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The Rise of Modern Monetary Policy

May 26, 2020 By Mircea Vasiu

Throughout time, various monetary theories sparked the imaginations of economists and split the community into fervent supporters or adversaries. The Ricardian, Austrian, or Keynesian models are only one of the several that shaped economic history.

During the coronavirus pandemic this 2020, one of the most interesting monetary theories throughout history has become evident  – the Modern Monetary Theory or MMT.

Modern Monetary Theory in the 21st Century

The Modern Monetary Theory, is a macroeconomic theory that argues  the government may use fiscal policy to create new money in order to achieve full employment and funding government purchasing programs.

If we look at the Fed’s measures to the coronavirus crisis (measures mostly copied by the rest of the other important central banks in the world), we notice that MMT concepts increased in popularity recently, despite critics arguing for high inflation as a result.

For instance, MMT calls for perpetual issuing of Federal debt by the Treasury.  As a consequence, the balance sheet is likely to remain high for several years after the crisis, and the explicit yield curve control will continue. Under the MMT principles, the recent $1200 cheques sent to American families may set the precedent of a universal basic income.

These are only a few examples that may be interpreted as the start of MMT within the world’s largest economy. The road to pure MMT measures is still long, however one could not wonder where central banks would go if the pandemic takes longer than the median forecast?

Inflation is a major problem under the MMT concept – it has the potential to quickly revive and as a consequence, investors will lose confidence in the USD, sending it lower. While the Fed will be forced to keep rates close to zero, the ball enters the fiscal dominance space where there is more room to maneuver, with negative rates possible.

Up until the 2008-2009 Great Financial Crisis, only Bank of Japan’s actions resembled some of the MMT concepts. Ever since Quantitative Easing (QE) was introduced in the US, it was quickly copied by major central banks. Moreover, negative rates are here in many economies, and some new ones (e.g. the United Kingdom) may see them sooner rather than later.

The point is that the Great Financial Crisis led to the rise of unconventional monetary policy tools. Is it possible that the coronavirus crisis will end up known as the one crisis that led to MMT adoption by major central banks?