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All you wanted to know about Modern Monetary Theory

Lokeshwarri SK | Updated on August 20, 2019 Published on August 20, 2019

We all know that fiscal constraint is a major impediment to the government’s efforts to increase spending to support sagging growth. Modern Monetary Theory attempts to provide a solution to fund-strapped countries such as ours. The theory, supported by economists such as Stephanie Kelton, L Randall Wray, Bill Mitchell and Warren Mosler, moved in to the limelight recently when US politician, Alexandria Ocasio-Cortez, stated that the theory needs to find a place in discussions revolving around stimulating growth. This is however a controversial idea with opponents outnumbering the supporters.

What is it?

In conventional economic theory, it is accepted that the government pays for its expenses through the taxes that it collects. To pay for the rest of the expenses, it borrows money by issuing bonds. But government borrowing has an effect of increasing the cost of borrowing or the interest rate paid by individuals and businesses.

MMT takes the opposing stance and states that countries that have the sovereign right to print their own currency can never run out of money and default. In order to default, it would have to mean that they do not have any more money to pay their creditors. But this can never be the case as long as countries are free to print as much money as they want.

So, taxes and borrowing do not pay for government spending, instead money is created through government spending. In other words, the theory gives governments the leeway to spend as much as they want on public expenditure and not worry about ballooning fiscal deficit or government debt.

MMT believes that governments can use taxes as a means to make people use the currency as well as to control inflation.

Why is it important?

With more than a decade having elapsed since the global financial crisis in 2008, it is obvious that central banks are quite clueless about the manner in which to stimulate growth further. Due to increasing criticism about the growing debt pile of various countries, public spending is being cut back, affecting growth further.

This is a quandary that India too faces as the focus on fiscal prudence is leading to the government keeping its spending on a tight leash. But the MMT’s suggestions mean that the governments could continue to fund their expenditure by printing extra notes. The argument of MMT that government borrowing should not be equated with borrowing of individuals and businesses and that governments just cannot default, as long as they can print notes to service the loan goes against conventional belief; but this has been proved right in Japan, Italy and now in the US.

The fear that excessive government borrowing could lead to inflation is also not borne out by current events as despite large government borrowings in developed countries over the past decade, inflation has been stubbornly low. The money issued by the government to various banks seems to have helped repair the banks’ balance sheets, rather than being brought out in to circulation in a large way.

Governments could possible turn towards MMT now to boost growth and move towards full employment.

Why should I care?

The Indian government has so far been treading the path of fiscal prudence. But it is obvious that the demands from various segments can be met only if the spending is hiked. This could, however, lead to wider fiscal deficit, which can in turn lead to more borrowing.

There are some experts in India who are now opining that the obsession with fiscal deficit needs to cease and the government should instead focus on moving towards full employment and maximum social security.

The bottomline

This is a theory that could be put into practice soon.

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Published on August 20, 2019
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