Coronavirus and modern monetary theory
- 82newsbulletin
- Sep 25, 2020
- 2 min read
Written by Guignard Nicolas
Most central banks serve two purposes: control inflation and regulate the economy through booms and busts. To fill those missions, they were given two tools: setting the interest rate and controlling the amount of money in circulation. By cutting down the interest rate, the central bank can support investment, and increase a country’s growth.
Those tools are powerful but should be used with caution. Indeed, an inadequate response might have direct consequences. For example, the FED is largely responsible for aggravating the Great Depression by increasing its interest rate when the economy crashed. But central banks should regulate growth.
Indeed, as modelized by Kaldor’s magic square, a high growth rate and low unemployment rate will lead to inflation. At least, this was the case in the past, but since the 1980’s and Voelker’s shock, inflation has largely been beaten.
The disappearance of inflation gave birth to heterodox theories such as the modern monetary theory (MMT). MMT argues that governments can pay for their expenses by simply printing money and use fiscal policy to control inflation (taxes will eliminate excess money supply not met by an increase in demand). Any government with control of its monetary and fiscal policies could therefore issue fiat money, to build schools, fund research and so on.
This theory sparked debate between economists but was never considered seriously. The European Union has a rule that a country may not exceed a 3% deficit in a year, and its debt should never weigh more than 60% of its GDP. Debt is largely regarded as a burden on future generations, a last resort tool.
The current pandemics hit most economies harshly, inducing both the negative supply and demand shock which will leave more than a mark. Governments used the classical Keynesian tool to fight a recession – a stimulus – meaning that they injected money into the economy. However, this stimulus is different in two ways: it is massive, and it serves more as a compensation for reduced economic activity than as an actual boost to the economy. Moreover, it also serves political purposes: buying votes in an election year (for the US at least).
If MMT proves right, then this was the correct move. If it proves wrong however, it would lead to the return of inflation and the weakening of currencies. The US dollar already lost 10% of its value since March…
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