Bad times bring back bad ideas - Editor's Blog -

Printing money and running up massive government debts will not solve the current economic malaise, writes Brian Caplen.

There are plenty of things to worry about in the current economic and political environment – rapid technological change that causes job losses, rising inequality, astronomical house prices in some countries, and the growth of populism as a result of these issues. Moreover, solutions seem to be thin on the ground and the populists have fewer ideas about what to do than the established parties they oppose.

In such circumstances it is tempting – but dangerous – to retry an old idea that failed previously, but now has a trendy new name that makes it seem attractive.

Modern monetary theory (MMT) is a prime example. MMT is a new name for the old idea of a government printing money to cover its debts. The argument is that a country with its own currency, and which borrows in that currency, cannot go broke as it can always print money and the only spending constraint is inflation. This is the thinking behind the New Green Deal put forward by US Democratic representative Alexandria Ocasio-Cortez. 

The problem is that once inflation takes hold it is difficult to control as expectations and behaviours have changed. What’s more, the state may not literally go broke – in the sense that a company does and is therefore closed down – but a state with high debts and deficits will lose the confidence of investors and will see its financing costs rise.

Eventually, after the failure of a policy of excessive spending, a government will be forced to cut back on real spending in order to service the costs of its debts. This outcome is worse than self-defeating as it imposes huge costs on the poorest sections of the community, the very ones that MMT advocates would presumably like to help.

There is a related bad idea, which is that while interest rates are low, governments can increase their spending (in this case to be covered by taxes not printing money) without worrying about the future consequences. In a Foreign Affairs article called ‘Who’s afraid of budget deficits?’, Larry Summers and Jason Furman argue that "…no one knows the benefits and costs of different debt levels" and that "although the [US] national debt represents a far larger percentage of gross domestic product [GDP] than in recent decades, the US government currently pays around the same proportion of GDP in interest on its debt, adjusted for inflation, as it has on average since World War Two".

But high debt that is affordable now may not be affordable in the future and leaves a government unable to respond to a future crisis with deficit spending. Even though we are hardly in boom times, we are over the worst of the financial crisis and should heed the maxim of John Maynard Keynes that “the boom, not the slump, is the right time for austerity at the Treasury".

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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