Putting pressure on monetary policy

The rise in interest in Modern Monetary Theory (MMT) would have occurred regardless of the movement’s sharp rise in relevance on the back of the COVID-19 pandemic, according to Dr Steven Hail, a lecturer for the School of Economics at The University of Adelaide.

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Although he acknowledges post-pandemic monetary policy had helped highlight the intricacies of MMT, Dr Hail said the old system of thinking was under pressure anyway.

"We were in for a paradigm shift within the next couple of years, regardless of whether there had been a pandemic or not.” – Dr Steven Hail

“The paradigm through which macroeconomic policy has been viewed in countries like Australia, at least since the early 1990s, was breaking down well before this pandemic,” he said, noting the impact of low interest rates had already run as far as it could go.

“The Reserve Bank of Australia had missed its inflation target on the low side almost the whole time for six years,” he said. “Other central banks had been using quantitative easing on and off since the global financial crisis, with a limited impact on their economies.”

“I think that we were in for a paradigm shift within the next couple of years, regardless of whether there had been a pandemic or not.”

Dr Hail made the comments on an ANZ customer call with ANZ Chief Economist Richard Yetsenga. You can listen to an edited version of the conversation below.

Yetsenga said while “breaking down” was a strong term, he agreed the previous policy regime was under stress and acknowledged it had been for “quite a period of time”.

“It certainly does seem - and maybe it's been my interest - but it does seem MMT is discussed in more breadth these days,” he said. “It's a little bit more mainstream, a bit less fringe. “

Yetsenga said the challenge MMT posed to mainstream thinking was twofold – one subtle, and one fundamental.

“The fundamental challenge is this idea around the government having no… financial budget constraint,” he said. “But there are other challenges, I think, that don't need such fundamental changes in our approach.”

Yetsenga said it was critical proponents of the approach considered all potential economic outcomes.

“I think the challenge, for me, is still the nagging feeling that while the existing monetary policy framework may have a deflationary bias, the fiscal approach may have an inflationary bias,” he said.

For his part, Dr Hail believes the inflation threat is overblown and there are already mechanisms in place to thwart any potential rise.

“I honestly don't think we would have any difficulty at all bearing down on inflation if there was a prospect of persistently, significantly higher inflation in Australia,” he said. “People love to scaremonger about these things.”

Something borrowed

Dr Hail said the pandemic had demonstrated a number of key tenets of MMT – which he clarified is a description of how the existing monetary system actually works, rather than any direct call for change.

In the early stages of the pandemic, Dr Hail said the Australian government “fairly rapidly announced it was prepared to countenance fiscal deficits of as much as $A200 billion a year if necessary, in order to support the economy during a pandemic”.

He added given “the dominant narrative down the years…you would have thought they'd have to go and borrow that $A200 billion dollars before they could spend it or it would be highly inflationary”.

“But in fact, that wouldn't even have been possible last March. Because last March, our banks had exchange settlement account balances of somewhere between $A30 billion and $A40 billion.

“There literally were not enough dollars in our monetary system for the government to have gone and borrowed all the dollars that it was going to deficit spend before it spent them.”

For Dr Hail, this gets its back to heart of the MMT argument: sovereign countries - which meet a set of requirements – are currency issuers and can operate as such in a way which is greatly beneficial to the broader economy.  

“The spending has to come first,” he said. “It's not the other way round. And when we misunderstand that, it affects the whole attitude towards the appropriate role of the government in the economy.”

Dr Hail said inflation needed to be correctly assessed as part of a government budgeting process.

“At the moment, those institutions, when assessing a planned budget, project the implications of that budget,” he said. “They're focusing on the wrong thing.”

“What we should be doing when looking at budgeting is working out what we want to achieve, how much we need to spend and where we need to spend the dollars.

“Do we have the real resources available to absorb that additional spending without it being inflationary?” If we do, then we can just go ahead and do it. We don't have to worry about paying for it.”

If the answer is no, a reassessment of priorities is required, Dr Hail said

Creaks and groans

Yetsenga said it was critical for modern economics to give more priority to the monetary system.

“I think the existing system has had, at the very least, some creaks and groans and some strains which weren't promised as part of the advertising,” he said.

“The conventional monetary policy led framework, I think, does have a deflationary bias to the extent it works primarily through the credit channel. Monetary policy stimulates by encouraging borrowing and that clearly faces limits.”

Yetsenga said some of the approaches of MMT may have even “given us better [economic] outcomes on a range of metrics. And we might, in fact, have had a much-more stable and credible inflation outcome.”

Dr Hail said unless the rate of wage growth in Australia – which has been subdued for some time – accelerated, there was unlikely to be persistent inflation.

“If everybody is thinking about inflation, then keep your eye on what's happening as far as wage increases are concerned,” he said.

The pair also touched on MMT considerations around economic equality and the drivers of the inflation seen in Australia in the 1970s. Listen to the podcast above to find out more.

Shane White is Content Manager, Institutional at ANZ

This article was originally published on ANZ’s Institutional website

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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