Monetary sanity or wizardry?

Modern monetary theory (known as MMT in the jargon) is all the rage at the moment. It suggests that a government can simply create more money without consequence since it is the issuer of the currency. The implication is that government deficits and national debt don’t matter nearly as much as we think they do. 

The theory became a popular alternative to the previous mantra as discussions about debt and government spending hit the stage at the beginning of the COVID pandemic. According to the theory’s supporters, instead of raising tax revenue or borrowing to finance government spending, a government can simply create more money instead. After all, central banks have a monopoly on the supply of money.

“The government can essentially print as much money as it would like to fund essential services and programmes and also stimulate the economy, and when inflation rises to an undesired level, you can increase taxes to bring inflation back down to your target rate. It’s, sort of, a seesaw,” says Ryan Cullen, CEO of Cullen Investment Group.

Modern Monetary Theory suggests that a government can simply create more money without consequence. 

According to economist Thomas Palley, MMT is too dismissive of the problem of inflation, while on the other hand Professor L.R. Wray of the Levy Institute writes: “Fortunately – or unfortunately depending on one’s view – modern economies usually operate with sufficient slack that even large boosts to aggregate demand are not likely to put much pressure on wages and prices. Our critics continue to fight an inflation battle that was won almost two generations ago.”

MMT adopts what the late economist James Tobin called the “fountain pen” approach to money the belief that money can be created ad libitum, by the stroke of a pen, so to say, applying it to the government, instead of the banks.

In this world, deficits aren’t necessarily a signal of a shaky economy, and money can be created without tanking the economy. Former US Federal Reserve Chairman, Alan Greenspan, followed that line of thought in 2005: “There’s nothing to prevent the federal government creating as much money as it wants.”  “The central bank just needs to keep interest rates low,” adds Robert R. Johnson, professor of finance at Creighton University.

But not everybody agrees. Nobel Prize winner Paul Krugman strongly believes that too much lending and low interest rates may cause inflation. José Antonio Ocampo, Director of the Economic and Political Development Concentration at the School of International and Public Affairs, Columbia University, has labelled MMT “Magical Monetary Thinking”. 

So, while historical examples of hyperinflation and unrest can give us a glimpse into what might happen with MMT policies, it is important to consider all relevant factors and unique considerations.

Thus, Malta is not, say, Argentina or Brazil. Though the Maltese government borrows a lot of money, very little of it is from foreigners, so it is not a problem like if Argentina or Brazil do it, who borrow in dollars from overseas. Argentina or Brazil cannot print the dollars. So if their currencies start to depreciate against the dollar for whatever reason, it becomes almost impossible for them to pay off their debt. 

Though the Maltese government borrows a lot of money, very little of it is from foreigners.

Another aspect of MMT is the potential transfer of wealth from common people to the rich elite. When more money is created, the wealth of the working class, generally stored in cash or bank accounts, loses its purchasing power. Meanwhile the purchasing power of the monied class grows exponentially.

Complementary to MMT is the belief that fiscal policy is much more effective than monetary policy at managing aggregate demand. Against this background, fiscal policy is adjusted when necessary to maintain full employment and moderate inflation, while monetary policy passively supports the financing of the fiscal deficit by printing money and keeping interest rates at very low, near-zero levels.

The massive expansion of central bank balance sheets since 2009 in countries with well-developed financial markets has not yet led to accelerating inflation. Though there are prominent voices on diametrically opposed sides of this argument, the winners have advocated increased reliance on monetary (vs debt) finance not only during the COVID crisis but also to fund future large-scale public investment projects. They believe that there remains ample scope to employ monetary finance without inflationary consequences.

The recent increases in Central Bank Direct Lending (CBDL)in the USA and EU have not been in the form of “helicopter money” for which there is no purpose other than to spend. Instead, central bank purchases of domestic government debt have merely substituted financial assets already in the hands of the public.  

The current negative interest rates on most developed country medium term debt suggests that it is a superior way to finance temporary surges in expenditure such as those related to COVID-19.

Here in the EU, the European Central Bank combatted the economic disruption and heightened uncertainty brought about by the pandemic, by a package of monetary policy measures. These included considerably more favourable terms for all Targeted Long Term Refinancing Operations (TLTRO) and easing of the conditions on them, such as reducing the interest rates on these operations. A temporary envelope of additional net asset purchases of €120.bn under the Asset Purchase Programme (APP) was added.

The ECB also launched a new series of non-targeted Pandemic Emergency Long Term Refinancing Operations (PELTRO). More importantly, the Bank launched the Pandemic Emergency Purchase Programme (PEPP) with an initial overall envelope of €750 billion that was later increased to a maximum of €1,850 billion, and expanded the range of eligible assets under the Corporate Sector Purchase Programme (CSPP) to include non-financial commercial paper.

All these set the scene for operations by our own central bank. During 2020, the CBM purchased €85.0 million worth of Maltese sovereign bonds under the public sector purchase programme (PSPP) – a higher amount compared to 2019, mainly owing to the increased rate of purchase arising from the additional temporary APP envelope introduced by the ECB. Meanwhile, purchases of sovereign bonds under the PEPP reached €236m. Apart from purchasing sovereign bonds for its PSPP and PEPP portfolios, the Bank made additional purchases for the ECB’s portfolios.

Since inception, the total securities purchased by the Central Bank of Malta for its PSPP portfolio amounted to €1,190.5 million at the end of 2020.

During the year, the Central Bank of Malta also purchased €31.9 million worth of Maltese sovereign bonds that were transferred to the ECB’s own PSPP portfolio, with total securities bought since inception in this portfolio amounting to €235.2 million.

These operations were against the backdrop of an expansion of credit to Maltese residents expanded at a faster pace during 2020, reaching €15.77bn by the end of the year. This represented an increase of €1.56bn over 2019 levels, or 11.1%. The expansion was largely driven by developments in credit to general government, which added €944m or 32.3%.

The figures show that the Government and the CBM have endorsed MMT in a confirmation of their aversion to austerity at a time when the economy was in the doldrums and suffering a severe demand shortage. Certainly, both recognise that deficits will have to be reined in should the economy give signs of overheating.  

Of course, there is no way that the credit loosening can become a perpetual free lunch. From then onwards there will be a trade-off between government expenditure and taxation.

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