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Tuesday, 9 April 2019

Modern Monetary Theory: An explainer

Modern monetary theory: An explainer. Modern monetary theory (MMT) has been getting a lot of attention in the global financial press as of late. The unorthodox set of policy prescriptions gaining traction among Democratic candidates in the US presidential election have been roundly denounced by Keynesians and neoliberals alike. Over the past month though, a debate has arisen in the press about the pros and cons of using MMT’s assumptions to structure a new approach to monetary policy. The theory, which has traditionally derived most of its support from left-leaning politicians, is now beginning to find supporters on Wall Street, according to the New York Times. And Paul Krugman, a long-time MMT skeptic, admitted recently that “policy debates over the next couple of years will be at least somewhat affected by the doctrine of MMT.” For all our readers who aren’t theory-junkies, we’re giving you the low-down on MMT, explaining how it differs from conventional thinking.

The house that Milton built: The established economic theory across much of the developed world emphasizes the need to lower government deficits, restrict public spending and keep macroeconomic decisions out of the hands of elected officials. Control of the money supply rests in the hands of an independent central bank, which sets interest rates accordingly. This approach, brought into the mainstream in the 1970s by Nobel laureate Milton Friedman and his Chicago School acolytes, is what many refer to (sometimes pejoratively) as neoliberalism.

MMT would do away with all of this. Proponents argue that the power to issue currency should be placed in government hands. The monopoly power to issue currency, they say, means that the state is always able to spend money, regardless of how big the budget deficit gets. While that disregard for public debt gets most mainstream economists seeing red, MMT theorists point to Japan (whose debt-to-GDP ratio is at an eye-watering 236.6%) to suggest that governments are able to deficit spend at a far greater level than we suspect. And the potential for runaway inflation? Government should combine preemptive tax increases with tighter financial and credit regulations to hold down prices, MMT theorists say.

This probably sounds like monetary policy branded with the hammer and sickle, but Wall Street analysts are responding positively to elements of the MMT program. Goldman chief economist Jan Hatzius highlighted the fact that private debt, rather than public debt, has been responsible for recent financial crises, stating that he is “more reassured by the US private sector surplus than concerned by the public sector deficit.” Meanwhile Steve Englander, Standard Chartered’s FX chief, suggested that MMT “would be more effective in raising inflation expectations and nominal rates than other proposals that central banks are now considering.”

Stay tuned tomorrow when we look at how MMT could impact emerging markets.

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