want on whatever they want until full employment is achieved, and without ever having to worry about the financing, because the central bank will provide the money by simply operating the printing press at no cost to the government. Whether this contribution to economic thought even deserves to be called a new “theory” is debatable, considering the unoriginality (and banality) of its central concept. Indeed, the ideas about government spending date back to the economist Abba P. Lerner’s concept of “functional finance” in the 1940s. MMT has merely tacked on a federal job guarantee.
The first publications on MMT – such as Modern Monetary Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, by the economist L. Randall Wray – appeared several years ago, and were met with near-unanimous criticism from economists across the political spectrum. Nonetheless, the debate about MMT continues, primarily because it has been picked up by politicians like the former UK Labour Party leader Jeremy Corbyn and US Senator Bernie Sanders.
During the Democratic primaries – both in 2015-16 and 2019-20 – Sanders was advised by Stephanie Kelton, one of the best-known exponents of MMT, and the author of a new book on the topic, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. In his most recent campaign, Sanders put MMT at the center of his economic-policy program, ensuring that it would gain wider purchase on the left of the Democratic Party. Whether Joe Biden will adopt the theory’s central idea if he wins the presidency remains to be seen.
In any case, leftists around the world will remain smitten by MMT, because they are convinced that it holds the key to pursuing a long list of public projects to boost employment, protect the environment, advance social justice, and so forth. The proposal for a federal job guarantee promises full employment and “good” jobs that pay a living wage for work geared toward useful public purposes.
But one wonders if MMT’s adherents would still favor it if it had been embraced with similar gusto by US President Donald Trump, perhaps to pay for his promised wall on the border with Mexico. If financing government expenditures at no cost knows no limits, whoever is in power is living in the land of milk and honey. But this would be a temporary paradise, because a government spending spree inevitably would lead to high inflation, at which point the window of opportunity would close, and citizens would be left to pay the bill via rising unemployment and weaker real wage growth.
Recognizing this problem, MMT proposes that the governments increase taxes when necessary in order to remove enough money from circulation to avoid inflation. Imagine that: whereas previously there had been no financial restriction whatsoever on government spending, now suddenly there are such restrictions – and taxes must be raised to claw back the excess money that had been put into circulation! It is hard to envisage an idea of democratic politics more naive than that implied by MMT.
Even if the politics did work, serious questions would remain. For example, at precisely what rate of inflation should money start to be collected through higher taxes? What happens to the already-approved public projects still in the pipeline? And how should policymakers account for inflation expectations, which probably will have already been priced into wages, interest rates, and numerous agreements? Experience shows that stopping an inflationary process once it has begun is possible only at considerable macroeconomic cost – not least in terms of rising unemployment. The West endured precisely this ordeal in the late 1970s and early 1980s.
To be sure, advocates of MMT are technically correct when they point out that any country able to pay its debts in its own currency cannot become insolvent, because there is no limit to the sums of money that it can create. But the idea that foreign investors would remain willing to invest in that currency under such circumstances doesn’t hold water. At some point, foreign capital would become effectively shut out, with serious implications for the financing of private ventures. Again, MMT claims to have accounted for this problem: in the US case, they pretend that the government cannot lose control of its interest rate.
Still, as many studies have shown, the higher the degree of central-bank independence, the lower a country’s inflation rate. That is why all leading economies saw fit to institutionalize central-bank independence in the first place (mainly in the 1990s). MMT, however, would revoke the central bank’s control over the printing press, and put that power in the hands of the government. As history shows, in times of emergency, the normal rules would be suspended. MMT is an approach that would create such chaos.
In today’s environment of near-zero or even negative interest rates and massive central-bank purchases of government securities, we are witnessing a move in the direction of MMT. If governments can rely on their central banks to buy unlimited amounts of government securities to prevent interest rates from rising, they have effectively already wrested control of money creation from the central bank.
In principle, an independent central bank has the power to end this process at any time, by reducing or even stopping purchases of government securities. But there would be significant political pressure weighing against such a move. Once a central bank de facto ends up in the position that MMT’s advocates seek, its ability ever to regain control becomes an open question.
Otmar Issing, former chief economist and member of the Board of the European Central Bank, is President of the Center for Financial Studies at Goethe University, Frankfurt.
Copyright: Project Syndicate, 2020.