Politicians led by Senate crossbench populists leapt at the opportunities offered by the US president’s new you-beaut! modern money doctrine. Why wouldn’t they? It meant the cash rate could be permanently set at zero and removed all spending limits.
The real magic? There was no need for Canberra to lift taxes because the long era of low inflation – and depressed sovereign yields – convinced people there was no danger ballooning government debt would lead to bankruptcy.
Happy days indeed.
Except, of course, that in this imaginary world, the introduction of a hugely expensive, state-guaranteed and funded “work for all” plan has sent unemployment to 0.5 per cent. The ultra-easy monetary policy has pushed household debt to 300 per cent of GDP and there is double-digit inflation.
To fix these problems, Treasury’s Modern Monetary Theory department – which has replaced the old Macroeconomic Group – tells Cabinet it had to hike taxes.
And not by a little bit … these hikes need to be big enough slow the economy and bring the inflation anchor back to the target band.
A depressed treasurer knows the prime minister will never approve such political suicide.
Welcome to the world of Modern Monetary Theory – or MMT, for short – hypothetical for now but perhaps not forever.
An old idea newly reprised, MMT is currently fuelling a frenzied debate-du-jour among economists, investors and politicians in the US but also increasingly in Europe and Australia.
Much of the battle is being waged in places like CNBC and social media. And the heaviest action is between Democrat “old guard” critics like Paul Krugman versus an energised far-left flank.
“Are we that desperate”
— Glenn Stevens, former Reserve Bank governor
The row has erupted with astonishing speed in recent months. One of the main catalysts appears to be the fact that a long-standing MMT advocate, Stephanie Kelton of Stony Brook University, is an economic adviser to Senator Bernie Sanders, who three weeks ago launched his campaign for the Democratic nomination.
At first glance the whole thing sparks incredulity.
“Are we that desperate,” as former Reserve Bank governor Glenn Stevens put it three years ago in a speech in New York, when he warned about the taboo-breaking dangers of “helicopter money”, which was briefly all the rage in 2016 amid another debate on a theory not dissimilar to MMT. That speech is worth re-reading today.
But many are taking such ideas seriously this time around because high-profile and populist figures on the left such as New York congresswoman Ocasio-Cortez are eager proponents.
Respected bond investor Mohamed El-Erian said this week MMT is fuelling an “interesting conversation,” partly because the heavy reliance on unconventional central bank policy since the GFC has not led where some economists feared it might: a “meaningful” inflation scare or the crowding out of economic activity.
Con Michalakis, chief investment officer at South Australia’s biggest industry fund, Statewide, who happens to be on a road trip through the US this week, says he’s been struck by both the intensity of the MMT debate and that so many big name market investors in the US are watching it so closely.
One such investor, from a big US west coast money manager, believes it underscores why the biggest risks facing markets these days are political, Michalakis told AFR Weekend.
The extraordinary lack of fiscal discipline displayed by Donald Trump and his Republican Party should take a good deal of the blame for the current fascination with MMT.
The president’s 2017 tax cuts have not, despite Republican assurances, become “self-funding”. Instead, according to a Congressional Budget Office report this month, cumulative federal budget deficits will amount to $US12.4 trillion ($17.6 trillion) over the next 10 years.
Total debt will leap from $US14.7 trillion to $US28.7 trillion in 2028, or nearly 100 per cent of GDP, putting the US on a path that increases chances of a “fiscal crisis”.
“There would be a greater risk that investors would become unwilling to finance the government’s borrowing unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply,” the budget office said.
So far, however, bond investors aren’t buying that story – inadvertently emboldening the MMT crowd who say it proves, as some Republicans have famously maintained for decades, that “deficits don’t matter”.
Nothing expresses that insouciance more than the benchmark US Treasury bond yield, which traded at 2.63 per cent on Friday, down from 3.24 per cent in October.
You can see the logic from here: If Republicans can get away with it, why should Democrats run hairshirt fiscal policy when they next win office?
MMT seeks to provide a rebranded intellectual framework to put that sentiment into practice on a monumental scale.
One of the world’s more prominent backers, Australian economist Bill Mitchell at the University of Newcastle, claims that unlike conventional monetary and fiscal policy, the MMT approach is grounded in what the government can “actually do”.
“Most of the so-called financial constraints on government, expressed in statements like ‘Well, how are you going to pay for it?’ are in fact political constraints,” says Mitchell in a video posted on this blog to promote the release last month of a “modern monetary theory textbook” that Sanders’ adviser Kelton has promoted on social media.
“A currency issuing government can purchase whatever is for sale in that currency, including all idle labour,” he adds.
— Jeffrey Gundlach, DoubleLine Capital
Except for the very real risk that people will also abandon that currency when they realise the whole thing is unsustainable – something that has been demonstrated time and time again through history.
For now, among economists, investors and policy makers, MMT’s supporters – as opposed to noisesome Twitter activists – are heavily outnumbered by critics.
It’s “complete nonsense,” Jeffrey Gundlach, co-founder of DoubleLine Capital, a Los Angeles firm overseeing $US120 billion, said this week. “This argument is ridiculous. It sounds good for a first-grader. What happens when the economy turns down?”
Benoit Coeure, a French member of the European Central Bank’s executive board, says more charitably that MMT has produced a “good discussion to have because it challenges the traditional way of looking at fiscal and monetary policy”.
But, he adds, there are “severe limitations to the assumptions”.
ECB chief economist Peter Praet was less diplomatic this week, describing as a “dangerous proposition” the notion of using central banks to finance government debt.
A Chicago Booth IGM Forum experts panel of some of America’s top economists, including a several Nobel Prize winners, this week showed none thought MMT is a good idea.
“The only real debate is between those who disagree with [MMT’s] policy prescriptions, and those who strongly disagree,” says Justin Wolfers at the University of Michigan.
“I figure that I’m a PhD economist with a fair bit of experience, and so if I’m not following along, perhaps it really isn’t my fault.”
— Justin Wolfers, economist
Wolfers, a high profile Australian economist who has dared tangle on social media with MMT’s cheerleaders, sounds mostly irritated by the debate and the way adherents continually move the goalposts of their arguments.
“You can probably tell that I’m not a fan,” he told AFR Weekend. “I’ve put in some time trying to figure out what these guys are on about, but at a certain point, if it isn’t clear, I stop blaming myself.
“I figure that I’m a PhD economist with a fair bit of experience, and so if I’m not following along, perhaps it really isn’t my fault.
“And many of my friends have said something similar – that they find it hard to discern just what the heck the MMT folks are saying.”
The danger is that MMT lures voters because it contains a few glimmers of truth – a bit like Trump’s “America first” vows to tear up trade deals and “bring back American jobs”.
All good in theory. In reality it creates a needless mess.
Odds are my fictional Aussie treasurer would throw in the towel over his terrible political economy conundrum. Tax hikes can wait until after the next election. It’s just not worth the pain, he’d conclude.
As Stan Veuger – a scholar at the American Enterprise Institute – puts it: when inflation takes hold, let alone hyperinflation, so will human nature.
“It is hard to imagine that elected officials would find it easier to maintain price stability through fiscal policy than they did when they directly implemented monetary policy.”
Do we really need to learn this again?