By Anjan Ray
Extreme situations bring forth extreme thinking. When the world is facing economic crisis from coronavirus pandemic and government spending is shooting through the roof, Modern Monetary Theory —or better known now-a-days as MMT— is putting forward an alternative viewpoint — don’t bother about rising deficit in government budget.
MMT is blasting conventional economics and saying that budget deficit is not all that bad, after all. The underlying logic is that government budget is not like a family’s budget that it should be balanced. The old proverb cutting your coat according to the cloth does not apply to government.
What the MMT exponents are saying is that while a family cannot issue currency, a government can always issue currency to pay its bills. Thus, in effect, the government would never be wanting when it comes to paying its bills or for making good public expenditure for upholding a soundly functioning economy.
MMT is arguing that government’s tax collection is withdrawing money from the economy. Whereas is spending is adding money into the economy. So by spending more than it is drawing from the economy by way of tax collection, is like creating surplus. Infusion of this surplus does good to the economy rather than harm it.
But then there are several catches. Continuous government expenditure can be supported only when the spending is in domestic currency. But many countries borrow from overseas to fund their spending programmes. This could result in disaster when their repayment obligations mature.
This logic, of course, does not apply to the US which is the issuer of the dollar. The US currency accepted all over the world and the US, by issuing additional dollars, is in effect forcibly borrowing from the rest of world and spending. However, other countries cannot do it.
Italy or Greece as members of the European Union could borrow the euro currency. However, when their deficits expanded too fast and borrowings overstepped their set prudential norms, their access to capital markets became restricted and they could not borrow any longer.
As their debt repayment obligations were falling due, these countries faced problems in honouring their debts which had to be paid back in euros. Greece and Italy had faced entered into a zone of financial crisis. They had to be bailed out by other members, particularly, Germany, agreeing to a package of relief.
But it would have been a different ending if these countries had not joined the common currency and retained their own national currencies. The exchange rate variations, in case of too much government debts were being issued, and some inflation would have provided the adjustment cushion.
Coming to India, the government deficit is met from domestic borrowings. Hence, there is not much of a problem for India to issue fresh currency and keep spending when the shove comes to a push. The government could then seek clean overdrafts from the RBI and meet its spending obligations.
If, for example, India unfortunately gets into a situation of war, the country would not come to a grinding halt because of lack of funds with the central government. It will keep spending and funding the war expenses all the same issuing fresh currency and with larger deficits. These spendings could even have some beneficial impact on the economy, as larger government expenditure on a host of new activities would encourage growth. Indeed, war time expenditure invariably results in higher economic activity and growth.
To this extent Modern Monetary Theory formulations are correct. The costs of such action come only later.
However much you try, such spending would surely result in run away inflation. With too large volume of current liquidity chasing the same amount of goods and services, the prices could increase. But MMT argues that if the additional spending results in a faster increase in overall production of goods and services, inflation should not be a problems. This is a dynamic game, which has to be played with some gut.
Indeed, economics is a pliable subject which can be turned around according to your preferences and situation, it appears. There are no universal truths in economics.
Not many years back, trade economists were a kind of fundamentalists who argued that barriers to trade detracted from overall economic efficiency and growth. However, when the developed countries were facing rough weather in competing with developing ones, they started talking about non-trade issues as well for limiting the onslaught of fierce competition from cheaper producers from developing countries. Their strategies included inclusion of non-trade issue like intellectual property rights and labour standards for determine trade relations among nations.
Again, America was the home of private sector capitalism. Their cardinal principle was laissez faire. No government involvement in business and industry. However, as the Lehman Brothers went into liquidation following the sub-prime crisis, it was the US government which was the first to subscribe to the paid up capital bases of major US banks to save from bankruptcy. Billions of dollars were sunk in to shore up the operations of otherwise crashing banks.
The results were not bad for the American economy. Many of these biggest banks, insurance companies and other financial institutions survive the crash and recovered. They even bought back the government shareholding and became private sector entities once again. The proof of the pudding is in eating — that is the ultimate principle in economics.
As long as you are successful in your management of the economy, whatever you do is eventually acceptable.
Large deficit or small deficit, as long as the economy is stable and growing everything goes. Good, isn’t it. (IPA Service)
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