Governments can try and stimulate the economy through various methods. One method used is monetary theory which involves increasing the money supply. Governments can adopt monetary policy by decreasing the interest rates, decreasing the reserves which banks are required to hold, or printing more money to increase the supply of money in the economy. However, there is another policy called Modern Monetary Policy which we discuss in this article and we include arguments for and against this theory.
What is Modern Monetary Policy?
Modern Monetary Theory involves countries spending money as necessary to boost up economic activity. These theorists believe that government spending should not be restricted by the size of the deficit. They believe that the objective should be to “do what it takes” to get the economy to optimal levels of full employment and inflation. These theorists believe governments should print money if they don’t have enough from taxes so they can then spend it on infrastructure and create jobs and boost the economy.
By increasing the money supply through printing more money, governments can increase private bank reserves which can then lower interest rates. We talk about quantitative easing in our recent article “What is quantitative easing”.
The lowered interest rates can encourage business to take on loans to expand operations. This can create jobs in the private sector. MMT theory proposes that governments should print as much money as they want as long as it doesn’t create inflation.
Arguments for Modern Monetary Theory
- Does not create inflation. Governments can print off all the money they want and it doesn’t create inflation. MMT does not generate inflation if there is unemployment. It only causes inflation when there is full employment which then causes the rising level of prices. For example, Japan is a country that has been running on a deficit but has not encountered inflation.
- The government does not need to have a positive balance to spend. The taxes the government collects do not need to be more than what the government spends. This is because governments can print more money if need be. Hence the government can operate in deficit.
- MMT can create public spending on infrastructure and social services which can create jobs in a weak economy.
Arguments against Modern Monetary Theory
- Challenges with paying off foreign debt. Foreign debt will be harder for the country to pay off if they continue to print more money as the currency will depreciate
- Value in FX Markets. If a country keeps printing money then currency investors may view the currency as less attractive compared to other less risky currencies in the market.
- Increases market volatility. Printing money with no limit can cause currency volatility
- Bond markets. Bond investors may not want to buy the debt of a country that has a large deficit and keeps printing out money as they may see this risky.
Lauren Hua is a private client adviser at Fairmont Equities.
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