Policy-makers focussed on taking more risks with inflation: Shane Oliver

For some years now Modern Monetary Theory (MMT) has been gaining prominence as a solution to the perceived failure of traditional economic policies to achieve full employment and meet inflation targets, despite at or near zero interest rates.

MMT basically advocates using printed money from the central bank to directly finance government to spending, which boosts the economy. This concept is not new.

However, it has been given added impetus by the hit to economic activity from coronavirus. And with even Reserve Bank of Australia Governor Philip Lowe referring to it in question time after an address last week.

But can it help or is it just another fad like monetary targeting?

MMT does provide some useful insights or reminders

The experience over the last decade has highlighted the already well-known failings of the quantity theory of money.

Put simply there are different forms of money and its speed of circulation in the economy (or V) is not constant.

For example, quantitative easing (QE) led to an increase in the money supply in Europe, the US and Japan last decade but it was narrow money (like cash and bank reserves) not credit and the circulation of money through the economy slowed so there was not much, if any, increase in inflation.

MMT reminds us that, as long as there is spare capacity in the economy, using printed money to finance public spending should not be inflationary.

This is consistent with the experience of last decade which was characterised by spare capacity globally and taken together with a fall in the velocity of circulation of money in the economy explains why inflation did not take off despite QE boosting the money supply.

After all, using government spending to employ unemployed workers also has merit. In fact, it’s standard Keynesian economics.

But what are the problems with MMT?

While MMT provides some useful insights it has big problems:

First, it gives the impression there is always some sort of free lunch. That the central bank can just print money – like some sort of Magic Money Tree – and all economic problems can be solved. But as an old friend of mine used to repeatedly remind me, “you can’t make something out of nothing.” Of course, in the current environment of high unemployment and inflation below target, there perhaps is a bit of a free lunch if more government spending financed by money printing can result in full employment and boost inflation back to target.

But contrary to what some MMT supporters imply, the economy is not always in a position of spare capacity.

Second, the traditional concern about budget deficits and rising public debt is not always overblown. When the economy is strong, it can cause overheating as the competition for workers and funding can push up wages, prices and interest rates “crowding out” more productive private sector activity. Budget deficits and high public debt are not a problem now as there is spare capacity, economies are not overheating and interest rates are low but this won’t always be the case.

Third, MMT underestimates the costs and low productivity associated with large scale public employment programs. This has been evident in the failure of “work for the dole” schemes in Australia to make much headway. The more fundamental problem with MMT is that governments may have trouble turning off the monetary and fiscal stimulus when spare capacity is used up and inflation hots up.

Not only is it hard to get the timing right economically, but it’s compounded by politicians in government having an incentive to keep the stimulus going to get re-elected. Politicians risk becoming addicted to the flow of money from the central bank’s Magic Money Tree, resulting in wasteful government spending and eventually high inflation or hyperinflation.

And once the inflation genie gets out of the bottle, it’s hard to get it back in as we saw in the 1970s.

This is precisely why central banks are independent of politicians.

For now, spare capacity is massive which is keeping inflation is below target and so there is plenty of room for big budget deficits and this may remain the case for a while – so interest rates could remain low for several years.

But the combination of massive quantitative easing and fiscal spending along with increasing talk of MMT highlights that policy makers are increasingly focussed on taking more risks with inflation.

Ultimately the combination of ultra-easy monetary policy, huge budget deficits and a retreat from globalisation will add to the risk of an eventual pick-up in inflation - but at this stage this looks like something to be wary of on a five to ten-year horizon, but not right now. 

SHANE OLIVER | Head of Investment Strategy and Chief Economist | AMP Capital