Unlimited government spending? Modern monetary theory is a seductive but dangerous idea
As recession looms and monetary easing options dwindle, the theory that governments can ‘borrow from themselves’ to finance unlimited spending is becoming attractive. But it hinges on complicit central banks buying up government debt
The end of the world (or, at least, the collapse of the global economy) has often appeared nigh, as one financial crisis succeeded another in recent decades. However, each time, Armageddon was averted by financial or monetary sleight of hand. Could this happen again now, as a recession looms?
The question has particular relevance because just about every key driver of global growth – trade, investment and production – is slowing ominously and central banks (our “saviours” in more recent crises) are commonly supposed to be out of ammunition.
As the world cowers at the sight of US President Donald Trump and Chinese President Xi Jinping hurling tariff thunderbolts Jove-like at each other, as stock markets shudder, sending spooked investors scurrying for cover in bonds, and as the debt mountain looms ever larger, the day of reckoning does indeed seem at hand.
Yet, an increasing body of academic opinion argues that all can still be well, provided that the governments of the world's most advanced economies open the taps of fiscal spending as wide as they have already opened the sluice gates of monetary easing.
This is a frontal challenge to the notion of central bank independence from finance ministries – a concept that has been severely eroded in Japan in recent times, and which arguably never existed in China, where the two institutions appear to think and act as one on matters of fiscal stimulus.
The new economic wisdom is enshrined in what has become known as “ modern monetary theory”, which is rather too abstruse for many to understand. But it has been summed up simply by economist John F. Weeks, who argues that governments do not need to live within their means – they “create” means.
The argument is lucidly (if perhaps credulously) set out by Weeks, an emeritus professor at London's School of Oriental and African Studies, in his new book The Debt Delusion. It implies that we can be bailed out of crises induced by Trump tantrums, market panic, debt distress or whatever.
Such arguments are appealing because, with interest rates having sunk to zero or below in Europe and Japan, and standing well below where they were on the eve of previous US recessions, the scope for further effective monetary stimulus appears to be severely limited.
There is always Keynesian fiscal stimulus of course, but the assumption is that heavily indebted governments (not least in the US and Japan) dare not embark on this for fear of spooking bond markets (while others, like Germany, would do anything rather than get into government debt).
Raising taxes to finance fiscal stimulus is hardly an option either, if the object is to boost confidence and ward off recession. So, it might be assumed that we have reached a dead end, with no place to go other than into recession. But Weeks and others argue that there is an easy way out.
Governments (or at least those that use their own currencies – dollars, pounds, yen or renminbi) can “borrow from themselves”, he suggests, if only they are prepared to monetise debt by having their (compliant) central banks buy it from them. This way, they can always “make ends meet”.
Unlike borrowing from the market, this is simply an “intra-government exchange”, says Weeks. A treasury sells bonds to the central bank, which pays for them by creating credit for the government – which, in turn, can then go out and finance new spending. This process can continue indefinitely.
It sounds too good to be true, yet, as economist Paul Sheard of the Harvard Kennedy School argues, “government always has the fiscal and monetary wherewithal to fight a recession” if it wishes. Central banks were given independence to check governments’ money creation. But this is “self-imposed, not God-given”.
The separation of monetary and fiscal policy was designed to deal with the threat of runaway inflation in previous decades, but the threats facing the global economy now – disinflation, deflation recession or even a depression, call for new thinking, some argue.
Turning conventional thinking on its head in this way could be risky, however. The idea that governments should be free to print money without restraint could erode faith in currencies when they have already been damaged by the “new norm” of zero or negative interest rates.
It is not surprising that gold and cryptocurrencies are attracting increased attention now as alternative repositories for savings and even for financing transactions. Even if modern monetary theory does not directly cause currency debasement and hyper inflation, its side effects could.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs