Photo: Mint
Photo: Mint

Opinion | The inexplicable allure of Modern Monetary Theory

Printing money for unlimited fiscal expansion might serve as a short-term growth fix but is not sustainable

The latest unlikely convert to half-endorse the idea of “helicopter money" is Stanley Fischer, a former vice-chairperson of the US Federal Reserve. In Washington this past week, amid the World Bank-International Monetary Fund autumn meetings jamboree, he said “there’s a kernel of truth to MMT", referring to Modern Monetary Theory. This theory says that governments can and ought to simply print their way out of a recession. Fiscal stimulus and deficit spending should be supported by central banks, which should buy government bonds by printing currency if necessary. Basically, monetary policy should be a handmaiden to fiscal policy, subservient to it. MMT calls for fiscal and monetary coordination, and practically opposes monetary policy independence. It regards achieving full employment as the primary goal of monetary policy; if inflation risks arise, then it proposes to curtail these by taking money out of circulation through the sale of bonds. MMT’s strongest proponents are currently the “leftist" crowd in American elections, including presidential contender Bernie Sanders. But it has cheerleaders all over the world, including in Europe and India. Some people believe that Japan has de facto been following MMT for the past two decades.

MMT has been gaining ground because conventional monetary policy has been ineffective against stagnant growth. Its advocates call for a big fiscal binge by putting cash in every consumer’s pocket, which is what helicopter money is all about—fiscal spending backed by the printing press. They also point out that despite a decade-long pursuit of loose monetary policy in the West, inflation is still stubbornly stuck near zero. This seems to contradict the famous Milton Friedman dictum that inflation is basically a monetary phenomenon. Friedman’s words have been treated as gospel by most mainstream economists. But now, even Larry Summers, former US treasury secretary, has said: “What was previously treated as axiomatic is in fact false." Summer has not joined the MMT camp, but he fully acknowledges the limitations of cutting interest rates indefinitely and pumping in money. He, too, is of the view that a “secular stagnation" needs a heavy fiscal response, not merely a monetary one. To this, the MMT crowd adds that fiscal spending is not to be backed by more debt or taxes, but more “printing". Even the outgoing chief of the European Central Bank, Mario Draghi, has invoked MMT as the way forward for the Eurozone. He is known to have always expressed his disapproval of a Maastricht Treaty limit on fiscal deficits. For its part, the ECB is pushing the definition of “unconventional monetary policy" by pumping cash into banks and buying all sorts of non-sovereign bonds, but to no avail. Even junk bonds are now trading with negative yields, pointing to the strategy’s futility.

Still, what was once considered wacky is being seriously examined by more and more policymakers, regulators and economists. Fischer is just the most recent semi-convert from the monetary conservative camp to have succumbed to the allure of MMT. The theory itself is more than a hundred years old, and its founders argued that “money is a creature of the law" and not a medium of exchange or store of value. Governments can create or retire fiat money at will. Since government debt can be repaid with fiat money, it has zero probability of default. In times of recession, deficit spending should be done until full employment is achieved, and such spending should be paid for by printing currency. This is in contrast to the mainstream economic thought, in which fiscal spending is constrained by taxation or the government’s borrowing capacity. Such a view is careful about “sustainable debt" and, hence, doesn’t allow unlimited fiscal expansion. The mainstream view is also that a government’s fiscal push being supported by borrowed money leaves less of it for private-sector credit. This is called crowding out. In India, overall public-sector borrowing (by the Centre and states, all included), exceeds the country’s total household savings. This is what keeps interest rates high. But the MMT view refuses to accept such a crowding-out hypothesis. It asks the central bank to print money and buy government bonds, which in turn fund the fiscal deficit and stimulus needs. In 2018-19, almost 85% of the bonds issued by the central government ended up with the Reserve Bank of India (RBI), which can be called 85% de facto monetization of the deficit. Was this not MMT in action? It was close, but not quite. The bonds ended up with the RBI not via automatic deficit monetization, as in the bad old days prior to 1991, but through RBI’s open market sales and subsequent open market operations. And, since inflation is still quite low, there is pressure on the RBI to flirt with MMT.

MMT does not answer how heavy fiscal spending is eventually to be paid for. It cannot be by money printed out of thin air. It has got to be through current or future taxes (i.e. debt). There is simply no other way. But as long as fiscal expansion can coexist with low inflation and interest rates, add to the disposable income of consumers, and not crowd out private investment, it can be a short-term fix. Optically, it would seem like MMT. But that does not validate the theory. Even the great John Maynard Keynes was believed to have been influenced by MMT, which may have been the inspiration behind his fiscal multiplier. But despite the liquidity trap of the 1930s (much like today), he remained resistant to the spell of MMT.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution