An economic theory that politicians will love

Business dailies are abuzz these days with Modern Monetary Theory (MMT). Politicians, while unconcerned about the finer aspects of the theory, are picking on a few concepts from the theory, sensing an opportunity to push their agenda. The theory is getting mixed up, but there are interesting responses from policymakers and analysts alike.

Love it or hate it, MMT is gaining traction. It has, it seems, turned conventional or mainstream economic theories on their heads. We have read about ‘helicopter money’. We have become familiar with ‘quantitative easing’, or simply QE, since the financial meltdown of 2008. In India, we have seen RBI resorting to ‘dollar-rupee swap’ to inject liquidity in the system. Is ‘MMT’ the new kid on the block?

What is MMT?

The theory, in short, argues that countries that issue their own currencies — called fiat money — can never run out of money the way individual households, firms or businesses can. MMT justifies why budget deficits do not matter and so governments need not worry too much about them. It further explains that budget deficits need not either be financed by raising taxes or borrowing money. It states that government spending can be funded simply by printing new notes and putting them in circulation.

Advocates of the theory say that printing money to cover the difference between government spending and taxes need not always lead to inflation as has been thought by economists of the old school. MMT’s leading proponent in recent times has been Prof. Stephanie Kelton, economic advisor to Bernie Sanders, who ran for US President in 2016 and could run in 2020, too.

Sanders and other politicians on the ‘progressive Left’ used MMT to dismiss governments’ concerns about programmes like Medicare for all or the Green New Deal that would involve huge federal spending and lead to bigger deficits.

While the views expressed in MMT are in sharp contrast to the economic models commonly applied in the US today, the radical views are not new. On the contrary, they draw heavily from theories propounded by the famous economist John Maynard Keynes during the 1930s, the difference between the two being that Kelton has a distinct political, if not economic, bias in favour of progressive causes.

This is what is making the political class sit up and take MMT seriously, and it is sure to find takers in countries like Zimbabwe or Venezuela that have been printing notes like there is no tomorrow.

Governments the world over have every reason to smile because they need not worry about fiscal deficit, spend on populist schemes without being concerned about fiscal discipline, and keep printing notes to fund the ballooning deficits. This can be a dangerous tool in the hands of politicians and can lead to runaway inflation.

While it does not mean that deficits do not matter to the proponents of MMT, they do believe that budget deficits do matter and that they can cause collateral damage to the economy. However, they contend that not all deficits are bad. If the deficits are due to increased spending on building of roads, infrastructure, health or education, then these will encourage and promote economic growth.

On the other hand, if the deficits are due to revenue expenditure like spending on subsidies, then they say the increase in aggregate demand due to more disposable incomes in the hands of the people without creating any goods or services can lead to inflation. This kind of inflation — called ‘demand-pull inflation’ — occurs when demand outstrips the economy’s ability to produce.

In this respect, MMT is not different from the economic theories propounded by Milton Friedman, who was a vehement critic of Keynesian economics and who advocated that increase in money supply creates inflation only when it outpaces the economy’s capacity for real growth.

Critics of MMT feel that borrowings by the government to fund the budget deficit is way better than printing new currency as it imposes fiscal discipline on the government since the borrowed money has to be repaid with interest whereas when the government prints notes, it need not repay any amount.

The proponents of MMT counter this argument by saying that increased borrowings by the government leading to issuance of government securities may suck out liquidity, lead to crowding out of investments of businesses and households, and slow down economic growth. They feel that countries can neither default on payments nor become bankrupt as they can simply print notes as and when they need money. And this is what has happened in the last decade with central banks across the world printing notes to finance deficits and it has not led to inflation, which has been surprisingly benign.

The theory could work well in countries that have a strong currency which is acceptable worldwide. MMT may find takers in countries like the US, Japan or China. In the final analysis, what the advocates of MMT need to answer is: if governments need not bother about deficits, then why impose taxes on people to raise revenues at all? Why not reduce, if not abolish taxes altogether?

(The writer is with Manipal Aca­demy of Banking, Bengaluru)