A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’
For centuries governments have taxed, borrowed or created money to pay for public spending. All carry risks. Heavy taxes dampen growth and upset voters. Excessive public borrowing triggers financial crises. Printing money to pay for public spending can look tempting. But, as rulers from Henry VIII to Venezuela’s Nicolás Maduro have discovered, creating money out of thin air and spending it tends to destroy confidence and send inflation rocketing.
In economics, as in investing, if something looks too good to be true, it generally is.
So, imagine finding a way to increase spending without borrowing, taxing or creating inflation.
Yet, in simplified form, this is pretty much the promise of a policy getting a lot of airtime in America at the moment – Modern Monetary Theory or MMT.
MMT asserts that a government that prints and borrows in its own currency cannot go bankrupt, since it can always print more money to pay back debt. The argument runs that since it can print money to pay off its debts such a government can also do so to pay for public services. This is a truly radical idea.
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Supporters of MMT argue that government should print money and spend it as long as the economy is operating with spare capacity, i.e. it has unemployed workers or underused factories. Once spare capacity is used up, and the economy risks overheating, proponents of MMT say the government should stop spending and raise taxes to dampen activity and inflation.
To its supporters MMT avoids many of the disadvantages of traditional forms of economic policy. Voters get better public services with unchanged taxes. There’s no extra public borrowing to alarm deficit-hawks. And it won’t push up private borrowing and asset prices in the way QE (quantitative easing) has in the last ten years.
Now, it’s worth noting that both MMT and QE involve the government creating money electronically – or, more graphically though incorrectly, printing it. But with QE a central bank creates money to buy assets, such as government bonds. This injection of new money into the system drives down interest rates and bolsters asset prices. Under MMT, by contrast, the government spends the money directly on public services.
That’s one crucial difference, and from it a second follows. With QE, as practised in the US and Europe, central banks have promised to reverse money creation. They can do so because, unlike under MMT, the money that has been created has been swapped for assets which can be sold. The idea is that central banks will, in time, sell these assets, withdrawing money from the system and dampening asset prices and activity. This has so far convinced investors that the new money created will eventually be absorbed back into the system. The message from central banks is that QE does not represent a permanent expansion in the supply of dollars, euros and pounds.
By contrast, the money created under MMT will be spent on public services and not in purchasing assets. And, since there are no assets to sell in future, the money creation is permanent.
These are important differences. They explain why so many prominent US economists, from Fed chair Jay Powell to former treasury secretary Larry Summers, have raised concerns over MMT.
The most obvious danger is of runaway inflation. If investors think a central bank would print money at the whims of the government they are likely to get rid of money and buy other assets to protect against inflation. That could cause the currency to collapse and inflation to soar.
A related concern is that government, with its infinite spending power, could hoover up people and resources and crowd out the private sector. This would reduce the tax take and could tempt the government to print more money to fill the gap.
More fundamentally, the state could end up with a far greater role in allocating capital in the economy. The market has flaws and limitations. But it tends to be better at allocating capital and raising efficiency than the government. A worry, therefore, is that MMT could enfeeble the private sector.
With numerous critics and few true believers among politicians MMT is unlikely to see action in the US. Even on the political left its support is qualified. While Stephanie Kelton, one of MMT’s leading proponents, worked as an adviser to Democrat presidential hopeful, Bernie Sanders in 2016, Mr Sanders has never explicitly endorsed the policy. MMT’s most high profile advocate is Democrat congresswoman Alexandria Ocasio-Cortez though she is not committed to it, saying MMT needs to be, “a larger part of our conversation”.
Yet the debate sparked by MMT highlights a willingness to push the boundaries of policy in pursuit of faster, more inclusive growth. Critics of the status quo point out that ten years of easy money have not stoked inflation. Nor has a soaring federal budget deficit, and vast issuance of US treasury bills, unsettled investors. This is an environment in which radical economic ideas, such as MMT, are attracting attention. To me MMT sounds rather like alchemy, the age-old search for ways of turning base metals into gold. Given the damage caused by the last recession I shouldn’t be surprised. It has reinvigorated the eternal search for new and faster paths to prosperity.