Modern Monetary Theory Revisited

Has the coronavirus proven the existence of the magic money tree?

Theresa May, in response to an NHS nurse who hadn’t received a pay rise in eight years, asserted that “there isn’t a magic money tree” during a 2017 election special of Question Time; on the 20th of March 2020, Rishi Sunak introduced the Coronavirus Job Retention Scheme that is estimated to cost around £78bn, on top of a business bailout package worth £350bn.

Governments and central banks across the world have enacted measures to offset the disruptions caused by the coronavirus, trying to stimulate their already slowing economies: Japan passed a package worth $989bn and doubled their QE scheme to $112bn; the US introduced an estimated $2tn stimulus package and launched QE infinity, buying as many bonds as needed to support the market. Policies like these give the impression that governments and central banks can simply create exorbitant amounts of money ex nihilo, giving credence to the existence of the magic money tree (or rather, the money printer).

The ability for fully monetary sovereign countries to inject vast amounts through government spending without being afraid of the debt accumulated is the core of Modern Monetary Theory, or MMT. Any debt gathered can be absorbed by the central bank printing more money, on which they have a monopoly given their monetary sovereign nature. This is why countries like Japan have incredibly high debt-to-GDP ratios (in this case 279%) while maintaining positive credit ratings (A+ by S&P) as they have issued that national debt on the Yen and can simply conjure money out of thin air to pay it off. Demand-pull inflation can be combatted by raising taxes which gets rid of the fiat currency, thereby reducing the supply of money in the economy. Moreover, when inflation is caused by firms raising wages and prices in competitive labour markets, MMT uses a job guarantee scheme on minimum wage to mitigate the rising price level while ensuring full employment.

Criticisms of MMT include discord between the fiscal and monetary sides of a country; eventual hyperinflation, caused by cycles of inflationary injections used to first incentivise saving over consumption, then to finance the rising payments on the bonds; and the “crowding out” effect on labour markets, which happens as a result of state-guaranteed jobs disincentivising working in the private sector, drawing closer to a command economy. Thomas Palley described MMT as “policy polemic for depressed times” and “based on unsubstantiated economics”.

However, such fears of MMT are misplaced during the coronavirus crisis – an initial supplyside shock caused by disruptions in the China-based supply chains leading to a demand-side crash as well, caused by ubiquitous lockdowns.

As people are forced to remain indoors for most, if not all, of the day, the economy loses workers and consumers. Although some may be able to work remotely, most cannot and so do not earn any income – the Bureau of Labor Statistics reported that only 29% of salary workers could work from home which reduces consumption, not accounting for the fall in the retail and hospitality sectors as people cannot leave the house and go to restaurants, cinemas etc. This demand-side shock has a deflationary effect as the velocity of money has fallen significantly with the reduction of consumption which allows and even legitimises MMT in putting inflationary pressures in the economy.

Although state-guaranteed jobs have not materialised as a measure, the UK’s furlough scheme is similar as the government still pays people and keeps them from unemployment, thereby giving them discretionary income to spend on the limited options they have. Together with the business loans to keep the supply of goods and services intact, the UK has seemingly embraced MMT as the solution to keeping the economy afloat. Alok Sharma, the UK business secretary, has said “Our overriding objective is to help UK companies … keep trading … and be ready when the crisis ends”, showing a desire to maintain the economy during and after the crisis; Rishi Sunak has also vowed to do “whatever it takes”. This has materialised in the form of MMT with vast government spending coming from the same party that enacted austerity programme a decade earlier.

Implementing these measures with the goal of returning to normality may be misplaced, however, as shown by the graph: after major crises, UK government spending as a percentage of GDP has increased from what it was before; it is likely that the same will happen post-COVID. The extent to which MMT remains unavoidable depends on the type of recovery experienced: a V-shaped recovery where the economy swiftly returns to its pre-COVID state would result in far less need for big government than in the event of a U- or even L-shaped recovery, with a languishing recession. Without a vaccine, the government will remain a large force in the economy, using MMT to keep businesses and people afloat with cash on hand to sustain a comatose economy. However, this is only true of governments with full control over their currency: countries in the Eurozone are unable to simply print more money without consequence – Italy’s debt situation will only get worse with coronavirus measures adding onto their public debt. Moreover, MMT is unfeasible with countries that must borrow in foreign reserve currencies, outlining yet another stark inequality in the world.

Whatever the recovery, the inadequacies of healthcare systems around the world have been clearly brought forward by the coronavirus, perhaps resulting in a shift in the attitude of increasing government budgets to allow for greater social welfare. People have finally seen the magic money tree and will want to see more.