One of the more-or-less less irritating things about this pandemic is the unrelenting smugness of the MMT (‘Modern Monetary Theory’) crowd. Central banks have shown absolutely no hesitation in turning the taps on to support markets in a financial crisis that – lucky for capitalism – was exogenously driven. And governments worldwide are experimenting, as they usually do during recessions, with jobs programs and direct cash payments to try and prime the economic pump for when lockdowns are lifted. These shifts in macroeconomic policy are massive, unprecedented, and will carry ramifications for years to come. What they have not (yet) done, however, is validate the ambition of MMT proponents to make use of such operations for routine financing of government - the pursuit of which I believe to be toxic to the left’s broader redistributive goals.
I wrote in a previous blog that: “The best evidence MMT proponents have is that [ten years of post-GFC] supply-side quantitative easing (QE) has been neither inflationary nor stimulatory; their ideal outcome is that demand-side 'peoples' QE is also not inflationary but does a better job at stimulating growth.”
I’m not an economist, nor have I worked in public finance. But even a bit of cursory and preliminary reading suggests that pandemic economics provides little, if any, theoretical, political or economic support for the utopian claims of MMT advocates. In my first book, “Politics for the New Dark Age: Staying Positive Amidst Disorder” I supported the approach of counter-cyclical fiscal expansion in an economic downturn, and for credit expansion in a credit crunch. Unlike the GFC, this time more governments are following Kevin Rudd’s advice on recession prevention: go hard, and go early. Central banks have gone very hard indeed, as we shall see. But two questions would need to be answered for MMT to be shown ‘correct’: why has QE not been inflationary until now, and will it become so at the scale currently being undertaken?
What are central banks actually doing
The core claim to fame of MMT economists is that they provide a descriptive account of central bank operations that is more sophisticated and realistic than mainstream economists. This is, I think, true and has been repeatedly acknowledged by bank governors themselves. Central banks are notoriously – perhaps even deliberately – opaque institutions with economic power vastly disproportionate to their level of accountability. Broadly speaking, a central bank underwrites the financial system of an economy through its influence over the money supply and interest rates. They have many tools for performing this function, which can be broadly categorised as conventional (routine functions that are essential to the economy), unconventional (functions that central banks can do to a limited extent and cognisant of risks), and taboo (functions that central banks don’t want, and shouldn’t want, to do). The core policy claim of MMT theorists, as I understand them, is that unconventional and taboo central bank operations are in fact, safe and effective and/or no more or less safe and effective than conventional operations.
A central bank usually regulates the economy by setting its own interest rates, including the rate it lends to other banks at and the interest it pays to depositors. Under ordinary economic conditions, this is sufficient to influence the amount of liquidity in the economy, but following the GFC interest rates have been near-zero in developed economies for nearly a decade and have dipped into negative territory for some purposes in Japan and the EU. Negative interests rates – where the central bank pays you to loan money and you pay it to deposit funds – are an unconventional monetary policy. However, negative interest rates are deleterious in the long-term, as they establish deflationary expectations and erode the value of savings.
The other main tool of conventional central bank operations are so-called ‘open market operations’, the dominant form of which are short-term ‘loans’ against the value of securities (usually, but not always, government bonds). Put very simply, a bond-holder agrees to sell it to the central bank in exchange for newly-created ‘cash’, on the understanding that after a short period of time (sometimes overnight, usually after a week, and rarely after a month or more) they will repurchase the bond. Through the use of such ‘repo’ markets, the central bank can control the availability of government bonds, and thus the interest on them. In unconventional times, central banks can dramatically extend market liquidity by expanding the scale and scope of such loans (‘expanding their balance sheet’), and who they are available to, as well as offering longer-term repayments (as the Reserve Bank of Australia has done). The central bank may also be willing to lend against a more diverse range of assets, including mortgage-backed securities (as the US did during the GFC), other forms of private debt, real property and even equity in firms.
A debt is, and always has been, a minor financial miracle. If I lend you a dollar, I have in effect doubled its value – because now you have the original dollar (minus interest), and I now own a dollar of debt (plus interest) that I can exchange for value with others. When the central bank ‘lends’ against an asset, it swaps that asset for cash (which it ‘creates’ by depositing the funds in the corresponding institutions accounts at the bank), increasing the overall money supply. This provides liquidity to firms at a time when they may need it. But when the balance sheet contracts, those loans are repaid, the debt is cancelled, and the money supply shrinks once again. MMT is suffused with what is often termed neo-chartalism, the fringe theory that taxation is the origin of the value of money. Chartalism argues that taxation creates demand for a government’s own currency, which it meets through fiscal spending - it’s a clever but misleading hypothesis. As both the financial and anthropological literature have repeatedly shown, debt is a more important source of the value of money (the ‘standard of deferred payment’). Unless we think in terms of whole-of-economy balances, as MMTers do, government spending is not debt (i.e. I don’t owe the government anything if I receive healthcare benefits) and taxation is not a repayment for services rendered. But MMT is suffused with this kind of libertarian thinking.
Next, central banks can regulate the money supply through the direct purchase of assets – this is what is usually meant by ‘pure’ quantitative easing (QE). Although some direct bond purchases may be part of conventional open market operations, quantitative easing differs in that central banks acquire a significant percentage of a nations net capital with no obligation for the assets to be returned. Unlike other measures which temporarily expand liquidity, asset purchases have proved hard to reverse. After 11+ years of off-and-on QE, central banks in the US and Europe owned assets worth close to 30 per cent of GDP (and in Japan, 50 per cent) prior to the current pandemic. In other words, QE has become a permanent feature of monetary policy under late-capitalism, a massive subsidy to the capital sector financed directly by monetary creation. It is this result, more than any other, than MMT proponents lean on in public debate to argue that monetary financing is not inflationary.
Breaking taboos
Finally, we come directly to ‘helicopter money’ or direct monetary financing, the most taboo form of central bank operation. When the central bank makes loans, those loans are secured against assets. When it buys assets, they will sit on its balance sheet until sold back. But central banks could also simply credit the bank accounts of its depositors with funds (without taking on any sort of collateral) - including, most notably, the accounts of the national government. It could, in theory, do the same in the bank accounts of every citizen, and this is usually what UBI proponents advocate. Expanding the money supply in this way is probably inflationary; its unconstitutional in Germany (of course) and most developed country banks swear up and down that it remains anathema. However, the scale of central bank intervention unleashed in response to the coronavirus pandemic suggests that some countries (though probably not Australia) have moved from the realm of merely unconventional QE to break the taboo of de facto debt monetization - in other words, the direct financing of government spending by ‘printing’ money.
The allegation (including from Germany’s Constitutional Court) is that by purchasing government bonds in the secondary market, central banks are monetizing government debt, albeit in a roundabout way, using only a thin veneer of capital markets to launder what it’s doing. Rather than owing private lenders, governments are using centrals banks to ‘re-nationalise’ bonds and print money instead. Even prior to the pandemic, the European Central Bank (ECB) had purchased more than two trillion euros of government debt between 2015-2019. In other words, though there’s still strong private sector demand for public bonds, if this demand is underwritten by a central bank guarantee that such bonds can always be offloaded for a profit, then there are perhaps no limits on the government’s ability to raise funds from private lenders. Oh, and private sector middle men make a tidy profit along the way. One has to trust that central banks have institutional safeguards against that outcome – Germany’s Constitutional Court essentially ruled this month that the ECB was operating without sufficient oversight to ensure that trust existed.
The pandemic has taken this practice from ‘cheeky and maybe a little suspicious’ to mainstream central bank policy overnight. Macroeconomics has moved from life support to death’s door. The US federal reserve monetized almost the entire initial US bailout in March, and although it has slowed its pace dramatically, the US may monetize trillions more in additional government stimulus over the remainder of 2020. The ECB and Bank of Japan haven’t slowed down much at all, and some developing economies are following suit. This activity is truly unprecedented in both scale and ambition and it remains an open question whether it’s been a necessary tool to prevent a worse financial crash, whether it will trigger a wave of inflation, or both. One suspects that we might have been better off forcing the markets to chip in more for their own rescue, if only as a way to mobilise excess savings from the top end of town.
The debt’s the thing
So now we return to the question raised in my previous blog. Why didn’t QE (supply-side money creation) generally lift inflation over the last ten years – which quite frankly governments and central banks had been counting on? Part of the answer lies in the failure of supply-side economics in general – what capitalism is suffering from – as a result of decades of austerity, rising inequality and now the novel coronavirus is a catastrophic collapse in demand. Any attempt to inflate the economy by providing the wealthy and large corporations with extra liquidity only inflates a capital bubble, and lowers the marginal cost of funds, encouraging hoarding, consolidation and wasteful consumption that doesn’t enter the real economy and benefits only the 1%. Labour productivity and GDP has diverged; the velocity of money has decreased; companies have been historically profitable since the GFC despite real wages stagnating; and stock prices, even after the pandemic panic, have been positively buoyant.
But the theoretical reason why inflation has remain stubbornly low may be more straightforward - and may suggest why the current round of debt monetization may be different When a central bank buys an asset, or loans funds to the private sector using a bond or other collateral, it exchanges newly-created money for a legal title or obligation. In essence, a real resource in the economy has been swapped for a virtual currency, and when the loan is paid back the currency disappears and the asset re-enters the economy in its place. As far as I know, and unlike a commercial bank, central banks do not re-invest or loan against the value of their balance sheet. In other words, when the central bank removes a real resource from the economy, it’s sequestered in much the same way that a sovereign wealth funds attempts to sequester excess profits from the economy. In my book, I describe wealth as un- or under-utilised capital (in much the same way that un- or under-employed people represent unutilised labour). In undertaking QE, a central bank essentially exchanges such assets for more fungible resources [i.e. currency].
This suggests a theory. QE has not reliably produced to inflation so far because it merely adjusted the mix of capital assets in the economy, and did not change the total ratio of available money to real production and consumption. This suggests that under normal conditions QE is not necessarily inflationary (i.e. related to the size of the money supply), but may have adverse distributional effects (i.e. related to the composition of the money supply). Increasing the liquidity of capital markets may help lubricate the economy in a credit crunch; but at other times, it provides opportunities for existing capital owners to expand and diversify their portfolios. And more liquid capital means more capital flight, and asset purchases and inflation in developing markets (again, much like sovereign wealth funds). This might help explain why academic studies can find no consistent inflationary effects from ten years of central bank QE in the developed world.
Monetary financing, including the current pandemic response and other policies advocated by MMT acolytes, is arguably an entirely different beast. Directly crediting bank accounts (including the bank accounts of the government) with newly-created currency without removing a corresponding volume of capital from the economy does change the ratio of money in circulation to real production and consumption. Money becomes less valuable, even as the wealthy hang on to the legal right to control and profit from their existing holdings. As has been widely noted, a monetised UBI would merely increase rents and other prices. Even if monetary financing were employed fairly and in ways that offset its severe distributional consequences, we still could not ignore the inflationary risk.
MMT is not a progressive policy
It will be months, and perhaps years, until we know the macroeconomic fallout from the current crisis. Just because central banks may be engaging in large scale debt financing, doesn’t meant that they should, or that there won’t be consequences from doing so. It’s possible - perhaps even likely - that at least some countries will end up with 1930s or 1970s-style stagflation. But even if by some miracle massive central banks interventions save capitalism, the long-term distributional consequences of monetary financing benefit the current owners of capital at the expense of workers, students, retirees and we on the left should want no part in them.
There’s no evidence, following ten years of on-and-off QE in the heart of the capitalist world that increasing market liquidity improves market conditions for consumers. When real economic growth is anemic, major financial institutions do not use additional liquidity to extend lending to small businesses or consumers. In fact, evidence suggests that central bank policies to make loans conditional on the funds being recycled into the real economy simply leads to those loan programs going unused - if investing in the real economy were profitable, banks would already be doing so. It’s hard to know where the money is all going but the fact that US billionaires have - personally! - increased their wealth by nearly half a trillion dollars since the pandemic began hints that most is being gambled on stock prices, used to buy-up distressed assets (including overseas), or otherwise entrench the economic power of the largest firms. Trickle down economics, unsurprisingly, is bullshit in such a heavily financialised economy.
Another major risk of QE on this scale is that government bonds eventually have to be repaid. Even if it looks like an accounting trick, those bonds on the central bank’s balance sheet will one day come due. The credit expansion has to be unwound, which means either the government voluntarily deleting vast quantities of its own revenues, or owing vast sums to private actors who buy the (possibly heavily discounted) bonds back. The inevitable political consequence, either way, is another age of austerity in which social programs are cut, regressive taxes rise, and wage labour remains in acute distress. MMT advocates will argue that they reject the fiction that issuing bonds are necessary to finance government spending, but if that fiction is all that stands between us and stagflation, the ultimate effect for the worker is the same: living standards will inevitably decline.
Could QE have been done in a fairer way? In the US, progressives have talked about using the central bank to buy up vast sums of student and medical debt, monetising distressed labour instead of distressed capital. That would certainly have been a strongly stimulatory, once-off transition policy, had the left any real political power to speak of. But as a socialist, who thinks that individuals should not have to go into debt to enjoy access to their fundamental economic and social rights, we should be using this crisis to organise people to fight for permanent, universal public programmes, not telling them that their financial problems are a macroeconomic illusion.
From bad to worse
MMT acolytes are wrong to say they’ve been vindicated by the response to the pandemic. The evidence just isn’t there yet - and if I were a betting man the widespread consensus that this level of monetized government debt will lead to inflation, austerity or both seems more plausible than a miraculous escape from hundreds of years of economic history. MMT’ers always emphases that money matters less than money’s power to control access to real resources in the economy. I agree. But by this very metric, if the sorts of financial policies MMT supporters envisage got off the ground, the unequal distribution of real resources in the economy would remain unchallenged, and there’s a high chance that access to those resources would become even more unjust as prices inflate and currencies devalue.