We can’t be trusted with the magic money tree

As central bankers prepare to meet in Jackson Hole, Wyoming, they may need to embrace more radical economic ideas. Policy makers face the worrying conundrum that wages have remained broadly static for the last decade despite global GDP growing.

In 2017 when a nurse pointed out that her wages had not increased for several years, then-prime minister Theresa May quipped: “There is no magic money tree.” Well, maybe Mrs May was wrong. I believe there is a magic money tree and it is coming to western economies very soon. I am talking about MMT. And strangely, MMT doesn’t stand for “magic money tree”; it’s Modern Monetary Theory.

MMT expounds that a country that issues debt in its own currency can never go bust as it can simply print money to repay its debts. The debtor nation’s only concern is to protect against debasement of its currency, which it does by keeping inflation under control. In a low-inflation, or nearly deflationary environment, MMT advocates significant, stimulative, public spending through public sector wage increases, infrastructure investment, expanded public services and selective tax breaks. The theory then says that when inflation does appear, it can be held in check through tax increases and reductions in public spending, as well as traditional rises in interest rates.

For now, MMT is an academic notion. But that could soon change. Quantitative Easing (QE) also started as the theory of an imaginative academic named Ben Bernanke, who proposed in a 2002 speech to the US Federal Reserve that the government could fire up its printing press and use the money to purchase financial assets, if interest rates ever reached zero while

deflation threatened. It was just an idea. Six years later it became real, and has subsequently become prevalent in many of the developed world economies. QE arguably prevented the world from slipping into deep economic depression and allowed for modest economic growth in developed western economies, along with lower unemployment. But all that printing of money to buy financial assets greatly enriched the owners of those assets while wages have remained stagnant.

More than a decade later, the world is still contending more with deflation than inflation, economies are still sluggish, interest rates can’t go much lower and societal pressures of an increasing wealth gap are rising. If it’s okay for central banks to print money to buy financial assets, then why can’t federal governments print money to give to the nurses, teachers, firefighters and restaurant workers who are trying to get by on the same income they had 10 years ago? It’s a particularly attractive notion because that money is likely to be spent and will circulate into the economy immediately rather than relying on trickle-down economics of QE.

The lure of MMT may become irresistible for politicians standing for election offering “sound economics” that provides “quantitative easing for masses”. Perhaps in the UK after Brexit, or perhaps in the US after the 2020 election, political leaders may heed the many demands for the government to spend on rising wages and living standards, the way it once spent to save banks and bankers.

Were MMT put into practice, its short-run results could even please both voters and politicians. Governments will be able to issue bonds and inject the proceeds directly into the economy so that optimism and living standards will rise. Inflation may remain muted as we’re still countering deflationary risks, and if inflation isn’t a problem, then neither is all that newly issued debt.

But MMT and QE differ in an important respect. QE is controlled by central banks that are broadly independent, run by technocrats and beholden to their mandate of low inflation. MMT, through fiscal and public spending policies, would be run by elected governments beholden to their electorate. When inflation does emerge and the time is right for taxes to go up and public spending to be reduced. It seems dangerously naïve to assume politicians and their electorate will implement policies that they perceive will make them worse off.

So MMT is flawed, not by economics but by human nature. They say central bankers should take away the punch bowl just as the party gets going. While we may trust central bankers to do so, I haven’t been to a party yet where the party goers themselves elected to remove the punch bowl.

‘Were MMT put into practice, its results could please both voters and politicians’