Imagine yourselves living in a humble household and then think of all the sources of income in your houses. Unless you imagined yourself living in a gigantic joint family, a common scenario would dictate that your family has at least one earning member and at most three. But your entire family spends that income on some of the other individual needs. The only way your family decides not to spend the entirety of the earning members’ income is by coming up with a family budget that accounts for each family members’ spending and how much you, as a family, should be saving for other needs. You follow this for a certain period until a major emergency comes up, and the savings you did aren’t enough to sustain it. Your family decides to take a loan, which puts your family in debt. Now, there are not many ways you can get out of it, except by clearing the debt in instalments from whatever income you subsequently earn. But, does the same hold true if your family is no more just a household, but the government of a country, a developed one?
To understand this better, we must first look at how the government interacts with the economy in a developed nation. Like every economy, the fiscal policy is governed by the Central Bank of that country, while the monetary policy is in the hands of the government of that country, except the control of fiat money or fiat currency is in the hands of the government. Since fiat money is a government-issued currency with no backing by a valuable physical commodity, it only holds value so long as the country’s public has faith in the credibility of the government in all its governing aspects, including politics. In status quo, the case with developed nations like the USA, UK, Japan, etc. is that even though these nations operate with fiat currency as every other nation does, these countries do not rely on the revenues flowing in from taxes or borrowing for the expenditure they are willing to make to keep their respective countries afloat. This may seem to baffle us for a minute because if not for revenues, like illustrated in our household example, how is the government planning to finance their expenditures towards the public? The answer is simple -through Modern Monetary Theory.
Modern Monetary Theory, or MMT, states that the governments of developed nations need not worry about the national debt or deficit when it comes to making expenditures towards the welfare of its public to aid the revival of the economy. This expenditure will, in turn, be financed by printing more currency whenever the government deems fit since it is the sole issuer of the same.
It is to be noted that this does not mean that the government stops borrowing altogether. Still, as per the MMT, the borrowing of money, which will eventually lead to increased debt for the government and increase inflation and cause a rise in interest rates, will all be taken care of by printing more notes and making the grass look greener. This comes off as a far-fetched notion, and understandably so, since we have been told all our lives that printing more money to aid a dying economy and generating more employment is not the solution but is, in fact, all the more a problem. Countries like Zimbabwe and Venezuela are the aptest examples in front of us. That is why this theory is critiqued a lot but is also supported by economic advisors like Stephanie Kelton and politicians like Joe Biden, Bernie Sanders and Alexandria Ocasio-Cortez.
We’ll be analysing both sides of this coin. In our household example, we saw an unforeseen emergency posed before us that caused us to use up all our savings and take up a loan and be indebted to someone. Drawing analogies from it to understand the overview of a country, let’s assume the emergency the countries faced to be COVID-19. All countries resorted to borrowing money from monetary institutions, such as the International Monetary Fund (IMF), for their healthcare and other expenditures. The inability to repay this loan would leave countries in a deficit and eventually lead to a rise in prices and inflation. A Modern Monetary Theorist would suggest letting the deficit situation happen, which will be dealt with later on. The MMT will dictate that the governments emphasise spending towards infrastructure and generating employment for the public. For this, it would ask governments to focus more on monetary policy rather than fiscal policy. When the economy reaches inflation, the government will increase taxes to control it. This will lead to a chain of deficits, which, according to MMT, will be financed by the Central Bank by printing more currency and monetising the economy. The MMT believes that public monetary debt is only a nominal debt that can be dealt with, but the actual debt is the one where there is a lack of real resources like workforce, raw materials, etc. Hence, it emphasises more on creating jobs and keeping the economy afloat until full employment. Modern Monetary Theorist Stephanie Kelton says, “Sometimes if the economy were overheating, the government might call for a budgetary surplus. This is, basically, standard Keynesianism: spending during downturns, which then tapers as the economy reaches full employment.”
Undoubtedly, there are critiques to this theory, who question its credibility when put to actual use in the real world. Some academicians have the belief that MMT holds a very surface-level understanding of inflation and does not cater to the circle of inflations that this may lead to, and also wholly neglects the occurrence of cost-push inflation, which may happen even when the economy is not at its maximum level of productivity or total capacity. Others believe that MMT relies too much on printing new currency while not considering the devaluation of the currency that may happen as a result, even if the government manages to sell off treasury bonds and tighten public spending.
Therefore, answering the central question: Is Modern Monetary Theory the solution to revive a post-COVID-19 economy?
The answer is yes, but with precautions. Despite all the criticism, Modern Monetary Theory is seen as a resort to revive the economy of developed countries amid a pandemic crisis, and some countries may even be adopting some elements of the MMT to head towards a full-employment situation slowly. Of course, complete reliance on the printing of currency is not the ideal situation. Hence, the need of the hour is for countries to focus on sustainable inflation and accurate forecasting of inflation. Kelton says, “the models aren’t perfect, but we can do a pretty good job.”
(Shruti is Studying Economics From University of Delhi)