The onset of Co-vid 19 has been met with massive intervention by public authorities around the world. Central banks in particular have injected huge amounts of money into the financial system through purchases of government (and other forms of) debt, which has lowered borrowing costs for governments. This has raised questions about the appropriate scale of such actions, how long they can be maintained, and what their limits are. An influential framework that has emerged in recent years, particularly on the US left, is Modern Monetary Theory (MMT). Stephanie Kelton, advisor to Bernie Sanders, is among its most visible proponents. Alexandria Ocasio Cortez is also an admirer, and even Mario Draghi reckons it deserves a hearing. While there are plenty of problems with MMT, some lessons can be drawn.
Modern Monetary Theory suggests that states which are in control of their own currency are unconstrained in their ability to spend. This is because a government in control of its currency can simply ‘print’ new money to finance its spending. In today's world, printing money does not mean opening up the printing presses, but rather is about creating money electronically at the click of a mouse. In its purest form, MMTers say the government need not borrow by issuing bonds, but should rely on money creation. An implication of the doctrine is that governments should not concern themselves with the size of government deficits, or the level of public debt. To stabilise the macroeconomy, MMT eschews reliance on monetary policy or changes in interest rates in favour of fiscal policy. Governments can, and should, spend big. An EU €750 billion stimulus plan in grants and loans currently being discussed goes some way toward that.
The function of taxation, in this view, is not to raise money to fund expenditures of the government. Rather, it is to withdraw money and resources from the economy. The creation of new money by the state has the potential to induce inflation, the proximate cause of which, everyone agrees, is too much money in circulation relative to the amount of goods and services. This is especially a concern when the economy is operating near full capacity. If the state-financed state spending is used to increase the productive capacity of the economy, this is less of a threat – more money, yes, but now chasing more goods and services. Still, raising taxes staves off the threat of inflation by absorbing some of the excess money arising from state spending. Issuing government bonds also drains money from the system.
A variety of what, at least to my mind, are valid criticisms of MMT have been made, and so I do not consider myself a subscriber. Without going into all of the technicalities, the current institutional make-up of advanced economies like the EU or Eurozone is such that it is not possible, for legal reasons, for governments to simply create new money à la MMT. The ECB would certainly be prohibited from doing so. Even if governments were willing and able, it is fanciable to assume that politics wouldn’t get in the way of a government raising taxes in just the right amount, and at just the right time to prevent inflation.
Nevertheless, some of its recommendations make sense at the current juncture. In particular, the ECB Pandemic Emergency Purchasing Programme (PEPP) sits well with MMTers. Through PEPP the ECB purchases public bonds of Eurozone countries in the secondary market. By effectively increasing the pool of deep-pocketed lenders, borrowing costs fall, which facilitates increases in government spending. Member states, of course, still have to repay those loans when they come due. There are also limits to ECB purchases – PEPP has committed to €750bn of purchases of public and private debt, with ECB purchases of a member state’s public bonds based on the size of that member’s economy (this is distinct from the stimulus plan above, which comprises mostly grants).
Though effective so far and likely to be extended, PEPP surely won’t go as far as many progressives and MMTers would hope. Presumably, when the worst of the crisis is over the ECB will scale back its purchases, which will put upward pressure on member states’ borrowing costs. States, Ireland included, will incur higher costs on future borrowing, and will be under pressure to close deficits and reduce the debt burden. When the now-suspended fiscal rules kick back in, the imperative to balance books will not only be economically binding, but legally binding. MMTers are correct to point to the experience of Japan which has a public debt-GDP-ratio of about 250%, almost 100 percentage points more than Italy’s projected 2020 debt level. By purchasing huge amounts of government debt, the Japanese central bank has enabled its government to engage in massive fiscal expansion over a sustained period. Despite what conventional economics would deem a flagrant violation of fiscal prudency, there’s nary a whimper from international financial markets about its sustainability – borrowing costs for the Japanese government continue to be extremely low.
Back in Europe, so long as the ECB continues to keep borrowing costs down member states should not overly concern themselves with deficits or the level of debt. The relevant economic metric for member states is the burden of repaying debts. Despite high levels of indebtedness in Ireland and elsewhere, ultra-low interest rates have meant that burden has not been particularly onerous. Pre-crisis the repayment burden here was around historical trend. Most of Ireland’s debt is fixed interest, moreover, so a rise in rates would not increase the cost of servicing historical debts.
Finally, the spectre of inflation is not yet haunting Europe, and is not threatening to do so in the near future. It may rear its head later as many households currently saving will not postpone spending indefinitely, among other reasons. Progressive revenue-raising measures are called for once economies are back up and running which, in Ireland, could mean raising employer’s PRSI. We need not conscript all aspects of MMT to realise we have policy space at our disposal, space that should be used.
Robert Sweeney @sweeneyr82
Robert Sweeney is a policy analyst at TASC and focuses on issues surrounding Irish political economy and distribution. He has a PhD in economics from University of Leeds, which concentrated on financial markets and investors, banking, international macroeconomics, and housing. He is also interested in debates on alternative schools and methodology in economics, and ownership.