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Could Modern Monetary Theory rescue us from the Covid-19 economic crisis?

The crisis has led to the usual discussion on whether one should use monetary policy or fiscal policy to ease it.

April 27, 2020 / 12:20 PM IST
Representative Image

Representative Image

Amol Agrawal

One of my favourite economics columnists, Niranjan Rajadhyaksha, recently quoted the Russian revolutionary leader Vladimir Lenin: “There are decades where nothing happens and there are weeks where decades happen.” If Lenin saw what was happening in the last few weeks, he might rephrase his famous quote to…  “there are weeks where centuries happen!” The outbreak of Covid19 is being compared to the outbreak of Spanish flu 100 years back in 1918, several European countries are calling this the worst crisis since the World Wars and other such dire comparisons.

The Covid19 crisis which started with public health concerns has quickly spread to become a major economic crisis. The crisis has led to the usual discussion on whether one should use monetary policy or fiscal policy to ease it. One has so far seen sharp and quick reactions from most central banks around the world. There are also pressures on the government to loosen their purses and pass a large fiscal stimulus. Someone on Twitter objected to the use of the word stimulus and said we should instead call it support, which I think is the right approach given the scale of the crisis.

Central bank support has been cheered by a few and questioned by others. Those who support it say the deep demand crisis needed a central bank response and actually argue for more such interventions. Those who question say the crisis is more of a supply shock and in such cases central bank policies are futile. The efforts should be made to boost aggregate supply by increasing productivity, technology and so on.

Amidst all the confusion, one is again seeing a sudden interest in looking at Modern Monetary Theory (MMT) for a possible solution (see my earlier piece on basics of MMT). The mainstream economics narrative is that all governments have a budget constraint and thus it can only spend based on the constraint, which is usually taxes. The proponents of MMT refute this claim and argue that a country which issues its own sovereign currency does not have to worry about deficits for pushing public investment into a useful programme. The government can always pay for the programme by issuing its currency. The constraint here is governance and the ability of government to conduct these programmes.


The MMTers go further and say the governments create money by spending which then comes back to them as taxes. Unlike the usual belief that central banks are independent of the governments, MMTers say governments and central banks create money in tango. The government issues bonds and these are used by central banks to create money in the markets by simple pressing of computer keys.

MMT has met with severe criticism, with detractors saying excessive government expenditure leads to high inflation. MMTers response is that the high inflation in some of these economies is because of governance (think Germany in 1920s, Zimbabwe today). If one sees some of the most highly indebted countries of today, such as Japan, US and so on, the problem there is of low inflation. Infact, MMTers turn the entire debate of public investment upside down. They argue that economists should not focus on an economy’s debt levels but instead focus on using the money to achieve economic objectives such as full employment, eradicate poverty and so on.

Going by MMT, what could be a better government programme than a solution against Covid19 and easing the sharp economic crisis? Households are cutting down on consumption and businesses on investments. If the government worries about its budget constraint and does not spend, we are headed for a severe recession. And a recession will lead to higher deficits eventually, due to a slowdown in economic activity and lower tax revenues.

Some of the leading MMTers have grabbed this opportunity to suggest policy measures. L. Randall Wray and Yeva Nersisyan wrote an article proposing a universal health programme to reduce the economic uncertainties. They suggested the programme should cover 1) all medical costs associated with testing and treatment of COVID-19,  2) mandated paid sick leave and full coverage of associated costs, 3) debt relief for families and 4) and swift deployment of testing and treatment facilities to underserved communities. We have seen China and South Korea practicing similar policies.

Prof Stephanie Kelton in an article (21/Mar/2020) said that the government should use this opportunity to fix the American healthcare system. It should accept the widening deficits calmly as there is no fear of the US going bankrupt as it prints the most powerful currency in the world. All the government needs to do is to send an instruction to the Federal Reserve (which it anyway does) to back the programme. In a series of blog posts, another proponent Bill Mitchell argues that the government should give a job guarantee to all those who have lost jobs/likely to lose jobs given the slowdown. Pavlina Tcherneva in another article said we should do exactly as Franklin Roosevelt did to resolve the crisis during the Great Depression: disburse cash to all households and also implement a federal job guarantee and other programmes such as a Green New Deal.

The Danish government has announced a programme under which it would pay 75 percent of their employees’ salaries to avoid mass layoffs, which will amount to 13 percent of GDP. The US has announced a programme but it has to be seen whether the Senate will approve it. Denmark has a debt to GDP ratio of 32 percent whereas in the US debt is 108 percent of GDP, telling us why it such a programme is easier in the former and difficult in the latter.

I had argued in my earlier piece that if one looks at the overall principles, the MMT ones are not very different from those proposed by mainstream economists such as Olivier Blanchard and Larry Summers. The duo advocate that the US Government should not worry about deficits when interest rates are so low and should spend liberally to reduce deficits in public policy areas. The difference is just that, for mainstream economists, interest rates are the constraint whereas MMTers do not believe there is any constraint for sovereign currency nations. But MMT will not apply to much of Europe which has become the centre of Covid19 as the sovereign nations there have given up their currency for a common currency Euro.

After being ignored (and humiliated), is this the MMTers moment in the sun? Will their ideas get a hearing? One would say that we should keep all options open and not be bound by the shibboleths of economics. The speed at which the pandemic has shifted gears and become an economic crisis needs all possible policies which need to be executed at even faster speed. My gut feel is most of the economies will eventually be implementing ideas from MMT without calling it so. The Governments are being pressed to introduce fiscal support and will be calling their central banks to finance the support. MMTers might not mind their not being given due recognition. First they are used to being ignored. Second, they may well think that as long as humanity benefits, a rose by any other name would smell as sweet.

(Amol Agrawal is faculty at Ahmedabad University. Views are personal.)
Amol Agrawal
first published: Mar 23, 2020 11:19 am

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