It’s something we learn in first year economics: that no country can just print their way out of a recession without the adverse effects of rampant inflation. But a new rising idea in the form of Modern Monetary Theory (MMT) appears to argue otherwise. If you’re wondering whether this is just the musings of a disgruntled few on a Facebook comment threads, the theory has many high-profile supporters such as Bernie Sanders’ chief economic adviser Professor Stephanie Kelton . Essentially, the theory states that not only are governmental budget deficits not a bad thing, they can actually be the fuel for economic growth. The MMT logic argues that countries with a floating exchange rate and one that issues their own fiat currencies, like Australia, can essentially print all the money it needs. Furthermore, as long as the money printing is within the bounds of a country’s productive capacity, an increase in inflation will not occur.
MMT in a nutshell:
There are several tenets to MMT, the first of which is that a budget deficit isn’t bad because it conveys that the government is spending on firms, businesses and households. Again, this runs slightly contrary to what is taught in most first-year economics classes, but MMT argues that such government spending (provided of course it is being spent on the right things) is akin to an investment in productivity and leads to better outcomes in metrics like health, productivity, infrastructure etc. The theory goes even further and states that our conventional logic of thinking that the notion that governmental budget deficits are bad needs to be chucked out the window MMT actually states that the government needs to pump money into the economy before they even start borrowing and/or taxing.
One tenet that MMT and orthodox economic theory can agree on is that taxation is still necessary but where they differ is the objectives of said taxation. MMT argues that taxation helps governments control inflation and helps to influence the taxpayer’s behaviours into producing things the nation actually needs.
The last and possibly most crucial pillar of MMT returns to the aforementioned point that a country with a floating exchange rate and one that issues their own fiat currency can continue to print and spend their own currency since the additional currency can be used to buy up their own goods and services, so long as the economy hasn’t already reached its productive capacity. If all this sounds like a bit of hogwash to you, let’s remember that this theory isn’t entirely new and in 2005, former Federal Reserve chairman Alan Greenspan was quoted as saying that there is really nothing stopping a federal government from printing money as long as there are enough resources and/or assets to fuel the demand created from the extra cash.
So, what are the major advantages of MMT?
First, MMT provides the freedom for sovereign currency-issuing governments to adopt fiat currencies, which can be issued without limit to fully employ the country’s real resources. These currencies carry no intrinsic value, have floating exchange rates and are not backed by gold, allowing countries to no longer fear the detrimental effects of a gold shortage.
Second, due to the ‘spend first, tax second’ nature of this theory for governments, it can also be used to stabilise failing markets, boost public spending on social services and infrastructure, invest in under-developed communities and increase prosperity and standard of living.
Additionally, government debt, is embraced by MMT – given inflation is unaffected. This theory illustrates that governments, like Australia, who have control over its own currency, cannot default on debt and do not need to tax or borrow before it spends. It also encourages governments to borrow through money creation, such as issuing liabilities and bonds to the private sector to gain full employment. This may boost investor confidence, causing a rise in demand, and therefore, does not crowd out the private sector of funds for investment. Moreover, some modern monetary theories propose job guarantees for people who cannot find a job in the government sector. This scheme not only reduces unemployment, but also does not increase inflation, due to the fixed wage offered to employees.
What are some potential disadvantages of MMT?
A major disadvantage is that MMT can only really be applied with countries that have floating exchange rates that issue their own fiat currencies. For countries that do not have sovereign currency-issuing governments, such as those within the European Union, this theory would need to overcome many difficulties in order to be utilised. Additionally, this theory only applies to the national government, as it is the only section that has power to issue sovereign currency. State governments must instead act like households when making spending decisions, as they are currency users, not issuers.
Moreover, the concept of printing money continuously to spend has been widely criticised due to the overestimation of the revenue that can be earned from money creation and the high inflation associated with this concept. One study revealed that the maximum sustainable amount of revenue that can be generated from money creation is approximately 4 percent of GDP. However, this would create an annual inflation rate of 266 percent.
Hyperinflation, a nasty consequence in the misuse of MMT, is frequently overlooked – as the ability of policy makers to keep it under control is often overestimated. In a recession, the government can increase the money supply without fears of hyperinflation. However, if this is conducted when the economy is near full capacity, inflation will rise, and the government will need to increase tax to decrease demand – which itself will have adverse consequences.
Finally, MMT contains too few safeguards against the risks of excessive public debt. Governments, like Greece, who find themselves unable to pay back the high amount of debt may default and will in time be forced into a recession, causing greater economic damage. Even if default does not happen, high debt, accompanied by increases in taxation to avoid hyperinflation, can prevent future economic growth and prosperity. Overall, the more debt borrowed, the weaker their currency will become, and more money would need to be spent to purchase imports and less money would be paid for their exports, causing the need for more money. The continued borrowing and weakening of the currency will become a vicious cycle and may result in total economic collapse.
In all, despite MMT offering a different economic outlook to traditional theories, it unequivocally has both advantages and disadvantages. Therefore, this theory may be an option that can be utilised in tandem with traditional theories to enhance policy making for governments.
Could MMT be a viable solution
to Australia’s budget deficit?
Within the 2020-2021 Federal budget, big spending took shape in the form of JobKeeper, income support, infrastructure spending and pensioner support. While the much-anticipated plan delivers large amounts of money to respond to the Covid-19 economic fallout, there were criticisms by some parties over the distribution of these funds.
Anthony Albanese, leader of the Federal Opposition, cited a lack of spending on social housing investment and childcare as key weaknesses of the budget – whose workers are predominately female. Under Albanese’s alternative, families would be subsidised 90% of childcare costs, which would result in an approximate saving of between $600 and $2900 annually. The expenditure on these subsidies amount to $5b a year with a projected return of an $11b increase of GDP per year. While the adoption of such recommendations would add more depth to the budget, financial constraints have created inevitable trade-offs.
The 2020-2021 Federal Budget forecasted $966.2 billion of net debt by June 2024 and $1.7 Trillion of gross debt by the end of the decade. The IPA, a conservative think tank concluded that with a budget surplus of 1% per year, it would take nearly 60 years to clear this debt. As Australia has not experienced a budget surplus for over a decade, this goal would be difficult and would require austerity measures, political stability and most importantly a Government with strong resolve. Because the Government is reaching the limit of its possible expenditure, some economists believe MMT could be worth trying.
Here are some of the reasons why MMT might work:
First, the concept of MMT could help to reduce Australia’s level of unemployment, which as of September 2020 has soared to 6.9%. The reasoning behind this is that MMT provides a kind of federal jobs guarantee. Covid-19 has altered Australia’s job landscape – ultimately favouring more educated workers who can use emerging technologies effectively. In order to protect and support those vulnerable peoples who may no longer have jobs available due to a skills misalignment the Government could utilise MMT. To prevent high levels of inflation from the ‘printing’ of sovereign currency, the Government would act as an Employer of Last Resort (ELR). By doing this the Government would seek to utilise untapped labour resources and expand the economy’s productive capacity, thereby reducing inflation.
Second, the lowered effectiveness of the Reserve Bank during these periods of low rates have made MMT more attractive. In MMT, the Reserve Bank’s role is greatly diminished as the Government becomes the sole manager of demand in the economy. Critics of MMT fear this would give the Government too much power. However, as it stands the realised and expected low interest rates that have existed in Australia for the past decade would prove testament that the Government is already wielding most of the influence on the economy’s demand. Therefore, it could be argued that MMT would not create this drastic power shift that its critics warn of.
A third and most obvious reason MMT could be applied to Australia is to boost government spending across the economy. For example, MMT could be used to facilitate Anthony Albanese’s social housing investment. Currently there is a backlog of over 100,000 people for this type of accommodation. By spending/printing money first and providing all these people with improved living conditions, their productivity and economic stability will rise. This would ultimately result in a double dividend of increased labour force productivity and participation as well as greater tax revenue.
Ultimately, as MMT has not been used in Australia before, it is unlikely we will be experiencing it any time soon. While it sounds like a silver bullet solution to the Covid-19 economic disaster, there needs to be a larger consensus on the theory, implementation, and impact of MMT before it is deployed into a large economy.
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