Modern Monetary Theory could cause one big problem for financial markets

March 3, 2019 Off By readly




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  • Modern Monetary Theory has come back into the spotlight in recent months.
  • Opponents argue it could spark hyperinflation and disrupt financial markets. 
  • For markets, it could have negative effects on long-term rates and credit spreads.

You can probably guess how markets would react if the government suddenly decided to just print money to fund its projects.

Modern Monetary Theory seems to say countries that control their own currency don’t need to rely on taxes or borrowing in order to spend. The main concern among opponents, however, is that too much money in an economy causes hyperinflation.

For financial markets, that could mean serious consequences for long-term rates and credit spreads. If there are concerns about the value of a currency, investors ditch bonds. And this would eventually pull dollars out of risky assets, according to Torsten Sløk, chief international economist at Deutsche Bank.

"The bottom line is that from the current level of 10-year Treasuries it may look like there is a free lunch with little impact from US deficits to US interest rates, but it is the impact of Treasury issuance on credit spreads which is most relevant for markets," he said.

The money going into Treasuries has to come from somewhere, he added, and there would eventually not be enough savings to buy those issued without consequences for other asset classes.

But according to Stephanie Kelton, an MMT proponent who advised Bernie Sanders’ presidential campaign in 2016, the money to buy government bonds comes from deficit spending itself. Interest would become a new expenditure in the budget, she said, but that payment would be made by instructing the Federal Reserve to credit the bondholders’ account.

"That is why it is so crazy that we use the word ‘borrowing’ to describe what’s happening," she said. "If I borrow money from a bank, I don’t give the money to the bank and then ask them for a loan. But that’s how the federal government ‘borrows.’ It all follows from the failure to see the dollar as a simple public monopoly."

Taxes could be increased to stave off inflation, so the MMT thinking goes. But with the political challenges accompanying such a proposal, it’s unclear how viable that would be.

"Implementing MMT would require a fundamental re-thinking of the way economic policy is conducted," said Josh Wright, chief economist at iCIMS and a former Federal Reserve researcher. "We have to ask ourselves: Do we really think Congress – or some new body it creates – will do that much better a job than the Federal Reserve at fine-tuning economic growth and price stability?”

Last week, Fed Chairman Jerome Powell called the idea that deficits don’t matter in countries with sovereign currencies "just wrong." But he added there weren’t enough specifics to comment on the policy directly.

"I haven’t really seen a carefully worked out description of what is meant by MMT," he said.

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Source of this (above) article: https://www.businessinsider.com/modern-monetary-theory-could-cause-problem-for-financial-markets-2019-3