Why we can expect MMT ideas to spring up in Australia

It might be garbage, but with monetary policy on its last legs, expect the MMT debate to do a tour down under.

New York Democrat Alexandria Ocasio-Cortez is one proponent of MMC on the left of American politics. Picture: AFP

The trouble with modern monetary theory (MMT) is that, as with fiscal policy generally, it would be run by politicians, and we’ve only fairly recently managed to prise monetary policy away from them.

Having MMT enable unlimited government spending is a left-wing politician’s wet dream, but a dry’s nightmare.

A passionate debate is now going on in the United States over MMT after Democrat Alexandria Ocasio-Cortez launched her “Green New Deal” last year and other Democrats like presidential candidate Elizabeth Warren have been proposing other big spending plans that would be “financed”, or rather enabled, by MMT.

As economist Paul Krugman has explained, MMT is basically a reheat of Abba Lerner’s “functional finance” doctrine from 1943, which argued that as long as a country controls its currency and doesn’t borrow in someone else’s currency, only its own, then there doesn’t need to be any constraints on government spending or debt because it can always print money to service the debt.

You can see the attraction, especially with the US budget deficit set to exceed $US1 trillion fairly soon because of the Trump tax cuts, and government debt already at $US22 trillion. Democrats need to find a way to propose spending programs that don’t seem crazily irresponsible. Enter MMT.

“It’s just wrong”, said Federal Reserve chairman, Jerome Powell. “It’s garbage,” declared Blackrock CEO, Larry Fink, adding: “It takes ideas that have a little bit of validity and extends them to a grotesque point … I believe MMT is very much misguided.”

Krugman was a bit less extreme but also opposes it: “While functional finance has a lot going for it, it’s not the kind of axiomatically true doctrine that Lerner — and, I think, modern MMTers — imagined it to be. Deficits and debt can matter … really big progressive programs will require major new revenue sources.”

The problem for deficit hawks and the opponents of MMT is that monetary policy is starting to look like a spent force, and we may be entering a time when fiscal policy will be needed — specifically for the next big downturn.

In Australia, most leading economists are now calling for two rate cuts this year to a 1 per cent cash rate, even though growth is 2.3 per cent and none of them is forecasting a recession. Imagine what they’d be calling for if they were also predicting a recession!

In 2008, before the GFC, the RBA cash rate was 7.25 per cent (thanks to four very ill-advised hikes from late 2007, after the GFC earthquake had already started rumbling). So plenty of room for cuts then, and indeed there was 4 percentage points worth of cuts in just five meetings between September 2008 and February 2009.

Nevertheless, a big fiscal stimulus was also needed to cushion the local economy from the global crisis, and that arguably worked better than the monetary stimulus.

The RBA did not have to go in for ZIRP (zero interest rate policy) and quantitative easing like the US Fed, or negative interest rates like the European Central Bank or Bank of Japan and the central banks of Sweden, Switzerland and Denmark, mainly because the currency devalued 30 per cent between 2013 and 2015 and absorbed much of the shock.

Even so, the cash rate has had to be cut from 2.5 to 1.5 per cent since the beginning of 2015, and now it seems likely to be 1 per cent by year end.

But monetary policy looks exhausted, at least in terms of stimulating real activity and employment, as opposed to asset prices. Sharemarkets certainly pay attention to what the Fed and the RBA are doing, but consumers and employers less so, which undoubtedly has to do with the fact that debt is already at pussy’s bow, so rate cuts can’t encourage much more of it.

So it seems likely that in the next downturn, fiscal policy will come into its own again, because monetary policy either has nowhere to go, or is ineffective.

That’s not why a debate about MMT has sprung up in the US, but maybe it should be. (At this stage, MMT is being used by Democrats in the US to justify big spending plans when that deficit is already nearly $1 trillion).

As economist Gerard Minack wrote over the weekend: “Excessive money printing is clearly not good, but the simple act of printing money does not put an economy on the path to Weimar. In other words, the problem is not printing money; it is printing money in excess of real capacity limits.”

An MMT theorist named Fadhel Kaboub explained it recently using dentistry: “Let’s say, tomorrow, we decide as a nation that dental care is a human right, and we are going to provide it to every person in this country.” To cut a long story short, everyone rings up the dentist and makes an appointment. “I’ll see you in 2035,” says the dentist.

“‘By the way, we have this premium platinum service where you pay $7,000 and we put you in an elite club and you can schedule your appointment next week.’ If you have a shortage of productive capacity, and a huge amount of demand, regardless of whether we have the money or not, that will cause inflation.”

In Australia in 2019, we don’t have fiscal policy. We have an election instead, although so far so good on the fiscal irresponsibility front. The local equivalent of the Democrats — the ALP — is looking to raise taxes to pay for its promises. PM Scott Morrison is attacking Bill Shorten for irresponsible taxes, not irresponsible spending.

But as the year wears on, and the housing bust gets worse, and the economy continues to weaken, watch the MMT debate do a tour down under.

Alan Kohler is Editor in Chief of InvestSMART