The onset of Covid-19 has been met with massive intervention by public authorities around the world. Governments have undertaken a range of supports to keep households and businesses afloat. It is now recognised that high levels of public indebtedness do not necessarily impose economic costs in terms of growth and stability, which constitutes a shift in thinking among policymakers and within the mainstream of the economics profession. Still, calls can be heard that belt tightening will be needed post-Covid, through either a reduction in public spending or an increase in taxation. This raises legitimate questions within progressive/left circles about how long the current fiscal path can be maintained, and the appropriate scale of public spending going forward. The answers to these questions are different depending on whether the question is posed at the nation state/Irish level or EU/Eurozone level. In this piece we discuss the utility of Modern Monetary Theory (MMT) to this debate, for Ireland and Europe.
Modern Monetary Theory
The central idea of MMT is that countries that issue their own currency are not financially constrained. This is because a government in control of its currency can simply ‘print’ new money to finance its spending. In today’s world, printing money does not mean opening up the printing presses, but rather is about creating money electronically at the click of a mouse. In its purest form, the central bank simply credits or increases the bank account of the government, which is then free to spend. Or it could come about if the central bank purchases government bonds when the government issues them. In cases where the government has decided to borrow from a third party, it is still financially unconstrained. This is because it can simply create new money to pay off those debts, using either of the methods just described. A less pure version would see the central bank purchasing bonds in the secondary market, so that when payment comes due it is still effectively one branch of the state paying another. The only constraint a ‘monetarily sovereign’ country faces are the ‘availability of real resources’ and the risk that money creation might induce inflation, of which we’ll say more about shortly.
Within MMT, neither taxation nor government bond sales serve to finance or fund the government. This is argued by walking the reader through a series of accounting exercises, though it also comes from argument.  To take taxation as an example. Proponents of MMT typically point out that the state is the sole arbiter of what form of payment is acceptable to settle taxes. It decides what type of money is or is not acceptable to pay taxes. Moreover, in order for there to be money to pay taxation, that currency needs to exist. Therefore payment of taxes comes after money. And money comes from spending by state. As above, after the central bank credits the government’s bank account, the government can then credit the private bank accounts of private actors, such as a construction company when it builds public roads. Therefore, neither taxation nor bonds sales fund or finance the government.
The role of taxation and bond sales, rather, is to withdraw money and resources from the economy. The creation of new money by the state has the potential to induce inflation, the proximate cause of which, MMT advocates and many others agree, is too much money in circulation relative to the amount of goods and services. This is especially a concern when the economy is operating near full capacity. If the state-financed state spending is used to increase the productive capacity of the economy, this is less of a threat – more money, yes, but now chasing more goods and services. Still, raising taxes staves off the threat of inflation by absorbing some of the excess money arising from state spending. Issuing government bonds also drains money from the system.
The state is therefore not completely unconstrained. The constraints it does face are based on the availability of real resources and the threat of inflation. With greater resources the possibility for money-creation to induce inflation is diminished. So if factories are operating below full capacity and the government creates money which is then used to purchase goods and services, businesses may be able to meet that demand. When, however, capacity is reached, prices will rise.
Aside from the real resource constraint, a country which is not monetarily sovereign is also limited. To be monetarily sovereign is for the government to issue its own currency (countries such as Ecuador which use the dollar do not qualify), to have most of the state’s debt denominated in that currency, and to have a floating exchange rate. Obviously if a government does not issue the currency it uses, it cannot ‘print’ that currency and is therefore financially constrained. Similarly, if much of its debt is denominated in foreign currency, it cannot meet those obligations by creating money and so, again, it is constrained. A fixed exchange rate limits the ability of a government to create money as excess money creation threatens the peg. This is because printing money leads to an increase in the supply of currency, and can therefore lead to a fall in its value. However, when these three conditions are met, the state can and should spend big. Programmes such as a Green New Deal and government employment can be rolled out without the nuisances of taxation and borrowing to get in the way. The latter programme, the so-called Jobs Guarantee, is a staple of MMT economic policy.
In essence, governments should create money to expand government spending without concern for the size of the deficit or level of debt. Only when the economy approaches full employment should the government raise taxes. Because of the focus on fiscal policy to achieve the government’s macroeconomic goals, monetary policy takes a back seat and interest rates should be set close to zero. But how relevant are these policies to a country like Ireland, or to the Eurozone? And, for that matter, how accurately does MMT describe things in the US, the country where its doctrine has most purchase?
MMT, Europe and the limits of ECB policy
MMT adherents recognise that institutional constraints limit the ability of most if not all nations to follow MMT economic policy. Having surrendered control over their national currencies on joining the euro, Ireland and other Eurozone countries are clearly not monetarily sovereign. It is the ECB not the nation state which decides on when and how much money to inject into the economy. And there are clear limits on what the ECB can do, aside from the economic arguments. Moulded by the German experience of hyperinflation in the 1930s, the ECB is widely regarded as among the most conservative and inflation averse of the world’s major central banks. The ECB and the national central banks to which it delegates much of its policy implementation are explicitly forbidden from engaging in what is called ‘monetary financing’, financing of governments through money creation. It is illegal for central banks of the Eurozone to purchase bonds directly from government. In the wake of the Eurozone crisis, it did eventually begin to purchase government bonds in the secondary market, from banks, pension funds, and other actors after they had purchased them from governments. But even that was met with legal challenges. Institutionally, then, the ECB cannot follow MMT.
A different question is whether it should, if unshackled from its various political and legal constraints. One of the most prominent critiques of MMT has come from left Keynesian economist, Thomas Palley. Though it is technically true that governments are financially unconstrained in the sense that money can be printed to service debts, it is not necessarily economically costless to do so. If financial markets expect governments to engage in large-scale public spending programmes financed by money creation, inflation expectations will rise. With higher expected inflation in the future, financial actors will seek compensation on holding government and other forms of debt, if the real returns on their investment are to remain the same. This will push up interest rates on borrowing, leading to a slowdown in economic activity. Arguably, the state could simply purchase more government debt and push down interest rates again, but with more inflation expected in the future the cost of borrowing in private markets will remain elevated, including mortgage markets. If interest rates rose sufficiently, it could induce a recession.
It is also unclear as to what would actually happen if the state’s holdings of government debt increased ever more. Government debt securities play a central role in private financial markets as their perceived safety renders them the most important form of collateral when banks, funds, and other players borrow, from each other and from the central bank.
It has on occasion been pointed out that the history of the Eurozone crisis and more recent developments are consistent with MMT or vindicate an MMT-centric view of the world. During the height of the crisis, around 2012 the periphery countries of the Eurozone came under immense pressure as falling tax revenues, bank bailouts and general uncertainty pushed up government borrowing costs. Unlike the other major central banks of the world, it was perceived by financial markets that ECB would not intervene with sufficient force by purchasing member states’ debt. Previous purchases were intended to provide liquidity rather than prevent peripheral countries defaulting. The timidity of ECB action raised the upward pressure on government borrowing costs and the spectre of Eurozone breakup grew.
In July of 2012, however, then governor of the ECB Mario Draghi made his now-famous speech to bankers in London that the ECB would ‘do whatever it takes to preserve the euro’ with potentially unlimited purchases of government debt in secondary markets. The mere commitment to buying debt in sufficient amounts had an immediate calming effect on financial markets, and the risk of default withered away. This was eventually followed by actual purchases of government debt through the ECB’s quantitative easing programmes.
A similar tale can be told during the pandemic when current governor Christine Lagarde committed the ECB to ‘do everything necessary to counter the virus’. After a previous fumble in which she stated that the ECB is not in the business of reducing spreads, the turnaround had an immediate calming effect on markets. Indeed under the ECB’s Pandemic Emergency Purchase Programme, the ECB has committed to purchasing €1.35 trillion of government debt. Add to that the purchases under quantitative easing and the central bank is now the largest holder of Irish government bonds. With a willing and able public purchaser of Irish debt, borrowing costs have come down dramatically. This is why the burden of servicing debts has been so low, and is set to fall in the coming years despite Ireland running an estimated budget deficit of 8.8 percent in 2020.
But the ability of central banks to create money and purchase government debt is and has been contingent on a number of historically unusual circumstances. In 2012 and beyond, private banks were still reeling from effects of the financial crisis that began in 2007/08. Banks across Europe were more risk averse and hoarded liquidity. The injection of unprecedented amounts of money into the financial system, mostly through ECB purchases of government debt, did not induce banks to lend. Banks were instead loaded with reserves (electronic cash), and lent only sparingly. Post-crisis regulatory reforms also had a constraining effect on bank lending. More recently, households have been accumulating savings, and private banks have again been exercising caution. The even larger injections of reserves by the ECB during Covid have not translated into spending, and hence inflation.
At a more conceptual level, the state can create cash and electronic cash but that constitutes only a small part of the money supply. Most of what is considered money, such as current and savings accounts, are not fully backed by cash, either physical or electronic (banks correctly assume they only need a small amount of cash on hand to meet withdrawals and process payments). Most money creation takes place as banks engage in lending, which is influenced by a variety of factors including the general economic outlook and regulatory factors, not just central bank actions. Ask an MMTer and they will surely agree. But MMT fails to account for how recent historical peculiarities have severed the link between state money creation and inflation.
MMT, Ireland and the Job Guarantee
MMT devotees would argue that if Ireland were not a member of the Eurozone then it would be freer to pursue MMT-type policies. Our historical experience suggests otherwise. For all but a very brief period before joining the euro, Ireland did not pursue a floating exchange rate system. It first pursued a currency board, an extreme form of fixed exchange rate whereby all of the Irish currency in circulation is backed by (in the sense that the national/Irish authorities hold) foreign currency against which it is pegged. Later Ireland followed more conventional fixed exchange rate systems; first a fixed exchange rate pegged to British sterling and later to different baskets of European currencies.
Today around half the world’s countries have fixed exchange rates. It is simplistic to say that a country necessarily should allow its currency to float as the choice of currency regime involves trade-offs. An advantage of pegging the punt to the pound was that Britain was by far Ireland’s most important trading partner, so stability of the exchange rate facilitated trade. Fixed exchange rates can be difficult to sustain, however. A floating rate system can also be beneficial in that a currency can depreciate in response to a fall in demand for exports, offsetting the falling export demand. A drawback is that because the country does not need to fix the value of its currency to another, states may be tempted to simply print money. For MMTers this is considered beneficial, but outside MMT economists of all political persuasions see the benefits as being much more circumscribed. That recent money creation has not resulted in inflation does not mean that it will not do so in the future, or has not done so in the past. Economic history is replete with examples of high and hyperinflation induced by excess money creation by the state/central bank.
The composition of government debt is also not a choice. The share of Ireland’s foreign currency borrowing increased significantly in the 1970s, contra MMT best practice. This was driven by a difficulty in raising funds domestically as economic difficulties began to grow. Moreover, Ireland was not the exporting powerhouse it is today, so foreign currency borrowing helped fund net imports. Real economic constraints, not discretionary policy decisions, led to rise in foreign currency debt.
Leaving such considerations aside, suppose a monetarily sovereign Irish government did decide to pursue MMT. What would happen? In the event that it did induce prices to rise, the answer is to raise taxes, which would cool down inflationary pressures. Depending on the size of the tax increase needed, this may not be straightforward politically. Capitalist societies are ridden with class conflict. The wealthy have control of mass communication and taxation has been much maligned. The richest are also good at stashing their money away out of the reach of state. State charges and taxation levied particularly on the lower and middle classes is contentious. Substantive changes in fiscal policy requires acceptance and political momentum which doesn’t appear overnight. Water charges and property taxes are examples of that, levied when the state was in its worst fiscal crisis in living memory. Even parties of the left such as Sinn Féin and People Before Profit recoil from taxing all but the wealthiest in society.
Interestingly, Randy Wray, who along with Stephanie Kelton is MMT’s leading scholar, weighed in on the Irish debate a few years ago. In 2012, he proposed that the government hire anyone who could not find work, and who was willing to work. The government would provide jobs in areas of goods and service need, such as health and social care, infrastructure, and public housing. The rate of pay would be close to the minimum wage and may also include benefits such as healthcare, and in-kind benefits such as provision of childcare and transportation services. The programme would be of unlimited duration, but as the economy recovered and the private sector expanded and offered higher wages, people would naturally be recruited out of the programme.
The jobs guarantee would indeed have been a humane way of dealing with mass unemployment as experienced in the last crisis, and now again during Covid. Ireland has deficits in many areas most notably in public housing and care, and it is reasonable that the state would step in to fill in those gaps. With wages set around the national minimum wage, the programme is unlikely to be inflationary. This is in contrast to a US-version of the proposal where wages would have been set at a level which would have put many private sector employers out of business and would have induced significant inflation.
To me, it is still unclear what the effect would be of guaranteeing employment even at or around the minimum wage. It is likely that the better conditions that would surely prevail in government employment would induce workers into the government sector, even if there were little differences in wages. This is to be welcomed in some sectors such as childcare, for instance. Childcare, for a variety of reasons, is more appropriately managed and delivered through the public sector. But most minimum wage workers are in retail and hospitality and they too may migrate toward the government sector. The answer in the retail sector would be to raise wages, which it can well afford to do. But sectors such as food services have much slimmer margins and a significant increase in wages may render them unviable, especially if and when the government implements the living wage. Would the state have the capacity to absorb much of the hospitality sector? Should the government be running restaurants, and what would the EU say about that? Given the political and perhaps legal capital needed for a jobs guarantee, those resources may be better spent on a conventional government works programme such as countercyclical spending on public housing. Moreover, work share programmes whereby firms reduce work hours so as to minimise job losses in a downturn are tried and tested, and have buy-in from social partners.
MMT has had undoubted successes, especially in the US where it has been most ascendant. It provides an antidote to the neoliberal takeover of economic policy and strikes at the heart of deficit hawks. For countries of the Eurozone, such as Ireland, its policy prescriptions are largely academic. Even it weren’t, for me it goes too far in terms of what the government can and cannot do in a capitalist economy. To say that a state is financially unconstrained may be true in the narrow sense that it’s a policy choice whether or not to default. But this ignores the consequences of excess money creation by the central bank. MMT also abstracts from political realities. We need not conscript MMT to chart a progressive way forward, which inevitably means a larger state which must be funded. This means that policymakers cannot eshew making difficult decisions, because there is no panacea.
Robert Sweeney is the Senior Economic and Policy Analyst at TASC, an independent think-tank whose mission is to address inequality and sustain democracy by translating analysis into action. He is currently the lead researcher on a project examining economic inequality in Ireland and Europe.
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