In the first part of this overview of Modern Monetary Theory, I suggested it provides the most logical explanation of what’s going on in the world’s economies that conventional economics is simply at a loss to account for.
One of the unexplained mysteries is how countries can have the lowest interest rates in history, which is supposed to stimulate the economy, with low unemployment and yet economic growth is also, surprisingly, low.
Back in the early 1980s the US central bank ‘put the inflation genie back in the bottle’ by cranking interest rates all the way to 20%. Soon after that, governments the world over happily passed responsibility for managing economic growth to their central banks in the form of targeted inflation and unemployment rates.
The problem is, central banks only have one weapon: short-term interest rates, also known as the cash rate. In an effort to stimulate growth over the past almost 40 years, central banks have been steadily reducing interest rates. Occasionally they’ve had to raise them when lending growth got out of hand, but the overall trend has been a steady decline.
The other side of this story is governments at the same time tried to minimise budget deficits, on the basis that conventional economic theory dictates it’s prudent economic management. However, another of MMT’s insights is that government spending creates money and activity. When a government spends more than it takes back in taxes, referred to as a budget deficit, it’s injecting money into the economy. But when it runs a budget surplus, it’s sucking money out of the economy, meaning the only way for the economy to grow is by the private sector making up for the reduction of government money in the system by running down their savings and borrowing money.
Here in Australia, the Howard government was lauded for running budget surpluses, so how did the economy grow so strongly over that period? In short, there was a credit boom. Household savings rates fell from 4% to -1%, and credit growth averaged around 12%, peaking as high as 16% in 2005. The result was household debt increased from around $200 billion to $900 billion, representing an almighty credit impulse to offset the lack of government spending.
MMT identified ages ago that relying on households to borrow in order to stimulate the economy will only work for so long, because eventually borrowing capacity maxes out and you’re left with the situation we have now, rates are the lowest they’ve ever been but credit growth is also the lowest since they started tracking it in 1977. Economists call it ‘pushing on a string’.
Not surprisingly, Philip Lowe, the governor of the Reserve Bank of Australia, has been all but begging the government to crank up fiscal spending in order to support the economy. And he’s not the only one, central bankers across the world, acknowledging that monetary policy has reached the end game, have been calling on governments to start doing some of the heavy lifting by increasing fiscal spending.
The problem is politicians are stuck in the conventional economic mindset that presumes a government’s finances are the same as a household’s, which we learned last time is fundamentally wrong, since a household cannot print its own money. A government that can print its own money is never financially constrained.
MMT does, however, acknowledge that a government is constrained by its economy’s total resources. Once government spending hits a level where it’s competing against private spending, prices will go up and inflation sets in.
Until that point, though, accumulated government deficits simply represent money the government has put into the economy that hasn’t been taken back out again by taxes. Another of MMT’s insights that conventional economists find hard to swallow, is that accumulated deficits don’t represent a burden on future generations that will result in crushing interest rates or catastrophically weak currencies as overseas investors refuse to fund our indulgent spending.
The best illustration of that is Japan, where government debt is 240% of GDP. As remarkable as it is, the government could print a ¥1,000,000,000,000,000 (that’s one quadrillion) yen note tomorrow and the debt will be instantly extinguished. Ah, but, the conventional economists scream, no one would ever trust the Japanese government again. Realistically, no one expects the government to repay that debt, ever, and it’s going up at about ¥1 million every two seconds! And yet the world continues to trade with Japan, the Yen is seen as a ‘safe haven’ currency and inflation has averaged around 0% for the last 25 years.
While MMT asserts government spending is not financially constrained, it also acknowledges some government spending is better than others. A big chunk of President Trump’s US$1.5 trillion of tax cuts went into the pockets of people who were already net savers, so the growth benefit was muted. That same US$1.5 trillion could have been used to eliminate student debt and almost all the money would have gone into the pockets of people who are net spenders, so the growth impact would have been far more pronounced.
Similarly, governments can spend on infrastructure, education, promoting R&D, or improving health, all things that underwrite long-term growth.
MMT uses iron clad rules of accounting to describe how government finances work, which is a such a radically different approach to conventional wisdom that it is understandably meeting stiff resistance, but if conventional thinking can’t explain what’s going on, then clearly it’s time to think unconventionally. With Australian households unable, or unwilling, to take on more debt to underwrite economic growth, and the Morrison government doggedly insisting it will deliver a budget surplus, the MMT school would be suggesting that does not auger well for a bright near-term outlook.