The concept of money is mysterious especially at a macroeconomic level. Realistically, if you try to explain the concept of fiscal stimulus to a 10 year old and tell him/her that “we need more money in the economy”, his/her response would be, why doesn’t the government just go and print some? This makes you think about the whole system of fiscal and monetary policies. The government is the institution that gives value to the money, then why does it have to be under debt. The irony that exists while assigning value to currency is that in reality money can never be scarce but it is this very scarcity that makes it valuable.
The modern monetary theory questions this very budget constraint that governments face and tries to strike a balance between economic reality and economic perception. This heterodox economic theory dates back to the 1970s, developed by Warren Mosler, an American investment fund manager and coined much later by Bill Mitchell, Economics Professor at the New Castle University. Although, it became prominent recently in the US, where it was widely popularized by American Economist Stephanie Kelton and U.S. Representative Alexandria Ocasião-Cortez.
A string of questions arise in a realistic world, about phenomena that do not come under the ambit of orthodox economics. These can be approached through heterodox economics, that tries to fill the gaps Keynesian and neoclassical approaches leave for us, by expanding our thought process. The Modern Monetary Theory is one such theory which advocates the idea that is presented to us by every economic textbook as something that will end in inflation. It disregards the fact that a government that assigns value to fiat money and has its account in the central bank can face a ‘no money crisis’. It goes on to say that unlike a household that has to ensure that earnings must be more than or equal to spending, there is no such constraint on the government. Fiscal policy is not as simple as maintaining a balance between tax revenue and government spending. M.M.T. argues that government spending doesn’t always have to be funded by taxes. Even the crux of this theory raises numerous questions and makes us doubt the macroeconomic tools and policies that have been governing our lives for many years now.
Let us first look into some key points that the theory talks about. We are not part of an era when currency is necessarily backed by gold or any other commodity. Without this backing it can be considered worthless, but we start by looking at the one way it still maintains validity in people’s life. M.M.T. says that people need currency only to pay taxes to the government and taxation is a means to pull or push money into the economy. This also means that taxation is not considered as a means to fund government spending. Secondly, although taxes may still exist in a limited form, the government will no longer have to issue bonds and borrow money because they have the power to create money. Lastly, it says that a budget deficit is favourable and not the other way round. More spending and less revenue from taxation pumps money into the private sector which creates savings and boosts investment into assets and vice versa a surplus reduces private savings which also has unemployment as a major consequence. This means that the size of the budget deficit is determined by the private sector.
Mosler developed the theory keeping in mind the U.S. economy and the reason why it is not being called obscure anymore is that the U.S. democrats are using it to their advantage. Not only does Alexandria Ocasio-Cortez believe that she can fund her proposed ‘Green New Deal’ focused on climate action through M.M.T. but at the same time Kelton also looks at it as a way to bring the economy out of the COVID-19 crisis. But this propagation of the theory, an idealistic approach, only increased the number of times it was searched on google by Americans and not the way economists have perceived it since years.
As heterodox as it sounds, the fantasy land shown to us by the modern monetary theory where a printing machine solves all our problems has its limitations. Stephanie Kelton in one of her explanations of the concept stated that “M.M.T. proposes that the constraint on government spending shouldn’t be debt but inflation: How much new money can you pump into the economy before prices rise?” Inflation can be a major drawback of the theory, but the proponents of M.M.T. choose to believe that it can be dealt with at later stages using taxation and other means and don’t see it as a major threat. It not only leaves little role for monetary intervention by central banks but ends up making them the last resort when things go haywire due to excessive government spending and the private sector losing faith in the government. The central bank will have to intervene and control interest rates in this case which basically means cleaning the mess created by the application of the theory. This kind of distortion in the economy will result in people viewing the government as even more unreliable and can also lead to asset bubbles, a point at which we won’t know where the economy is going.
Will modern monetary theory get a nod from economists and governments? I don’t think so. If found successful it would have been widely adopted by now. But, after its massive failure in Japan, Venezuela and Brazil, economists would rather use known and reliable policies to bring about the same results that the sugar coated theory presents as its own. Ultimately, sensitive situations that have to be handled at a large scale don’t allow you to take the road less travelled.
Technical Terms
Fiscal Stimulus: Fiscal stimulus refers to policy measures undertaken by a government that typically reduce taxes or regulations—or increase government spending—in order to boost economic activity. (Investopedia)
Neoclassical Economics: Neoclassical economics is a broad theory that focuses on supply and demand as the driving forces behind the production, pricing, and consumption of goods and services. It emerged in around 1900 to compete with the earlier theories of classical economics. (Investopedia)
Keynesian Economics: Keynesian economics is a macroeconomic economic theory of total spending in the economy and its effects on output, employment, and inflation. (Investopedia)
Asset Bubbles: An asset bubble occurs when the price of an asset, such as stocks, bonds, real estate, or commodities, rises at a rapid pace without underlying fundamentals, such as equally fast-rising demand, to justify the price spike. (Investopedia)
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Further Readings
by Shruti Bhardwaj (shruti.bhardwaj50@gmail.com)