Magic money trees simply don't bear fruit - the drawbacks to printing money

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Opinion

COMMENT:

Imagine that the government never had to worry about running a deficit and could simply print enough money to guarantee every person a decent income, great public services and a job if they wanted one - with enough left over to save the planet too.

That, for many, is the promise of a new economic paradigm known as "modern monetary theory".

To be fair, modern monetary theory (MMT) has a respectable academic pedigree, which some trace all the way back to Keynes himself. It has several prominent advocates, notably Prof Stephanie Kelton (an adviser to the US Democrats) and the Australian economist, Prof Bill Mitchell.

Above all, MMT appears to offer a credible alternative to conventional thinking on the importance of balancing the government's books. The global economic slump and the explosion of debt and money printing during the pandemic has only added to its appeal.

Alas, this "new paradigm" is far more hype than substance. I'll begin by outlining the principles of MMT, before explaining why I think it falls short.

MMT can be broken down into three propositions. The first is that a sovereign country with its own currency and central bank, such as the UK, can always print more money to pay its bills and service its debts (so far, so good).

Second, MMT recognises that there may be other constraints, especially when unemployment is already low. If the government spends so much that the total demand for goods and services exceeds the capacity of the economy to supply them, the result will be higher inflation.

More orthodox economists would see this form of overheating as something to be tackled by monetary policy. But most MMTers would argue that central banks should set official interest rates close to zero indefinitely. Instead, the government should keep inflation in check by raising taxes to reduce private spending.

Third, MMTers argue that government deficits play a crucial role in balancing the economy and are therefore essential, rather than something to fear. The key point here is that deficits and surpluses have to balance out. If the private sector needs to run a surplus to repay debts that have become unsustainably high, then the government has to run a deficit.

What's more, instead of public spending being financed by taxes, either now or in the future, MMTers claim that all public spending is in fact paid for (in some convoluted way) by the creation of money. Some go even further and argue that the government has to run deficits in order to provide the additional money required to support economic growth.

However, most economists - myself included - find all this a frustrating muddle of tortuous logic, dubious claims and statements of the obvious. Let's take each proposition in turn.

The starting point is that countries with their own currencies can be more relaxed about debt, because they can always print more money to finance it. This much is essentially true. The UK, for example, is clearly in a much better position here than members of the euro, such as Italy and Greece. However, this is neither a new idea, nor does it give the government a free hand to spend and borrow as much as it likes.

In particular, the cost of government borrowing does not depend solely on the risk of default. It also depends on factors such as expectations for inflation, as well as the opportunity cost of diverting resources from the private sector.

This is where the second plank of MMT is important, but frequently glossed over. Many of its more fanatical supporters have looked at the recent surge in borrowing and concluded that there never has been - and never can be - a lack of money to pay for better healthcare, education, welfare, or green infrastructure. Sadly, this is baloney.

Money itself may not be a "scarce resource", but the same cannot be said of the goods and services that it is expected to buy. Otherwise, any country with its own currency could use its "magic money tree" to pay for world-leading healthcare, education and so on. Most people, including the more sensible proponents of MMT, recognise that unlimited monetary financing of public spending could simply lead to higher inflation, or crowd out private spending in other ways.

The third point about the benefits of running a deficit is often the most confused. It is simply not true that deficits are necessary for economies to grow, or to pay for good public services. Many countries, notably in Scandinavia, have run budget surpluses for long periods and still enjoyed sustained increases in living standards.

In addition, deficits are usually financed by conventional borrowing, not money printing. This is true even now during the pandemic. Bond purchases by central banks have helped to keep long-term interest rates low, but direct monetary financing of deficits is mostly still taboo.

Indeed, if all that MMTers are saying is that governments should be willing to borrow more to stimulate demand during recessions, and especially when interest rates are already close to zero, that's hardly new or controversial either. You certainly do not have to be an MMTer to recognise what Keynes called the "paradox of thrift", which is that if everyone tries to repair their finances at the same time the result is likely to be an even longer depression.

MMT also comes with a lot of unhelpful baggage. If some MMTers had their way, central banks would lose what independence they have, risking higher inflation and a loss of fiscal discipline. It is also unclear what people working on government-guaranteed jobs would actually be doing, or what would happen when they move on.

Finally, MMT is being used to support a "big state" agenda with little thought for the constraints in the real world. In practice, it would mean that the government plays a much larger role in the allocation of resources, in good times as well as bad. Higher public spending would also still mean higher taxes, even if the rationale is to prevent overheating rather than balance the books.

Unfortunately, then, MMT is another illustration of the adage that if something sounds too good to be true, it probably is.