Why modern monetary theory is such a dangerous drug
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Modern monetary theory is a new term for an old idea. Its proponents argue a state that issues fiat money does not have to resort to taxation and borrowing to pay its bills. It can fund itself simply by printing money.
While there are numerous historical examples of unfunded fiscal spending being followed by hyperinflation and economic collapse, the modern supporters of what would previously have been regarded as economic heresy say this time it is different.
Central banks in the US, Europe and Japan have been applying the precepts of modern monetary theory for the past decade, and in responding to the Covid-19 crisis have abandoned any sense of traditional financial prudence. The US Federal Reserve has been the most aggressive, increasing its balance sheet from $4-trillion to $7-trillion over the three months since the market meltdown in March.
Most of this new money has been used to fund an exploding federal fiscal deficit. The balance sheets of the Fed, European Central Bank and Bank of Japan have collectively increased by $6.3-trillion this year. Modern monetary theory has arrived almost by accident. Its longer-term unintended consequences pose a grave risk to the financial stability of the global economy.
For centuries a golden rule of public finance has been that a state should live within its means. Fiscal spending should not exceed sustainable tax revenues and prudent borrowing. The wisdom of this precept was confirmed when governments tried to sustain economic growth by Keynesian deficit spending into the recession triggered by the first oil price shock in 1973. The consequence was damaging inflation, which was only brought under control in the early 1980s when the Fed raised dollar interest rates to levels that caused a serious recession. After this bad experience financial prudence again became the guiding principle of public finance.
In recent years in many countries political leadership has become increasingly restive about the constraint on government spending imposed by what have generally been regarded as prudent targets for fiscal deficits and the appropriate stock of government debt relative to GDP. This is not restricted to the political left, which usually favours increased expenditures.
In the US the Republican party has pushed through tax cuts, and in the UK prime minister Boris Johnson has abandoned Margaret Thatcher’s legacy of fiscal conservatism. Usually the justification offered is pressing need, for example to combat climate change, meet the growing cost of ...
While there are numerous historical examples of unfunded fiscal spending being followed by hyperinflation and economic collapse, the modern supporters of what would previously have been regarded as economic heresy say this time it is different.
Central banks in the US, Europe and Japan have been applying the precepts of modern monetary theory for the past decade, and in responding to the Covid-19 crisis have abandoned any sense of traditional financial prudence. The US Federal Reserve has been the most aggressive, increasing its balance sheet from $4-trillion to $7-trillion over the three months since the market meltdown in March.
Most of this new money has been used to fund an exploding federal fiscal deficit. The balance sheets of the Fed, European Central Bank and Bank of Japan have collectively increased by $6.3-trillion this year. Modern monetary theory has arrived almost by accident. Its longer-term unintended consequences pose a grave risk to the financial stability of the global economy.
For centuries a golden rule of public finance has been that a state should live within its means. Fiscal spending should not exceed sustainable tax revenues and prudent borrowing. The wisdom of this precept was confirmed when governments tried to sustain economic growth by Keynesian deficit spending into the recession triggered by the first oil price shock in 1973. The consequence was damaging inflation, which was only brought under control in the early 1980s when the Fed raised dollar interest rates to levels that caused a serious recession. After this bad experience financial prudence again became the guiding principle of public finance.
In recent years in many countries political leadership has become increasingly restive about the constraint on government spending imposed by what have generally been regarded as prudent targets for fiscal deficits and the appropriate stock of government debt relative to GDP. This is not restricted to the political left, which usually favours increased expenditures.
In the US the Republican party has pushed through tax cuts, and in the UK prime minister Boris Johnson has abandoned Margaret Thatcher’s legacy of fiscal conservatism. Usually the justification offered is pressing need, for example to combat climate change, meet the growing cost of ...