The revival of magical thinking in modern monetary theory

The Modern Monetary Theory has gained popularity once again

How anxious should we be?

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What has brought Modern Monetary Theory back into the public eye?

Zack Polanski, the leader of the Green Party, speaks about economics and fiscal constraints in a way that is eerily familiar to observers of the Modern Monetary Theory (MMT) debate. Under Polanski's more assertive, charismatic, and left-populist tenure, the party has seen a dramatic surge in the polls to within a few points of both Labour and the Conservatives.

"The fiscal rule we need to have is to make sure that inflation doesn't go higher than the skills and resources that we have in our economy," Polanski stated to The New Statesman last month. He told Laura Kuenssberg in a TV interview that since "this isn't about creating public investment, we can do that anyway, we don't need to tax the wealthy to do that," his massive public spending plans won't require higher taxes on the wealthy.

Bank of England loans, he continued, are "money we owe to ourselves, it's not borrowing or a debt in any real sense." Put differently, it's all traditional MMT stuff.

What does modern monetary theory entail?

Rather than being a specific set of policy recommendations, MMT is a general and ambiguous term for a group of economists and supporters. However, MMT is essentially a set of ideas that gained popularity in the 2010s and were popularized by Stephanie Kelton's book The Deficit Myth. These ideas are based on the claims that, for a government that issues currency, like the UK, debt is not a significant constraint, at least when compared to inflation; that macroeconomic policy can and should be managed through fiscal rather than monetary policy; and that it doesn't matter if the two are blurred.

The concept of printing money to address a country's problems is almost universally viewed as being extremely detrimental in conventional economics. MMT, on the other hand, suggests that countries that issue their own "fiat" currencies are free to create and spend their own money; this does not have to result in inflation, currency devaluation, or an economic collapse.

What else is stated in it?

According to The Economist, governments should use their fiscal budgets to "manage demand and maintain full employment"tasks currently delegated to monetary policy, which is determined by central banks. Additionally, it maintains that the availability of underutilized resources, such as unemployed workers, rather than the harsh realities of the bond market, is the primary barrier to government spending. The goal of taxes is to control inflation because increasing spending when the economy is already operating at full capacity can cause rapid inflation. Taxes are the brakes, and spending is the accelerator. As long as prices are stable and unemployment is low, fiscal deficits are unimportant. The "

The conventional wisdom that high public debt is detrimental to economies and burdens future generations is thus reversed in the MMT worldview. On the other hand, proponents contend that in nations with high levels of government (or fiscal) debt, private individuals and companies typically perform better. When MMT is taken to its logical extreme, it permits large expenditures without taxes or borrowinga genuinely radical concept that is sometimes mocked as the Magic Money Tree.

Why is Modern Monetary Theory considered credible?

Because utopianism is alluring and infectious. Even though mainstream economistsincluding prominent left-leaning economists like Paul Krugmanhave harshly criticized MMT, its appeal is clear when it comes to financing ambitious, wasteful political initiatives, particularly in light of the low-growth climate that has persisted since the Great Financial Crisis.

Many economists, not just left-wingers, believe that excessively contractionary policies have resulted from an overly conservative, "austerity" approach to deficits, particularly during recessions (like the UK in the early 2010s). At the very least, MMT provides a helpful critique of the overly simplistic comparisons that predominate in public discourse between household finances and government budgets.

Furthermore, supporters would contend that MMT is consistent with empirical findings that have humiliated traditional macroeconomics. Japan, for instance, has maintained extremely high levels of public debt for decades without experiencing inflation or a revolt in the bond market.

However, is it incorrect?

It is. "A question that young children often ask" is the fundamental source of MMT, according to Christopher Snowdon in The Spectator. The answer is that we can print a large amount of money and give it to the world's impoverished. "There's nothing to prevent the federal government creating as much money as it wants," as Alan Greenspan famously stated.

The problem is that the quantity of goods and services will not rise as a result of printing money. Inflation will only make them more costly. According to Andy Haldane, former chief economist at the Bank of England, Modern Monetary Theory is not monetary (it is a political project), not modern (it is a descendant of discredited ideas from the early 20th century), and not a theory (it is more wishful thinking).

What ought investors to do?

Don't worry too much just yet. On the left, the majority of analysts believed that MMT had been permanently eliminated by the post-Covid inflation spike. Ironically, the supposedly pro-growth Truss-Kwarteng mini-Budget of 2022, which showed that excessive borrowing can in fact cause financial distress for a country without an international reserve currency, was the last straw on the right.

However, investors should be on the lookout for additional indications of MMT-style thinking among political party leadership. In the years to come, unlikely alliances that would have seemed ridiculous even a few years ago may emerge in British politics, which are undergoing extraordinary change. Jeremy Corbyn's Labour party received 40% of the popular vote in 2017 thanks to his "Peoples QE" plan, which is related to MMT and calls for printing money to finance direct government investment. MMT is a populist ideology that has the potential to be extremely well-liked.