Modern Monetary Theory (MMT) – An Economic Devil or A Realistic Macro Policy Framework?

 

The objective of this article is to present a practical insight into the usefulness of the MMT as a macroeconomic policy approach to drive fiscal and monetary policies for the economic development and upliftment of living standards in countries without any differentiation between developed countries and developing countries.

Accordingly, monetarists’ criticism on the MMT as always being inflationary money printing is disputed as baseless. Therefore, it is the duty of the policymakers to choose between the MMT and other policy models as there is no single economic model universally tested and accepted.

Commencement of the MMT Dialogue

Fighting with the global Corona pandemic required the governments world over to spend huge sums of money to protect households and businesses from the humanitarian crisis associated with the pandemic. As governments generally fund their spending through borrowing from the credit/financial markets including printing of money, central banks also undertook a large volume of money printing and creation so that ample liquidity was available in the economy to fund the fiscal spending while maintaining the financial stability without being shaken by uncertainties associated with the pandemic.

This expansionary fiscal operation which prevailed for nearly two years, 2020 and 2021, is described by some economists of the conventional monetary school as the Modern Monetary Theory (MMT) which has been gaining popularity in the US during the last decade. However, what governments and central banks actually did was the implementation of a well-coordinated fiscal and monetary policy mix to protect and rescue the societies from the pandemic like in other crises dealt with in the past. 

It is the common sense that fiscal expansion during crisis times needs funding through new credit as tax hikes are not practical whereas it is a separate duty of central banks as independent monetary authorities to keep money and credit markets stable.

However, when inflationary pressures started rising rapidly since the third quarter of 2021 from low levels that existed during the last two decades in the world, monetarists started blaming the policymakers for the cause as the excessive money printing to fund the fiscal expansion under the MMT model.

It is in this context that the present Governor of the Central Bank of Sri Lanka immediately after assuming duties on 8 April 2022 also criticized the two former Governors that high inflation in Sri Lanka was a result of excessive money printing to fund a home-grown economic model by the Central Bank.

However, generally accepted causes behind the present inflationary pressures are the supply side disruptions and geopolitical shocks connected with the Corona pandemic and Russian invasion in Ukraine. As the high monetary expansion is generally believed to cause inflationary pressures through the increase in demand side when the supply side is subdued, the high fiscal expansion accompanied by the supportive monetary expansion during the past two years is also considered as a factor contributing to the present global wave of inflation.

For example, the money printing by the US central bank rose by nearly historic 110% and, therefore, its interim inflationary pressure cannot be discarded. However, the US central bank Chairmen at a press conference stated that the monetary policy during the pandemic was not restricted by the inflation hypothesis and used its full scale to help dealing with the humanitarian crisis in the century.

Therefore, there is no evidence to establish the MMT-based money printing to be the only cause for the present inflationary wave in the world or in any one country. However, conventional monetarists still tend to argue that the cause of rising inflation is the adoption of the MMT. This view is followed by opposition politicians as usual to criticize the government for printing money as the sole cause for the rising inflation.

The MMT Concept in the Nutshell

Proponents of the MMT seek ongoing improvement in socio-economic welfare and safety net with the expansion of production capacity through the fiscal policy.

Accordingly, they propose to increase fiscal spending financed by creation of money for undertaking national expenditure projects without any fear of inflation if the production capacity is increased by such spending. Therefore, they propose to monitor inflation along with the production capacity.

The spending can cover all economic and social projects that enhance the production capacity and social safety net. Some examples are as follows.

• Economic infrastructure such as irrigation, road network, seaports and airports.

• Environment protection such as reforestation and forest conservation, soil conservation and green finance policies.

• Social safety net policies such as unemployment insurance and protection of children, adult and the poor.

• Promotion of services and affordability of social investment such as education and health.

• Fiscal incentives to priority sectors such as commercial agriculture, exports and import substitution.

• Fiscal instruments for reduction of inequality of income and economic opportunities, control of inflationary pressures and asset bubbles and maintaining socio-economic stability.

According to MMT proponents, there is no separate monetary policy with separate mandates such as price stability and financial stability which are generally not achieved by it independently. They believe that fiscal instruments are more efficient and direct in achieving monetary policy objectives such as inflation controls and maximum employment than monetary instruments such as interest rates. 

For example, increases in taxes on inflationary or non-priority spending sectors is more efficient and faster than the policy interest rates hikes that have long delays and unknown transmission effects whereas central banks have no tested records on achievement of such stability objectives.

Therefore, MMT recognizes the fiscal policy as a broader framework that goes beyond the fiscal revenue based policy model in the wider public interest in modern monetary economies.

Accordingly, MMT can be implemented in countries which have the sovereign power to create own currency. Therefore, MMT is not adoptable in countries with currency board systems as their currencies are created on the net receipt of foreign currency which is beyond the direct sovereign control unlike discretionary printing of money by central banks. 

Similarly, EU member countries also cannot follow MMT as the currency system is operated by a common central bank known as European Central Bank. However, as the European Central Bank as part of its monetary policy finances debt issued by the member countries to ensure the stability in debt markets in member countries across the EU, they also can adopt MMT to some extent as currency creation in the EU area is primarily based on member country sovereign debt operations.

Is the MMT a new economic theory?

No. It is an existing fiscal policy extension. However, it is a practical approach or conceptual framework to drive all state policies for integrated national objectives to maximize the welfare and living standards of the public through a centralized fiscal policy. According to MMT proponents, state policies even at present in fact are implemented under de facto MMT. For example, monetary policies of all countries are implemented through government debt finance and central banks never allow default on government cheques issued for spending because it could lead to a financial system panic and collapse.

For example, money printing of the Central Bank of Sri Lanka until the onset of the present foreign currency and debt crisis primarily depended on government foreign debt whereas the present money printing is primarily based on Central Bank’s purchase of government Treasury bills. Therefore, fiscal operations are in fact funded by the money creation although money creation is regarded as an independent policy instrument.

However, the present policy regime contains various compartments allocated among the state policymaking institutions operating with scattered objectives and concepts which are not aligned to national priorities and objectives. In many cases, compartmentalized policies and objectives are conflicting each other and tend to cause national crises too. 

For example, current soaring inflation in Sri Lanka cannot be controlled by the monetary policy interest rate hikes, but the Central Bank implements sugar-rush interest rate hikes to historically high levels that have already caused a chain of government, business and household bankruptcies that worsen the present economic crisis. No body can think of national economic growth, stability and better living standards under interest rates of government domestic debt around 30%.

Therefore, MMT is not a separate fiscal or money printing framework per se, but a newly rationalized policy framework aligned to a comprehensive range of national socio-economic objectives.

Criticism by Conventional Monetarists

Monetarists are the group of economists who believe the 16^th century tribal society’s mathematical concept of quantity theory which shows the interaction between monetary transactions and goods and services transactions that are used to detect a positive relationship between the volume of money available for spending and the general price of goods and services available for sale under various unrealistic assumptions. According to such monetarists, the inflation or the increase in general price level in the economy is always a monetary phenomenon or a cause by the increase in the money stock.

Therefore, they are inclined to the view of the control over the stock of money in order to drive the economy with price and economic stability. Accordingly, central bank monetary policies around the world are inclined to this hypothesis added with subsequent theories of policy transmission. However, other than the hypothesis, no one has empirically established its validity in real world, but these economists are mentally sick of an omni-present inflation ghost behind the money. Therefore, they demand that they be given the autonomy to operate the state money printing press as their own property to ensure the economic stability free from inflation.

Therefore, these economists outright reject the MMT framework based on two reasons.

• First, inflation is caused by the reckless fiscal policy carried out through creation of money. This is their blind hypothesis where they always finger at the fiscal policy for any inflationary instances even in normal times without any regard to its macroeconomic benefits to the public. They make this criticism without good understanding of the broad policy framework under the MMT which talks about a wider scope of production capacity combining with social and economic capacity to distribute economic welfare with greater equality.

Even at present, socio-economic capacity and development of countries are a direct result of the fiscal policy where monetary policies with their hypotheses have not been able to control inflation to keep the so-called price and economic stability. The best example is the recovery from the pandemic with the help of the fiscal policy and the inability of central banks across the globe to control inflation. Therefore, one candidate for the UK Prime Minister post has proposed to review the mandate of the Bank of England.

Sri Lanka is facing a situation of hyper-inflation and debt crisis, despite the inflation control/target monetary policy adopted by the Central Bank in the past two decades. In fact, data show that the bad monetary policy model has created the present economic crisis in Sri Lanka.

• Second, they state that the MMT is suitable for only developed countries like the US whose currencies are global reserve currencies whereas it would cause debt and BOP crises if followed in developing countries. However, conventional monetary theories are common for all countries and there is no differentiation between the developed countries and developing countries.

For example, present global inflation wave and reasons are common to all countries and MMT followed in one particular country such as Sri Lanka cannot be established as the reason. Further, if the level of money printing is excessive, its economic response through rising demand for domestic products and imports and currency depreciation as predicted in the macroeconomic theories is common to all countries although the response time and the scale could be different across the countries due to differences in economic structures and markets.

Some economists discard the MMT as a garbage whereas old monetary theory itself has failed to stabilize the economies. These economists led by some economic god fathers acting through a student network always talk about inflation threat even when the economy is in recession and only analyse the past economic and policy events what they have read and understand. They don't have any solutions to human economic problems other than model analyses.

Therefore, conventional monetarists’ criticism against the MMT is practically baseless.

Final Comment

Unlike conventional monetary hypothesis of inflation and money, the MMT is an integrated policy framework or approach that can be practically adopted to drive the economies for improved socio-economic welfare of the general public.

Accordingly, the MMT can integrate presently compartmentalized policy concepts and models such as fiscal reform to reduce the fiscal deficit, independence of flexible inflation targeting monetary policy, trade policy for export promotion and import control, foreign currency stability through debt financed foreign reserve, carbonic agriculture for healthy lives and green finance for the environmental protection and control over climate warming.

Therefore, democratic governments who are responsible for the public welfare on all fronts can use the MMT to drive a national policy framework which will help the government to take charge of the governance of the country on all fronts and to minimize social protests, agitations and insurgencies that generally occur due to large distributional disparities including unemployment and poverty of weaker segments of the people.

However, the challenge here is the lack of key public officials who can think and perform in such an integrated policy framework because it will deprive of their comfort zones, personal images and professional beliefs.

It should be noted here that all economic theories and models are conceptual paper works whose effects can be known only after some time upon the implementation of suitable policy instruments depending on the response of the markets. However, there is no scientific methodologies or tests to predict exact results of any of such policy models including the monetary policy concept in modern dynamic economies with a global presence.

Therefore, the MMT is a more accountable policy framework that can be sold by promising governments to the general public, especially in the present crisis situation. My previous article released on 6th August proposed a new macroeconomic governance system through the Constitution in place of the present compartmentalized macroeconomic management system which can adopt the MMT as the policy approach. 

Instead, if compartmentalized policies with different hypotheses and objectives are carried out as at present, the economic recovery will take decades where political and public agitations will continue to destabilize the country and society.

It is not human fairness under democracy if the majority public have to suffer rationalzed by the concept of KARMA while policymakers enjoy their concepts at a cost to the public.

Therefore, the new President has an enormous challenge in choosing the policy framework if he is really determined to recover the public from the present economic crisis because it is the President who has to answer the public.

(The next article will be on the inability of the monetary policy to control high inflationary pressures currently confronted by the public)

(This article is released in the interest of participating in the professional dialogue to find out solutions to enormous economic difficulties presently confronted by the general public consequent to the global Corona pandemic and subsequent disruptions and shocks.)

 

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published)