Is ‘modern monetary theory’ worth a try?

Starting as an obscure economic idea a few decades back, the modern monetary theory (MMT) has achieved rock-star popularity in the developed world — more so since US congresswoman Alexandria Ocasio-Cortez endorsed the theory.

Policymakers in the developing world have hitherto escaped getting drawn into the MMT debate as the theory is considered to have applicability only for the developed world. This is changing and MMT will soon knock at the doors of policymakers in the developing countries including India.

MMT states that a government which issues its own currency cannot go bankrupt as it can always print currency to settle all debts. Thus, rather than targeting “arbitrary” fiscal deficit targets, the government should spend to ensure full employment. According to MMT, the only constraint to the government’s expenditure is inflation, and not tax revenue. It is easy to see that adherence to MMT will open the door for substantially higher government expenditure and jettison attempts to limit fiscal deficits. Most of the discussions on MMT revolve around using it to implement a universal job or income guarantee scheme in the developed world. Since the tax revenue required for implementing such a scheme will be large, MMT provides the rationale for justifying the much larger fiscal deficits that such a scheme will entail.

Changing priorities

Developing countries have escaped talking about MMT up to now. This is changing. The demand for ensuring a basic minimum income for the entire population is loud, clear and immediate in developing countries as well.

India is a good example of a developing country moving towards implementing an income guarantee scheme for a large part of its population. MGNREGA was launched in 2006 to provide annually hundred days of employment in rural areas. The PM-KISAN scheme was launched to provide an annual income support, initially to small and marginal farmers, later extended to all farmers. The ruling government’s key national opposition party contested the last general elections on a plank of an ambitious income scheme.

In the just concluded Budget, the government has nearly doubled the allocation for the Ministry of Agriculture and Farmers’ Welfare to a record ₹1,304 billion, of which more than half the allocation is for the PM-KISAN scheme.

Though the government has overall maintained fiscal prudence, the direction is clear. We will witness demand for more economically weaker sections of the population to be bought under some kind of income or job support scheme. This will put pressure on the government to set aside fiscal deficit targets — exactly the path that proponents of MMT propose.

The two key challenges of implementing MMT in a developing country has been the fear of inflation and balance of payments concerns. A developing country, due to supply-side bottlenecks, can witness accelerating inflationdue to the push to aggregate demand caused by higher fiscal deficit. Also, the higher fiscal deficit can spill over to a wider trade deficit leading to a BoP crisis. The balance of payment situation can further deteriorate due to drying up of foreign capital inflows spooked by higher government profligacy.

Both these concerns, conventionally held to be very relevant, are being challenged. In a recently released study titled ‘Using fiscal policy to alleviate job crisis’, by The Centre for Sustainable Employment at Azim Premji University, the author attempts to rebut the claim that high fiscal deficits lead to high inflation and high trade deficit. The study makes the claim that India has run a structurally higher fiscal deficit since the 1980s and exceeding the fiscal deficit targets is nothing new. The study also challenges the notion that a high fiscal deficit can spill over to a high trade deficit.

Given that MMT has not been implemented even in developed nations, the risk for developing countries like India is not that MMT will make a splash in our policymaking. The risk is that under the guise of social justice, MMT will make a small beginning by weakening the resolve of policymakers to adhere to fiscal discipline.

What effect this has on economic stability is anybody’s guess — or perhaps not, given how numerous the examples are of what happens to a developing country on a path of fiscal profligacy.

The writer is a member of the CPD committee of CFA Society India. Views are personal.