The COVID-19 pandemic has highlighted the fragility of the economy in times of uncertainty. The impact on economic activity was unprecedented and extraordinary measures were implemented to mitigate the potential damage. These measures focus on using both monetary and fiscal policy tools. Governments used fiscal policy to provide stimulus checks, increased unemployment benefits, loans, and grants to businesses. Since the money required for these measures exceeded the revenue, the government relied on borrowed money, thus contributing to deficit spending.
Usually, people do not like the term deficit spending, because they think the government is borrowing money at the expense of the taxpayers having to pay generations later. It was no surprise that news channels were filled with discussions and interviews regarding the ‘debt crisis’ due to the current debt level of the US government. The US debt currently stands at $28 trillion and represents more than 100% of the nation’s GDP. The US is not alone, many other developed nations are experiencing a rise in their nation’s debt.
But Modern Monetary Theory (MMT) states that there is no need to worry about public debt if the debt itself is not contributing to excessive inflation. Instead of relying on monetary tools, MMT focuses on broadening the impact of fiscal policy. MMT dismisses any doubt of the debt crisis based on the notion that the government can never default on its debt if the government can issue currency and the debt is dominated in the government-issued currency. In simple words, the US government can just print money to pay off the debt as long as the debt is in US dollars.
Indeed, the US can never default on its debt, but MMT puts too much emphasis on this fact. Stephanie Kelton, in her book, The Deficit Myth, argues that the government is not a household, since households cannot issue but only earn currency. Since the government can just issue currency, there isn’t any necessity to budget like a household. The government might not act like a household, but it does raise certain implications with these assumptions. Let us assume that there is a family of two parents and their child. Since the family operates like a household, there is a need to budget and determine long-term prudent financial planning. So, the parents taught their child on managing income and expenses. The child later wants to start a new venture, so they ask their parents for money, and since the child knows that the spending power of the household is limited, they will ensure that they are getting the maximum returns on the money and prevent any inefficiencies. Now, if the household has unlimited supply of currency, and the child knows that there is an unlimited supply, then there will not be enough incentives to even try to maximize returns or reduce inefficiencies. The child knows that their parents can just simply give them more money. Similarly, it is estimated that only 10% of wealthy families will see their third generation preserving their wealth. The US government is not a computer, but an institution that is run by representatives (humans) elected by citizens. If these elected people and voters have the same notion of unlimited currency, then there wouldn’t be any incentive to reduce economic inefficiencies. Simply relying on the fact that the government can just print money, can create a moral hazard.
Another problem with relying on the assumption that the government can just issue currency is the narrative that can play out among the public. People choose to do transactions in US dollars due to its stability in value. Simply holding US dollars will reduce your purchasing power, but usually to a certain predictable level. If the government decides to just print money, people might lose faith in the US currency. MMT relies on the people’s faith in wanting US dollars, but faith can quickly transform into distrust. Cryptocurrencies such as Bitcoin have seen recent popularity, and part of the popularity is attributed to the narrative that the government is printing money whenever it wants and that people demand more control over the currency. If too much US dollar is issued to pay off debt, the possibility of instability in US dollars will have implications.
MMT argues that taxations boost demand for the currency, so taxation in effect ensures that people will value the US dollar. Taxation will indeed ensure a consistent demand in currency in certain scenarios. If the government taxes people on their income, and only collects these taxes in US dollars, then people will try to maximize the number of transactions using US dollars. But there isn’t any clear relationship between currency and taxation. The US dollar was created in 1785, and the country did not have any significant income taxes until the 20th century. Most of the government revenue came from import and export tariffs. The assumption that taxation drives up demand for the currency has not been backed by substantial proof.
The current monetary policy focuses on controlling inflation and the unemployment rate. The central banks (Federal Reserve) control interest rates, which impacts the borrowing costs and provides stability in prices. MMT argues that this approach is ineffective as the perceived inverse relationship between inflation and interest rates cause people to suffer through high unemployment rate. It also argues that the central bank’s policy to have the unemployment rate above 0% is itself detrimental to the growth of the country. MMT argues that it is fiscal policy that should provide full employment and will eventually impact inflation. If people are given too much economic stimulus, it can push prices upward, and vice versa. Even if fiscal policies lead to price instability, MMT states that the government can adjust taxes to ensure price stability. It is true that majority of families spend most of their income, so a change in their after-tax income will impact the demand-supply equilibrium, and there is a possibility that taxes might have a stronger influence on prices than interest rates. The argument does not hold in the real world, especially given the current political environment. Suppose the government provides more than enough fiscal support to the economy, and now inflation is increasing. In this scenario, it will be prudent to increases taxes to lower after-tax income, thus lowering the purchasing power of consumers. As mentioned earlier, the government is a political institution, and politics is the business of maximizing votes, not economic stability. The risk of politicians taking too long to change tax rates will have numerous implications for the economy. The Federal Reserve is quicker to change interest rates than the government will be in changing taxes.
Full employment is another area focussed by MMT. MMT economists argue that fiscal policy should ensure full employment — employment for everyone. The Federal Reserve has an unemployment rate target and assumes that there will always be unemployment in the economy due to various factors, such as job transition. MMT argues that having any employment in the economy is harmful and such policies lead to certain people being permanently unemployed. MMT version of full employment is that the government provides opportunity for anyone looking for a job, and these jobs would normally involve supporting the community. Once the private sectors demand more labor, they will hire from the pool of people already working for the government. While providing full employment is not a bad idea, the feasibility of this policy is highly debatable. Instead of focussing on full employment, government can provide monetary incentive for private sector to boost hiring. If governments focus on spending on infrastructure, education, and healthcare, it will increase employment and income in industries that are already in need of massive reform. While these programs won’t ensure job guarantee, it does increase overall employment in the economy.
The narrative that the government will just print money is stronger than many economists recognize. If people continue to believe in this narrative, it can contribute to reckless expenditures or investments. For example, the recent boom in asset prices in 2020 was surprising, given the uncertainty of the economic future. But when people interpreted the Federal Reserve and government’s action to ‘turning on the money printer,’ the narrative had a huge influence on stock prices. As mentioned before, if people believe that the government will just print money, it can lead to both positive and negative outcomes. While MMT focusses on the positive aspect, it is important not to neglect the negative outcomes.
