The COVID-19 outbreak has inflicted global economic distress that is rivalled only by the Great Depression of the 1930s. Millions have been forced into unemployment, businesses are teetering on the brink of collapse, and deteriorating consumer confidence has placed many countries into economic hardship.
Money tree: Proponents of MMT argue that the government can simply enforce the central bank to print more money on-demand.
In response to the fallout, governments and central banks have rushed to support their respective economies. From job security packages to a flush of stimulus, public officials have been jolted into action.
While their efforts have alleviated some of the pain, there is a limit to how much they can achieve. Specifically, governments must find a balance between stimulating the economy and sustaining a sensible budget or risk being fiscally irresponsible to the point that deficits widen and public debts soar.
This idea that the government can only do as much as its budget allows has led to some economists calling for an alternative approach to economic management.
The theory proposes that a country that issues its own currency, such as Australia, should throw caution to the wind and forgo the desire for a balanced budget.
Since the 1990s, central banks have been the custodians of stable inflation and full employment. The idea was simple, central banks independently control interest rates to influence the economy, while the government sticks to their game of fiscal policy (such as spending on infrastructure and education) and levying taxes.
This formula, however, has come under pressure over the past decade as persistently lower-than-targeted inflation and lacklustre economic growth have plagued the global economy. When thrown on top of this already fragile situation, the pandemic has left many advocating for a rethink of economic policy.
Spending for the welfare of everyone
Modern Monetary Theory (MMT) has been thrust into the spotlight as a thought-provoking substitute that challenges many of the traditional principles of economics and blurs the lines of separation between the central bank and the government. While in Australia this separation is unlikely due to the legally mandated independence of the Reserve Bank, it has sparked an interesting debate among academics about what the future of economic policy could look like.
Pros and cons: Hamid Yahyaei says MMT can be viewed as a full reallocation of economic decision-making into the hands of the government.
The theory proposes that a country that issues its own currency, such as Australia, should throw caution to the wind and forgo the desire for a balanced budget that may be limiting the economy from reaching its full potential.
Instead, the government should spend as much as needed to maximise the welfare of everyone in the economy, despite widening budget deficits. This includes spending on education, targeting maximal employment and, in the current climate, offsetting the effects of the pandemic.
The theory is far from a simple cash handout, but rather, it can be viewed as a full reallocation of economic decision-making into the hands of the government. The end goal is to generate economic growth, eliminate unemployment, and spur productivity through mass bouts of unlimited fiscal policy funded by printing money.
There are arguments for and against, and history is no stranger to the devastating effects of excessive money printing.
How would this work? Proponents of MMT argue that the government can simply enforce the central bank to print more money on-demand, thus covering the cost of stimulating the economy and paying the interest owed on external debts, if any.
When the economy experiences inflationary pressure, the government can increase taxes to keep the economy in check, thus allowing for some form of equilibration.
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Like any policy, however, there are arguments for and against, and history is no stranger to the devastating effects of excessive money printing.
Time and time again hyper-inflationary pressures have crushed the value of a country’s currency and have caused financial instability. Think Zimbabwe in 2007-2009. Some would argue that MMT simplifies the mechanics and behaviours exhibited in a real-world economy, rendering the theory unrealistic in the face of frictions such as inflation.
Unorthodox theories suit a time of crisis
Moreover, the erosion of central bank independence is a particularly significant cost to pay, which for the most part limits the conflicts that may arise from shorter-termed political policies. Corroding this separation between monetary and fiscal policy may very well lead to policy uncertainties that could hinder longer-term investments.
On the other hand, it is often in times of crisis that unorthodox theories prove to be the most effective. Central banks are already conducting unconventional monetary policies including purchasing trillions worth of financial assets to grow the money supply. MMT would argue, why do governments need the middleman? The same rationale can be applied to the Federal Government’s recent JobKeeper initiative.
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Under MMT, the government could theoretically pay unemployment subsidies indefinitely without the constraints of a budget or needing to borrow for each dollar of a deficit.
Whether MMT is the next standard of economic management remains an open question. The abandoning of the gold standard, the introduction of inflation targeting, and the use of unconventional monetary policies all mark significant turning points in economic theory that were met with scepticism and even hostility at first.
Is MMT a new paradigm? Or is it simply an extension of what we are already seeing? In the words of the late Paul Volcker, Chairman of the US Federal Reserve (1979-1987): “I am suspicious of the idea of a new paradigm, to use that word, an entirely new structure of the economy.”
Hamid Yahyaei is a Specialised Lecturer and Senior Researcher in the Department of Applied Finance at Macquarie Business School.
